To the relief of taxpayers and financial professionals alike, the IRS’s April 15 federal income tax return filing deadline is now in the rearview mirror. Unless you requested a six-month extension to file your return, you have fulfilled your obligation until next spring. It’s tempting to forget about taxes altogether until next season, but looking ahead can alleviate headaches and help you hang on to more of your savings. To help, we put together several ideas to consider when creating your tax strategy.
Understand how your current lifestyle will affect the taxes you pay next year.
Your lifestyle choices are the most influential determinant of your tax situation. For instance, an unmarried person renting their home will have a vastly different tax return than a married couple with children who own a home. The married couple has the option to file jointly, which would impact the tax bracket they fall into. They can also claim the Child Tax Credit for each of their children that are under age 17 and for which they provide at least half of their financial support, among other stipulations. The Home Mortgage Interest Deduction allows borrowers to lower their taxable income by the amount of interest paid on their mortgage during the tax year if they did not take the standard deduction.
If you plan on making a major lifestyle change, it’s worth considering its tax impact. While you would likely not make such a change solely for tax reasons, they could incentivize you to take the next step. For specific details regarding the scenarios above, or to explore the impact of other life events, please visit the official IRS website.
Select tax-efficient investment options.
A solid tax strategy begins at the investment level. Particularly within non-retirement or taxable accounts, tax-efficient options can greatly reduce your tax burden. ETFs – Exchange Traded Funds – avoid the capital gains distributions inherent to mutual funds, thereby avoiding hefty capital gains taxes. Tax-conscious investors might also consider index funds in lieu of actively managed funds, whether they are mutual funds or ETFs. Index funds are designed to mimic a particular index, essentially following a market instead of attempting to outperform it. Consequently, index managers trade in and out of positions with far less frequency than their active counterparts. This results in fewer chances to generate taxable gains. Within the bond market, tax-exempt individual bonds and bond funds can offer excellent income opportunities in an attractive package. The main feature of these municipal bonds, which are issued by state and local government entities, is their exemption from federal income tax. Often, municipal bonds are also exempt from state or local income tax for residents of the issuer’s jurisdiction. Particularly if you fall into a high tax bracket, adding tax-free bonds to your portfolio now can help cushion the blow of next year’s taxes. Each of these tax-efficient investments is worth considering as you build out your portfolio.
RELATED: Read more about Mutual Funds and ETFs.
Consider tax-advantaged accounts.
We discussed the advantages of tax-conscious investment options, but how about the accounts that hold your portfolio? Opening a tax-advantaged account can lower your tax bill and help you save for retirement. 401(k)s and similar employer-based retirement plans allow participants to contribute directly from their paychecks on a pre-tax basis, meaning contributions lower their taxable income. Earnings grow tax-deferred until retirement, at which point taxes are paid upon withdrawal at the person’s ordinary income tax rate. Traditional Individual Retirement Accounts (IRAs) provide similar benefits, while after-tax Roth IRAs give account holders the benefits of tax-free growth and withdrawals. Investors might opt to hold tax-efficient investments in their taxable accounts and use such tax-advantaged accounts for holdings with heavier tax consequences. These could include actively managed funds, taxable bonds, and individual stocks – especially those with large growth potential. An experienced financial advisor can help you decide how to spread your assets among these different types of accounts.
Our industry is all about planning, and proper tax planning can save you money and hassles at tax time. If you’d like professional help with tax preparation, now is an opportune time to seek out a tax pro – before most folks come knocking on their doors next spring. At Bill Few Associates Wealth Management, we can help you implement the strategies mentioned above to optimize the tax efficiency of your savings and investment plans. Contact our experienced financial advisors today at 412-630-6000.
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