In between your holiday shopping and New Year's plans, make time for these time-sensitive tax moves.
You know that the window to finish your holiday shopping is closing fast. Well, so is the time you have to cut your 2014 tax bill. 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.
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.
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.”
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.
Q: I am maxing out my 401(k). I understand there’s a new way to make after-tax contributions to a Roth IRA. How does that work?
A: You can thank the IRS for what is essentially a huge tax break for higher-income retirement savers, especially folks like yourself who are already maxing out contributions to tax-sheltered retirement plans.
A recent ruling by the IRS allows eligible workers to easily move after-tax contributions from their 401(k) or 403(b) plan to Roth IRAs when they exit their company plan. “With this new ruling, retirement savers are getting a huge increase in their ability contribute to a Roth IRA,” says Brian Holmes, president and CEO of investment advisory firm Signature Estate and Investment Advisors.
The Roth is a valuable income stream in retirement because contributions are after-tax, which means you don’t owe Uncle Sam anything on the money you withdraw. Unlike traditional IRAs which require you to start withdrawing money once you turn 70 ½, Roths have no mandatory distribution requirements, so your investments can continue to grow tax-free. And if you need to take a chunk out for a sudden big expense, such as medical bills, the withdrawal won’t bump you up into a higher tax bracket.
For high-income earners, the IRS ruling is especially good news. Singles with an adjusted gross income of $129,000 or more can’t directly contribute to a Roth IRA; for married couples, the income cap is $191,000. If you are are eligible to contribute to a Roth IRA, you can’t contribute more than $5,500 this year or next ($6,500 for people over 50). The IRS does allow people to convert traditional IRAs to Roth IRAs but you must pay income tax on your gains.
Now, with this new IRS ruling, you can put a lot more into a Roth by diverting your 401(k) assets into one. The annual limit on pre-tax contributions to 401(k) plans is $17,500 and $23,000 for people over 50; those limits rise to $18,000 and $24,000 next year. Including your pre-tax and post-tax contributions, as well as pre-tax employer matches, the total amount a worker can save in 401(k) and 403(b) plans is $52,000 and $57,500 for those 50 and older. (That amount will rise to $53,000 and $59,000 respectively in 2015.) When you leave your employer, you can separate the after-tax money and send it directly to a Roth, which can boost your tax-free savings by tens of thousands of dollars.
To take advantage of the new rule, your employer plan must allow after-tax contributions to your 401(k). About 53% of 401(k) plans allow both pre-tax and after- tax contributions, according to Rick Meigs, president of the 401(k) Help Center. You must also first max out your pre-tax contributions. The transfer to a Roth must be done at the same time you roll your existing 401(k)’s pre-tax savings into a traditional IRA.
The ability to put away more in a Roth is also good for people who want to leave money to heirs. Inherited Roth IRAs are free of tax, and because they don’t have taxable minimum required distributions, they can give your heirs decades of tax-free growth. “It’s absolutely the best asset to die with if you want to leave money behind,” says Holmes.
Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.
To figure out the right pace for your retirement withdrawals—and to avoid ending up in higher tax brackets—start planning before you stop working.
Having your own tax-deferred retirement account is a bit like having one of those self-titrating morphine buttons that hospitals use: Press it whenever you need quick relief.
But once you’re retired and able to tap your 401(k) or individual retirement account (IRA), it’s not easy to titrate your own doses of cash. Withdraw too much, and you use up your nest egg too quickly; too little, and you might unnecessarily crimp your retirement lifestyle.
Overlaying the how-much-is-enough question are several finer points of tax planning. Because you can decide how much money to pull out of a 401(k) or individual retirement account, and because those withdrawals are added to your taxable income, there are strategies that can help or hurt your bottom line.
That’s especially true for early retirees trying to decide when to start Social Security, how to pay for health care and more. Here are some money-saving withdrawal tips.
CURB TAXABLE INCOME
If you are buying your own health insurance via the Obamacare exchanges, keep your taxable income low to qualify for big subsidies, advises Neil Krishnaswamy, financial planner with Exencial Wealth Advisors in Plano, Texas.
“It’s a pretty substantial savings on premiums,” said Krishnaswamy.
Here’s an example using national averages from the calculator on the Kaiser Family Foundation web page. Two 62-year-old spouses with annual taxable income of $62,000 would receive a subsidy of $8,677 a year, against a national average premium of $14,567. If they took another $1,000 out of their tax-deferred account and raised their taxable income to $63,000, they would be disqualified from receiving a subsidy.
Not every case may be that dramatic, but it’s worth checking the income limits and available subsidies in your own state.
If you retired early, consider taking out extra money to live on and delaying Social Security benefits until you are older. Withdrawing money from retirement savings hurts. You not only lose the savings, you lose future earnings on those savings. And in most cases, you have to pay income taxes on withdrawals from those tax-deferred accounts.
But Social Security benefits go up roughly 8% a year for every year you don’t claim them. And even after you claim them, they rise with the cost of living and are guaranteed for life. When you draw down your own savings to protect a bigger Social Security payment, tell yourself you are buying the cheapest and best annuity you can get.
PLAN IN ADVANCE
Plan ahead for mandatory withdrawals. In the year you turn 70 1/2, you have to begin drawing down your tax-deferred IRAs and 401(k) accounts and paying income taxes on those withdrawals. Unless you expect to be in the lowest tax bracket at the time, it makes sense to start withdrawing at least enough every year before then to “use up” the lower tax brackets.
For single people in 2014, you’re in a 10% or 15% marginal tax bracket until you make more than $36,000 a year. For married people filing jointly, that 15% bracket goes up to $73,800. It’s a lot better to pull out that money in your 60s and use up other savings to live on, than it is to save it all until you are 70 and then withdraw large chunks at higher interest rates.
GET A GOOD ACCOUNTANT
You may want to use early years of retirement to take the tax hit required to move money from a traditional IRA into a Roth IRA that will free you of future taxes on that money and its earnings.
You may pull a lot of money out of your account in one year and spend it over two or three years, to keep yourself qualified for subsidies in most years.
You may titrate your withdrawals to keep your Medicare premiums (also income linked) as low as possible.
The best way to optimize it all? Get an adviser or accountant who is comfortable with a spreadsheet and can pull all of these different considerations together.
Yet many of the same folks are hardly saving anything for retirement, study finds.
A large slice of middle-class Americans have all but given up on the retirement they may once have aspired to, new research shows—and their despair is both heartbreaking and frustrating. Most say saving for retirement is more difficult than they had expected and yet few are making the necessary adjustments.
Some 22% of workers say they would rather die early than run out of money, according to the Wells Fargo Middle Class Retirement survey. Yet 61% say they are not sacrificing a lot to save for their later years. Nearly three quarters acknowledge they should have started saving sooner.
The survey, released during National Retirement Savings Week, looks at the retirement planning of Americans with household incomes between $25,000 and $100,000, who held investable assets of less than $100,000. One third are contributing nothing—zero—to a 401(k) plan or an IRA, and half say they have no confidence that they will have enough to retire. Middle-class Americans have a median retirement balance of just $20,000 and say they expect to need $250,000 in retirement.
Still, Americans who have an employer-sponsored retirement plan, especially a 401(k), are doing much better than those without one. Those between the ages of 25 to 29 with access to a 401(k) have put away a median of $10,000, compared with no savings at all for those without access to a plan. Those ages 30 to 39 with a 401(k) plan have saved a median of $35,000, versus less than $1,000 for those without. And for those ages 40 to 49 with 401(k)s, the median is $50,000, while those with no plan have just $10,000.
Clearly, despite its many drawbacks, the venerable 401(k) remains our de facto national savings plan, and the best shot that the middle-class has at achieving retirement security. But only half of private-sector workers have access to a 401(k) or other employer-sponsored retirement plan, according to the Employee Benefit Research Institute. Those without access would benefit from a direct-deposit Roth or traditional IRA or some other tax-favored account, but data show that most Americans fail to make new contributions to IRAs, with most of those assets coming from 401(k) rollovers. One exception: a growing number of Millennials are making Roth IRA contributions.
Most people do understand the need to save for retirement, but they don’t view it as an urgent goal requiring spending cutbacks, the survey found. Still, many clearly have room in their budget to boost their savings rates. Asked where they would cut spending if they decided to get serious about saving, 56% said they would give up indulgences like the spa and jewelry; 55% said they’d cut restaurant meals; and 51% even said they would give up a major purchase like a car or a home renovation. But only 38% said they would forgo a vacation. We all need a little R&R, for sure. But a few weeks of fun now in exchange for years of retirement security is a good trade.
Of course, the larger problem is that a sizeable percentage of middle-class Americans are struggling financially and simply don’t enough money to stash away for long-term goals like retirement. As economic data show, many workers haven’t had a real salary increase for 15 years, while the cost of essentials, such as health care and college tuition, continues to soar.
Given these economic headwinds, it’s important to do as much as you can, when you can, to build your retirement nest egg. If you have a 401(k), be sure to contribute at least enough to get the full company match. And if you lack a company retirement plan, opt for an IRA—the maximum contribution is $5,500 a year ($6,500 if you are 50 or older). Yes, freeing up money to put away for retirement is tough, but it will be a bit easier if you can get tax break on your savings.
Q: I want to invest $5,000 for my 35-year-old daughter, as I want to get her on the path to financial security. Should the money be placed into a guaranteed interest rate annuity? Or should the money go into a Roth IRA?
A: To make the most of this financial gift, don’t just focus on the best place to invest that $5,000. Rather, look at how this money can help your daughter develop saving and investing habits above and beyond your contribution.
Your first step should be to have a conversation with your daughter to express your intent and determine where this money will have the biggest impact. Planning for retirement should be a top priority. “But you don’t want to put the cart before the horse,” says Scott Whytock, a certified financial planner with August Wealth Management in Portland, Maine.
Before you jump ahead to thinking about long-term savings vehicles for your daughter, first make sure she has her bases covered right now. Does she have an emergency fund, for example? Ideally, she should have up to six months of typical monthly expenses set aside. Without one, says Whytock, she may be forced to pull money out of retirement — a costly choice on many counts — or accrue high-interest debt.
Assuming she has an adequate rainy day fund, the next place to look is an employer-sponsored retirement plan, such as a 401(k) or 403(b). If the plan offers matching benefits, make sure your daughter is taking full advantage of that free money. If her income and expenses are such that she isn’t able to do so, your gift may give her the wiggle room she needs to bump up her contributions.
Does she have student loans or a car loan? “Maybe paying off that car loan would free up some money each month that could be redirected to her retirement contributions through work,” Whytock adds. “She would remove potentially high interest debt, increase her contributions to her 401(k), and lower her tax base all at the same time.”
If your daughter doesn’t have a plan through work or is already taking full advantage of it, then a Roth IRA makes sense. Unlike with traditional IRAs, contributions to a Roth are made after taxes, but your daughter won’t owe taxes when she withdraws the money for retirement down the road. Since she’s on the younger side – and likely to be in a higher tax bracket later – this choice may also offer a small tax advantage over other vehicles.
Why not the annuity?
As you say, the goal is to help your daughter get on the path to financial security. For that reason alone, a simple, low-cost instrument is your best bet. Annuities can play a role in retirement planning, but their complexity, high fees and, typically, high minimums make them less ideal for this situation, says Whytock.
Here’s another idea: Don’t just open the account, pick the investments and make the contribution on your daughter’s behalf. Instead, use this gift as an opportunity to get her involved, from deciding where to open the account to choosing the best investments.
Better yet, take this a step further and set up your own matching plan. You could, for example, initially fund the account with $2,000 and set aside the remainder to match what she saves, dollar for dollar. By helping your daughter jump start her own saving and investing plans, your $5,000 gift will yield returns far beyond anything it would earn if you simply socked it away on her behalf.
Do you have a personal finance question for our experts? Write toAskTheExpert@moneymail.com.
Attention tax procrastinators: Time’s nearly up if you filed for an extension last spring.
Remember the relief you felt last April when—faced with a looming tax-filing deadline—you simply applied for an automatic six-month extension for your 2013 return? The dread is back. October 15, next Wednesday, is the filing deadline for everyone who took advantage of the government’s grace period. As of the end of September, more than a quarter of the nearly 13 million taxpayers who had filed for an extension had yet to file, according to the IRS. If you’re one of those procrastinators, here’s what you need to know.
1. This time the deadline is real. No more extensions (one exception: members of the military serving in a combat zone). If you don’t file and pay your tax bill, you’ll get a failure-to-file notice. And you’ll start the clock on a failure-to-file penalty (5% of your unpaid taxes per month, up to a max of 25%), a failure-to-pay penalty (0.5% of your tax bill per month, up to a max of 25%), and interest (currently 3%).
“You could have three things adding up month by month if you do nothing by October 15,” says Mark Luscombe, principal federal tax analyst for Wolters Kluwer, CCH. Of course, if you’re expecting a refund, there’s no penalty for not filing—and also no refund until you do.
2. Do nothing, and the IRS will eventually file for you. And you may not like the results. That’s because the IRS will base your tax bill on the information it has, such as the income reported on your W-2, notes White Plains, N.Y., CPA Paul Herman. But they won’t know other things that could lower your tax bill, like all the deductions you’re entitled to or what you paid for stocks, bonds, or mutual funds you sold last year.
3. If you can’t pay your entire bill, throw out a number. File your return for sure—that at least saves you the failure-to-file penalty. When you do, request an installment agreement (Form 9465), and propose how much you can pay a month, or the IRS will divide your balance by 72 months. If the offer is reasonable, says Herman, the IRS may accept it.
4. Free help hasn’t gone away. Through October 15, you can still use the IRS’s Free File program, which makes brand-name tax-filing software available at no cost if your income is $58,000 or less. Earn more than that, and you can still use the free fillable forms at the IRS website.
5. You have one less way to cut your taxes. You’re out of luck if you had hoped to trim your tax bill by funding an individual retirement account for 2013 (depending on your income, as much as $5,500 was deductible last year, $6,500 if you’re 50 or older). Even though you got an extension to file, the deadline for opening an IRA for 2013 was last April 15. (Make a note: You have six months to open a 2014 IRA).
However, if you switched a traditional IRA into a Roth IRA last year—which meant a tax bill on your conversion—you still have until October 15 to change your mind. That’s something you might do if the value of your Roth has since dropped. You can “recharacterize” the conversion (in effect, switch back to a regular IRA) and then convert to a Roth again later, this time realizing a smaller taxable gain and owing less in taxes.
Finally, if you find yourself doing your taxes every fall, think about changing your ways. Maybe invest in a better system for organizing your records? “If you waited this long,” says Herman, “try to begin planning earlier for next year.”
Q: When I do my IRA required minimum distribution I take some extra money out and move it to a taxable account. Good idea or bad idea? Thanks – Bill Faye, Rockville, MD
A: After years of accumulating money for retirement, figuring out what to do with “extra” money withdrawn from your IRA accounts seems like a nice problem to have. But required minimum distributions, or RMDs, can be tricky.
First, a bit of background on managing RMDs. These withdrawals are a requirement under IRS rules, since Uncle Sam wants to collect the taxes you’ve deferred on contributions to your IRAs or 401(k)s. You must take your distribution by April 1st of the year you turn 70 ½; subsequent RMDs are due by December 31st each year. If you don’t take the distribution, you’ll pay a 50% tax penalty in addition to regular income tax on the amount that should have been withdrawn.
The size of your required withdrawal depends on your age and the account balance. (You can find the details on the IRS website here.) If you’re over 59 ½, you can take out higher amounts than the minimum required, but the excess withdrawals don’t count toward your future distributions. Still, by managing your IRAs the right way, you can preserve more of your portfolio and possibly reduce taxes, says Mary Pucciarelli, a financial advisor with MetLife Premier Client Group.
For those fortunate enough to hold more than one IRA, you must calculate the withdrawal amount based on all your accounts. But you can take the money out of any combination of the IRAs you hold. This flexibility means you can make strategic withdrawals. Say you have an IRA with a big exposure to stocks and the market is down. In that scenario, you might want to pull money from another account that isn’t so stock heavy, so you’re not selling investments at a low point.
You can minimize RMDs by converting one or more of your traditional IRAs to a Roth IRA. Roths don’t have minimum distribution requirements, so you can choose when and how much money you take out. More importantly, you don’t pay taxes on the withdrawals and neither will your heirs if you leave it to them. You will owe taxes on the amount you convert. To get the full benefit of the conversion, consider this move only if you can pay that bill with money outside your IRA. Many investors choose to make the move after they’ve retired and their tax bill is lower. Pucciarelli suggests doing the conversion over time so you can avoid a big tax bill in one year.
You could avoid paying taxes on your RMD by making a qualified charitable contribution directly from your IRA to a charity. The tax provision expired last year but Congress has extended the rule through 2014 and President Obama is expected to sign it.
As for the extra money you’ve withdrawn, it’s fine to stash it in a taxable account. If you have sufficient cash on hand for living expenses, you can opt for longer-term investments, such as bond or stock funds. But be sure your investments suit your financial goals. “You don’t want to throw your asset allocation out of whack when you move the money,” says Pucciarelli. Consider a tax-efficient option, such as an index stock fund or muni bond fund. That way, Uncle Sam won’t take another big tax bite out of your returns.
Update: This story was changed to reflect the Senate passing a bill to extend the IRS rule through 2014 allowing the direct rollover of an IRA’s required minimum distribution to a charity.
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