The recent stock market plunge provided a swift and significant decline that hasn’t been seen in years. Whether the action has made you and your clients bullish or bearish, you may be making some trades. Here are five steps your clients can take to boost their net returns by reducing their income taxes and capital gains taxes.
1. Buy smart
Working clients who are looking to take advantage of recent declines in the equity markets should first ensure that they are maxing out their contributions to pretax retirement plans. In 2015 the limit for contributions to 401(k)s and 403(b)s is generally the lesser of the client’s earnings or $18,000. Those over age 50 can bump up that figure by an additional $6,000. Clients who qualify to make IRA, Roth IRA, and SEP contributions for the 2015 tax year don’t have to wait until the last minute to make their deposits. If they have the cash and the courage, they can invest that money immediately. Outside of retirement accounts and annuities, new purchases come with a potential pitfall: When buying mutual funds in nonqualified accounts, beware that many may make taxable distributions between now and the end of the year. Clients who invest now may end up owing taxes on those distributions even though the value of the account may be equal to, or less than, the original invested amount.
2. Sell strategically
Clients who want to reduce certain positions should first consider selling from their at-work retirement plans. Those sales won’t incur any taxes, nor incur significant fees or commissions. In nonqualified accounts, if the clients sell a position at a loss, verify that they haven’t bought the same shares for at least thirty days before or after the sale. Otherwise, the IRS “wash sale” rules could negate any tax deduction from the loss. Last but certainly not least, when selling profitable positions in a taxable account, you and your clients should pay attention to the purchase date of those investments. If possible, wait until the holding period has reached at least one year so the profits will qualify for the lower tax rate on long-term capital gains—currently 15 percent for most earners and 20 percent for high earners. Otherwise, gains are taxed at personal income rates. Benevolent clients who want to help out younger family members should consider eschewing cash, and instead “gift” shares of appreciated stock held in nonqualified accounts. If the recipient is in a lower-income tax bracket, he may be able to sell the shares and qualify for the zero-percent federal tax rate on long-term capital gains.
3. Clean up the portfolio
Some clients may be hesitant to sell some positions held outside of tax-sheltered accounts because they don’t want to go through the headache and hassle of figuring out an unknown cost basis for the securities. You can save them some stress (and taxes) by suggesting that they donate those investments to a qualified charity. Clients who itemize will be able to deduct the entire value of the donation, subject to income limitations (see IRS Publication 526—Charitable Contributions at www.irs.gov). The charity will then sell the stock without having to pay capital gains taxes, and the client won’t have to dig through piles of receipts and statements to come up with a nebulous estimate of what was originally paid for the shares. If the clients have more shares that fit in this category than they wish to donate right now, suggest they use a donor-advised fund. They’ll still get a tax break on the amount donated, but can have the money transferred to qualified charities in smaller amounts during future years.
4. Liquidate misguided money
Some clients who have been thinking of getting out of certain tax-deferred annuities might notice that the recent decline has reduced the gain on their original deposit. They may be more inclined to cash out of the annuity now, while the tax bill on the liquidation would likely be lower than it has been for a few years. Make sure they are aware of any potential loss of guaranteed income or death benefits, and that they avoid incurring any surrender charges if possible. The same strategy can be applied to 529 accounts when the funds are either no longer needed for the beneficiary’s higher education expenses, or could be put to better use by the family. If there are no matching qualified higher-education expenses incurred in the year of the withdrawal, the now-diminished earnings portion of the account will be taxed as ordinary income to the recipient, and will be hit with a 10% penalty. One tactic that may help offset those taxes and penalties is to transfer the 529 account to the adult child, and then have her cash out the balance. Her tax rate is likely to be lower than her parents’, and if she uses the proceeds to pay off high-interest debt or save for retirement in a pretax plan at work, the net effect could be positive.
5. Convert IRAs to Roths
If clients’ IRA balances are lower now than what is hoped for in the future, and/or their tax rate is lower now than what it might be down the road, now might be a good time to convert a portion of the accounts to Roth IRAs. This move is especially useful if it can be performed while still keeping the client under the top of the 15% federal income-tax bracket. That figure is determined by what’s on Line 43 of their 1040s, and for 2015 it’s $74,900 for married couples filing jointly, and $37,450 for single filers. You and your clients can get an estimate of this year’s potential tax status via Turbotax’s TaxCaster, available at tinyurl.com/calctax. Even if you make the conversion before the end of this year, and then discover that the conversion incurred more taxes than the client would have preferred, they can undo the conversion by next April 15th (or next October 15th if they file an extension).
Full article may be found: http://wealthmanagement.com/equities/five-tax-smart-strategies-turbulent-markets#slide-0-field_images-1001281 Use is for educational purposes only.
Securities and investment advice offered through Investment Planners, Inc. (Member FINRA/SIPC) and IPI Wealth Management, Inc. 226 W. Eldorado St., Decatur, IL 62522. 217-425-6340.