Three Little Known Ways to Save On Taxes

December 6, 2016

Author: Dave Gardner

Little has been predictable in the national political arena over the last three weeks.  Few pundits predicted Trump would win, and even fewer presaged that the domestic stock markets would rally to all time highs.  Interest rates have moved upwards sharply as the market starts building in expectations for increased growth and a phenomenon gone missing since before the Great Recession: inflation.

Experts have identified three areas of meaningful policy change over the next six months: health care, taxes, and immigration.  As soon as the presidential election was in the books, the political sages have shifted their energies toward prognosticating what laws may be passed in the first 100 days of the new administration.  You could spend days reading through well-informed, albeit highly speculative guesswork on what tax reform may be in the offing.

I do anticipate that there will significant tax reform implemented next year and pledge to keep you informed as it develops.  But rather than joining in the panoply of predictions, let’s focus on what you can do now under current law to save on taxes.

Accelerate the funding of retirement accounts.  Most savers are familiar with the annual limits for contributions to retirement plans through work, most commonly 401(k) or 403(b) plans.  Individuals can put aside up to $18,000 a year of their income into these plans, with those 50 or older able to contribute $24,000.

What if you look up your latest paystub and find that you’re well short of this goal?  With most employers, you can adjust your plan contributions up to much higher percentage of your pay for the rest of the year.

Let’s say you earn gross pay of $6,000 a pay period and you have two remaining in 2016.  You’re behind on your retirement plan saving with $10,000 year to date contributions.  You could potentially adjust your withholding percentage to 50 percent of pay for the rest of the year, which would add $6,000 to your retirement plan.  Of course, you could face a cash flow crunch.  But it may be that you have other reserves to get you through minuscule paychecks for the rest of the year.

Take tax losses (in spite of gains).  This time of year tax-focused financial advisors and CPAs talk about harvesting your tax losses.  For investments that you hold in a taxable account, you can sell those that have lost value for a capital loss.  Those losses can offset capital gains, up to $3,000 of ordinary income, or can be carried forward to future years.  You can even purchase a similar investment with the proceeds as long as you don’t purchase a nearly identical replacement, which would disallow the loss.

What you may not realize is that you may have investment that have largely gone up in the value of which you could sell a portion for a loss.  Most mutual fund investors automatically reinvest their dividends and other distributions.  In addition, many invest periodically into their taxable investment account.   This means that you have purchased several “lots” of mutual fund shares.  Those shares that you purchased three years ago may have a large gain, but you may have a bond or REIT fund purchased in part last summer that have a loss.  By selling the shares in the lot that show a loss, you can harvest tax losses even if you have largely have gains with that investment.

The key is to have the investment company track the basis of your mutual funds in a way that lots that you purchased at a specific time are identified.  Whenever you see “average cost” or “FIFO” as the basis tracking method, harvesting tax losses will be difficult.  You should look at choices such as “specific identification.”  Some custodians such as Charles Schwab have an option called Tax Lot Optimizer that automatically looks for losses.

Don’t let Roth IRAs scare you.  Roth IRAs are wonderful vehicle to invest up to $5,500 a year ($6,500 a year if 50 or over) into an account that won’t be taxed for the rest of your life.  But some hesitate putting funds into a Roth because they may need those funds in the next few years.  In their eyes, the Roth IRA is locked up until retirement and so is not suitable for medium term savings.

Few realize that you can always access the contributions (not the earnings) that you have made to a Roth IRA for any reason at any age without penalty.  Roth conversion dollars (funds you’ve moved from a traditional IRA or retirement plan) are not as accessible.  This rule only applies for contributions.  So if the deadline for 2016 Roth contributions rolls around next April, consider funding a Roth even if you might need the funds within a few years.  After all, you’ll never get another chance to put aside tax-free money for 2016.

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About Dave Gardner

David Gardner is a certified financial planner with a practice in Boulder County and can be reached at dave@confluencefa.com and at twitter.com/Dave_CFP.