Firm VP: Save, invest, protect during good times and bad

You know the joke: there are no guarantees in life except death and taxes. But while there’s no getting out of your annual obligations to the IRS, you may have more control than you think over just how much you owe each year.

America’s labyrinthine tax codes contain a variety of options for reducing your tax burden, from savings strategies to charitable giving. Taking full advantage of these opportunities, however, means thinking long term about how your financial decisions throughout the year will play out come tax time.

Incorporating tax strategies into your overall financial plan is one important way to maximize your tax savings each year.

“The difference between working with a firm like Berkshire Money Management versus just going to your CPA, is that we have a more full understanding of the entire picture,” said Scott Little, a certified financial advisor with the Dalton-based company. “We understand the different types of accounts you have, we understand what tax bracket you fall into. We understand your investment gains or losses that may influence your taxes in a certain year.”

Using this information, BMM advisors can guide clients through the tax savings vehicles available to them, and how those options fit within their existing financial goals. When it’s time to file, clients can go to their CPA confident that they’ve taken all the right steps to reduce their tax burden for the year.

Career-based opportunities

The options available to each taxpayer vary based on several factors, one of which is employment status.

“Most Americans who are working full time have a 401(k) available to them through their employer,” Little said. “That is really one of the best ways to not only save for retirement, but also to lower your taxable income. Regardless of how much you earn, every dollar you put into a 401(k) is deducted off of your income.”

Adults under 50 are allowed to contribute up to $20,500 to their 401(k) each year.

“At the very least you want to be contributing as much as you can to get the company match,” Little said. This is especially true for higher earners. “For a tax savings, it really makes a lot of sense to put in as much as you can afford, because no matter how much you make, those deductions are going to be allowed for you. Whereas with other instruments like an IRA, for example, if you make too much money it may not be deductible.”

Another, less obvious avenue for tax savings relates to your employer-provided health benefits.

“In this day and age, more and more employers are offering what are called high-deductible plans — meaning that your individual deductible is greater than $1400 a year, or if you’re married, the deductible is greater than $2800 a year,” Little said.

In addition to charging a lower premium than lower-deductible plans, high-deductible plans allow subscribers to establish a Health Savings Account.

As the name suggests, a Health Savings Account, or HSA, is a dedicated savings account that can be used to pay qualifying health care expenses like insurance co-pays, over-the-counter medications and eyeglasses — all tax-free. Individuals can contribute up to $3,650 each year, or up to $7,300 for a family. Any money you don’t spend will roll over into the next year, and interest earned on that money also won’t be subject to tax.

“Not only is the contribution to the HSA tax deductible, it grows tax free,” Little explained. “And then if you remove the money for any qualified healthcare expenses, that is also tax free.”

Like 401(k) contributions, HSA deductions are not subject to income limits, so workers at every pay level can take advantage.

Moving toward retirement

Another major factor in finding opportunities for tax savings is age, especially pre-retirement.

At age 50, individuals are able to deposit an extra $6,500 per year into their 401(k), the so-called ‘catch up contribution.’ Similarly, the maximum annual contribution to an HSA goes up by $1,000 at age 55. This allows older workers to further lower their tax burden — and hold on to more of their income — as they approach retirement.

After retirement, tax strategies change significantly, particularly in the early years.

“Retirement can make for a very big change in taxes, in a good way,” Little said. “Your income tends to come down after you retire, and if you’re able to, that would be the time to consider looking into Roth IRA conversions.”

Moving retirement savings from a company 401(k) to another type of account can save money in fees and offer more investment choices, but it can also come with serious tax implications. Carefully timing these transfers can limit the total taxes paid long-term.

“Let’s say you’re retired, and you’re rolling over the 401(k) to an IRA,” Little said. “Now you have this large IRA that you’re looking at having to start taking mandatory distributions from at age 72. What you can do in the meantime, between when you retire and when you turn 72, is take advantage of those lower income tax years and begin moving money from your regular IRA to your Roth IRA, at a lower tax rate.”

Moving money out of the traditional IRA decreases the required distribution after age 72 and so decreases the amount of income that will be subject to tax.

Instead of focusing solely on what will save you the most for the current tax year, the idea is to look at how your income is likely to change in the coming years and make moves now that will protect you from an unmanageable tax burden in the future.

“What we tend to advise clients on is to create a tax equilibrium,” Little said, “We can level that tax rate from what you’re paying in your first years of retirement with what you’re going to be paying through much of your retirement later on.”

Taxes and investing

One of the many benefits of talking taxes with your financial advisor is that they can help navigate the relationship between your tax liability and your investing strategy. Both big gains and big losses can impact your taxes for the year.

“What’s very relevant right now as the market is going through a correction, is considering some tax loss harvesting,” Little said. “For investments that we bought that have lost value since we purchased them — let’s sell those, and take a loss to offset some other investments that we sold that have gains. Even if we don’t have any offsetting gains, the IRS will let you take $3,000 of that loss every year and use it against your income, or to offset gains realized in future years, which could help you save for perhaps several years.”

As with retirement savings, the type of investment you put your money in affects how that money will be counted when it comes to taxes.

“Adjust your asset allocation — what types of investments you own, in which accounts — can be very beneficial on taxes,” Little said.

Dividends paid by corporate bonds, for instance, count as (and are taxed as) regular income. If those bonds are owned in an IRA, however, the dividends aren’t added to your tax liability.

“When it comes to your joint account, your individual account, your trust account, let’s consider pushing more of your stocks to those accounts,” Little said. “Stocks pay what are called qualified dividends, so those are going to be taxed at a potentially lower capital gains rate.”

Home ownership is another investment to consider when thinking about taxes, especially if you expect to sell in the next few years.

“Keep in mind, if you’re doing renovations to your home over the years, keep the receipts,” Little said. “Because if you remodel the kitchen, if you put in a swimming pool, if you put on a new roof — all those capital improvements can get added on to the cost basis of the home and further reduce your tax liability when you sell that home.

Strategic giving

Charitable giving is a well-known mechanism for saving on taxes. But, Little explains, philanthropically-minded peo­ple don’t understand the mul­tiple avenues available to them that can increase the tax benefit they receive for their donations.

“In terms of tax savings, a lot of people don’t understand charitable donations,” he said. “Many people feel that when you want to donate to the church or the humane society, you write a check. And while that’s fine, there are ways to really get more tax bang for your buck.”

Often, Little will encourage clients to make their donations in the form of appreciated stock, rather than cash.

“Let’s say you bought a stock 20 years ago and it has a very large gain,” Little explained. “You’re looking to donate $10,000 to your local humane society. Instead of cutting a check for $10,000, many of these charities now have brokerage relationships, where they’re able to receive appreciated stock. So not only can a person donate to a charity and the charity benefit from that, but if you’re donating an appreciated stock you forgo having to pay taxes on the gains in those shares of stock.”

The same principle applies to other big spikes in your income during the year — for example, a large bonus at work — especially if you were already planning to make a donation.

“If you’re very charitably inclined, consider clustering your donations in a particular year,” Little said. “If you donate $1,000 to St. Jude every year, consider donating five to ten years’ worth of donations in a given year so that you can offset some of that income.”

For especially large gains, Little suggests exploring more advanced options.

A donor-advised fund, for instance, is a dedicated account, opened with a sponsoring organization, into which a philanthropic party can make large, irrevocable contributions of both cash and non-cash assets, with limits based on the donor’s income. Those contributions can then be donated to charitable organizations over time, at the donor’s discretion — a way to compress several years’ worth of donations into a single year for the sake of a larger tax break.

“Say you sold a business and have a very large capital gain, and you want to offset some of the tax liability. Consider funding a do­nor-advised fund. What you can do is make a sizable upfront contribution, get the tax deduction in that particular year and then gradually disperse it as you see fit.” Little said.

Older donors have additional options, as well. At 70.5 years of age, you become eligible to make Qualified Charitable Distributions (QCDs) — donations of up to $100,000 directly from your IRA to a charity of your choice. Not only will the donation not be counted as income, but those over 72 can count their QCDs towards their mandatory minimum IRA distributions, skipping out again on claiming the amount as taxable income.

Ultimately, the best method for saving on taxes is a coordinated combination of multiple methods. A financial advisor with knowledge of the many moving parts within your finances can address each of your tax concerns with a variety of options, based on your unique situation.

“Let’s max out those 401(k)s, let’s contribute to a Health Savings Account if you have a high deductible plan,” Little said. “If you’re older, let’s make sure at age 50, we’re doing that catch up contribution to the 401(k). At 55, let’s make sure we’re adding that additional $1,000 to our Health Savings Account. And then, as you look to retire and your income drops off, before you begin collecting social security, and before those IRA distributions start, let’s consider getting a plan for Roth conversions. We can manage those tax liabilities, and create that equilibrium.”

This content was paid for and coordinated with the Adviser. Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients.

Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.

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