Your Money Matters: Tax strategies

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Tax Strategies:

Increase your contributions to your retirement plan. We see people that are already saving money every month above and beyond what they’re contributing to their retirement plans. If they haven’t maxed out their retirement plans they can switch this monthly savings from non-retirement accounts to their retirement accounts and end up reducing their taxes. An employee can put up to $17,500 a year into a 401k, a 403b, or a 457 plan completely tax-sheltered. Plus, if they happen to be age 50 or older, they can put in an additional $5,500, which would take them up to $23,000; no matter how much money they make, they can still participate. In essence, they’re taking this money off the table as far as being taxed, and at the same time, they’re saving money for retirement.

Buy tax favored investments outside of retirement accounts and buy fully taxable investments inside the retirement accounts. There is a nice tax break for buying stocks outside of retirement accounts.  Stock dividend income is now permanently taxed as a long-term capital gain as opposed to being taxed as ordinary income. If you’re in a 10% or 15% bracket, for example, your tax on a stock dividend is zero.  Stocks have less need to be sheltered in retirement accounts since their income is either tax-free or taxed at a very low long-term capital gains tax rate. Remember some dividend paying stocks are paying income equal to that of taxable bonds, but the stocks are taxed more favorably.  Also, tax-free municipal bonds are good investments to buy outside of retirement accounts because the interest is free of all tax. To be properly diversified, you would also want to own some investments, however, that are fully taxable, such as most bonds as well real estate investment trusts.  These types of investments could be purchased inside your retirement account where they would be sheltered from ordinary income tax.

Watch for mistakes on calculating the tax owed on the sale of investments. A very common mistake investors make is to give their CPA the wrong price, better known as cost basis, that they paid for an investment.  This happens because they think that the original price they paid is the basis, but if you reinvest the dividends, your basis increases. Remember, basis is not taxable when you sell investments, so the higher the basis, the less tax you pay. A rule of thumb is this: If the sales price of an investment showing on Schedule D of your tax return is three times the basis, it’s often a mistake that is going to trigger a lot of unnecessary tax.

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