Are You Ready to Wrap Up Your 2016 Tax Year?

Wooden blocks displaying the year "2016" with the last block partly turned to reveal "2017" on a blurred background.

Although bringing up end-of-year tax planning in October can feel like holiday creep, October 1st marks the beginning of the fourth quarter. It’s a key time to focus on minimizing tax liabilities for the current year. And one of our goals is to help our clients be as tax efficient as possible, especially with their investments. So to that end, here are some tax planning techniques to consider before the curtain comes down on 2016.

Charitable Donor Advised Fund

Would you like to maximize the tax benefit of your charitable gifts? Consider donating to a Donor Advised Fund. Donor Advised Funds allow you to donate cash – or more ideally appreciated securities that you have held for a year or more – to a charitable account that you control. You receive a tax deduction in the year of transfer for the full fair market value of the cash or securities without realizing any capital gains. Assets transferred to a donor advised fund are then liquidated by the sponsoring organization and invested on your behalf in a separate account. Whenever you wish, you can request that some or all of those investments be liquidated and the proceeds donated to qualified charities.

You get the best of both worlds: a tax deduction in the current tax year plus flexibility regarding the amount and timing of the final distribution of your charitable funds. Please see our earlier blog post on donor advised funds for more information [].

529s for College Savings

If you are paying an additional 3.8% tax on your investment earnings because your total income is greater than $250,000 (the “Obamacare tax”), consider saving for your children’s college education in a qualified College Savings Plan, aka a “Section 529 Plan.” Current earnings on these plans are shielded from current taxation, and withdrawals are exempt from federal and state income taxes as long as the funds are used for qualified college expenses. In addition, some states allow their residents to take a state tax deduction for contributions to their state-run plan. But even if your state does not offer this added incentive (California doesn’t), a 529 plan can help you minimize the taxes on your current investment earnings. Finally, donors can ‘telescope’ 5 years of contributions (up to $14,000 per year for a total of $70,000) into a single year, effectively removing that money from their estate.

Are Gains or Losses Best for You in 2016?

One good thing about investing outside of tax-sheltered account, such as IRAs and 401(k)s, is that the choice of when to realize gains and losses is large up to you. But remember that capital gains and losses within a single year are netted out against each other, so if you have taken capital gains so far this year you may want to see if there are losses in your portfolio that you could realize in order to net out those gains. Alternatively, if you expect your income to rise significantly in the future, you could also realize gains in the current year in order to take advantage of a (relatively) beneficial tax rate.

Remember, however, that your primary goals in managing your portfolio should be an appropriate choice of risk strategy as well as a well-thought-out long-term investment program. Your tax strategy should always complement those core investment goals rather than replace them.

Is a Roth IRA Conversion Right for You?

If you have an IRA, and your income is lower than usual this year, you may want to consider a Roth conversion before the end of the year. In a Roth conversion, some or all of your traditional, pre-tax IRA is transferred to a Roth IRA. You pay taxes at ordinary income tax rates on the amount that is transferred. But if your marginal rate is lower than is typical for you this year, the taxes you end up paying on the conversion may also be lower than normal. And because withdrawals from Roth IRAs are not taxed, once you pay for the conversion you are free to leave those funds invested – tax free – for as long as you live. For younger but affluent investors, this can truly be a wonderful deal.

One-time events, such as business losses, rental losses, capital losses – or even just a sabbatical year – can often reduce an individual’s income to unusually low levels. This can be a perfect time to consider a Roth conversion. Recently retired individuals, especially those who haven’t begun to receive Social Security benefits yet, can also be good candidates for Roth conversions, especially if they sizeable IRA assets that will require large Required Minimum Distributions (RMDs) at age 70 ½. The time between their active earning years and the onset of Social Security and RMDs may be a time when they have unused “tax capacity” in low tax brackets that they can utilize to make strategic Roth conversions. If carefully thought out and executed, such a strategy can shave many thousands of dollars off one’s lifetime tax bill.

Health Savings Accounts

A Health Savings Account (HSA) can be a great way to save for future medical expenses and save on current taxes at the same time. The savings feature depends on your having a qualified “high deductible health plan” (HDHP). But if you are willing to live with the possibility of foregoing first dollar insurance coverage, HSA contributions are deductible “above the line” on your tax return, meaning that the amount directly reduces the all-important adjusted gross income (AGI) number. Those contributions, plus earnings, are available to you at any time for qualified medical expenses, even before you retire. However, the biggest bang for your HSA buck comes when you can contribute more than you need in any one year and leave the surplus money in the account to grow tax free until you need it.

Most people we talk to think of HSAs like they would a FSA, or flexible spending account: they try to spend everything in it each year. But unlike FSAs, HSAs allow you to accumulate and grow funds that you contribute over your lifetime. And since experts currently estimate that each one of us will need to spend almost $250,000 during our retirement years on out-of-pocket medical expenses, and HSA offers a wonderfully tax-efficient way to save for those inevitable retirement expenses.

So now is the time to start thinking about how to both save on taxes as well as boost your own savings for 2016!

Image by BlueBoeing from Shutterstock

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