The end of the year is fast approaching, so now is a good time to think about actions that could potentially help to reduce your 2013 tax liability. This time of year can be very busy when it comes to preparing your finances.
Several new laws were implemented in 2013 under the American Taxpayer Relief Act of 2012, including a 39.6 percent income tax bracket, a 20 percent capital gains tax, and 3.8 percent investment surtax on high-income taxpayers. To help reduce your taxes, you may want to investigate strategies that can help you defer income or reduce income below thresholds. The following strategies are among several that can be implemented before year’s end.
When you’re given lemons, make lemonade. The tax code currently allows you to realize or “harvest” capital losses to offset capital gains and possibly ordinary income. If you have experienced market losses, you are allowed to offset investment gains against those losses on a dollar-for-dollar basis.
Capital losses up to $3,000 per year or $1,500 (for married filing separately) can be used to offset ordinary income. Losses not used in the given year can be carried forward to be used in future years, always offsetting capital gains first, and then ordinary income. If you plan to use this strategy, be aware of the “wash sale” rule, which prohibits you from deducting the loss on an investment if you purchase a substantially identical investment within 30 days before or after the sale.
Roth IRA conversions
Income restrictions on converting traditional retirement accounts into Roth Individual Retirement Accounts (IRAs) were eliminated in tax year 2010. Now, regardless of your income, you can convert any pre-tax retirement account—such as a traditional IRA, a Simplified Employee Pension (SEP) IRA, a Savings Incentive Match Plan for Employees (SIMPLE) IRA (after 2 years of participation), or any other qualified retirement plan—to a Roth IRA. If you are still employed and have a qualified retirement account, you may be able to convert that plan to a Roth 401(k); check the plan documents to see if this is allowed.
One of the main items to consider when converting any pre-tax funds to a Roth account is whether or not you believe your tax rate in the future will be lower than your current rate. You should also take into account any future Required Minimum Distributions (RMDs) from your current pretax accounts. Because Roth accounts do not have any RMDs, converting your funds to a Roth account now can potentially reduce your future modified adjusted gross income. This will enable you to receive tax-free distributions, which will help reduce or eliminate the 3.8 percent Medicare surtax under the Affordable Care Act. However, any Roth conversion will cause income taxes, payable at your current rates, to be due in the year of conversion.
This rule also allows anyone—regardless of income—to contribute after tax dollars to a traditional IRA and simultaneously convert those funds to a Roth IRA, therefore taking a back-door approach to depositing funds into a Roth IRA. Conversions must be complete by Dec. 31, 2013.
A 529 plan is a college savings plan that allows assets to grow tax-deferred and be withdrawn for qualified higher education expenses tax-free. Contributions to a 529 plan follow the annual gifting rules. In 2013, you can make an annual gift of $14,000 to a 529 plan, or you can make an accelerated gift of up to 5 times the annual gift exclusion (a total of $80,000).
Depending on your state of residence, you may be able to receive a state tax deduction on your 529 plan contributions. To qualify for a deduction for 2013, you must make the contribution by Dec. 31, 2013.
Employer retirement plans
If you are a business owner or self-employed individual, you still have some time to establish and fund a retirement plan for your business and employees. Profit-sharing plans, non–safe-harbor 401(k), or individual 401(k) plans must be established by Dec. 31, 2013, to receive contributions for tax year 2013.
Don’t delay your 2013 year-end-preparations because 2014 will be here very soon. Any advantageous preparations done at this time should only help enhance your overall financial well-being.
Brian Carlson, CFP®, CLU®, CLTC, vice president, insurance and investment services, and Bill Adolph, financial advisor, are with GCG Financial in Bannockburn, Ill. (www.gcgfinancial.net).
Disclosure: Securities and advisory services are offered through Securian Financial Services, Inc., member FINRA/SIPC.
Editor’s Note: This information may contain a general discussion of the relevant federal tax laws. It is not intended for, nor can it be used by any taxpayer for the purposes of avoiding federal tax penalties. This information is provided to support the promotion or marketing of ideas that may benefit a taxpayer. Taxpayers should seek the advice of their own tax and legal advisors regarding any tax and legal issues applicable to their specific circumstances.