Don’t wait for the holidays to give yourself the gift of lower taxes

Jeff Bernier |
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By Jeff Bernier

From delicious holiday treats to carefully wrapped—and hastily unwrapped!—presents under the tree, it’s the time of the year when kids of all ages gleefully anticipate surprises and gifts of every kind. Of course, there’s one surprise no one wants: a shocking tax bill. Just ask Susan.

At age 60, Susan has built a long and successful marketing career at a major corporation. But with retirement on the horizon, she’s been working to build up a small freelance business to help bolster her income and “stay in the game” in the years ahead. Her efforts last year paid off, and she earned a surprising amount of money in addition to her already sizable salary. She was thrilled… until tax time rolled around. Because she hadn’t taken steps to reduce her Adjusted Gross Income (AGI), that extra income pushed her into a higher tax bracket, plus she was hit with a penalty for underpayment, as well as self-employment tax. Though she’d almost always received a refund in the past, last year she found herself writing a check for tens of thousands of dollars. Suddenly her fruitful side business felt like more of a burden than a blessing.

To avoid finding yourself in Susan’s shoes, smart, consistent tax planning is vital. By the time December rolls around, it’s often too late to make valuable adjustments. And while journalists love to share last-minute tax “tricks” to help reduce your tax bill, the most effective path is to work with a trusted tax professional—all year long—beginning with these basic tax-planning strategies:

  • Fulfill your RMDs.
    It’s always best to have a retirement income strategy in place to keep your RMDs (required minimum distributions) on track. If you must take additional distributions but need to minimize taxes on that income, consider directing excess RMDs to charity. If you’re 70½ or older, you can move money directly to a charity from your IRA using a qualified charitable distribution to make your IRA withdrawal tax-free.
     
  • Defer or accelerate income to minimize your tax bracket.
    Tax brackets matter. In 2017, married couples filing jointly pay 15% on taxable income up to $75,900, 25% on taxable income up to $153,100, and 28% on taxable income up to $233,350. With those numbers in mind, it may make sense to defer income to stay in the lowest possible bracket, or to accelerate income to reach the bracket ceiling this year—and avoid being bumped into a higher bracket in 2018. Bunch up or delay gifting based on income and tax projections. Sell some stock. Do what’s necessary to find your own sweet spot.
     
  • Reduce your Adjusted Gross Income (AGI).
    With the right planning, it’s not uncommon for retirees to be living on $100K, but to be paying taxes on only a fraction of that amount. Strategies include “eating your principal” (see my blog post Retirement may be the best time to “eat your principal”), filling up your Qualified Retirement Plan (QRP), pulling funds from your IRA, giving to charity, and pre-paying your state income and property taxes. If your AGI plus tax-exempt interest income exceeds $170,000 (if you're married filing jointly), you'll pay extra for Medicare Part B and Part D. Plan well to be sure you don’t exceed that threshold.
     
  • Consider a Roth IRA conversion.
    Roth IRAs allow you to make an after-tax contribution into an investment account and, subject to certain terms and conditions, allow for tax-free growth and tax-free withdrawal of dividends, interest, and capital gains. It sounds great (and it is!), but if you make even a moderate income, you may not be eligible. However, a Roth conversion allows you to take existing retirement plan balances that have been funded with pre-tax dollars and convert those balances into a Roth IRA—regardless of your current income. Plus, if income rates decline, you have a one-time option to unwind the conversion down the road if it makes sense to do so. A Roth conversion isn’t right in every situation, but it’s certainly worth exploring.
     
  • Utilize tax-harvesting strategies.
    The market hasn’t produced many loses recently but, of course, that isn’t always the case. When you have a capital gain, you'll owe taxes on those gains. Tax loss harvesting uses capital losses in one fund to offset capital gains in another to reduce or eliminate the capital gains tax and reduce your regular income. You can also minimize taxes in a regular brokerage account by using “asset location” to place tax-efficient investments within taxable accounts to reduce income from dividend-paying mutual funds and taxes from capital gains distributions.

Yes, tax-planning strategies are complex, but a qualified tax professional will know when and how to apply them to your own situation. Work together year-round and your end-of-year tax planning will become a simple process of refining and optimizing your plan to create the best possible outcome. What a wonderful gift to give yourself every year!

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