MONEY stocks

10 Smart Ways to Boost Your Investing Results

stacks of coins - each a different color
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You don't have to be an investing genius to improve your returns. Just follow a few simple steps.

Recent research shows that people who know their way around investing and finance racked up higher annual returns (9.5% vs. 8.2%) than those who don’t. Here are 10 tips that will help make you a savvier investor and better able to achieve your financial goals.

1. Slash investing fees. You can’t control the gains the financial markets deliver. But by sticking to investments like low-cost index funds and ETFs that charge as little as 0.05% a year, you can keep a bigger portion of the returns you earn. And the advantage to doing so can be substantial. Over the course of a career, reducing annual fees by just one percentage point can boost the size of your nest egg more than 25%. Another less commonly cited benefit of lowering investment costs: downsizing fees effectively allows you to save more for retirement without actually putting aside another cent.

2. Beware conflicted advice. Many investors end up in poor-performing investments not because of outright cons and scams but because they fall for a pitch from an adviser who’s really a glorified salesman. The current push by the White House, Department of Labor and Securities and Exchange Commission to hold advisers to a more rigorous standard may do away with some abuses. But the onus is still on you to gauge the competence and trustworthiness of any adviser you deal with. Asking these five questions can help you do that.

3. Gauge your risk tolerance. Before you can invest properly, you’ve got to know your true appetite for risk. Otherwise, you could end up bailing out of investments during market downturns, turning paper losses into real ones. Completing a risk tolerance questionnaire like this one from RealDealRetirement’s Retirement Toolbox can help you assess how much risk you can reasonably handle.

4. Don’t be a “bull market genius.” When the market is doing well and stock prices are surging, it’s understandable if you assume your incredible investing acumen is responsible for those outsize returns. Guess what? It’s not. You’re really just along for the ride. Unfortunately, many investors lose sight of this basic fact, become overconfident, take on too much risk—and then pay dearly when the market inevitably takes a dive. You can avoid such a come-down, and the losses that accompany it, by leavening your investing strategy with a little humility.

5. Focus on asset allocation, not fund picking. Many people think savvy investing consists of trying to identify in advance the investments that will top the performance charts in the coming year. But that’s a fool’s errand. It’s virtually impossible to predict which stocks or funds will outperform year to year, and trying to do so often means you’ll end up chasing hot investments that may be more prone to fizzle than sizzle in the year ahead. The better strategy: create a diversified mix of stock and bond funds that jibes with your risk tolerance and makes sense given the length of time you plan to keep your money invested. That will give you a better shot at getting the long-term returns you need to achieve a secure retirement and reach other goals while maintaining reasonable protection against market downturns.

6. Limit the IRS’s take. You should never let the desire to avoid taxes drive your investing strategy. That policy has led many investors to plow their savings into all sorts of dubious investments ranging from cattle-breeding operations to jojoba-bean plantations. That said, there are reasonable steps you can take to prevent Uncle Sam from claiming too big a share of your investment gains. One is doing as much of your saving as possible in tax-advantaged accounts like traditional and Roth 401(k)s and IRAs. You may also be able to lower the tab on gains from investments held in taxable accounts by investing in stock index funds and tax-managed funds that that generate much of their return in the form of unrealized long-term capital gains, which go untaxed until you sell and then are taxed at generally lower long-term capital gains rates.

7. Go broad, not narrow. In search of bigger gains, many investors tend to look for niches to exploit. Instead of investing in a broad selection of energy or technology firms, they’ll drill down into solar producers, wind power, robotics, or cloud-computing firms. That approach might work, but it can also leave you vulnerable to being in the wrong place at the wrong time—or the right place but the wrong company. Going broader is better for two reasons: it’s less of a guessing game, and the broader you go the lower your investing costs are likely to be. So if you’re buying energy, tech or whatever, buy the entire sector. Better get, go even broader still. By investing in a total U.S. stock market and total U.S. bond market index fund, you’ll own a piece of virtually all publicly traded U.S. companies and a share of the entire investment-grade bond market. Throw in a total international stock index fund and you’ll have foreign exposure as well. In short, you’ll tie your portfolio’s success to that of the broad market, not just a slice of it.

8. Consider the downside. Investors are by and large an optimistic lot, otherwise they wouldn’t put their money where their convictions are. But a little skepticism is good too. So before putting your money into an investment or embarking on a strategy, challenge yourself. Come up with reasons your view might be all wrong. Think about what might happen if you are. Crash-test your investing strategy to see how you’ll do if your investments don’t perform as well as you hope. Better to know the potential downside before it occurs than after.

9. Keep it simple. You can easily get the impression that you’re some kind of slacker if you’re not filling your portfolio with every new fund or ETF that comes out. In fact, you’re better off exercising restraint. By loading up on every Next Big Thing investment the Wall Street marketing machine churns out you run the risk of di-worse-ifying rather than diversifying. All you really need is a portfolio that mirrors the broad U.S. stock and bond markets, and maybe some international exposure. If you want to go for more investing gusto, you can consider some inflation protection, say, a real estate, natural resources, or TIPS fund. But I’d be wary about adding much more than that.

10. Tune out the noise. With so many investing pundits weighing in on virtually every aspect of the financial markets nearly 24/7, it’s easy to get overwhelmed with advice. It might make sense to sift through this cacophony if it were full of investing gems, but much of the advice, predictions, and observations are trite, if not downright harmful. If you want to watch or listen to the parade of pundits just to keep abreast of the investing scuttlebutt, fine. Just don’t let the hype, the hoopla, and the hyperbole distract you from your investing strategy.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Social Security

The Taxing Problem With Working Longer

Earning money after you start collecting Social Security can be a tax headache.

The question of when and how to file for Social Security is a tough one for many retirees—I regularly field questions on the topic. Recently a reader wrote to say he’d like to draw Social Security benefits at age 66 yet keep working until 75. What are the tax implications?

When you continue to work and draw Social Security, your benefits are reduced temporarily if you’re 65 or younger and your outside income exceeds certain levels. After 65, these reductions do not apply. You may, however, owe taxes on your Social Security income.

How Earnings Can Hurt

Not all of your Social Security income is taxable. Social Security uses a measure it calls “combined income” to determine how much of your benefit is taxable, and it can be tricky to understand.

To determine your combined income, take your adjusted gross income (check last year’s tax return), then add any nontaxable interest income and half of your Social Security benefit. (If you haven’t started claiming, you can get a projection online by setting up an account at ssa.gov.)

If the total is less than $25,000 ($32,000 on joint tax returns), you owe no income taxes on your Social Security benefits. If the total is between $25,000 and $34,000 ($32,000 and $44,000 on joint returns), you may have to pay taxes on half of your Social Security that’s over that threshold. Above that, 85% of your benefits may be taxable—the top rate.

Here’s how that could play out. Take a retiree in the 15% federal tax bracket who is taxed on 50% of his Social Security. When he earns another $1,000, his so-called combined income rises by that much too, subjecting another $500 of Social Security income to taxes. So the tax bill on that $1,000 won’t be $150 (15% of $1,000) but $225 (15% of $1,500), for an effective rate of 22.5%.

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MONEY

Your Workarounds

Beefing up your tax-free holdings, especially Roth IRAs, can mean money coming in that won’t trigger more taxable Social Security income. (Working less lowers your tax bill too, but you’re usually better off earning the money.)

If you can live on just your salary, deferring Social Security until age 70 also helps. Your taxes should be lower while you wait. And delaying benefits will increase your monthly Social Security payments by 8% a year (plus annual inflation adjustments).

Hedging Your Bets

Single retirees should think about one other option: filing for and suspending Social Security benefits at age 66. By doing so you will be able to request a lump-sum payment for all the suspended benefits
anytime until age 70.

Even the best of plans can change, so that payment could come in handy if you face an emergency cash crunch. But there’s a downside: Once you request a lump sum, your payout will be valued as if you took benefits at 66, as will your regular monthly benefit going forward.

Philip Moeller is an expert on retirement, aging, and health. His book, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” was published in February by Simon & Schuster. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

 

MONEY IRAs

The Retirement Investing Mistake You Don’t Know You’re Making

The investor rush to beat the April 15 deadline for IRA contributions often leads to bad decisions. Here's how to keep your investments growing.

It happens every year around this time: the rush by investors to make 11th-hour contributions to their IRAs before the April 15 tax deadline.

If you’ve recently managed to send in your contribution, congrats. But next time around, plan ahead—turns out, this beat-the-clock strategy comes at a cost, or a “procrastination penalty,” according to Vanguard.

Over 30 years, a last-minute IRA investor will wind up with $15,500 less than someone who invests at the start of the tax year, assuming identical contributions and returns, Vanguard calculations show. The reason for the procrastinator’s shortfall, of course, is the lost compounding of that money, which has less time to grow.

Granted, missing out on $15,500 over 30 years may not sound like an enormous penalty, though anyone who wants to send me a check for this amount is more than welcome to do so. But lost earnings aren’t the only cost of the IRA rush—last-minute contributions also lead to poor investment decisions, which may further erode your portfolio.

Many hurried IRA investors simply stash their new contributions in money-market funds—a move Vanguard calls a “parking lot” strategy. Unfortunately, nearly two-thirds of such contributions are still stashed in money funds a full 120 days later, where they have been earning zero returns. So what seems like a reasonable short-term decision often ends up being a bad long-term choice, says Vanguard retirement expert Maria Bruno.

Why are so many people fumbling their IRA strategy? All too often, investors focus mainly on their 401(k) plan, while IRAs are an after-thought. But fact is, most of your money will likely end up in an IRA, when you roll out of your 401(k). Overall, IRAs collectively hold some $7.3 trillion, the Investment Company Institute (ICI) found, fueled by 401(k) rollovers—that’s more than the money held in 401(k)s ($4.5 trillion) and other defined-contribution accounts ($2.2 trillion) combined.

Clearly, having a smart IRA plan can go a long way toward improving your retirement security. To get the most out of your IRA—and avoid mistakes—Bruno lays out five guidelines for investors:

  • Set up your contribution schedule. If you can’t stash away a large amount at the start of the year, establish a dollar-cost averaging program at your brokerage. That way, your money flows into your IRA throughout the year.
  • Invest the max. You can save as much as $5,500 in an IRA account in 2015. But for those 50 and older, you can make an additional tax-deferred “catch up” contribution of $1,000. A survey of IRA account holders by the ICI found that just 14% of investors take advantage of this savings opportunity. (You can find details on IRS contribution limits here.)
  • Select a go-to fund. Skip the money fund, and choose a target-date retirement fund or a balanced fund as the default choice for your IRA contributions. You can always change your investment choice later, but meantime you will get the benefits—and the potential growth—of a diversified portfolio.
  • Invest in a Roth IRA. Unlike traditional IRAs, which hold pre-tax dollars, Roths are designed to hold after tax money, but their investment gains and later payouts escape federal income taxes. With Roths, you also avoid RMDs (required minimum distributions) when you turn 70 ½, which gives you more flexibility. Vanguard says nine out of every 10 dollars contributed to IRAs by its younger customers under age 30 are flowing into Roths. Here are the IRS rules for 2015 Roth contributions.
  • Consider a Roth conversion. High-income earners who do not qualify for tax-deferred Roth contributions can still make post-tax contributions to an IRA and then convert this account to a Roth. The Obama Administration’s proposed 2016 federal budget would end these so-called backdoor Roth conversions, which have become very popular. Of course, it’s far from clear if that proposal will be enacted.

Once you have your IRA set up, resist tapping it until retirement. The longer you can let that money ride, the more growth you’re likely to get. Raiding your IRA for anything less than real emergency would be the worst mistake of all.

Philip Moeller is an expert on retirement, aging, and health. His latest book is “Get What’s Yours: The Secrets to Maxing Out Your Social Security.” Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: 25 Ways to Get Smarter About Money Right Now

MONEY Ask the Expert

How to Secure Your Finances When Reality Doesn’t Bite

Investing illustration
Robert A. Di Ieso, Jr.

Q: I am a 22-year-old college grad with a six-figure income and minimal student debt. I have no car and live with my parents. Is there something I should do now to lead a secure and fiscally responsible life? My father gave me the name of his planner but he was of little help — Timothy

A: Given your age, healthy salary, low expenses, and minimal debt, you’re financial situation is pretty straight forward. “There is a time and a place to work with a financial planner, and now may not be one of them,” says Maggie Kirchhoff, a certified financial planner with Wisdom Wealth Strategies in Denver.

If you still want some guidance, you may have better luck getting referrals from friends or colleagues. “A planner who’s a good fit for your parents may not be a good match for you,” she adds.

In the meantime, there are plenty of things you can be doing to improve your financial security. The biggest one: “Save systematically,” says Kirchhoff. If you start saving $5,500 a year, even with a conservative 5% annual return, you’ll have nearly $600,000 when you turn 60. “That assumes you never increase contributions,” she says.

It sounds like you’re in a position to save several times that amount now that your expenses are still low. Make use of your current economic sweet spot by taking full advantage of tax-friendly retirement vehicles, such as an employer-sponsored 401(k) plan. You can sock away up to $18,000 a year in such a plan, and any contributions are exempt from federal and state taxes. If your employer offers matching benefits, contribute at least enough to get the most you can from that benefit.

Your 401(k) plan likely offers an allocation tool to help you figure out the best mix of stocks and bonds for your time horizon and risk tolerance. Based on that recommendation, you’ll want to choose a handful of low-cost mutual funds or index funds that invest in companies of different sizes, in the United States and abroad. “You can make it as complicated or simple as you like,” says Kirchhoff.

If you want to keep things simple, look at whether your plan offers any target-date funds, which allocate assets based on the year you expect to retire (a bit of a guess at this point) and automatically make changes to that mix as that date nears. Caveat: Don’t overpay to put your retirement plan on autopilot; ideally the expense ratio should be less than 1%.

Now, just as important as investing for retirement is making sure you protect that nest egg from its biggest threat: you. Build an emergency fund so you won’t be tempted to dip into your long-term savings — and owe taxes and penalties — if you lose your job or face unexpected expenses.

“A general rule is three to six months of expenses, but since his expense are already so low, he should aim to eventually save three to six months of his take-home pay,” says Kirchhoff, who recommends keeping your rainy-day fund in a money market account that isn’t tied directly to your checking account.

With the extreme ends of your financial situation covered, you’ll then want to think about what you have planned for the next five or 10 years.

Is graduate school in your future? What about buying or renting a place of your own? Once you get up to speed on your retirement savings and emergency fund, you can turn your attention to saving up for any near-term goals.

You might also consider eventually opening a Roth IRA. You’ll make after-tax contributions, but the money will grow sans tax, and you won’t owe taxes when you withdraw for retirement down the road. (Note: You can save up to $5,500 a year in a Roth, but contributions phase out once your modified gross adjusted income reaches $116,000 to $131,000.)

A Roth may not only save you more in taxes down the road, it also offers a little more flexibility that most retirement accounts. For example, you can withdraw up to $10,000 for a first-time home purchase, without tax or penalty, if you’ve had the account at least five years. Likewise, you can withdraw contributions at any point, for any purpose.

What about the student debt? Depending on the interest rate and whether you qualify for a tax deduction (in your case probably not), you could hang onto it and focus on other financial priorities.

That said, if you can make large contributions to your 401(k) plan, build your emergency fund and pay off your student debt at a quicker pace, says Kirchhoff, so much the better.

MONEY Savings

Why Illinois May Become a National Model for Retirement Saving

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Chris Mellor—Getty Images/Lonely Planet Image

Illinois will automatically enroll workers who lack an employer retirement plan into a state-run savings program

In what may emerge as a standard for all states, Illinois is introducing a tax-advantaged retirement savings plan for most residents who do not have such a plan at work. The program echoes one that President Obama has endorsed at the federal level, and it boosts momentum that has been building for several years at the state level.

Beginning in 2017, Illinois businesses with 25 or more employees that do not offer a retirement savings plan, such as a 401(k) or pension, must automatically enroll workers in the state’s Secure Choice Savings Program, which will enable them to invest in a Roth IRA. Workers can opt out. But reams of research suggest that inertia will keep most employees in the plan.

Once enrolled, workers can choose their pre-tax contribution rate and select from a small menu of investment options. Those who do nothing will have 3% of their paycheck automatically deducted and placed in a low-fee target-date investment fund managed by the Illinois Treasurer.

The plan may sound novel, but at least 17 states, including bellwethers like California, Connecticut, Massachusetts and Wisconsin, have been considering their own savings plans for private-sector employees. Many are taking steps to establish one. In Connecticut, lawmakers recently set aside $400,000 to set up an oversight board and begin feasibility studies. Wisconsin and others are moving the same direction. Oregon may approve a plan this year.

But Illinois appears to be the first set to go live with a plan, and for that reason the program will be closely watched. If more workers open and use the savings accounts, more states are almost certain to push ahead. The estimate in Illinois is that two million additional workers will end up with savings accounts.

The Illinois plan may serve as a model because there is little cost to the state—that’s crucial at a time when many states face budget problems. (The budget shortfalls in Illinois, in particular, led to a pension crisis.) All contributions come from workers, and employers must administer the modest payroll deduction. Savers will be charged 0.75% of their balance each year to pay the costs of managing the funds and administering the program.

About half of private-sector employees in the U.S. have no access to retirement savings plans at work, which is one key reason for the nation’s retirement savings crisis. Those least likely to have access are workers at small businesses. The Illinois program addresses this issue by mandating participation from all but the very smallest companies.

These state savings initiatives have been spurred by the lack of progress in Washington to improve retirement security. President Obama promoted a federally administered IRA for workers without an employer plan in his State of the Union address last year, but bipartisan bills to establish an automatic IRA have long been stalled in Congress. Still, the U.S. Treasury unveiled a program called myRA for such workers to invest in guaranteed fixed-income securities on a tax-advantaged basis. Clearly, there is broad support for these kinds of programs. Now Illinois just has to show they work.

Read next: 5 Simple Questions that Pave the Way to Financial Security

MONEY Roth IRA

Cut Taxes and Get a Bigger IRA With This One Neat Trick

A Roth IRA is a great tool for retirement savings. Here's how to make it even better.

At the beginning of every year, we work with some of our clients to convert their IRAs to Roth IRAs, knowing, even then, that we will undo most of those conversions at the end of the year. The whole process involves a lot of paperwork and tracking of their accounts throughout the year.

So why do we go through all this trouble? It’s a great way to save on taxes.

First, let’s do a quick review. An IRA is typically funded with pre-tax dollars and grows tax-deferred. When the account holder withdraws the money from the account, those withdrawals are fully taxed as regular income. A Roth IRA, on the other hand, is funded with after-tax dollars, and withdrawals are tax-free.

When you convert an IRA to a Roth IRA, you have to pay regular income taxes on the amount you convert. By doing the conversion, thus, you’re effectively paying income taxes now so that your withdrawals later — from the new Roth IRA — will be tax-free.

There’s a twist: You’re allowed to undo the conversion in the same tax year of the conversion without incurring any taxes or penalties. It is this ability to undo the conversion which provides for a great tax planning strategy.

So when and why might you want to do a Roth IRA conversion? And why might you want to undo it?

  • Low Income Taxes: Let’s say you lost your job, and you end up having a year owing little or no income tax. You could convert some amount of your IRA to a Roth IRA without much of a tax hit. Or maybe, because you’re self-employed or work on commission, your income varies widely; in a year with very low income, you could use the conversion to move money to a Roth at very low tax rates. Whatever your situation, you can convert at the beginning of the year, then depending on your earnings over the year, you can decided to keep the conversion or undo.
  • Topping off Your Tax Bracket: Similar to the low income taxes, if you find yourself in a lower-than-expected tax bracket, you may want to keep some of the conversion to fill up that lower tax bracket.
  • Investment Performance: The more your assets increase in value after conversion, the better. Since no one can time the markets, however, the best strategy (again) is to convert at the beginning of the year. Then, as year-end approaches, you can decide if the conversion was worthwhile. Let’s say, for example, that you convert a $10,000 IRA to a Roth in January. If in December the Roth is worth $15,000, you’ll still pay taxes only on the $10,000 you converted — a pretty good deal. If, however, the account is worth only $5,000 by December, you’d still have to pay taxes on that original $10,000 you converted. So if the converted assets lose money, you can just undo the conversion and pay no taxes on it at all.

If you’re taking this wait-and-see approach, you can increase your tax advantages even further — as we do with clients — by converting IRAs into multiple Roth accounts. In this multiple-account strategy, we put different assets into each new Roth. That process lets you select the asset that had the best returns after the conversion and keep it as a Roth, while undoing the conversion of other assets with low or negative returns.

To explain this strategy, let me use the hypothetical example of Sally, a self-employed graphic designer with $40,000 in a traditional IRA. In March 2014, she converts that IRA into a Roth.

For illustrative purposes, let’s suppose that she divides up her new Roth by investing $10,000 apiece in four different index funds, each representing a different asset class:

  • US large-cap stocks
  • US small-cap value stocks
  • International large-cap stocks
  • International small-cap value

At the end of November, Sally has more business income than she expected, and she decides that she would like to convert only $10,000 to a Roth — one-quarter of the original $40,000.

Let’s take a look at where her account has ended up:

Initial Investment Total Return End Value
US Large-cap $ 10,000 12.89% $ 11,289
US small-cap value $ 10,000 0.91% $ 10,091
International large-cap $ 10,000 -2.39% $ 9,761
International small-cap value $ 10,000 -8.09% $ 9,191
TOTAL $ 40,000 0.83% $40,332

The usual approach, in this situation, would have been for Sally to convert the entire IRA into one new Roth conversion account. In such a case, since she wants to convert only one-quarter of the original amount, she will be able to keep only one-quarter of her $40,332 balance at the end of November, or $10,083.

But the strategy we use would be to open four separate Roth conversions — one for each asset class. In that case, when Sally wants to undo the conversion on three-quarters of her original $40,000, she can keep the Roth account with the best return and undo the conversion on the other three. In this particular example, she would keep the US large-cap fund in her Roth, which is now worth $11,289.

So under this four-account option, she starts out with exactly the same investments as in the original scenario, and has exactly the same tax liability on the $10,000 Roth conversion she doesn’t undo. But she also ends up with $11,289 in her Roth account, not the $10,083 she would have had by converting into a single account. That’s an extra $1,206 in the Roth, for no added tax liability.

The following year, Sally can take the $29,000 that reverted to her traditional IRA and do the conversion all over again. (IRS rules dictate that once you’ve reversed an Roth conversion, you have to wait at least 30 days, and until a new calendar year, to do another.)

Neat trick, huh?

———-

Scott Leonard, CFP, is the owner of Navigoe, a registered investment adviser with offices in Nevada and California. Author of The Liberated CEO, published by Wiley in 2014, Leonard was able to run his business, originally established in 1996, while taking his family on a two-year sailing trip from Florida to New Caledonia in the south Pacific Ocean. He is a speaker on investment and wealth management issues.

MONEY Taxes

10 Last-Minute Ways to Save on Your Taxes This Year

woman donating clothes
JGI/Jamie Grill—Getty Images Clean out your closet by Dec. 31 and cut your tax bill.

In between your holiday shopping and New Year's plans, make time for these time-sensitive tax moves.

The window of time to cut your 2014 tax bill is closing. Before you pop open the champagne on New Year’s Eve, make sure you’ve ticked off these valuable tax tasks.

1. Be Charitable Now

Individual Americans donate some $250 billion dollars to charity every year, according to the annual Giving USA report, and December is high season for giving.

By donating to charity, you can trim next your tax bill next April. You must itemize to get a write-off, and the organization must be a qualified charity. Check at IRS.gov.

Then you simply need to get a check in the mail by Dec. 31. Or put the gift on a credit card before year-end and pay the bill in January. Make sure you have a receipt, be it a cancelled check or your credit-card statement. But if you donate $250 or more, you must get a written record from the charity.

If you give away clothes or stuff from around the house, you’ll be able to deduct the fair market value, as long as the goods are in good condition or better.

“The end of the year is a great time to donate some items to charity,” says financial planner Trent Porter. “Your good deed will be rewarded with a bigger tax refund and a clean closet”

2. Be Charitable Later

If you’re in search of a big deduction in 2014, but you’re not ready to support a single charity now, here’s a good option. With as little as $5,000, you can set up a donor advised fund with a brokerage of fund company such as Fidelity or Schwab. You get the upfront tax savings, the money is invested, and you can then donate a portion of the fund to the charities of your choice for years to come.

“These accounts make it easy to use appreciated securities and other assets to fund your philanthropy, thus avoiding paying capital gains tax on the appreciation,” says financial planner Eric Lewis.

3. Invest in Education

A year of tuition and fees at even a public college will cost you more than $23,000 today. You need all the tax breaks you can get.

If you’re saving for school in a 529 college savings plan, that money grows tax-free, and withdrawals are tax-free as long as the money goes toward higher ed.

You can’t deduct those contributions on your federal return. But in 34 states and the District of Columbia, you can qualify for at least a partial deduction or a credit on your state tax return, as long as you fund the account by Dec. 31. Look up your state’s rules at savingforcollege.com.

4. Speed Up Deductions

A popular strategy for cutting your tax bill is to move up as many deductible expenses as you can. This is especially smart if your income will be high this year—say you cashed out winning investments or sold property.

One simple way is to donate more to charity. You can also make your January mortgage payment in December, which will give you extra interest to deduct. You could also prepay your property taxes, or send in estimated state and local taxes that you would otherwise pay in January. Or pay next year’s professional dues and subscriptions to trade publications.

Don’t employ this strategy, however, if you expect to be in a higher tax bracket in 2015. In that case, the deductions will be more valuable to you next year.

5. Top Off Retirement Plans

In 2014, you can save $17,500 in a 401(k) plan, or $23,000 if you’re 50 or older. If you haven’t saved that much, see if your employer will let you make an extra lump-sum contribution before Dec. 31. If you can’t, make sure you hit the max next year by raising your contribution rate now. The limit will rise to $18,000 in 2015, or $24,000 if you’re 50 or older.

You have until next April 15 to fund a traditional or Roth IRA for 2014, but the sooner you save the more time you’ll have to get the benefit of tax-deferred growth. What’s more, planning ahead might make for better investment choices. A recent Vanguard study found that last-minute IRA investors are more likely to simply park the money in cash and leave it there.

You can contribute $5,500 dollars to an IRA in 2014, or $6,500 if you’re 50 or older.

If you run your own business and want to save in a solo 401(k), you must open that plan by Dec. 31, though you can still fund it through next April 15.

6. Look for Losers

Nearly six years into this bull market, long-term stock investors are sitting on big gains. Maybe you cashed in a profitable stock or mutual fund this year. Or you trimmed back your winners when you rebalanced your portfolio. Unless you sold within a retirement account, you’ll face a tax bill come April. And the best way to cut that is to offset your investment gains with investment losses.

By pairing gains with losses, you can avoid paying capital gains taxes. If you have more losses than gains, you can use up to $3,000 worth to offset your ordinary income, and then save the rest of the losses for future years.

However, don’t let tax avoidance get in the way of sound investing. You should sell a stock or fund before year-end because it doesn’t fit with your investing strategy, not just because you have a loss.

If you want to buy the investment back, you must wait 31 days. Do so sooner, and the IRS will disallow the write-off (what’s called the “wash sale” rule).

7. Part With Big Winners

If you donate winning stocks, bonds, or mutual funds directly to a charity, you can enjoy two tax breaks. You won’t owe any taxes on your capital gains. And you can deduct the full market value of the investment on your 2014 return.

8. Tap Your IRA

With a tax-deferred plan like an IRA, once you hit age 70 1/2 you must take out some money every year. You have to take your first distribution by April 1 the year after you turn 70 1/2. Then the annual deadline for your required minimum distribution, or RMD, is Dec. 31.

This rule doesn’t apply to Roth IRAs, and if you have a 401(k) plan and you’re still working, you can usually wait until you do retire to start withdrawing money.

The IRS minimum is based on your account balance at the end of last year and your current life expectancy. Your broker or adviser can help you with the calculation, but you’re responsible for making the withdrawal. If you fail to do so, you’ll owe a 50% penalty on the amount you should have withdrawn.

You can also donate your RMD directly to charity and avoid paying income taxes on the withdrawal. In mid-December, Congress extended that rule, which had expired, for at least one more year.

9. Spread the Wealth

Making outright gifts is a smart move tax-wise, says Ann Arbor financial planner Mo Vidwans. Your heirs are less likely to face estate taxes down the road—and you can help out your kids or grandchildren when they need it the most. In 2014, you can give as many people as you want up to $14,000 tax-free. If both you and your spouse both make gifts, that’s $28,000.

If you’re funding 529 plan, you can frontload five years worth of gifts and put $70,000 into a child’s account now.

10. Pay Taxes Now and Never Again

With a traditional individual retirement account, your contributions are tax deductible, but you’ll owe income taxes on your withdrawals. A Roth IRA is the opposite: You invest after-tax money, but your withdrawals are 100% tax free.

Before year-end, you can convert a traditional IRA to a Roth. You’ll have to pay taxes on the conversion in 2014. But then you’ll never owe taxes on that money again.

Converting to a Roth is an especially smart move if your income was down this year and you’re in a low tax bracket. “If you have a low-income year, do a Roth conversion,” says New York City financial planner Annette Clearwaters. “Whenever I see a tax return with negative taxable income I cringe, because it’s such a wasted opportunity.”

And if you later change your mind, you have until the extended tax-filing deadline next October to switch back to a traditional IRA. Clearwaters recommends undoing any conversion that puts you above the 15% federal tax bracket.

Update: This post was updated to reflect Congress’s extension of the rule allowing for direct charitable donations of RMDs.

MONEY IRA

How to Use Your Roth IRA to Buy Foreign Stocks

Investing illustration
Robert A. Di Ieso, Jr.

Q: I would like to invest in foreign stocks and LLPs within my Roth IRA. Do I need to file any special forms at the end of the year? Are there any type of investments within the Roth that would not require a special filing? — Tom

A: Depending on what’s available in your Roth IRA or whether you have a self-directed Roth, there are any number of investments you can own beyond the usual stocks, bonds and funds. But just because you can, doesn’t mean you should.

Let’s start with the question of foreign securities. Assuming you’re able to buy stocks listed on foreign exchanges in your Roth — policies vary from brokerage to brokerage — you will need to file IRS Form 8938 to report these foreign assets, says David Lyon, CEO of Main Street Financial in Chicago.

One way to avoid having to file this paper work, among other headaches, is to stick with foreign stocks that are available to U.S. investors as American Depository Receipts, or ADRs. Most of the largest foreign companies have ADRs, which trade on U.S. exchanges and in U.S. dollars, and don’t require the additional paperwork, though there may be other tax considerations.

As always, consider how any such holdings fit into the bigger picture of your portfolio. By all means, you want exposure abroad, but buying individual securities on your own, a la carte, may not yield the best results over the long run.

To wit, a much easier way to gain exposure to foreign companies is via an exchange-traded fund or mutual fund that invests in foreign stocks on your behalf, says Lyon. For broad market exposure, he likes the Vanguard FTSE All-World ex-U.S. ETF (ticker: VEU). As the name indicates, this low-cost fund gives you broad, diversified global exposure, ranging from the developed markets of Europe and Japan to emerging markets in Asia, Latin America and the Middle East.

If you’re looking for a more targeted approach, you can find ETFs that specialize in just one sector of the global economy, or one region of the world, or even one country.

Similarly, if you hold a limited liability partnership (LLP) in your Roth IRA you will need to fill out Form 990-T for unrelated business taxable income.

That said, you probably don’t want to invest Roth IRA assets in an LLP. The reason: “Essentially you’ll be taxed twice,” says Lyon. In addition to first paying tax on the contributions you make to the Roth, he says, you will be taxed on LLP income above $1,000 a year. He adds: “Investors are typically better off focusing their investable assets in traditional investments that allow them to take full advantage of the tax deferred growth and tax free distributions.”

 

MONEY year-end moves

3 Smart Year-End Moves for Retirement Savers of All Ages

golden eggs of ascending size
Getty Images

To give your long-term financial security a boost, take one of these steps before December 31.

It’s year-end, and retirement savers of all ages need to check their to-do lists. Here are some suggestions for current retirees, near-retirees, and younger savers just getting started.

Already Retired: Take Your Distribution

Unfortunately, the “deferred” part of tax-deferred retirement accounts doesn’t last forever. Required minimum distributions (RMDs) must be taken from individual retirement accounts (IRAs) starting in the year you turn 70 1/2 and from 401(k)s at the same age, unless you’re still working for the employer that sponsors the plan.

Fidelity Investments reports that nearly 68% of the company’s IRA account holders who needed to take RMDs for tax year 2014 hadn’t done it as of late October.

It’s important to get this right: Failure to take the correct distribution results in an onerous 50% tax—plus interest—on any required withdrawals you fail to take.

RMDs must be calculated for each account you own by dividing the prior Dec. 31 balance with a life expectancy factor (found in IRS Publication 590). Your account provider may calculate RMDs for you, but the final responsibility is yours. FINRA, the financial services self-regulatory agency, offers a calculator, and the IRS has worksheets to help calculate RMDs.

Take care of RMDs ahead of the year-end rush, advises Joshua Kadish, partner in planning firm RPG Life Transition Specialists in Riverwoods, Ill. “We try to do it by Dec. 1 for all of our clients—if you push it beyond that, the financial institutions are all overwhelmed with year-end paperwork and they’re getting backed up.”

Near-Retired: Consider a Roth

Vanguard reports that 20% of its investors who take an RMD reinvest the funds in a taxable account—in other words, they didn’t need the money. If you fall into this category, consider converting some of your tax-deferred assets to a Roth IRA. No RMDs are required on Roth accounts, which can be beneficial in managing your tax liability in retirement.

You’ll owe income tax on converted funds in the year of conversion. That runs against conventional planning wisdom, which calls for deferring taxes as long as possible. But it’s a strategy that can make sense in certain situations, says Maria Bruno, senior investment analyst in Vanguard’s Investment Counseling & Research group.

“Many retirees find that their income may be lower in the early years of retirement—either because they haven’t filed yet for Social Security, or perhaps one spouse has retired and the other is still working. Doing a conversion that goes to the top of your current tax bracket is something worth considering.”

Bruno suggests a series of partial conversions over time that don’t bump you into a higher marginal bracket. Also, if you’re not retired, check to see if your workplace 401(k) plan offers a Roth option, and consider moving part of your annual contribution there.

Young Savers: Start Early, Bump It Up Annually

“Time is on my side,” sang the Rolling Stones, and it’s true for young savers. Getting an early start is the single best thing you can do for yourself, even if you can’t contribute much right now.

Let the magic of compound returns help you over the years. A study done by Vanguard a couple years ago found that an investor who starts at age 25 with a moderate investment allocation and contributes 6% of salary will finish with 34% more in her account than the same investor who starts at 35—and 64% more than an investor who starts at 45.

Try to increase the amount every year. A recent Charles Schwab survey found that 43% of plan participants haven’t increased their 401(k) contributions in the past two years. Kadish suggests a year-end tally of what you spent during the year and how much you saved. “It’s not what people like to do—but you have a full year under your belt, so it’s a good opportunity to look at where your money went. Could you get more efficient in some area, and save more?”

If you’re a mega-saver already, note that the limit on employee contributions for 401(k) accounts rises to $18,000 next year from $17,500; the catch-up contribution for people age 50 and over rises to $6,000 from $5,500. The IRA limit is unchanged at $5,500, and catch-up contributions stay at $1,000.

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