Financial Strategies to Reduce Taxes



Here are several financial moves that can save you money and lower your tax bill:

Save More and defer your income

Due to the power of compounding, tax-deferred retirement accounts are an optimal strategy to grow your wealth. If you are saving in a 403(b), 457(b) or 401(k) plan, you are saving with pre-tax money, which can lower your current income and taxes due. In 2017, you can contribute $18,000 (or $24,000 if you are over 50). At a minimum, try to contribute as much as you can to qualify for an employer match in a 401(k).

If you can afford it, make sure that you contribute the maximum amount each year to your plan. If you haven’t taken out an IRA, do so by April 15, 2017 and you can save on your 2016 tax bill too.

Convert to a Roth IRA

A Roth IRA is a retirement account that allows you to contribute after-tax earnings now and keep all the appreciation tax-free. That means when you retire and start permitted withdrawals from your Roth IRA, the funds will not be taxed.

For example, if you put $10,000 of after-tax earnings into a Roth IRA at age 30, you would have $106,766 at age 75 (assuming a 7% annual return and no further contributions). If you are a millennial, a Roth IRA makes good financial sense because you are relatively early in your career and can generally expect your income and tax bracket to increase over time.

If you have a Traditional IRA, you may want to consider converting to a Roth IRA. If you choose to convert to a Roth IRA, you will owe taxes on the current balance of your Traditional IRA. One major factor that may drive your decision is your expected tax rate in retirement. If you expect your tax rate to increase in retirement, then it may be better to pay taxes now on the existing balance in your Traditional IRA and convert to a Roth IRA. If you expect your tax rate to decrease in retirement, then keeping your Traditional IRA may be the better decision. Another advantageous time to convert is a tax year in which you have low income because you will be in a lower tax bracket.

With tax rates likely to fall this year or next, 2017 might be the optimal time for a Roth IRA conversion. Why? Once you convert to a Roth IRA, you have until the last date, including extensions, for filing your prior-year tax return, which is typically on or about October 15, to change your mind and undo (or “recharacterize”) your Roth IRA conversion. Therefore, during this period, you can monitor the stock performance of your converted holdings and decide to recharacterize your Roth IRA to a Traditional IRA if the value of your stock portfolio declines.

Sell Portfolio Losers

Tax loss harvesting, or selling stock that has declined in value to realize a tax loss, is an optimal strategy, especially at year end. Why? Tax loss harvesting enables you to offset all investment losses against your investment gains, thereby lowering your tax bill.

For example, let’s say you recently sold 100 shares of Company ABC stock and made a $1,000 profit. If you owned the stock for more than one year, you would pay long-term capital gains tax on your profit. However, there is a way to offset your stock gain and not pay capital gains tax.

For more information, please contact a Focus Financial representative.