MONEY Taxes

9 Rules for Tax-Smart Charitable Giving

donating money to box
Jeffrey Coolidge—Getty Images

When you support a good cause, make sure you also get the tax benefits you deserve.

Year-end is peak charitable giving season. To make sure your generosity pays off on next April’s tax return, know the rules for writing off your donations.

You have to itemize deductions. Sorry, but if you take the standard deduction, you can’t write off your gifts to charity on top of that.

You need to give to a legit charity. To check if a nonprofit is a qualified charity in the eyes of the Internal Revenue Service, use the IRS’s Select Check tool. You can also deduct donations to your church, synagogue, mosque, or temple.

You can donate right down to the wire. For a gift to qualify for a deduction, you simply need to get your check in the mail by December 31. Need more time? You can put your gift on a credit card before year-end and then pay the bill in January. (Keep in mind, though, that when you pay by credit card, processing fees may reduce the value of your gift.)

You should save your backup. Make sure you have a receipt for your gift. A cancelled check or credit card statement may be enough. But if you make a donation worth $250 or more, you must get a written acknowledgment from the charity.

Your time can be worth money. As a volunteer, you can’t deduct the value of your time. But you can deduct 14¢ for every mile you drive as part of your volunteer work, so keep track.

You shouldn’t take credit for giving away actual junk. If you donate clothes or household items, you’ll be able to deduct the fair market value—as long as the items are in good condition or better. Keep any paperwork you have for valuable items, and take photos of your donations for your records. It’s up to you, not the charity, to assign a value to your stuff. To do that, you can use thrift store guides published by the Salvation Army, Goodwill, and others, or the ItsDeductible app.

You can’t inflate the value of your old car. When you donate your old wheels to charity, your deduction is generally limited to what the nonprofit brings in by selling your car, not the Kelley Blue Book value. Plus, when you donate a car or other property worth more than $500, you’ll need to file IRS Form 8283.

You can get two tax breaks if you donate winning investments. Another way to save on taxes is to give highly appreciated stocks, bonds, or mutual funds directly to a charity. You won’t owe any taxes on your capital gains. And you can deduct the full market value of the investment as a charitable gift.

You can contribute a big sum now and give it away later. If you open what’s called a donor-advised fund, you can deduct the entire gift on your 2014 tax return and parcel out the money to good causes later. With as little as $5,000, you can open a donor-advised fund at firms such as Fidelity or Schwab.

More tax tips from MONEY 101:
When does it makes sense to itemize?
What kind of expenses can I write off if I’m self-employed?
How can I reduce my tax bill?

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.

MONEY Taxes

7 Tax Credits You Shouldn’t Overlook

Woman learning to use computer in library
Alina Solovyova-Vincent—Getty Images

Pay all the taxes you owe—but not a penny more.

The IRS provides multiple tax credits for low- to moderate-income taxpayers to lower what they owe the government. Unlike tax deductions, which lower your taxable income, tax credits directly lower the amount of money you owe the government.

Let’s go over seven tax credits you may be able to claim to lower your tax bill this year. But first, a quick primer on tax credits and the difference between refundable and nonrefundable credits.

Tax credits: The basics

A tax credit allows you to directly subtract the amount of the credit from your taxes due. Say you are single and had $50,000 in income. Based on the 2014 tax brackets, with the standard deduction and one personal exemption, you would owe a little over $5,819 in taxes. A $5,000 tax credit would cancel out all but $819 of your taxes owed.

There are two types of tax credits: refundable tax credits and nonrefundable tax credits. You can get money back for a refundable tax credit even if you didn’t earn any income or pay any taxes. A nonrefundable tax credit is only applied to your taxes owed.

Let’s say you owe $1,000 in taxes from income during the year, and at the end of the year you claimed a $2,500 tax credit. If the tax credit is refundable, you’ll get $1,500 back from the government. If the tax credit is nonrefundable, then it is deducted from the taxes you owe — so in this example, you don’t owe the government anything, but you can only zero out your taxes, meaning you miss out on the remaining $1,500 of the tax credit.

The IRS provides multiple tax credits to lower what you owe the government; see if you can take advantage of any of them.

1. Lifetime Learning Credit (nonrefundable)

The Lifetime Learning Credit allows taxpayers who take postsecondary school classes, or whose dependents take postsecondary school classes, to claim as a tax credit 20% of qualified education expenses up to a maximum $2,000 tax credit. The advantage of this tax credit is that it is open to anyone at any point in his or her life, unlike the American Opportunity Tax Credit, which I will detail next.

The full Lifetime Learning Credit is only available to individual taxpayers who make $52,000 or less, or $104,000 for a married couple filing jointly. The credit phases out for individual taxpayers with income between $52,000 and $62,000 and married couples filing jointly with income between $104,000 and $124,000. Those who earn more than the upper threshold are ineligible for the Lifetime Learning Credit.

2. American Opportunity Tax Credit (partially refundable)

The American Opportunity Tax Credit differs from the Lifetime Learning Credit in that it is only available for eligible students for their first four years of higher education. The credit allows you to claim up to $2,500 per eligible student. Forty percent of the credit is refundable, so there is a maximum refund of $1,000. You cannot claim both this credit and the Lifetime Learning Credit for the same student in one tax year. The full American Opportunity Tax Credit is available to individuals with incomes less than $80,000 ($160,000 for married couples filing jointly), and the credit phases out for individuals with incomes of more than $90,000 ($180,000 for married couples filing jointly).

3. Retirement Saver’s Tax Credit (nonrefundable)

For low-income taxpayers who are not full-time students, the government provides a tax credit for contributing to a retirement savings plan such as an IRA, 401(k), etc. The credit is anywhere from 10% to 50% of up to $2,000 of your retirement plan contributions (or $4,000 for married couples filing jointly).

Source: IRS

4. Earned Income Tax Credit (refundable)

The Earned Income Tax Credit is a refundable tax credit for low- to moderate-income working taxpayers to raise their incomes without discouraging work. The income limit for an individual is $14,590 but rises significantly for each child you can claim as a dependent. You can read more about the earned income tax credit here.

5. Child Tax Credit (depends)

The Child Tax Credit provides up to $1,000 per qualifying child for individual taxpayers with income less than $75,000 (or $110,000 for married filing jointly). The child tax credit is nonrefundable, however, for taxpayers whose child tax credit is less than $1,000 per child there is an additional child tax credit that is refundable that can raise the two tax credits to a total of $1,000 per qualifying child. You can read more about the child tax credit here.

6. Premium Tax Credit (refundable)

The Premium Tax Credit is for low- to moderate-income taxpayers who get health insurance through the health insurance exchanges, i.e., Obamacare. To be eligible for the credit, you must buy health insurance through the exchange, be ineligible for coverage through an employer or government plan, not be married filing separately, and meet certain income limits. The Premium Tax Credit has both minimum and maximum income limits, because if your income falls below a certain level, you are eligible for Medicaid. Your household income must be between 100% and 400% of the federal poverty line — the current dollar amounts of these limits, which change with family size, are shown below:

Poverty Level Individual Family of 2 Family of 4
100% $11,490 $15,510 $23,550
400% $45,960 $62,040 $94,200

Source: IRS.

To estimate your premium tax credit, it is best to use an online calculator. Note that Obamacare contains a penalty for not having insurance unless you meet certain exemptions. Motley Fool contributor Todd Campbell recently examined how much Obamacare penalizes you for not having health insurance.

7. Elderly and Disabled Tax Credit (nonrefundable)

The Elderly and Disabled Tax Credit is for low-income taxpayers over age 65 or those who are retired on permanent and total disability and received taxable disability income during the tax year. Eligibility is rather strict. To qualify for the elderly and disabled tax credit, individual taxpayers must have income less than $17,500 ($25,000 for married filing jointly) and nontaxable income (nontaxable Social Security, pension, annuities, or disability income) of less than $5,000 ($7,500 for married filing jointly). The tax credit can theoretically be as high as $500, but the calculations for the credit are complicated enough that the IRS will do them for you if you ask. You can read more about the Elderly and Disabled Tax Credit Here.

More ways to reduce your taxes

As Mitt Romney famously (or infamously, depending on whom you ask) said: “I pay all the taxes owed. And not a penny more.” Whatever your political leanings, those are wise words to live by. The U.S. tax code contains multiple ways to lower what you owe the government. Be sure you don’t end up paying more than what you should really owe.

MONEY College

The Best and Worst Places to Live for a Low-Cost College Education

Classroom with map of United States on chalkboard. Wyoming is shaded pink.
Want to save $50,000 on your kids' college education? Move to Wyoming. Sarina Finkelstein (photo illustration)—John Kuczala/Getty Images (classroom); Tuomas Kujansuu (chalkboard)

With a wide spread in tuition and tax burdens, the cost of sending your children to local public schools can come to just over $40,000 for four years—or more than $130,000—depending where you live. See where your state ranks.

Want to cut your family’s college tuition bills by more than $50,000? Bring up your kids in Wyoming. Or Florida. Or even New York. But not New Hampshire.

Using new College Board data on the average cost of tuition and fees at public colleges in all 50 states and the average amount of state tax dollars that go toward higher education, MONEY calculated where parents would spend the most and least to raise two children and send both to an in-state public university.

Wyoming, which the Tax Foundation reports has the lowest total tax burden in the country, is also the nation’s best bargain in higher education, thanks to the lowest public-college tuition in the U.S. Yet low taxes alone aren’t enough to make a state a good deal. Although New Hampshire has the sixth-lowest tax burden in the nation, Granite State parents face the highest college-related bills.

To estimate the total cost of a public education in each state, MONEY calculated how much a family earning $50,000 a year would likely pay in state taxes earmarked for higher education over 25 years, and added that to four years of in-state tuition for two children. This back-of-the-envelope analysis, of course, assumes no change in prices or taxes, nor any financial aid.

The results, while rough, do a reasonable job of showing the impact of different philosophies toward government services, says Andy Carlson, senior policy analyst at the State Higher Education Executive Officers Association.

You’ll generally pay more if you live in a state where the students who earn the benefits of the degree have to pay the bulk of the costs, Carlson says. And you’ll usually—though not always—face lower overall college costs in states that view access to higher education as a public good, and as a result direct significant tax support to public universities.

The Best Places to Live

For families, how this difference usually plays out is in higher or lower in-state tuition. And you’ll end up paying the most for your kids’ education in states with high in-state tuition, even if those states have comparatively low college-related taxes.

New Hampshire has no tax on earned income. It funds government services with taxes on things like investment income, real estate, and liquor. For a family earning $50,000, the amount of state revenues that support the state’s colleges equates to about $82 this year, or a little more than $2,000 over 25 years. Not surprisingly, New Hampshire has the highest average public college tuition in the country—$14,712 this year—pushing total higher education tuition and tax spending for parents of two children to more than $132,000 over two decades.

Wyoming, which has low direct taxes on its residents, funds much of its government services with taxes on mineral and energy mining. Out of those revenues, it allocates the equivalent of nearly $600 a year per family to higher education, the highest subsidy in the nation. As a result, tuition and fees at the University of Wyoming are just $4,646. The total higher education taxes and tuition costs for a typical Wyoming family adds up to just $42,000—or $90,000 less than New Hampshire families pay.

Some high-tax and high-subsidy states are bad deals for parents, however. Illinois taxpayers, for example, spend 13% more than the national average on higher education support—about $340 a year per middle-class family. And Illinois public colleges charge some of the highest tuition in the U.S. As a result, Illinois has the nation’s fifth-highest combined tax-and-tuition bill for a typical family—$115,000.

In contrast, a middle class household North Carolina contributes about $500 worth of state taxes to higher education annually. That high level of taxpayer support helps keep North Carolina’s in-state tuition, $6,700 this year, below the national average. The total higher education tax and tuition costs for parents with two children comes in at about $60,000.

One last surprising note: You don’t have to travel far to reap big savings. Moving across the river from high-tax New Jersey, for example, to slightly higher-tax New York cuts the public college tuition you’re likely to pay by about $5,000 a year, and a family’s total lifetime higher education bill by more than $50,000.

The 50-State Ranking

Here’s how the math plays out in all 50 states. For more on finding a great college value, check out our Best Colleges rankings, including the 25 Best Public Colleges.

State State higher-ed spending per $1,000 in personal income 25-year total state higher-ed spending for families earning $50,000 Average in-state tuition 2014-15 Estimated total tuition costs for two children Total estimated tuition + taxes
1. Wyoming $11.92 $14,896 $4,646 $37,168 $41,814
2. Alaska $10.48 $13,101 $6,138 $49,105 $55,243
3. Utah $7.63 $9,537 $6,177 $49,416 $55,593
4. New Mexico $11.51 $14,387 $6,190 $49,523 $55,714
5. Montana $5.70 $7,125 $6,279 $50,233 $56,512
6. Florida $4.84 $6,048 $6,351 $50,808 $57,159
7. Nevada $4.49 $5,616 $6,418 $51,341 $57,759
8. Idaho $6.59 $8,236 $6,602 $52,816 $59,418
9. West Virginia $7.80 $9,753 $6,661 $53,292 $59,953
10. North Carolina $9.62 $12,027 $6,677 $53,418 $60,096
11. Mississippi $9.50 $11,877 $6,861 $54,888 $61,749
12. Oklahoma $6.52 $8,145 $6,895 $55,157 $62,052
13. New York $4.91 $6,134 $7,292 $58,338 $65,631
14. Louisiana $5.98 $7,471 $7,314 $58,510 $65,824
15. Nebraska $8.07 $10,093 $7,404 $59,234 $66,638
16. North Dakota $10.02 $12,522 $7,513 $60,106 $67,620
17. Arkansas $8.01 $10,013 $7,567 $60,535 $68,102
18. South Dakota $5.04 $6,303 $7,653 $61,224 $68,877
19. Iowa $5.92 $7,402 $7,857 $62,857 $70,714
20. Kansas $6.06 $7,577 $8,086 $64,684 $72,770
21. Georgia $7.31 $9,139 $8,094 $64,753 $72,847
22. Missouri $4.02 $5,023 $8,383 $67,068 $75,451
23. Tennessee $6.25 $7,810 $8,541 $68,324 $76,865
24. Maryland $5.42 $6,771 $8,724 $69,790 $78,514
25. Wisconsin $4.51 $5,632 $8,781 $70,248 $79,029
26. Texas $5.78 $7,226 $8,830 $70,637 $79,467
27. Oregon $4.01 $5,018 $8,932 $71,453 $80,385
28. Indiana $6.69 $8,363 $9,023 $72,182 $81,205
29. California $5.84 $7,306 $9,173 $73,381 $82,554
30. Kentucky $7.44 $9,301 $9,188 $73,508 $82,696
31. Maine $4.99 $6,243 $9,422 $75,378 $84,800
32. Alabama $8.18 $10,220 $9,470 $75,759 $85,229
33. Colorado $2.78 $3,479 $9,487 $75,897 $85,384
34. Hawaii $8.08 $10,106 $9,740 $77,921 $87,661
35. Ohio $4.42 $5,526 $10,100 $80,799 $90,898
36. Arizona $3.57 $4,468 $10,398 $83,181 $93,578
37. Minnesota $5.42 $6,780 $10,527 $84,217 $94,744
38. Connecticut $4.63 $5,782 $10,620 $84,957 $95,577
39. Washington $4.81 $6,017 $10,846 $86,765 $97,610
40. Virginia $4.40 $5,503 $10,899 $87,192 $98,091
41. Rhode Island $3.45 $4,316 $10,934 $87,469 $98,403
42. Massachusetts $2.88 $3,605 $10,951 $87,608 $98,559
43. Delaware $5.44 $6,798 $11,448 $91,581 $103,029
44. South Carolina $5.38 $6,729 $11,449 $91,594 $103,044
45. Michigan $4.31 $5,386 $11,909 $95,271 $107,180
46. Illinois $6.77 $8,467 $12,770 $102,156 $114,926
47. New Jersey $3.99 $4,993 $13,002 $104,020 $117,022
48. Pennsylvania $3.02 $3,775 $13,246 $105,967 $119,213
49. Vermont $3.21 $4,018 $14,419 $115,353 $129,773
50. New Hampshire $1.64 $2,050 $14,712 $117,698 $132,411

Sources: College Board, MONEY calculations

MONEY retirement income

Retirees Risk Blowing IRA Deadline and Paying Huge Penalties

Egg timer
Esben Emborg—Getty Images

With just seven weeks left in the year, most IRA owners required to pull money out have not yet done so.

Two-thirds of IRA owners required to take money out of their account by Dec. 31 have yet to fulfill the obligation, new research by Fidelity shows. Now, with the year-end in sight, and thoughts pivoting to holiday shopping and get-togethers, legions of senior savers risk getting distracted–and socked with a punishing tax penalty.

IRA owners often wait until late in the year to pull out their required minimum distributions. Especially at a time when interest rates are low and the stock market has been rising, leaving your money in an IRA as long as possible makes sense. Some retirees may also be reluctant to take distributions for fear of spending the money and running short over time.

But blowing the annual deadline can be costly. The IRS sets a schedule of required minimum distributions, or RMDs, to keep savers from deferring taxes indefinitely. After reaching age 70 1/2, IRA owners must begin to take money out of their account each year and pay income tax on the amount. Failure to pull money out triggers a hefty penalty equal to 50% of the amount you were supposed to take out of the account.

Among 750,000 IRA accounts where distributions are required, 68% have yet to take the full amount and 56% have yet to take anything at all, Fidelity found. These IRA owners should begin the process now to avoid end-of-year distractions and potential mistakes like using the wrong form or providing the wrong mailing address, which can take weeks to find and correct.

A report by the Treasury Inspector General estimated that as many as 250,000 IRA owners each year miss the deadline, failing to take required minimum distributions totaling about $350 million. That generates potential tax penalties totaling $175 million. The vast majority of those who fail to take their minimum distributions are thought to do so as part of an honest mistake, and previously the IRS hasn’t always been eager to sock seniors with a penalty. But the IRS began a crackdown on missed distributions a few years ago. Don’t look for leniency if you miss the deadline without a good reason, like protracted illness or a natural disaster.

Early each year, your financial institution should notify you of any required distributions you must take by year-end. If this is the first year you are taking a required distribution, you have until April 1 to do so, but then only until Dec. 31 every subsequent year. Once notified, you still need to initiate a distribution. A lot of people simply do not read their mail and fail to initiate action in time.

Among other reasons IRA owners miss the deadline:

  • Switching their account Institutions that open an account during the year are not required to notify new account holders of required minimum distributions until the following year.
  • Death Often there is confusion about inherited IRAs. The beneficiary must complete the deceased IRA owner’s distributions in the year of death. Non-spousal beneficiaries of any age must begin taking distributions in the year following the year that the IRA owner died—and no notice of this is required.

With the penalties so stiff and the IRS cracking down on missed mandatory distributions, this is a subject that seniors and their adult children should talk about. In general, financial talk between the generations makes seniors feel less anxious and more prepared anyway. Required distributions can be especially confusing, and the penalties may have the effect of taking away money that heirs stand to receive. So it’s in everyone’s interest to get it right. Consider putting mandatory distributions on autopilot with a firm that will make the calculation and send you the money on a schedule you choose.

Related:

How will my IRAs be taxed in retirement?

Are there any exceptions to the traditional IRA withdrawal rules?

When can I take money out of my IRA without penalty?

MONEY Ask the Expert

Here’s a Smart Way To Boost Your Tax-Free Retirement Savings

140605_AskExpert_illo
Robert A. Di Ieso, Jr.

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.

Read next: 4 Disastrous Retirement Mistakes and How to Avoid Them

MONEY capital gains

How the IRS Taxes Stock You Didn’t Buy

Investing illustration
Robert A. Di Ieso, Jr.

Q: I received some shares of stock some years ago that were given to me as part of an agreement through a class-action lawsuit. Do I have to pay taxes on these shares when I sell? — Bob from Livingston, Tex.

A: In most instances, you would, says Michael Eisenberg, a certified public accountant in Los Angeles.

When you receive stock in lieu of cash for payment for services rendered or, in this case, a settlement, you’ll first owe income tax based on the value of the stock at that time. “Compensation is compensation, whether it’s cash or stock,” says Eisenberg. “It’s considered ordinary income.”

If you later sell the stock for a profit, you’ll also owe capital gains tax. How much you owe is based on the difference in value from the time you received the stock and the time you sold it, after accounting for such things as dividends, stock splits or capital distributions. This is called “basis.”

If you own the stock for less than 366 days – one year plus a day – your capital gains rate will be based on your income tax rate. If you own it longer, you’ll pay a lower rate.

Taxpayers in most brackets are taxed at 15% for long-term gains. Those in the 10% or 15% bracket may owe no long-term capital gains tax, while those in the 39.6% rate will need to pay up at 20%.

Are there any exceptions?

If for some reason this stock was given to you as a result of a class-action related to your retirement account, you may not owe tax. “If the stock settlement was applied to your IRA, it wouldn’t be taxable,” says Eisenberg, though such an example is pretty rare.

What if you receive stock as a gift or an inheritance?

In this case, you won’t owe income tax on that gift. You will, however, still owe capital gains tax when you sell.

If the stock is part of an inheritance, your capital gains rate will be based on the value of the stock at the time the original owner passed away. If your Granny gifts you stock while she’s still alive, however, your basis is based on when she bought the stock.

MONEY Taxes

Amazon, Pepsi, and Other Household Brands Accused of (Another) Huge Tax Dodge

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Hiroshi Higuchi—Getty Images

A new report accuses Luxembourg of making secret tax deals with hundreds of companies to help them avoid taxes.

Hundreds of international companies, including IKEA, Amazon, Pepsi, and FedEx have been receiving secret deals from Luxembourg, enabling the corporations to cut their tax bill by billions of dollars, according to a report from the International Consortium of Investigative Journalists.

The report, which stems from a review of almost 28,000 pages of confidential documents obtained by the ICIJ and journalists from 26 countries, found Luxemburg’s tax authorities granted hundreds of secret tax rulings—known unofficially as comfort letters—that allowed various corporations to reduce their tax rate, often to less 1%. In one instance, according to the report, New York-based Coach funnelled €36.7 million euros through Luxemburg and payed €250,000 in taxes—a rate of just below 0.7%. The ICIJ’s review showed that in 2012, American corporations paid 1.1% in taxes on the $95 billion in profits transferred through the European dutchy.

The documents appear to show how Luxembourg is using a particularly complex tax code to deprive foreign governments of massive amounts of revenue. “This is the first time really that we’ve seen inside the workings of Luxembourg as a tax haven,” Richard Brooks, the author of The Great Tax Robbery, told the ICIJ. “The countries . . . that are losing money, they don’t know about it, don’t know how it operates at all.”

The country’s tax authority is so friendly to international business that thousands of companies have rushed to establish “offices” inside the duchy, many of which contain no visible employees and amount to little more than a mailing address. The ICIJ found 1,600 companies were technically housed in a single Luxembourg City building, and that other properties were also home to a seemingly impossible number of businesses. One-hundred and seventy Fortune 500 companies have a branch in Luxembourg.

Despite hosting branches of so many U.S. corporations and having received $416 billion in U.S. direct investment last year, Luxembourg has only 500,000 citizens and represents about one-tenth of one-percent of all overseas jobs with American companies.

The way that Luxembourg helps companies slash tax expenses is highly technical: One deal involving the Illinois-based Abbott Laboratories is said to consist of 79 different steps and companies in Cyprus and Gibraltar. According to the report, it appears that companies use Luxembourg as a base to pit different nation’s tax rules against one another.

One example offered by the consortium is something called a “hybrid debt instrument.” This procedure apparently lets a company move profits from a European country with a higher tax rate to a Luxembourg subsidiary. These profits are then treated as tax-deductible interest payments in Luxembourg, and dividends, eligible for tax exemption, in the company’s home country. The two country’s tax laws essentially cancel each other out, resulting in a substantially reduced effective tax rate.

The European Union has banned this type of tax evasion, but EU members like Luxembourg don’t have to enforce the law until 2015. But the EU is nevertheless investigating whether Luxembourg’s secret tax rulings for Amazon and Fiat Finance are equivalent to illegal state aid. European Union law forbids any member from giving one company an agreement that isn’t available to all businesses.

Ironically, Luxembourg’s former prime minister, Jean-Claude Juncker, recently assumed the presidency of the European Commission, one of the EU’s most important posts. Junker has claimed his country’s tax system is in “full accordance” with the law, but has also vowed to fight tax evasion as the commission’s president.

 

MONEY retirement income

Retirement Withdrawal Strategies That Can Pay Off Big

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.

DELAY BENEFITS

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.

Related:

When do I have to take money out of my 401(k)?

How will my IRA withdrawals be taxed in retirement?

Are my Social Security payouts taxed?

MONEY college savings

One Foolproof Way to Earn More on Your College Savings

handing money over
PM Images—Getty Images

Tax breaks, matching grants, and scholarships can effectively boost your investment by an average of 6%.

Savers in many states don’t have to rely solely on the markets to build up a college fund. Grants or tax benefits can effectively boost the value of your investment in a 529 college savings plan by 10%, 20% or even 30%, according to a newly released analysis by Morningstar.

In the 32 states (plus the District of Columbia) that offer subsidies to college savers who contribute to their home state’s 529 plan, the average benefit is a one-time boost worth about 6%.

In New Jersey, parents who seed a NJ BEST 529 account with $1,200 when their kid is about six and kick in at least $300 a year after that will qualify the student for a one-time $1,500 freshman scholarship to an in-state public university. That’s a return of 31.5% on a total investment of $4,800.

Most states simply give parents a tax credit or deduction for a 529 contribution, which translate into a lower state tax bill and thus more money in your checking account. That’s money you can use for anything—including adding to your 529 or offseting the cost of saving for any college.

Residents of Indiana, for example, qualify for a state tax credit worth up to 20% of what they invest in the state’s 529 plan, which can reduce a typical family’s state tax bill by $480. Vermonters get tax breaks typically worth 10% of their investments in their local 529 plan.

Five states offer tax breaks for an investment in any 529, allowing residents to shop for the best plan anywhere. Two of those five states reward both choices: Maine offers a 1.7% tax benefit for any 529 investment, but also provides matching grants for saving in the state’s 529. Pennsylvania’s has tax breaks worth about 3% for any college savings, but it also offers scholarships to hundreds of mostly private colleges across the country for those who invest in-state.

Fifteen states either have no income tax or don’t offer any subsidy to college savers. Check out this 50-state map to see whether to invest in your state, or out of state.

Beware of the Gotchas

The author of the Morningstar report, Kathryn Spica, says you should watch for two big potholes when trying to maximize these freebies.

1. High fees: Some states charge such high fees in their 529 plans that any parent with a child younger than, say, 13 should probably forgo the tax benefit and choose a low-cost, highly-rated direct-sold plan. But for parents of teens close to college, the immediate tax benefits can outweigh only a few years of higher fees.

For example, D.C. offers tax breaks that amount to a one-time 8.5% effective boost to your college savings. But D.C.’s plan charges a high annual fee of 1.35% of assets. Utah’s plan, which gets the highest rating by Morningstar, charges only 0.2%. Within eight years, D.C.’s higher fees would likely eat up your tax benefit.

2. Changing rules: North Carolina cancelled its tax break for 529 savings last year. And Rhode Island has stopped enrolling new parents in its savings match program, Spica says. Parents in states that end or slash tax benefits should take a few minutes to run the numbers and see which investment option best meets their needs.

The Value of the Tax Breaks

The chart below lists the states that offer benefits for investing in the home state 529 as of fall 2014. Morningstar’s estimated value of the subsidy is based on a family earning $50,000 a year and saving $2,400 a year for college. The fees are those charged for an age-based fund for a 7- to 12-year-old that employs a moderate (as opposed to conservative or aggressive) investment strategy.

The final column is Money’s recommendation on whether parents of kids younger than 13 should stick with their state’s best 529 option, or risk giving up the state’s benefit and shop for the best plan nationally.

If your state is not listed here, you won’t be giving up anything if you simply pick the best plan available. Here are Money’s recommendations for the best 529s nationally, based on a combination of the fund’s fees, the state’s tax benefits, and the ratings given the plans by Morningstar and Savingforcollege.com.

State Est. value of state tax benefit on savings of $2,400 a year Effective yield on $2,400 investment Average fee for moderate equity plan for 7- to 12-year-old Should parents of kids under the age of 13 invest in-state or shop?
Indiana $480 20% 0.57% In-state
Vermont $240 10% 0.45% In-state
Oregon $216 9.0% 0.38% In-state
District of Columbia $204 8.5% 1.35% Shop
Idaho $178 7.4% 0.75% In-state
Arkansas $168 7.0% 0.60% In-state
South Carolina $168 7.0% 0.12% In-state
Montana $166 6.9% 0.88% Shop
Iowa $156 6.5% 0.26% In-state
New York $155 6.5% 0.17% In-state
Wisconsin $150 6.3% 0.23% In-state
Georgia $144 6.0% 0.33% In-state
West Virginia $144 6.0% 0.32% In-state
Maine $140 5.8% 0.30% In-state
Virginia $138 5.8% 0.61% In-state
Oklahoma $126 5.3% 0.51% In-state
Alabama $120 5.0% 0.32% In-state
Connecticut $120 5.0% 0.40% In-state
Illinois $120 5.0% 0.19% In-state
Mississippi $120 5.0% 0.65% Shop
Nebraska $120 5.0% 0.48% In-state
Utah $120 5.0% 0.22% In-state
New Mexico $118 4.9% 0.36% In-state
Maryland $114 4.8% 0.88% In-state
Colorado $111 4.6% 0.39% In-state
Michigan $102 4.3% 0.28% In-state
Louisiana $96 4.0% NA In-state
Ohio $90 3.8% 0.23% In-state
North Dakota $68 2.8% 0.85% Shop
Rhode Island $38 1.6% 0.20% In-state
Pennsylvania Variable N.A. 0.38% In-state
New Jersey Up to $1,500 N.A. 0.77% In-state can pay if student definitely will attend a participating college

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