IFYF Monthly Investing Messages

Personal Finance October 02, 2015 Print Friendly and PDF




Investing For Your Future Monthly Message

October 2015

Barbara O’Neill, Extension Specialist in Financial Resource Management

Rutgers Cooperative Extension


Year-End Tax Planning Opportunities


Income taxes and investments are strongly related. For example, investors in the highest federal income tax brackets often purchase tax-free municipal bonds, versus taxable bonds, to receive a higher after-tax return. In addition, workers at all income levels can postpone taxes due on money saved in tax-deferred Traditional IRAs and employer retirement savings plans (e.g., 401(k) and 403(b) plans), including investment plan earnings.

Income tax planning related to investments takes on an increased urgency during the last quarter of the calendar year because many planning opportunities expire at year-end. Below is a description of year-end tax-planning strategies and tax law opportunities than can legally reduce your federal and/or state income taxes:


  • Know Your Tax Bracket- By the last quarter of the year, you should have a good estimate of your annual income. Knowing this information will help you make wise moves to save on taxes. An example is converting a Traditional IRA to a Roth IRA in a year when taxable income is reduced. By doing this, you’ll pay taxes now at a lower than normal interest rate in exchange for the opportunity to receive taxable income in retirement. Federal marginal tax brackets indicate the tax rate paid on an individual’s or married couple’s last dollar of income and range from 10% to 39.6%. A list of federal income tax brackets can be found at http://njaes.rutgers.edu/money/.


  • Beware of the Alternative Minimum Tax (AMT)- The AMT is a parallel income tax filing method that disallows certain “tax preference’ items such as state income taxes and local property taxes. It especially hits hard residents of states with high state and local taxes (e.g., New Jersey). Among the items that can bump up a tax filer’s income to the range where the AMT takes effect are exercised stock options and large recognized capital gains on investments. The IRS has a tool called the AMT Assistant to help determine if the AMT will apply: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Alternative-Minimum-Tax-(AMT)-Assistant-for-Individuals.


  • Hold Securities for Long-Term Gains- If investments such as stocks and bonds are held for more than a year, favorable long-term capital gains income tax rates apply. These tax rates are 0% for taxpayers in the 10% and 15% marginal tax brackets, 15% in the 25% to 35% tax brackets, and 20% in the 39.6% tax bracket. The short-term capital gains tax rate on investments held for one year or less is an investor’s ordinary income tax rate. An exception applies for collectibles, which have a maximum tax rate of 28%.


  • Net Gains and Losses- During the last three months of the tax year, many investors engage in tax-motivated investment transactions. An example is selling certain securities with a capital loss to offset others with a capital gain. Investors can claim up to $3,000 of capital losses to offset capital gains and up to $3,000 of ordinary income. Any additional capital losses above this amount can be carried forward to deduct in future tax years.


  • Increase Tax-Deferred Retirement Plan Contributions- During the last quarter of the year, consider increasing retirement plan savings contribution for the remainder of this year as well as next year. Contact your employer to execute the required paperwork or online election link. In 2015, the maximum savings limit for tax-deferred plans such as 401(k)s, 403(b)s, and the Thrift Savings Plan is $18,000 for workers under age 50 and $24,000 for workers age 50+. Even a 1% of pay contribution increase will amount to thousands of dollars in additional savings over time. Federal income taxes on the amount contributed are postponed until withdrawal in retirement.


  • Save for College in Tax-Advantaged Plans- College savings plans with tax benefits include state-sponsored college savings plans and Coverdell Education savings Accounts (ESAs).  A variety of investments can be selected including age-based target date funds with a glide path that becomes more conservative as a child approaches college age. Some states offer tax write-offs for 529 plan contributions. In addition, earnings on 529 plans that are used to pay qualified educational expenses are free from federal income tax.  The same benefit applies for Coverdell ESAs, which can also be used for elementary and secondary school expenses.


  • Invest to Reduce Adjusted Gross Income (AGI)- Increasing so called “above-the-line” deductions that are used to calculate AGI can help avoid limitations on tax breaks that are tied to AGI, such as employee business expenses. Several of these allowable income adjustments include investments including contributions to traditional IRAs, health savings accounts (HSAs), and self-employment health insurance premiums.


  • Donate Appreciated Investments- Not only can donors make a valuable gift to a qualified charity but they can also avoid capital gains tax and possibly the 3.8% surtax on the net investment income of higher tax households.


  • Make Business Retirement Plan Investments- Self-employed individuals and workers who “moonlight” can reduce taxable income with retirement plan investments. The simplest of these is a simplified employee pension or SEP.


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