This year is quickly coming to a close. There are only a few weeks left to make changes for the tax year. Here are some guidelines to help reduce taxes now or in the future.
This year we had some nice positive surprises on Wall Street considering all the bad news the media was pushing. Debt problems in Europe, austerity measures in Greece, a significant drop in growth in China and our own political bickering could have brought the stock market to its knees. However we had double-digit returns in most equities, including foreign holdings, and many bond portfolios had above-average returns as well. If you followed our tax planning from last year, you would have taken tax losses from unwanted investments in 2011. You can now use up some of those losses that carried forward and adjust your portfolio once again. While tax loss harvesting remains a good tax saving strategy, this year the goal may be to rack up as many long-term capital gains as possible before the current tax law expires.
You can take up to $3,000 each year as a loss against your ordinary income or 100 percent of losses against investment gains. Review your account and search for long-term capital gains that can be harvested this year. This will push the tax liability into 2012 before the possible increase in capital gains taxes in the future. This is a great strategy that can offset losses, step up your cost basis and realign your portfolio all at once.
Current tax law allows both qualified dividends and capital gains on assets held more than a year to be taxed at the 15 percent limit or lower, depending on your tax bracket. Consider realizing capital gains in a child's account where the capital gains rate may actually be zero this year.
You may also consider converting a traditional IRA into a Roth IRA. While individual situations vary, this would be a good year to volunteer to pay the taxes at current rates on IRA assets and convert them into a Roth before rates increase. Given that the income limits are waived for conversions, even high wage earners may feel this year has potentially lower tax rates. Distributions after age 59½ are tax-free if the Roth account is held for five years. This pushes the future gain into a tax-free status which could last a lifetime or longer to a beneficiary.
Review your accounts at work and maximize your pre-tax contributions. This will help to reduce your taxable income for the year and you could put more money to work. The maximum contribution this year is $17,000 in a 401(k) with an extra $5,500 catch-up if you are over age 50. Beginning in 2013, these numbers have been indexed up to $17,500 with the same catch-up provision. IRA limits also increased by $500.
Self-employed individuals may have a better advantage if they have the cash flow to fund their individual 401(k) accounts up to $50,000 plus the $5,500 catch-up if eligible. The plan must be opened by year-end, which may be different than other self-employed plans.
Parents or relatives funding a college plan that is eligible for the state income tax deduction may want to maximize their contribution before year-end. You can put in up to $13,000 per child without filing a gift-tax return.
Review your spending for 2012 and plan a budget for the New Year. Plan early to have enough savings to fund retirement and college. Meet with your advisor to design a strategy for the future, which may include rising taxes and inflation. The new tax laws and economic recovery may require a different investment strategy in the coming year.
Patricia Kummer has been an independent Certified Financial Planner for 26 years and is President of Kummer Financial Strategies Inc., a Registered Investment Advisor in Highlands Ranch. She welcomes your questions at www.kummerfinancial.com or call the economic hotline at 303-683-5800. Any material discussed is meant for informational purposes only and not a substitute for individual advice.
Investing is subject to risks including loss of principal invested.