Eric is Betterment's Head of Tax. His experience includes working for Ernst & Young and Fidelity Investments. Eric holds M.S. degrees in Accounting and Taxation from Seton Hall University as well as an MBA in Quantitative Finance from NYU. He also serves as an adjunct taxation professor at Seton Hall University.
Most popular by Eric Bronnenkant
How to Use Your Bonus Wisely to Get a Tax Break
Bonuses are tricky. Here's how you can make your bonus work harder for you by reducing the tax ...How to Use Your Bonus Wisely to Get a Tax Break Bonuses are tricky. Here's how you can make your bonus work harder for you by reducing the tax impact. How are you planning to spend your annual bonus? Like with any cash windfall, we all want to use it wisely. But bonuses can be tricky because of taxes. To use a bonus most tax-efficiently, you’ll need to juggle multiple objectives and concerns. If you’re expecting to get more than one bonus per year, it’s important to consider all of the possible ways to invest a bonus to maximize its potential value. In this article, we’ll review how bonuses are typically taxed, what factors you should be aware of, and how to take advantage of different accounts and investing strategies to make your bonus work harder for you. How Does a Bonus Get Taxed? Bonuses are considered “supplemental income” by the IRS, which means they could be withheld differently than your regular salary. The IRS suggests a flat withholding of 22% from bonuses, and many employers follow that method. (Remember that withholdings are meant to be an estimate of how much you’ll owe at the end of the year, not the actual tax itself.) But some employers use the aggregate method, in which your whole bonus is added to your regular paycheck, and the combined amount is withheld at the normal income rate, as though that amount is representative of what you make every paycheck, which could be higher (or lower) than 22%. Some people believe that bonuses are taxed at a higher rate than ordinary wages, but that’s not the case. The aggregate method of withholding can result in bumping you into a higher estimated tax bracket, which creates the illusion that you “keep less of it,” but no special tax rates apply just because a payment from your employer is characterized as a bonus. A bonus is like a raise, but when your income goes up, it could do more that just move you to a higher tax bracket—you could potentially lose certain deductions and tax credits. Bear in mind, while we hope you find this information helpful, you should consult a tax professional to understand your individual circumstances. Betterment is not a tax advisor, so while we like to offer helpful information to get you started, this should not be considered tax advice. With that said, here are some simple suggestions for how you can use tax-deferred or even taxable accounts to help preserve and grow your windfall. 1. Boost Your 401(k) Before you add your bonus to your 401(k), check with your employer about how bonuses are handled. In some cases, your company may not allow you to make 401(k) contributions using your bonus. In others, your 401(k) plan may be set up to withhold the same percentage from your bonus as from your paycheck. Thus, if you typically contribute 10% from every paycheck to your 401(k), that same amount could be withheld from your bonus (unless you say otherwise). In the case of a $15,000 bonus, $1,500 would go into your 401(k), which may be too little for your aims. The Max Contribution Limit for a 401(k) Of course, you can’t contribute more than the annual limit, so be sure to check how much you’ve contributed for the year to date. The contribution limit for your 401(k) for 2020 is $19,500 ($26,000 if you’re 50 or older). You can choose any combination of pre-tax or Roth contributions as part of your total contribution limit. Not sure which type is good for you? Many participants “split the difference” and contribute 50% pre-tax and 50% Roth. To figure out what kind of contribution might work well for you, use Betterment’s traditional vs. Roth 401(k) calculator. Also, don’t assume that a lump-sum deposit is best, especially if your employer matches your 401(k) contributions. A single large deposit might not get the same amount of matching dollars that a comparable amount would if you spread the deposits over time. Betterment’s resident CFP® professional Nick Holeman notes that it depends on your employer’s matching structure. Certain plans offer a “true-up” for matching contributions if you max out early in the year while many plans do not offer that feature. Talk to your employer to find out exactly how they calculate the match. 2. Take Advantage of Multiple Accounts Now here’s the part you may not be aware of: depending on your income and whether you or your spouse is participating in a company retirement plan, you might be able to reduce your taxable income further by contributing to your flexible spending account this year (the maximum is $2,750 for 2020), a health savings account (the maximum for a family is $7,100 for 2020), and a traditional or Roth IRA. Many people don’t realize that you can participate in a company plan and still fund a traditional or Roth IRA. You could contribute to your 401(k) this year, and contribute to a traditional or Roth IRA as well, or a combination of those. As the IRS notes: You can contribute to a traditional or Roth IRA whether or not you participate in another retirement plan through your employer or business. However, you might not be able to deduct all of your traditional IRA contributions if you or your spouse participates in another retirement plan at work. Roth IRA contributions might be limited if your income exceeds a certain level. 3. Invest in a “Happiness Annuity” If it’s not possible or advantageous to put your money only into tax-deferred accounts, use your windfall to invest by creating “a gift that keeps on giving.” You could spend it all, sure, but by investing your windfall in a well-diversified portfolio, you can create an additional source of cash flow that steadily adds to your quality of life, year after year: i.e. a happiness annuity. Studies show that steady cash flow increases often feel better than a lump sum that’s here today, spent on the Canary Islands tomorrow.
9 Tax Planning Moves to Consider Before 2021 Ends
As we approach the end of the year, keep in mind year-end financial opportunities, especially ...9 Tax Planning Moves to Consider Before 2021 Ends As we approach the end of the year, keep in mind year-end financial opportunities, especially tax-smart moves that could help you keep more of what you’ve earned. As we approach the end of the year, many people think about the holidays and year-end family gatherings. While I enjoy seeing my family and eating peanut butter sugar cookies, I also try to keep in mind all of my year-end financial opportunities—especially those that could shape my taxes for 2022. While your December may be bustling with merriment, consider the numerous actions you can take to help make your experience of filing taxes a little sweeter—and the amount you take home after taxes potentially a little higher. Turn on Tax Loss Harvesting+ by Dec. 30. In 2021, stock and bond markets have seen both ups and downs. These fluctuations are part of the pursuit for potential higher long-term returns. When assets fall in value, Betterment can take advantage of it by capturing losses that you may be able to use against gains on other investments (or offset $3,000 in other income). Tax Loss Harvesting+ is a one-time decision for you to turn on and Betterment takes care of the rest. Even if you do not use all the losses currently, no worries, you can carry them forward into future years. See if TLH+ is right for you. Make a 2021 IRA contribution by Dec. 30. Saving in an IRA can be a powerful way to help meet your retirement goals. These tax-advantaged accounts can potentially provide a tax deduction (Traditional IRA) or tax-free withdrawals (Roth IRA). The 2021 IRA contribution deadline is April 15, 2022, but maxing out by the end of 2021 will help you start making 2022 IRA contributions right after the new year. For 2021, contribution limits for IRAs are $6,000 if you’re under age 50, and $7,000 if you’re over 50. Max out your 2021 IRA here. Donate to charity—ideally, your appreciated shares. If you’re like me, you’ve come to realize giving can mean more than receiving. Charitable giving is one approach to supporting your community and our broader society. It’s also a way to optimize your taxes. We at Betterment suggest that a tax-smart way to make charitable donations is by giving away appreciated investments, rather than cash. We help you do this by automatically identifying the most appreciated long-term investments and partnering with charities you can donate to. This strategy allows you to avoid capital gains taxes and potentially deduct more on your taxes. To have deductions that count, you’d have to itemize your deductions above the standard deduction (which is $12,550 for individuals), so you may want to consider “bunching” a couple years’ worth of charitable contributions. Start a donation here. IRA’s Required Minimum Distributions (RMDs). IRS rules require that traditional IRA owners start withdrawing a certain portion of their account every year once they attain age 72. If the distribution is not taken by the deadline, the IRS imposes a 50% penalty on any shortfall. If the deadline is missed, the withdrawal still needs to be taken and the regular taxes still need to be paid. For some high income individuals, the penalty plus the taxes could exceed the required distribution. If you are not sure what your RMD is for 2021, you can review your 2020 Form 5498 or FMV statement if you had a December 31, 2020 account balance. You can find your Betterment tax statements here. Adjust your last 401(k) contributions to max out for the year. IRAs are great savings vehicles, but your 401(k) can be an even more powerful tool in enhancing retirement security as 401(k) plans have substantially higher contribution limits. For 2021, the 401(k) contribution limit is $19,500 with a catch up contribution limit of an additional $6,500 for individuals age 50 and up. These limits apply on a combined basis for the Traditional and Roth 401(k). Consider seizing on the opportunity to maximize these contributions by increasing your 401(k) payroll percentage today. You may need to speak to your payroll department to make the change. If your company’s 401(k) is managed by Betterment, max out your 401(k) here. Review withholding for remaining 2021 paychecks. Taxpayers have to meet certain withholding requirements to avoid paying a penalty for underpaying on taxes during the year. You may want to consider doing a tax projection for all of your income and withholding for 2021 before the year ends. You can check yourself using the IRS’ official withholdings calculator. If you are not expecting to meet the safe harbor requirements, you may want to increase your withholding at your job by adjusting your W-4 election for your remaining 2021 paychecks. Convert your Traditional IRA into a Roth IRA in 2021. Did you know there is no income limit for converting a traditional IRA into a Roth IRA? 2021 might be the year to do it. While it’s not the right choice for every person, you may have one of these compelling reasons to do so: Capturing the benefit of tax rates that are lower due to 2017 tax legislation. Being in a lower bracket than normal due to retirement or low income year. Gaining the benefits of tax-free income in retirement or for a beneficiary. Capture the benefit of an unused AMT (alternative minimum tax) credit carryover. Capture the benefit of a NOL (net operating loss) carryover. The taxable portion of the conversion may be lower due to after-tax contributions made previously. Remember, Roth conversions are permanent, so you should be certain about the decision before making a change. You can discuss the complicated choice of making a Roth conversion in a retirement planning advice package with one of our licensed professionals. Think twice about selling a large taxable investment or making a big portfolio allocation change. The bull market for the last 10 years has left some investors with enviable gains on their investments. However, any substantial appreciation does come with significant tax risks upon a withdrawal or a significant rebalancing. Capital gains are realized and can increase your tax liability. Some investors may have losses to offset the gains while others may be forced to pay taxes currently. While Betterment’s tax-smart technology sells the most tax-efficient investments first on partial withdrawals, if you remove an entire balance, all of your gains will be taxable income. Before you pull the trigger on an investment sale, consider if you need your invested money now or if you can draw down a balance over time. Even spreading withdrawals over multiple tax years could be more advantageous in terms of taxes. Capture the benefit of 0% long-term gains tax rates. If you have an income below $40,400 (single) or $80,800 (married filing jointly) for the year, you may benefit from the 0% long term capital gains tax rate. This means that you can sell capital gains (held more than one year) for any amount less than the gap between your regular income and those limits without getting taxed by the IRS. However, you should know that using this tax advantage could impact other positive tax moves, like qualifying for the Retirement Savings Contribution Credit (which has similarly low income limits). Also, most state taxes will still tax your long-term gains. Additional rules apply, so this move may be one to talk over with a qualified tax professional.
Convert or Recharacterize—What’s the Difference For Your IRA?
If conversions and recharacterizations are foreign to you, don’t worry. We’re here to help you ...Convert or Recharacterize—What’s the Difference For Your IRA? If conversions and recharacterizations are foreign to you, don’t worry. We’re here to help you decipher IRS jargon and learn the differences between the two. When it comes to making changes to past Traditional or Roth IRA contributions, recharacterizing and converting seem like interchangeable concepts—but they actually have very different meanings. Confusing the two can result in unintended tax consequences, so we’ll help you understand the differences. Please note, however, that Betterment is not a tax advisor, and we don’t provide tax advice as a service, so this information is just for educational purposes. You should consult a qualified tax professional regarding your personal situation. We have more information on the differences between a Traditional IRA and a Roth IRA to help you decide which is right for you. What exactly is a conversion? A conversion is a one-way street. It’s a potentially taxable event where funds are transferred from a Traditional IRA to a Roth IRA. There is no such thing as a Roth to Traditional conversion. There is no cap on the amount that’s eligible to be converted, so the sky’s the limit for those that choose to convert. If your Traditional IRA includes non-deductible contributions, part or all of the conversion may be non-taxable. If the Traditional is all pre-tax money, then the conversion is fully taxable. Let’s say you want to fund a Roth IRA to take advantage of tax-free withdrawals in retirement, but your income is too high. For 2019, this would be the case if your income is over $137,000 if you file as single, or over $203,000 if you file as married filing jointly. For 2020, this would be the case if your income is over $139,000 if you file as single, or over $206,000 if you file as married filing jointly. What’s a backdoor Roth? IRA rules allow you to get around this income restriction by making a Traditional IRA contribution and then converting funds from a Traditional to Roth. Because your Roth IRA has the advantage of offering tax-free withdrawals in retirement, many people who anticipate being in a higher tax bracket later in life prefer a Roth IRA over a Traditional. A “backdoor Roth” contribution is a way for individuals who might be disallowed from contributing directly to a Roth IRA to still get their retirement savings into a Roth IRA. A “backdoor Roth” refers to a process in which you make after-tax, non-deductible Traditional IRA contributions, and then you convert your contributions into Roth IRA funds. Contributions to a Traditional IRA may be non-deductible if you’re a high earner and you’re also covered by a retirement plan at work. After the Traditional IRA contributions are made, those same funds are converted to a Roth IRA—usually within a few business days after the contribution. At Betterment, you can convert right from your account on the next business day after you make your Traditional IRA contribution. This strategy can be most beneficial tax-wise if you don’t have other deducted IRA funds, including those previously rolled out of a 401(k), SEP IRA, or Simple IRA. If you do, then a portion of your conversion may be taxable. This is an important point that often surprises IRA converters at tax time. While you can do a conversion at any time during the year, keep in mind that the transaction will be reported on your tax documents for the calendar year in which it occurs, so you’ll have until December 31st of each year to complete a conversion for that tax year. Because transactions can take a few business days—especially in a multi-step conversion process where you must first deposit into your Traditional IRA and then convert on the next business day—it’s important not to wait until the last minute or you could miss the deadline. Conversions cannot be undone, so be sure you’ve spoken with a licensed tax professional to make sure this is the right strategy for you. Undoing conversions by recharacterizing used to be an option, but was eliminated due to tax reform in 2017. Benefits Of A Roth Conversion You generally won’t have to pay taxes when you withdraw money from a Roth IRA at retirement, as long as you’ve had the account for more than five years and are over 59½, or you’ve had the account for more than five years and you are disabled. If you think your tax rate will be the same or higher than your current rate when you withdraw your money, paying taxes now could be beneficial. There are no required minimum distributions as long as you are alive. There are no income limits for converting to a Roth IRA. Disadvantages Of A Roth Conversion You may have to pay income taxes now on converted amounts that were previously deducted from your income, or from any earnings that you have earned since your contribution. Betterment will not withhold these taxes for you. You may need to make estimated tax payments to avoid an underpayment penalty. The taxable portion of a conversion will be added to your gross income for the year, and could potentially increase your tax bracket overall. Taxpayers with an income or an adjustable gross income (AGI) over $200,000 who file individually, or $250,000 for married couples filing jointly, could be subject to a 3.8% tax on income from interest, dividends, annuities, royalties, and rents which are not derived in the ordinary course of trade or business. Step-by-Step Instructions For Converting Your IRA We’ve created a quick process that allows an investor to authorize a Roth conversion on our website in less than a minute. Log in to your account on a web browser. Click on Settings in the menu on the left-hand side of the page. Click the Accounts tab at the top of the page. Find your Traditional IRA and click the 3 dots that appear off to the right. Choose the option that says “Convert IRA to Roth.” You’ll have the option to convert either a partial amount or the full amount. What exactly is a recharacterization? In some cases, the IRS allows you to reclassify your IRA contributions. A recharacterization changes your contributions (plus the gains or minus the losses attributed to them) from a Traditional IRA to a Roth IRA, or, from a Roth IRA to a Traditional IRA. Generally, there are no taxes associated with a recharacterization if the amount you recharacterize includes gains or excludes dollars lost. You cannot recharacterize an amount that’s more than your allowable maximum annual contribution. You have until each year’s tax filing deadline to recharacterize—unless you file for an extension or you file an amended tax return. Reasons to Consider A Recharacterization If you made a Roth contribution during the year but discovered later that your income was high enough to reduce the amount you were allowed to contribute—or prohibit you from contributing at all. If you contributed to a Traditional IRA because you thought your income would be high enough to reduce the amount you would be allowed to contribute (perhaps down to nothing), but your income ended up lower than you’d expected. If you contributed to a Roth IRA, but while preparing your tax return, realize that you’d benefit more from the immediate tax deduction a Traditional IRA contribution would potentially provide. How To Request A Recharacterization To recharacterize Roth IRA contributions to Traditional IRA contributions, which is the most common type of recharacterization, simply: Log in to your Betterment account on a web browser—not the mobile app. On the left-hand menu, choose Transfers. Scroll down to “Other ways to transfer” and choose “IRA Recharacterization.” Click through the screens that follow—we’ll ask you some questions about the contributions you would like to recharacterize, and we’ll help calculate the gains or losses that will adjust that amount. If you don’t already have a Traditional IRA into which to move your money, we’ll help you create one. There’s a small chance we’ll tell you that your situation would best be handled by contacting our support team—don’t worry, they’re here to help. If you need to recharacterize Traditional IRA contributions to Roth IRA contributions (which is a less common situation), email our support team. We’ll ask you a series of questions to calculate your gains or losses. If you do not already have a Roth IRA, you’ll need to set one up before emailing us. When To Request A Recharacterization You must complete a recharacterization by the IRS mandated filing (or extended filing) deadlines. According to the IRS: The election to recharacterize and the transfer must both take place on or before the due date for filing your tax return for the tax year for which the contribution was made to the first IRA. You can get an automatic 6-month extension if you file Form 4868 no later than the date your return is due. Even if you did not file for an extension, you can still recharacterize your contribution up until the extended filing deadline if you filed your original tax return by the first filing deadline and you will amend the tax return. If you cannot get your IRA recharacterization completed in time, you may consider whether filing for an extension is appropriate. We’ll Help You Get Started Get started or log in to complete your retirement plan and see personalized savings advice, including advice on which type of IRA may be right for you. You can even sync up your existing IRAs, 401(k)s, and other financial accounts to see an overall picture of your finances. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
Further writing from Eric Bronnenkant
4 Ways Betterment Can Help Limit the Tax Impact Of Your Investments4 Ways Betterment Can Help Limit the Tax Impact Of Your Investments Betterment has a variety of processes in place to help limit the impact of your investments on your tax bill, depending on your situation. Let’s demystify these powerful strategies. In the US, approximately 33% of households have a taxable investment account—often referred to as a brokerage account—and approximately 50% of households also have at least one retirement account, like an IRA or an employer-sponsored retirement account. We know that the medley of account types can make it challenging for you to decide which account to contribute to or withdraw from at any given time. Let’s dive right in to get a further understanding of: What accounts are available and why you might choose them. The benefits of receiving dividends. Betterment’s powerful tax-sensitive features. How Are Different Investment Accounts Taxed? Taxable Accounts Taxable investment accounts are typically the easiest to set up and have the least amount of restrictions. Although you can easily contribute and withdraw at any time from the account, there are trade-offs. A taxable account is funded with after-tax dollars, and any capital gains you incur by selling assets, as well as any dividends you receive, are taxable on an annual basis. While there is no deferral of income like in a retirement plan, there are special tax benefits only available in taxable accounts such as reduced rates on long-term gains, qualified dividends, and municipal bond income. Key Considerations You would like the option to withdraw at any time with no IRS penalties. You already contributed the maximum amount to all tax-advantaged retirement accounts. Traditional Accounts Traditional accounts include Traditional IRAs, Traditional 401(k)s, Traditional 403(b)s, Traditional 457 Governmental Plans, and Traditional Thrift Savings Plans (TSPs). Traditional investment accounts for retirement are generally funded with pre-tax dollars. The investment income received is deferred until the time of distribution from the plan. Assuming all the contributions are funded with pre-tax dollars, the distributions are fully taxable as ordinary income. For investors under age 59.5, there may be an additional 10% early withdrawal penalty unless an exemption applies. Key Considerations You expect your tax rate to be lower in retirement than it is now. You recognize and accept the possibility of an early withdrawal penalty. Roth Accounts Includes Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457 Governmental Plans, and Roth Thrift Saving Plans (TSPs) Roth type investment accounts for retirement are always funded with after-tax dollars. Qualified distributions are tax-free. For investors under age 59.5, there may be ordinary income taxes on earnings and an additional 10% early withdrawal penalty on the earnings unless an exemption applies. Key Considerations You expect your tax rate to be higher in retirement than it is right now. You expect your modified adjusted gross income (AGI) to be below $140k (or $208k filing jointly). You desire the option to withdraw contributions without being taxed. You recognize the possibility of a penalty on earnings withdrawn early. Beyond account type decisions, we also use your dividends to keep your tax impact as small as possible. Four Strategies Betterment Uses To Help You Limit Your Tax Impact 1. We use any additional cash to rebalance your portfolio. When your account receives any cash—whether through a dividend or deposit—we automatically identify how to use the money to help you get back to your target weighting for each asset class. Dividends are your portion of a company’s earnings. Not all companies pay dividends, but as a Betterment investor, you almost always receive some because your money is invested across thousands of companies in the world. Your dividends are an essential ingredient in our tax-efficient rebalancing process. When you receive a dividend into your Betterment account, you are not only making money as an investor—your portfolio is also getting a quick micro-rebalance that helps keep your tax bill down at the end of the year. And, when market movements cause your portfolio’s actual allocation to drift away from your target allocation, we automatically use any incoming dividends or deposits to buy more shares of the lagging part of your portfolio. This helps to get the portfolio back to its target asset allocation without having to sell off shares. This is a sophisticated financial planning technique that traditionally has only been available to larger accounts, but our automation makes it possible to do it with any size account. Beyond dividends, Betterment also has a number of features to help you optimize for taxes. Let’s demystify these three powerful strategies. Performance of S&P 500 With Dividends Reinvested Source: Bloomberg. Performance is provided for illustrative purposes to represent broad market returns for the U.S. Stock Market. The performance is not attributable to any actual Betterment portfolio nor does it reflect any specific Betterment performance. As such, it is not net of any management fees. The performance of specific U.S. Stock Market funds in the Betterment portfolio will differ from the performance of the broad market returns reflected here. 2. Tax loss harvesting. Tax loss harvesting can lower your tax bill by “harvesting” investment losses for tax reporting purposes while keeping you fully invested. When selling an investment that has increased in value, you will owe taxes on the gains, known as capital gains tax. Fortunately, the tax code considers your gains and losses across all your investments together when assessing capital gains tax, which means that any losses (even in other investments) will reduce your gains and your tax bill. In fact, if losses outpace gains in a tax year you can eliminate your capital gains bill entirely. Any losses leftover can be used to reduce your taxable income by up to $3,000. Finally, any losses not used in the current tax year can be carried over indefinitely to reduce capital gains and taxable income in subsequent years. How do I do it? When an investment drops below its initial value—something that is very likely to happen to even the best investment at some point during your investment horizon—you sell that investment to realize a loss for tax purposes and buy a related investment to maintain your market exposure. Ideally, you would buy back the same investment you just sold. After all, you still think it’s a good investment. However, IRS rules prevent you from recognizing the tax loss if you buy back the same investment within 30 days of the sale. So, in order to keep your overall investment exposure, you buy a related but different investment. Think of selling Coke stock and then buying Pepsi stock. Overall, tax loss harvesting can help lower your tax bill by recognizing losses while keeping your overall market exposure. At Betterment, all you have to do is turn on Tax Loss Harvesting+ in your account. 3. Asset location. Asset location is a strategy where you put your most tax-inefficient investments (usually bonds) into a tax-efficient account (IRA or 401k) while maintaining your overall portfolio mix. For example, an investor may be saving for retirement in both an IRA and taxable account and has an overall portfolio mix of 60% stocks and 40% bonds. Instead of holding a 60/40 mix in both accounts, an investor using an asset location strategy would put tax-inefficient bonds in the IRA and put more tax-efficient stocks in the taxable account. In doing so, interest income from bonds—which is normally treated as ordinary income and subject to a higher tax rate—is shielded from taxes in the IRA. Meanwhile, qualified dividends from stocks in the taxable account are taxed at a lower rate, capital gains tax rates instead of ordinary income tax rates. The entire portfolio still maintains the 60/40 mix, but the underlying accounts have moved assets between each other to lower the portfolio’s tax burden. Here’s what asset location looks like in action: 4. We use ETFs instead of mutual funds. Have you ever paid capital gain taxes on a mutual fund that was down over the year? This frustrating situation happens when the fund sells investments inside the fund for a gain, even if the overall fund lost value. IRS rules mandate that the tax on these gains is passed through to the end investor, you. While the same rule applies to exchange traded funds (ETFs), the ETF fund structure makes such tax bills much less likely. In fact, most of the largest stock ETFs have not passed through any capital gains in over 10 years. In most cases, you can find ETFs with investment strategies that are similar or identical to a mutual fund, often with lower fees. We go the extra mile for your money. Following these four strategies can help eliminate or reduce your tax bill, depending on your situation. At Betterment, we’ve automated these and other tax strategies, which means tax loss harvesting and asset location are as easy as clicking a button to enable it. We do the work, and your wallet can stay a little fuller. Learn more about how Betterment helps you maximize your after-tax returns.
Investing in Your 40s: 4 Financial Goals You Should Prioritize at Mid-LifeInvesting in Your 40s: 4 Financial Goals You Should Prioritize at Mid-Life In your 40s, your priorities and investing goals become clearer than ever; it’s your mid-life opportunity to get your goals on track. It’s easy to put off planning for the future when the present is so demanding. Unlike in your 20s and 30s when your retirement seemed like a distant event, your 40s are when your financial responsibilities become palpable—now and for retirement. You may be earning more income than ever, so you can benefit far more from planning your taxes carefully. Perhaps you have increased expenses as a result of homeownership. If you have kids, now may also be the time that you’re thinking about or preparing to pay for college tuition. When all of these elements of your financial life converge, they require some thoughtful planning and strategic investing. Consider the following roadmap to planning your investments wisely during these rewarding years of your life. Here are four ways to think about goals you might prepare for. Preparing for Your Next Phase: Four Goals for Your 40s You may have already made a plan for the future. If so, now is a good time to review it and adjust course if necessary. If you haven’t yet made a plan, it’s not too late to get started. Set aside some time to think about your situation and long-term goals. If you’re married or in a relationship, it’s best to include your spouse or partner in identifying your goals. Consider the facts: How much are you making? How much do you spend? Will your spending needs be changing in the near future? (Perhaps you're paying for day carte right now but can plan to redirect that amount towards savings in a few years instead.) How much are you setting aside for savings, investments, and retirement? What will you need in the next five, 10, or 20 years? Work these factors into your short- and long-term financial goals. 1. Pay off high-interest debt. The average variable-rate credit card charges more than 16% a year in interest, so paying off any high-interest credit card debt can boost your financial security more than almost any other financial move you make related to savings or investing. Student loans may also be a high-cost form of debt, especially if you borrowed money when rates were higher. For instance, even federally subsidized loans taken out in the 1990s may carry interest rates as high as 8.25%. If you have a high-interest-rate student loan (say more than 5%), or if you have multiple loans that you’d like to consolidate, you may want to consider refinancing your student debt. These days, lenders offer many options to refinance higher-rate student loans. There’s one form of debt that you don’t necessarily need to repay early, however: your mortgage. This is because mortgage rates are lower than most credit cards and may offer you a tax break. If you itemize deductions, you may be able to subtract mortgage interest from your taxable income. Many people file using the standard deduction, however, so check with your tax professional about what deductions may apply to your situation come tax time. 2. Check that you’re saving enough for retirement. If you’ve had several jobs—which means you might have several retirement or 401(k) plans—now is a good time to organize and check how all of your investments have performed. Betterment can help you accomplish this by allowing you to connect and review your outside accounts. Connecting external accounts allows you to see your wealth in one place and align different accounts to your financial goals. Connecting your accounts in Betterment can also help you see higher investment management fees you might be paying, grab opportunities to invest idle cash, and determine how your portfolios are allocated when we are able to pull that data from other institutions. There could also be several potential benefits of consolidating your various retirement accounts into low-fee IRA accounts at Betterment. Because it’s much easier to get on track in your 40s than in your 50s since you have more time to invest, you should also check in on the advice personalized for you in a Betterment retirement goal. Creating a Retirement goal at Betterment allows you to build a customized retirement plan to help you understand how much you’ll need to save for retirement based on when and where you plan on retiring. The plan also considers current and future income—including Social Security income—as well as your 401(k) accounts and other savings. Your plan updates regularly, and when you connect all of your outside accounts, it provides even more personalized retirement guidance. 3. Optimize your taxes. In your 40s, you’re likely to be earning more than earlier in your career–which may put you in a higher tax bracket. Review your tax situation to help make sure you are keeping as much of your hard-earned income as you can. Determine if you should be investing in a Roth (after-tax contribution) or traditional (pre-tax contribution) employer plan option, or an IRA. These days, more than half of employer-sponsored plans like 401(k)s offer a Roth option, and unlike Roth IRAs, it’s not limited by a maximum income threshold. The optimal choice usually depends on your current income versus your expected income in retirement. If your income is higher now than you expect it to be in retirement, it’s generally better to use a traditional 401(k) and take the tax deduction. If your income is similar or less than what you expect in retirement, you should consider choosing a Roth if available. Those without employer plans can generally take traditional IRA deductions no matter what their taxable income is (as long as your spouse doesn’t have one, either). You can use Betterment’s 401(k) vs. IRA calculator to help decide which one you should be contributing to, or if you’re a Betterment customer, consult your Retirement Goal’s “How To Save” section, after ensuring that you have connected any external retirement accounts. You’ll also want to make sure you take advantage of all the tax credits and deductions that may be available to you. For instance, if you work and pay for childcare, you may be eligible for a dependent care tax credit. Depending on your income, this credit may be worth anywhere from 20% to 35% of what you spend on childcare, and the expenses are capped at $3,000 for one qualifying individual, and $6,000 for two qualifying individuals. Check also to see whether your company offers tax-free transportation benefits—including subway or bus passes or commuter parking. The value of these benefits isn’t included in your taxable income, so you can save money. You can also save money on a pre-tax basis by contributing to a Health Savings Account (HSA) or Flexible Spending Account (FSA). You might not think using these accounts is worth the time, but for a couple making $100k in taxable income per year, you should receive a 29.65% return on investment in the federal/social security/medicare income tax break.1 You may not have that much in expenses, but even if you only pay $200 a month for commuter parking and/or transportation passes and only contribute $500 annually to your FSA, paying those costs pre-tax is the equivalent to paying yourself over $850 in tax savings - it’s worth the time it takes to sign up! Health Saving Accounts (HSA) Health savings accounts (HSAs) are like personal savings accounts, but the money in them is used to pay for health care expenses. Only you—not your employer or insurance company—own and control the money in your HSA. The money you deposit into the account is not taxed. To be eligible to open an HSA, you must have a special type of health insurance called a high-deductible plan. Your 401(k) may be tied to your employer, however your HSA is not. As long as your health plan meets the deductible requirement and permits you to open an HSA, and you’re not receiving Medicare benefits or claimed as a dependent on someone else’s tax return, you can open one with various HSA “administrators” or “custodians” such as banks, credit unions, insurance companies, and other financial institutions. You can withdraw the funds tax-free at any time for qualified medical expenses. Flexible Spending Accounts (FSA) A Flexible Spending Account (FSA) is a special account that can be used to save for certain out-of-pocket health care costs. You don’t pay taxes on this money—this is a tax-favored program that some employers offer to their employees. If you have an FSA, remember that in most cases your spending allowance does not carry over from year-to-year. It’s important to find out whether your employer offers a grace period into the next year (typically through mid-March) to spend down your account. Before you waste your tax-free savings on eyeglasses, check what you can buy with FSA money—with and without a prescription. Any unused funds will be forfeited, so it’s a good idea to use up what you can. If you find yourself with more than you can spend, then you might want to adjust how much you’re allocating to your FSA. 4. If you have children, start saving for college—just don’t shortchange your retirement to do it. If you have children, you may already be paying for their college tuition, or at least preparing to pay for it. For 2020-2021, the average annual costs of college tuition and fees in the United States were $10,560 for in-state public colleges, $27,020 for out-of-state public colleges, and $37,650 for private education, according to the College Board. This doesn’t include the cost of room and board, so you can see why paying for college is something many people have to plan strategically for. Kids grow up fast, so if you haven’t started thinking about college costs, here’s some information to get started. According to the College Board’s College Cost Calculator, today’s fifth grader today will need approximately $268,8832 to graduate from an average four-year private college by the year 2033. Scholarships, grants and federal loans can help, but many parents feel it is up to them to make sure that their kids can get the education they deserve. It is a mistake to save for your kids’ college costs while neglecting your own financial security. Plenty of parents submit a final tuition payment only to realize that they’ve saved nothing for retirement—without any time left to save more. It is a mistake to save for your kids’ college costs while neglecting your own financial security. So, first things first, make sure you’re saving enough for your own retirement. Then if you have money left over, think about tax-deferred college savings plans, such as 529 plans. A 529—named for the section of the tax code that allows for them—can be a great way to save for college because earnings are tax-free if used for qualified education expenses. Some states even allow you to deduct contributions from your state income tax, if you use your state’s plan. (While each state has its own plan, you can use any state’s plan, no matter where your child will go to college.) An alternative is to put money away in your own taxable savings accounts. Some investors prefer this method since it gives them more control over the money if things change, and may be more beneficial for financial aid. Your 40s are all about taking stock of how far you’ve come, re-adjusting your priorities, and getting ready for the next phase of life. By working on your financial goals now, you can gain peace of mind that allows you to concentrate on important things like family, friends, work, and the way you want to spend this rewarding decade of your life. Get a better handle on your 40s with Betterment. Betterment handles your investments so you don’t have to. We make it easy to roll over your retirement accounts (or get new accounts set up), and much of what we do is designed to help you save money on taxes. Our customer support team is available to answer questions, and we have licensed experts available to help you plan. Get started today. 1 Assuming taxable income of 100k, married filing jointly, the tax bracket of 22% applying to the 2021 taxable income Bracket of 22% for $81,051 to $172,750, 1.45% medicare tax (2.9% split evenly by employees/employers), and 6.2% Social Security tax (12.4% split evenly by employees/employers). 2 Assuming 8 years remain until college, 4 years of attendance, 5% education inflation, average 4-year private college as of June 2021 ($42,224), full tuition covered by savings. The information in this article is provided solely for marketing and educational purposes. It does not address the details of your personal situation and is not intended to be an individualized recommendation that you take any particular action, including rolling over an existing account. When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. Specific factors that may be relevant to you include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account, consult tax and other advisors with any questions about your personal situation, and review our Form CRS relationship summary and other disclosures. If you currently participate in a 401(k) plan administered or advised by Betterment (or its affiliate), please understand that this article is part of a general educational offering and that neither Betterment nor any of its affiliates are acting as a fiduciary, or providing investment advice or recommendations, with respect to your decision to roll over assets in your 401(k) account or any other retirement account. Betterment’s Licensed Concierge Team offers support for individuals transferring assets to Betterment of $100,000 or more, and receives incentive compensation based on assets brought to or invested with Betterment. Betterment’s revenue varies for different offerings (e.g., Betterment Digital and Premium) and consequently Team members have an incentive to recommend the offering which results in the greatest revenue for Betterment. The marketing and solicitation activities of these individuals are supervised by Betterment to ensure that these individuals act in the client’s best interest. Disclosure: Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Betterment or its writers endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
Taking Time Off From Work Can Be A Secret Tax OpportunityTaking Time Off From Work Can Be A Secret Tax Opportunity If you’re taking off time from work—e.g. sabbatical, leave of absence, or traveling the world—you might be able to take advantage of a special tax boon if you put money toward retirement. If you’re taking time off work, it’s probably not for tax reasons. But did you know that doing so could open up a major tax opportunity. It turns out, if you work less than half the year—without becoming dependent on another person—you may be able to take advantage of a special tax credit that could save you hundreds of dollars. And, get this: This year may be one of the only times in your life you’re eligible. Today, we’ll show you how you can potentially take advantage of the retirement saver’s credit. The only major move you have to make is to contribute to an IRA (which you might want to make a Roth IRA) or your employer-sponsored retirement plan, like a 401(k) or 403(b). Why is this tax opportunity a big deal? It’s a win-win. You could potentially pay less in taxes simply by saving for retirement. But you’d have to save this calendar year. If you can put away money for your future self right now, while you aren’t working, you’ll actually get more back from Uncle Sam for your current self. Chances are, you may never be eligible to receive this tax credit again if you normally make more than $32,500 for 2020 ($33,000 for 2021) per year as a single person. It works this year because even if you make a high amount per month, you’re only working a few months in total for the year. It’s one of the rare triple tax advantages in life. This tax credit helps reduce how much you pay in taxes for this year, while letting you save into a Roth IRA or Roth 401(k) where gains are tax deferred, and you don’t have to pay taxes on withdrawals in retirement. In this way, it’s one of the few opportunities where the government offers three tax advantages at once. How does this tax opportunity for not working work? Getting the retirement saver’s credit during a year of taking time off isn’t going to be possible for everybody, but if you plan the next few months effectively, it might just work for you. Let’s walk through exactly what you’d need to do to take advantage. 1. You have to file taxes as an independent person. If you’re taking time off in May, then depending on what choices you make next, you’ll either be independent for the year (supporting yourself in the government’s eyes) or you might be dependent on somebody else (like a family member). If you plan to work and live off existing savings while you take time off, then more than 50% of your lifestyle support will come from yourself, and you can file your taxes independently. This situation opens up tax credits and deductions for you that otherwise would not be there because somebody would be claiming you as a dependent. One of these is the Retirement Savings Contribution Credit. 2. You have to be a full-time student for less than 5 months during the year. In general, if you’re taking off to start school, you’re usually not eligible for this credit, but there are a few exceptions. For instance, if your school is on a quarter/trimester schedule and you’re only taking one term, then you could be eligible. Also, if you’re only enrolled part-time and still supporting yourself, then you could be eligible too. 3. Because you’re only working 50-60% of the year, your annual income will likely be significantly lower than in future years. Because you’re only probably working six or seven months of the year, your federal tax bracket will be far lower than you might expect for future years. If you make a salary, and the annual amount is $50,000, then you could earn as little as $25,000 in gross income. You can qualify for the saver’s credit if your income for the tax year is less than $32,500 for 2020 ($33,000 for 2021) if you’re single and less than $65,000 for 2020 ($66,000 for 2021) if you’re married filing jointly. The level of credit you get is tied to how much you save and depends on the size of your income. If you live and work in an area with a low cost of living, you could have a respectable entry salary of $36,000, and you could be eligible for the maximum credit. We have the entire Saver’s Credit income table below for 2020 and 2021. 4. Start saving into a Roth IRA or employer plan when you’re ready. If the three steps above apply, you’re ready to go after the saver’s credit. Your next step should be to start putting away money for retirement. We suggest using a Roth account, given that if you qualify for the credit, you’re almost certainly making less money than you expect to take during retirement. You can read more about why a Roth accounts might make sense for you, but the short of it is this: any employer plan you’re eligible for may not offer a Roth 401(k)/403(b), but you can always open a Roth IRA as an individual. 5. You need to have a tax liability. The retirement savers credit is non-refundable which means that it cannot reduce your tax liability below zero. Some other credits like the Earned Income Tax Credit are refundable which means you may receive net payout (otherwise known as a negative tax) from the IRS. One of the challenges is keeping your income low enough to qualify for the credit but high enough to have a tax liability that will allow the greatest amount of the credit to be used. 6. Decide how much you’ll save each month. The final step is to decide how much you’ll save and to set up automatic savings deposits. To qualify for the credit at all, your gross salary isn’t likely to be more than $54,000 for the year (and more likely, it will be less)—or just over $4,500 per month before taxes. Since IRA contributions are limited to $6000, you’d need to contribute $2,000 to capture the maximum retirement saver’s credit, which could easily be a half of a month’s salary. In other words, maxing out might be aggressive as you’re getting your first post-collegiate paychecks. But even if you don’t max out, every amount saved supports your long-term retirement and your 6-month chance to get the retirement saver’s credit. If you have a lot in savings, then you can definitely consider transferring savings account money or even taxable invested savings into a Roth IRA to take advantage. FAQs about the Retirement Saver’s Credit So, there you have it: the tax incentive that few people taking a sabbatical or time off work think about using, but many should consider. What other questions might you have? Should I save into my new employer’s 401(k) or an IRA? The great thing about this credit is that both your contributions to your employer’s plan and your IRA help you qualify. So, if you can contribute to an employer plan for part or all of the year, which one should you choose? The answer is that it depends. If your employer plan offers a company match on your contributions, then you should certainly contribute there to capture the match—that’s free money. However, as explained above, it probably makes sense to contribute to a Roth plan—where you pay taxes now and not in retirement—so if your employer doesn’t offer a Roth 401(k) or 403(b), you may want to contribute to get the match, then save further in a Roth IRA. Moreover, some employer plans may have higher fees on the investments provided than you might find by opening a Roth IRA. Is there any way I can qualify for the saver’s credit if I my salary is greater than $66,000? There may be situations that help you qualify for the saver’s credit. For instance, if you get married this year—maybe taking a 6-month honeymoon using savings—then you and your spouse could feasibly qualify for a partial credit if your annual income is not more than $66,000 for the year—meaning your combined salary could be far greater. Also, as you’ll see in the table below, the limits are based on adjusted gross income (AGI), which isn’t just your gross income. Certain life situations can adjust your income, lowering it in a way that may help you qualify or increase your credit. Examples of ways you can reduce your AGI include: pre-tax employer retirement contributions, health insurance premiums, medical expenses, saving into a health savings account (HSA), moving expenses, capital losses, school tuition or fees you paid, or student loan interest. What are the qualification rules for the credit? See the table below full table of adjusted gross income limits and partial credit rates. Be sure to read the IRS’ detail on the Retirement Savings Contribution Credit too. 2020 Saver's Credit Credit Rate Married Filing Jointly Head of Household All Other Filers* 50% of your contribution up to $1,000 per spouse AGI not more than $39,000 AGI not more than $29,250 AGI not more than $19,500 20% of your contribution up to $400 per spouse $39,001 - $42,500 $29,251 - $31,875 $19,501 - $21,250 10% of your contribution up to $200 per spouse $42,501 - $65,000 $31,876 - $48,750 $21,251 - $32,500 0% of your contribution more than $65,000 more than $48,750 more than $32,500 2021 Saver's Credit Credit Rate Married Filing Jointly Head of Household All Other Filers* 50% of your contribution up to $1,000 per spouse AGI not more than $39,500 AGI not more than $29,625 AGI not more than $19,750 20% of your contribution up to $400 per spouse $39,501 - $43,000 $29,626 - $32,250 $19,751 - $21,500 10% of your contribution up to $200 per spouse $43,001 - $66,000 $32,251 - $49,500 $20,251 - $32,500 0% of your contribution more than $66,000 more than $49,500 more than $33,000 Any tax information provided by Betterment is not a substitute for the advice of a qualified tax advisor. You should consult with your tax advisor to discuss tax-related concerns.
Save for Retirement While You’re Self-EmployedSave for Retirement While You’re Self-Employed Entrepreneurs and small business owners have several options for saving for retirement while saving on taxes. Owning a small business is a lot of work, and planning for retirement may feel like the last thing on your to-do list. CNBC reports that up to 34% of entrepreneurs don’t have a plan for how they’ll retire. Getting started isn’t as hard as it seems. We’ll outline the most common self-employment retirement account options, including tips for who should consider using them, how much you can contribute, and how to set them up. Common Sources of Self-Employment Income While it is widely believed that you must set up a formal business, such as an LLC, to be classified as self-employed—it’s not true. Working freelancers and independent contractors with no formal legal business structure are treated as self-employed individuals. Examples might include Uber drivers, tax preparers, and any freelance workers, such as software engineers. The gig economy has propelled more workers than ever to venture out on their own, seeking to be their own boss and therefore managing their own retirement plan. One Participant 401(k) Plan—Solo 401(k) A Solo 401(k) is similar to a regular 401(k). However, with a Solo 401(k), the participant is both the employer and the employee. This means they can contribute up to the regular employee contribution limit plus up to the employer contribution limit as well. You can also set it up as a Roth 401(k) and make non-deductible contributions now so that you can take tax-free withdrawals after retirement. Who: Self-employed individuals who either have no employees or only employ their spouse. How: Complete the paperwork provided by investment companies that offer Solo 401(k)s. Be sure to research, among other things, plan fees and investment fees. Note that Betterment does not currently support Solo 401(k)s. Contribution Limits: In 2021, you can contribute up to $19,500 as the employee plus up to either 20% of the business’s net earnings or 25% of total wages as the employer—as long as your total contribution does not exceed $58,000. If you are 50 or older, you can catch up with an additional $6,500, bringing the total amount to $64,500 total. Note that if you are also participating in another employer’s 401(k) plan, the employee limits apply per person, not per plan. Dates to Know: You must set up the account by December 31st, but you can contribute up until the tax filing deadline of the following year. Heard about the “Mega Backdoor Roth” 401(k)? Simplified Employee Pension—SEP IRA With a SEP IRA, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee. Who: Self-employed or small business owners who do not qualify for a Solo 401(k), or who have employees and are looking for a low-cost retirement plan for their company. How: Simply file a form with the IRS (Form 5305-SEP) and open a SEP IRA at a bank or financial institution. Betterment offers SEP IRAs for self-employed individuals with no employees—read more here. Contribution Limits: For 2021, the business can contribute up to 25% of either the employee’s compensation or 20% of the net earnings from self-employment up to $57,000—whichever is less. There is no catch-up amount for those 50 and older. For 2020, the business can contribute up to 25% of either the employee’s compensation or the net earnings from self-employment or up to $57,000—whichever is less. There is no catch-up amount for those 50 and older. Dates to Know: Set up your SEP IRA by the first tax filing deadline for the year, and you can contribute for the 2020 tax year until your taxes are filed. Learn more about Betterment SEP IRAs. Savings Incentive Match Plan for Employees—SIMPLE IRA A SIMPLE IRA is ideal for small business owners who have 100 employees or less. Both the employer and the employee can contribute. Who: Ideal for small business owners with employees. How: File form 5305-SIMPLE or 5304-SIMPLE with the IRS and open a SIMPLE IRA at a bank or financial institution. Note that Betterment does not currently offer SIMPLE IRAs. Contribution Limits: For qualified employees earning more than $5,000, the 2021 maximum contribution amount is $13,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. Catch up with $3,000 extra per year if you’re 50 or older. For qualified employees earning more than $5,000, the 2020 maximum contribution amount is $13,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. Catch up with $3,000 extra per year if you’re 50 or older. Dates to Know: You must open the SIMPLE IRA by October 1st of the year you wish to contribute in. Traditional IRA or Roth IRA In addition to one of the business-sponsored accounts described above, you can also fund a Traditional IRA or Roth IRA. If you’re looking to use a Traditional IRA to get an income tax deduction, you may be limited in that deduction by the amount of your contributions to other retirement accounts and by the amount of your earned income. If you’re a new business owner or entrepreneur that’s just starting out, you may find yourself in a lower tax bracket, which may mean it’s a good time to convert an old Traditional 401(k) or Traditional IRA into a Roth. That would allow you to capture lower taxes today, and in the future when you’re in retirement and withdrawing from the Roth, there won’t be any taxes on qualified distributions. Learn more about how a Roth conversion might benefit you. You can might be able to roll over your old 401(k) into an IRA to consolidate and possibly save on fees. Who: Anyone with earned income can contribute to an IRA. How: Open a Roth or Traditional IRA with a bank or financial institution. Betterment offers both Traditional and Roth IRAs at a low cost. And the best part? We don’t require any paperwork to open and start funding an IRA. Contribution Limits: For 2020 and 2021, you can contribute a maximum of $6,000 per year to a Traditional or Roth IRA, or $7,000 if you’re age 50 or older. Roth contributions may be limited by your income level. Dates to Know: You can open your IRA at any time. You have up until the first tax filing deadline—no extensions—to contribute to an IRA for the preceding tax year. How to Choose Which tax-advantaged account should you consider using to save for your retirement? That depends on the nature and size of your small business, as well as your own age and future plans. Here’s a scenario for a 30-year old entrepreneur with no other employees, and who is classified as a single member LLC (disregarded entity). The business nets $100,000. Type of Plan Maximum Contribution (2021) Solo 401(k) plan $39,500 SEP IRA $20,000 SIMPLE IRA $16,500 Source: IRS Publication 560 Based on this chart, you might be wondering why anyone would do anything but the Solo 401(k). Here’s why. First, setting up a Solo 401(k) typically requires more advance planning and paperwork than opening a SEP IRA or SIMPLE IRA, either of which can usually be opened online in just a few minutes. In addition, Solo 401(k) plans require you to file Form 5500-EZ with the IRS every year once the plan reaches $250,000 in assets. And of course, with the Solo 401(k), you have to be your own company with no employees. And remember, if your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account. Betterment is not a tax advisor, and this post is not tax advice. Please seek out qualified professionals that provide advice on these issues for your specific circumstances. When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. The information on this page is being provided for general informational purposes and is not intended to be an individualized recommendation that you take any particular action. Factors that you should consider in evaluating a potential rollover include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account and consult tax and other advisors with any questions about your personal situation. Uber is a trademark of Uber Technologies, Inc.
Put Your Tax Refund To Work—We’ll Show You HowPut Your Tax Refund To Work—We’ll Show You How You finally got your tax refund. Now what? We’ll show you how to put it to use so that you can get the most of your money. Today is the day you’ve been patiently awaiting. You’ve just received your tax refund. While some ponder a vacation on the beach, others—such as smart investors like you—think about how they can invest the funds for the long-term. There is no one right strategy on how to use your refund, but here are some smart money moves you may want to consider. Pay down high-interest debt. Credit cards and personal loans typically charge interest rates as high as 15% to 30% on outstanding balances. Using your refund to pay off this debt is a wise move because it helps you avoid future interest charges on your outstanding balance. Many customers ask us the question—should I invest, or pay off debt? Check out this article if you aren’t sure where paying off debt falls on your priority list. Build a rainy day fund Like it or not, rainy days happen—and we need to be prepared to weather them. That’s why most financial planners recommend having a short-term savings account that holds 3 to 6 months’ worth of expenses. Unfortunately, not all of us have that much cash readily available to immediately access, which can expose us to additional risks in the event of an unexpected major expense or the loss of a job. Consider opening a Safety Net to stash away cash for emergencies. Increase your 401(k) contributions. Although you generally can’t contribute directly to your 401(k) from your bank account, you can increase your contribution rate through your employer and use your refund to cover daily living expenses. First, make sure you contribute at least the amount that your employer will match, if they have a 401(k) matching policy. If your employer offers a Roth 401(k), still consider making contributions, which can provide tax-free income in retirement and a hedge against future tax increases. If you are able, consider contributing the maximum amount for the year. For 2021, if you are under 50, the maximum contribution amount is $19,500. If you are age 50 or older, the maximum contribution amount is $26,000. Contribute to your IRA. If you are looking for another place to grow your retirement investments with additional tax benefits, consider contributing to a Traditional or Roth IRA. If you’re unsure which type of IRA is best for you, we have a tools and resources that can help you decide. For 2020 and 2021, if you are under 50, the contribution limit is $6,000. If you are over 50, the contribution limit is $7,000. Remember that if you contribute earlier in the year, your future growth could be more than if you had contributed at the end of the year. Invest in education. Benjamin Franklin said it best when he stated, “An investment in knowledge pays the best interest.” Using your tax refund to save for education can turn out to be a wise decision. Tax-advantaged education savings accounts, like your state’s Section 529 plan, allow for your investments to grow tax-deferred. If the funds are used for qualified education expenses, you won’t have to pay taxes when you withdraw. Donate to charity. Giving feels good, but did you know it can also reduce your taxes? Donating to charity allows you to deduct your charitable contributions from your itemized taxes for 2020, while also contributing to causes you care about. You can read more about the rules for deducting charitable contributions on the IRS website. Make Energy-Efficient Home Improvements Using your refund to make energy-efficient upgrades to your home can help reduce your utility bills. The U.S. Government currently has a number of incentives to promote energy efficiency that you can take advantage of. The amount you reduce your utility bills by can then be saved and invested to help maximize the benefit. Good for the planet, good for your wallet—energy efficiency is truly a gift that keeps on giving. Get Started Ready to save? Get started or log in to set up a Safety Net, contribute to an IRA, or start giving to charity. If you plan to use your tax refund to save towards other financial goals, learn how to prioritize each goal. Please note that Betterment is not a tax advisor—please consult a tax professional for further guidance.
6 Tax Filing Hurdles When Investing6 Tax Filing Hurdles When Investing Taxes can be confusing, even for the most savvy investors. Enter Eric Bronnenkant, our Head of Tax, with six things to look out for when filing your taxes while investing. Whether you’ve been investing for years or not, holding money in an investment account can make your filing process a bit more complicated. I’m here to help guide you through that process with a few tips. 1. Haven’t taken a withdrawal from your taxable account? Still expect some taxable income. Even if you haven’t withdrawn funds from your account, dividends you’ve earned and capital gains from sales in your account may still be taxable. Sales that don’t result in withdrawals can come from rebalancing that helps keep your portfolio on track, as well as any allocation changes you might have made. The dividend and investment sales will be reported to you on a Form 1099-B/DIV. Interest on your Cash Reserve account will be reflected on a Form 1099-INT. Learn more » 2. If you only have IRA investments, your taxes may be simpler than you think. One of the key benefits of investing in an IRA is that all the income inside the account is tax-deferred. As long as you leave your funds in the IRA, you do not report any of the dividends or investment sales. If your only investments are within an IRA or 401(k), you aren’t typically required to report investment sales on Schedule D/Form 8949 (which you might experience as buying tax software that includes investments), so that may make your filing process more straightforward. Learn more » If you do take an IRA distribution (make a withdrawal), you should expect to receive a Form 1099-R from us. An IRA distribution may or may not be taxable, but it is always reportable. 3. A globally diversified portfolio is a good strategy. Know how it can affect your tax filing. Diversification is one of the key tenets of Betterment’s portfolio advice. International investments help decrease the risk of a portfolio heavily invested in U.S. stocks and bonds. Because of this, you should know that these foreign investments add a few steps when you’re filing your taxes. You’ll need to calculate the foreign tax credit to mitigate the double taxation between the US and foreign countries. Learn more » 4. Tax-smart investing starts with government bonds. Look out for reporting that income. To be as tax-smart as possible, you’ll want to take advantage of every tax benefit available to you. One benefit built into Betterment’s portfolios is income from government bonds, which is exempt from state and local income taxes due to federal law. It is common for investors to overlook this tax benefit and subject all of their taxable interest to state and local income taxes. Be more tax-smart by being sure to report income from government bonds on your state tax returns. Learn more » In addition, municipal bond income is generally exempt from federal income tax. The rules at the state level are a little more tricky. If your resident state has an income tax, it will tax all out-of-state muni income. Knowing what portion of your income falls into the in-state versus out-of-state is important to paying the appropriate amount of tax. Learn more » 5. 2020 markets were volatile, which means Tax Loss Harvesting+ was hard at work.1 Stock and bond markets are inherently volatile. While you hope that they appreciate in value over the long term, it is expected that there may be substantial fluctuations in the short term. Betterment’s Tax Loss Harvesting+ helps to take advantage of volatility by “capturing losses,”—selling investments at opportune times and buying similar replacement investments that do not violate certain IRS rules. These captured losses can then be used to help offset any gains you’ve recognized or against other income in the tax year up to $3,000. If there are any additional losses, they may be carried forward until used in a future year. Learn more » 6. We saw new tax legislation starting in 2019. This changed IRA contribution rules and required minimum distribution provisions. The SECURE Act, which was passed in late 2019, paved the way for retirement rule changes starting in 2020. Traditional IRA contributions have historically been limited to owners under the age of 70 1/2. The age restriction has been lifted starting for 2020 tax year, and even 100 year olds can now contribute to a Traditional as long as they (or their spouse) have “earned income”. Non-spouse beneficiaries of IRAs and 401(k)s historically had been able to withdraw funds over the beneficiary’s life expectancy. For deaths that occur in 2020 or later, the beneficiary is now required to completely distribute the entire account by the end of the 10th year after death. Learn more » Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. 1Tax Loss Harvesting works automatically for customers who have elected the service in their accounts.
What Should I Know About Taxes on My Investment Accounts?What Should I Know About Taxes on My Investment Accounts? An informed and educated investor can make better decisions if they know the unique tax attributes of each type of investment account. In the US, 33% of households have a taxable investment account—often referred to as a brokerage account—and 89% of those households also have at least one retirement account, like an IRA or an employer-sponsored retirement account. We know that the medley of account types can make it challenging for the average investor to decide which account to contribute to or withdraw from at any given time. Further, the factors that might inform this decision don’t necessarily align with a straightforward, black-and-white rubric. Taxable Accounts Taxable investment accounts are typically the easiest to set up and have the least amount of restrictions. Although you can easily contribute and withdraw at any time from the account, there are trade-offs. A taxable account is funded with after-tax dollars and any capital gains your incur by selling assets, as well as any dividends you receive, are taxable on an annual basis. While there is no deferral of income like a retirement plan, there are special tax benefits only available in taxable accounts. Any gains avoid taxation until they are realized, or in other words, sold. Investments held for over one year qualify for long-term capital gains treatment, so those gains are taxed at a lower rate than investments that have been sold before being held for a year. There is an additional exception for an investor who holds investment assets until death: their cost basis is “stepped-up” (reset) to the market value on the date of their death. This means that the original cost of the assets is now considered to be the current value, and gains on any growth during their lifetime are avoided. Note too that inherited assets, when sold, are always taxed at the lower capital gains tax rate for long-term gains. The term dividend is frequently used in a broad sense but can ultimately be referring to distributions from a variety of investment activities. Qualified dividends paid from the the earnings and profits of corporations are taxable at the reduced long-term capital gains rates. Foreign taxes paid on dividends from non-US investments may be eligible for a foreign tax credit—to partially or fully offset taxation in the US so you aren’t paying double taxes. Dividends paid from taxable bond investments are taxed at ordinary income tax rates. Dividends paid from municipal bond investments are generally tax-free. Main Considerations for Choosing a Taxable Retirement Account You would like the option to withdraw at any time with no penalties. You have already contributed the maximum amount to all tax-advantaged retirement accounts. Traditional Accounts Includes Traditional IRAs, Traditional 401(k)s, Traditional 403(b)s, Traditional 457 Governmental Plans, and Traditional Thrift Savings Plans (TSPs) Traditional type investment accounts for retirement are generally funded with pre-tax dollars. The investment income received is deferred until the time of distribution from the plan. Assuming all the contributions are funded with pre-tax dollars, the distributions are fully taxable as ordinary income. For investors under age 59.5, there may be an additional 10% early withdrawal penalty unless an exemption applies. There are a number of possible 10% penalty exemptions, such as death, disability, or taking distributions as an annuity stream—refer to IRS.gov for more information. Unlike a taxable account, retirement plans do not receive a step-up in cost basis upon death. Foreign taxes paid on retirement account investments are not eligible to be claimed as a tax credit. Main Considerations for Choosing a Traditional Retirement Account You expect your tax rate to be lower in retirement than it is now. You recognize and accept the possibility of an early withdrawal penalty. Roth Accounts Includes Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457 Governmental Plans, and Roth Thrift Saving Plans (TSPs) Roth type investment accounts for retirement are always funded with after-tax dollars. Qualified distributions are tax-free. For investors under age 59.5, there may be ordinary income taxes on earnings and an additional 10% early withdrawal penalty on the earnings unless an exemption applies. While there is no step-up in cost basis upon death, distributions made to beneficiaries after the account has been open for five years are automatically tax-free. Foreign taxes paid on retirement account investments are not eligible to be claimed as a tax credit. Main Considerations for Choosing a Roth Retirement Account You expect your tax rate to be higher in retirement than it is right now. You desire the option to withdraw contributions without being taxed. You recognize the possibility of penalty on earnings withdrawn early. Summary of Key Considerations Are the retirement account contributions pre-tax or post-tax? Are the retirement account distributions expected to be tax-free? Is there a 10% early withdrawal penalty from a retirement distribution? Is there potential for long-term capital gain tax rates and qualified dividend rates? Going the Extra Mile With Additional Tax Efficiencies Betterment can help you be a smarter investor, because we offer additional features — at no extra cost — to help you minimize taxes so that you can maximize your money. Tax Coordination can help increase your overall returns if you are investing in multiple types of investment accounts, because it allocates your assets within each account type as tax-efficiently as possible. Tax Loss Harvesting+ can be used to capture losses during market declines so that you can use them to help offset future gains or even lower your tax bracket. Learn more about how Betterment helps you maximize your after-tax returns. Betterment is a financial advisor, not a tax advisor—consult a tax advisor or IRS resources for additional guidance. Getting Started Within a Betterment account, we can provide additional advice regarding which accounts you should be funding and in what order. You can even sync up your 401(k)s and other accounts to see an overall picture your finances. Get started or log in to complete your retirement plan and see personalized savings advice.
If You Live In Pennsylvania, These Tax Rules Might Help You Save On TaxesIf You Live In Pennsylvania, These Tax Rules Might Help You Save On Taxes If you're a Pennsylvanian, it’s important to be aware of certain tax rules so that you can save more of your hard-earned money. The Declaration of Independence and the Constitution were both signed in Philadelphia, Pennsylvania. The city represents the foundation of American history and it attracts visitors from around the world. What else makes the state so popular? Maybe it’s the opportunities to engage in a variety of experiences—from devouring the best twisted pretzels—when not eating cheesesteaks—to visiting Punxsutawney for Groundhog Day. As a state of many historic “firsts”, the first zoo in America was built in 1874 in Philadelphia. There, you can currently see endangered Amur tiger brothers Wiz and Dimitri, who were actually born one day apart. The PA state income tax rate is 3.07%, which is lower than state taxes in nearby NY, NJ, and CT. Unlike most other states in the area which have a progressive tax system, PA’s state income tax rate is the same regardless of the amount of income received. Many localities in PA impose an additional tax on earned income at the rate of 1%, but this may vary depending on the locality. Philadelphia residents pay an extra 3.8712% tax on earned income and investment income. We’ll show you how you can take advantage of PA tax rules for education, retirement, and investments. First, a reminder: Due to 2017 tax reform, the federal tax deduction for state and local taxes (otherwise known as SALT) is now limited to $10,000 per year. Prior to the implementation of tax reform in the 2018 tax year, there was no dollar limit on the deduction. This article is intended for purely educational purposes. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. Education Saving for your child’s college education might feel overwhelming, especially when you’re trying to prioritize education savings with your other goals in life, such as retirement. PA makes saving for education a little easier by allowing a $30,000 deduction per beneficiary for married couples who contribute to a 529 plan (or $15,000 for single taxpayers). PA is among a small number of states (AZ, AR, KS, MN, MO, MT) that allow for tax parity, which is a tax benefit for contributions to any state 529 plan. Rinse and repeat—because you can contribute and take the deduction every year. Retirement Ever wonder why so many people retire in Florida? Sunshine aside, moving to Florida is a common strategy for many northeast highly taxed residents because Florida has no income taxes. To encourage Pennsylvanians to retire in their own state, PA allows for a broad retirement income exemption on IRAs and employer sponsored plans, such as 401(k)s and pensions. Example: A retired married couple who are both age 65 years with a $60,000 annual pension, $30,000 annual IRA distribution, and $40,000 in Social Security benefits, would be fully exempt from PA income taxes. PA does not allow for pre-tax employee contributions to any type of retirement plan. Employee contributions to Traditional 401(k), 403(b), 457 governmental, Thrift Savings Plan, Traditional IRA, SEP IRA, and Simple IRA accounts are always after-tax for PA state tax purposes. It is a good idea to keep track of these contributions in the event of an early distribution which would only be PA taxable after all employee contributions have been recovered. Social Security Prior to 1984, Social Security benefits were tax-free to all recipients, regardless of how much other income they received. After the 1984 change went into effect, the federal government has expanded the taxation of Social Security benefits to potentially include up to 85% of benefits as taxable income. PA has taken a generous step to fully exempt Social Security benefits from state income taxes for everyone—regardless of income level. Investments As a state, PA does not always have the power to choose what income it allows exemptions for. Due to federal law, PA is required to exempt U.S. government interest from income taxes. This tax break also applies to mutual funds and ETFs that invest in U.S. government bonds. Municipal bonds issued by the state of PA and its municipalities are exempt from PA income taxes. However, interest received on bonds issued by other states and local governments are subject to PA income taxes.1 PA does not recognize capital loss carryovers. Why is this important? Let’s say you have a $100,000 unused capital loss from a prior year, and a $100,000 capital gain for the current year. The federal government would allow the carryover loss and the gain to offset each other. However, PA would ignore the unused capital loss from last year and the $100,000 gain from the current year would be subject to PA income tax. Also not recognized by PA is the netting of capital losses between one spouse’s individual account and capital gains from the other spouse’s individual account in the same tax year. Why is this important? Let’s say one spouse has a $100,000 capital loss and the other spouse has a $100,000 capital gain for the current year. PA would ignore the $100,000 capital loss and require the 3.07% tax to be paid on the $100,000 gain. This can be a solvable problem as long as you put in some advance planning. If all assets are held jointly, the current year’s capital losses can offset the current year’s capital gains. Here are some fun tax facts to tell your fellow Pennsylvanians. PA has a reciprocal agreement with six states: Indiana, Maryland, New Jersey, Ohio, Virginia, West Virginia. The agreement allows a PA resident who works in any of these states to “make believe” they never crossed PA state lines, so that they only pay PA income tax on their compensation. The benefits of this agreement include avoiding paying higher state taxes to their work location state, as well as avoiding additional tax software filing fees. If every state had a reciprocal agreement with all of its neighboring states, it might send the tax software business into a tailspin. PA adds an 18% flood tax to the sale of every bottle of alcohol. The tax was instituted to fund the recovery of the Johnstown flood in 1936 and still remains today. Once the tax spigot is turned on, it is very difficult to turn off. Candy and gum are exempt from sales tax. Good lobbying, Hershey. 1 The only exception to this “out of state rule” are for bonds issued by governments who have an exemption per federal law. Examples include Puerto Rico and Guam. Note that Betterment is currently available to residents in Puerto Rico and the Virgin Islands, but we currently do not support residents in Guam. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
If You Live In New Jersey, These Tax Rules Might Help You Save On TaxesIf You Live In New Jersey, These Tax Rules Might Help You Save On Taxes If you're a New Jerseyan, it’s important to be aware of certain tax rules so that you can save more of your hard-earned money. New Jersey is the most densely populated state in the nation. What makes the state so popular? Maybe it’s the opportunities to engage in a variety of experiences—from devouring the best thin crust pizza to relaxing at historic Liberty State Park. Due to its unique geography, South Jersey is one of the few places where you can see both a sunrise and a sunset over the water. It’s not shocking for residents of the Garden State, whether they live in Central NJ or on a prayer, when I remind them that NJ income taxes are among the highest in the nation. The maximum NJ state income tax rate is 10.75%, but that rate only applies on income above $5,000,000. The top rate for most people is 6.37%, which is the tax rate for married couples filing above $150,000 on their joint tax return. Unlike some other areas of the country, there are no local income taxes in NJ, so residents are only taxed on income at the state and federal level. Because NJ taxes are so high, people who are usually uninterested in taxes are all ears once they learn more about how they might be able to save on taxes by taking advantage of certain New Jersey tax laws. First, a reminder: Due to 2017 tax reform, the federal tax deduction for state and local taxes (otherwise known as SALT) is now limited to $10,000 per year. Prior to the implementation of tax reform in the 2018 tax year, there was no dollar limit on the deduction. This article is intended for purely educational purposes. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. Medical Expenses I've written about tax deductions and how they work previously. The federal government allows for a deduction for unreimbursed medical expenses that exceed 10% of your Adjusted Gross Income (AGI). That’s a high threshold to meet, so it makes it pretty difficult to get any tax benefit. NJ is substantially more generous and allows a deduction for unreimbursed medical expenses that exceed 2% of NJ gross income. NJ medical expenses also include employee-paid health insurance premiums, as those are included as income for NJ income tax purposes. Retirement Ever wonder why so many people retire in Florida? Sunshine aside, moving to Florida is a common strategy for many NJ residents because Florida has no income taxes. In 2016, one high-income NJ taxpayer moved to FL and it was the “first time a state official has warned of a budget risk because of one resident’s relocation” per the New York Times. To encourage New Jerseyans to retire in their own state, NJ allows a $60,000 retirement income exclusion for a single taxpayers age 62 or older. The exclusion for married couples is $80,000 (for those unfamiliar, the fact that the married couple does not receive twice the exclusion of a single person is known as the “marriage penalty”). This exclusion benefit also applies to distributions from IRAs and qualified employer-sponsored plans like 401(k)s and pensions. This means that up to $80,000 of retirement income will not have any income taxes—as long as the NJ total income on the tax return does not exceed $100,000. Unfortunately, the retirement exclusion completely disappears if total NJ income exceeds $100,000 per tax return threshold—even by just $1.00. In addition to the retirement income exclusion mentioned above, retirees who are receiving a military pension are also eligible for an unlimited exclusion for pension income related to that specific employment. Example: A single former Army officer who is currently 65 years old, with a $60,000 annual pension and a $30,000 annual IRA distribution, would be fully exempt from NJ income taxes. NJ only allows for pre-tax employee contributions to one type of retirement plan: Traditional 401(k) accounts. Employee contributions to 403(b), 457 governmental, Thrift Savings Plan, Traditional IRA, SEP IRA, and Simple IRA accounts are always after-tax for NJ state tax purposes. Whenever I meet a NJ teacher who has a 403(b), they are typically unaware that NJ taxes the contributions at the state level. These teachers can track their contributions in order to avoid potential double taxation in retirement. If the contributions are left untracked, double taxation could occur if they cannot use their retirement exclusion due to their total NJ income exceeding $100,000 or they take an early distribution before the age of 62. Social Security Prior to 1984, Social Security benefits were tax-free to all recipients, regardless of how much other income they received. After the 1984 change went into effect, the federal government has expanded the taxation of Social Security benefits to potentially include up to 85% of benefits as taxable income. NJ has taken a generous step to fully exempt Social Security benefits from state income tax for everyone—regardless of income. Investments As a state, NJ does not always have the power to choose what income it allows exemptions for. Due to federal law, NJ is required to exempt U.S. government interest from income taxes. This tax break also applies to mutual funds and ETFs that invest in U.S. government bonds. Municipal bonds issued by the state of NJ and its municipalities are exempt from NJ income taxes. However, interest received on bonds issued by other states and local governments are subject to NJ income taxes. NJ does not recognize capital loss carryovers. Why is this important? Let’s say you have a $100,000 unused capital loss from a prior year, and a $100,000 capital gain for the current year. The federal government would allow the carryover loss and the gain to offset each other. However, NJ would ignore the unused capital loss from last year and the $100,000 gain from the current year would be subject to NJ income tax. To help make tax time even easier for our customers who invest, we’ve introduced a new supplemental tax statement which provides a breakdown of US Government interest and in-state vs. out-of-state municipal bond interest. Here are some fun tax facts to tell your fellow New Jerseyans. Sales tax can be funny sometimes. NJ does not tax unprepared food like a whole bagel, but one that is toasted for you is taxed. As an avid consumer of poppy seed bagels lathered in cream cheese, this tax is pretty unavoidable for me. NJ does not tax pumpkins used for food, but they do tax pumpkins used for decoration. NJ didn’t have income taxes until 1976 when it first introduced a personal income tax with only two brackets: 2% on the first $20,000 of income, and 2.5% on any additional income after that. You’ll probably never guess what I think about on my daily commute as I traverse the Hudson river on the PATH train to get to the Betterment office. Ok, you’re right–I’m always thinking about how taxes can apply to my current situation. I previously mentioned that NJ generally taxes interest on bonds issued from outside of NJ. What about bonds issued by the Port Authority of NY and NJ? There is no state or local tax on interest earned from their bonds for both NY and NJ residents. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
If You Live In New York, These Tax Rules Might Help You Save On TaxesIf You Live In New York, These Tax Rules Might Help You Save On Taxes If you're a New Yorker, it’s important to be aware of certain tax rules so that you can save more of your hard-earned money. New Yorkers get to experience the best of everything—from a beautiful rainbow at Niagara Falls to the classic symbol of our freedom that is the Statue of Liberty. But, it’s not shocking for people living in the Empire State when I remind them that NY income taxes are among the highest in the nation. The maximum NY state income tax rate is 8.82%. Some New York City residents might pay as much as an additional 3.876% for the privilege of living in the five boroughs: Manhattan, Brooklyn, Queens, The Bronx, and Staten Island. Because NY taxes are so high, people who are usually uninterested in taxes are all ears once they learn more about how they might be able to save on taxes by taking advantage of certain New York tax laws. First, a reminder: Due to 2017 tax reform, the federal tax deduction for state and local taxes (otherwise known as SALT) is now limited to $10,000 per year. Prior to the implementation of tax reform in the 2018 tax year, there was no dollar limit on the deduction. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. Education Saving for your child’s college education might feel overwhelming, especially when you’re trying to prioritize education savings with your other goals in life, such as retirement. NY makes saving for education a little easier by allowing a $10,000 deduction for married couples who contribute to a NY-sponsored 529. Rinse and repeat—because you can contribute and take the deduction every year. Retirement Ever wonder why so many people retire in Florida? Sunshine aside, moving to Florida is a common strategy for many NY residents because Florida has no income taxes. To encourage New Yorkers to retire in their own state, NY and NYC allow a $20,000 retirement income exclusion for people 59 ½ or older. This means that up to $20,000 of income will not have any income taxes. What about married couples? Each spouse who meets the age requirement is entitled to their own $20,000 tax break. This benefit also applies to distributions from IRAs and qualified employer plans like 401(k)s and pensions. In addition to the $20,000 pension exclusion mentioned above, retirees who were employed by the Federal government, NY state, or local government are also eligible for an unlimited exclusion for retirement income related to that specific employment. Example: A former NYC firefighter who is currently 60 years old, with a $50,000 annual pension and a $20,000 annual IRA distribution, would be fully exempt from NY and NYC income taxes. Social Security Prior to 1984, Social Security benefits were tax-free to all recipients, regardless of how much other income they received. After the 1984 change went into effect, the federal government has expanded the taxation of Social Security benefits to potentially include up to 85% of benefits as taxable income. NY and NYC have taken a generous step to fully exempt state and local taxes for all Social Security benefits for everyone regardless of income. Investments As a state, NY does not always have the power to choose what income it allows exemptions for. Due to the federal law, NY and NYC are required to exempt U.S. government interest from income taxes. This tax break also applies to mutual funds and ETFs that invest in U.S. government bonds—as long as they represent at least 50% of the assets in the fund. Municipal bonds issued by the state of NY and its municipalities are exempt from NY and NYC income taxes. However, interest received on bonds issued by other states and local governments are subject to NY and NYC income taxes.1 Betterment’s standard portfolio for taxable accounts utilizes MUB, a bond ETF that provides exposure to municipal bonds across many states. We also offer an ETF that invests solely in New York municipal bonds—for New York residents with a minimum balance (or an intent to fund)—of at least $100,000. If you want to switch out MUB in your portfolio to NYF, please email us. We generally recommend making this switch before you fund your account, if possible. To help make tax time even easier for our customers who invest, we’ve introduced a new supplemental tax statement which provides a breakdown of U.S. Government interest and in-state vs. out-of-state municipal bond interest. Here are some fun tax facts to tell your fellow New Yorkers. Sales tax can be funny sometimes. For example, NY does not tax unprepared food like a whole bagel, but one that is sliced for you is taxed. As an avid consumer of poppy seed bagels lathered in cream cheese, this tax is pretty unavoidable for me. Until 1999, NYC income tax applied to commuters working within NYC. However, there was a court ruling which stated that NYC could not exempt NY commuters from the tax and impose it on only NJ and CT commuters. Consequently, the NYC commuter tax was ultimately repealed for all commuters. Unfortunately, another version of a NYC commuter tax called “congestion pricing” will be implemented for drivers who enter the southern part of Manhattan, starting in 2021. You’ll probably never guess what I think about on my daily commute as I traverse the Hudson river on the PATH train to get to the Betterment office. Ok, you’re right–I’m always thinking about how taxes can apply to my current situation. I previously mentioned that NY generally taxes interest on bonds issued from outside of NY. What about bonds issued by the Port Authority of NY and NJ? There is no state or local tax on interest earned from their bonds for both NY and NJ residents. 1 The only exception to this “out of state rule” are for bonds issued by governments who have an exemption per federal law. Examples include Puerto Rico and Guam. Note that Betterment is currently available to residents in Puerto Rico and the Virgin Islands, but we currently do not support residents in Guam. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
State and Local Taxes Affect Your WalletState and Local Taxes Affect Your Wallet There are other types of taxes besides income tax. We’ll walk you through common types of state and local taxes, and provide tips on how you can minimize your tax liability so that you can keep more money in your wallet. Long before I started working in the tax profession, I had my first experience with state and local taxes as a young child. While at the grocery store with my mother, I wanted a pack of gum. It was advertised as $1.00 and I felt pretty energized about persuading my mother to give me a one dollar bill to pay for it. Once at the register, I found out that with the 7% state sales tax in New Jersey at the time, the actual price came to $1.07—and I came up short. Smart investing can help you minimize your tax liability. First, let’s define some of the various types of state and local taxes that you will face. Income tax: Tax that is paid to the state or local authority based on income such as wages, business profits, interest, dividends, capital gains, etc. Wage income is typically subject to tax withholding at the time it is received (and reconciled through annual filing). In contrast, taxes on investment income are typically paid through quarterly estimated payments or at the time of annual filing. Sales tax: Tax that is paid to a local authority on goods and services, typically at the time of the sale. In some states, there may be an exemption for basic necessities such as medicine, food, or clothes. New York City has a sales tax rate of 8.875%, which is one of the highest in the nation. Sales tax can be funny sometimes. For example, New York does not tax unprepared food like a whole bagel, but one that is sliced for you is taxed. Real estate tax: A tax on the value of owned real estate and property, based on the appraised value. It’s typically paid either on a quarterly basis to the local authority, or through an escrow account as part of a monthly mortgage payment. Excise tax: A tax typically paid at the time of sale on a variety of goods and services such as alcohol, tobacco, gasoline, and gambling. Sometimes these taxes are referred to in the context of “double taxation” because sales tax may also be imposed in addition to the excise tax. The good news is that you can minimize or even avoid certain state and local taxes. Investing in specific types of funds, or in specific types of accounts, can help reduce what you owe. You can even reduce or avoid certain taxes by living in a state with tax laws that help you keep more in your wallet. Treasury bond interest is not taxable at the state level. Most states and localities with income tax requirements look at your federal tax return as a starting point, and then they make adjustments. This means that your taxable income at the federal level might be higher or lower than your taxable income at the state level. One reason your state income might be lower is due to U.S. government interest, because it’s taxed at the federal level but not at the state level. Most of our portfolios here at Betterment contain at least some income from U.S. Treasury bonds, unless your allocation is set to 100% stocks. Municipal bond interest provides double, or even triple, tax benefits. Municipal bonds are another component of tax-smart investing, particularly because the interest they earn is generally not taxed at the federal level. The highest income tax rate at the federal level is 37% plus an additional 3.8% tax on investment income. Reducing what’s taxed helps you keep more in your wallet. Not having to pay any % of income tax on your municipal bond interest can help you keep more of what you earn. But, why settle for one tax exclusion when you can get two...or even three? States generally don’t tax interest on municipal bonds issued within their borders (but they do tax interest from out-of-state municipal bonds), so residents who buy them can typically collect interest without having to pay state taxes. Residents of cities that assess their own income tax, like New York City, could exclude income from municipal bonds issued within their state on their city tax forms, too, resulting in a tax-break trifecta of federal, state, and city tax breaks. New York and California Residents State municipal bonds are most advantageous for those in high-income tax brackets. Our standard portfolio for taxable accounts utilizes MUB, a bond ETF providing exposure to municipal bonds from all states. We offer ETFs that invest solely in either New York or California municipal bonds, for New York and California residents with a minimum balance, or an intent to fund, of at least $100,000. If you want to switch out MUB in your portfolio to CMF or NYF, please email us. We generally recommend making this switch before you fund your account. The state you live in affects how much you’ll owe in taxes. State and local income taxes can significantly reduce the amount of cash you have left after paying taxes—and this varies based on the state you live in. California, New York State, and New York City typically have the highest personal income tax rates in the U.S. California’s highest income tax rate is 13.3% and New York City residents pay up to 12.696%. Note that only New York City residents pay New York City income tax. New Yorkers who live outside of New York City do not pay any New York City income tax, instead, they’ll pay the state up to 8.82%. These rates apply to all types of income unless there is a special exclusion or exemption. The state and local income tax burden has recently increased due to tax reform. The federal tax deduction for all state and local taxes paid by a taxpayer is now limited to $10,000 per year. Distributions From Retirement Accounts Certain states provide a full or partial exemption from state and local taxes for distributions from your retirement accounts. Each state has its own rules and limitations. There are a few states with income tax rules that are generous to retirees. Illinois has a blanket retirement income exemption for withdrawals from 401(k)s, IRAs, pensions, and even for Social Security payments. Pennsylvania has similar income tax exemptions to Illinois but may impose taxes for early retirees. New York allows for each spouse to exclude up to $20,000 from 401(k)s, IRAs, and corporate pension income per year, and also excludes Social Security payments from income tax. California taxes all retirement income at the same rate as the federal government with the exception of Social Security payments, which are automatically exempt. If you move states in retirement, your former state of residence cannot tax your retirement income. Only the new state can, which means you can avoid taxes by moving to a state that generally doesn’t have any taxes on retirement income, like Florida or Pennsylvania. Please note that Betterment is not a tax advisor—please consult a tax professional for further guidance.
3 Time-Sensitive Tax Moves to Consider this December3 Time-Sensitive Tax Moves to Consider this December Tax planning can help you make the most of your hard-earned money, and December is a great time to do it. December is a great time to plan your taxes. Why? Because most of your 2018 numbers are now known, and you still have time to take actions that can reduce your tax bill come April. What’s different about 2018 is that it’s the first year after the tax reform bill, the Tax Cuts and Jobs Act of 2017. That means the experience of filing your taxes may feel different than past years. The good news is there’s no better time to plan your taxes than December, and most strategies still apply even after the reform. Here are three tax moves to consider this December. 1. Finish up your contributions to your IRA, HSA, 401(k), or 529 plans—better yet, max them out. For many taxpayers, the most straightforward way to lower your current year tax bill can be to contribute to a tax-deferred savings account such as a Health Savings Account (HSA), traditional IRA, 401k, or 403(b). If you aren’t sure whether or not you’ve hit the 2018 limits (up from 2017), however, check the rules twice. Did you reach the age 50 at any time during 2018? If you have, you get extra catch-up contributions to your retirement plan. For HSAs, you’ll have to wait until age 55. With 529 plan contributions, there’s no federal tax deduction, but you might get a break on state taxes. Either way, last year’s tax reform bill offers new incentives to consider a 529. Specifically, you can take a tax-free withdrawal of up to $10,000 annually for qualified elementary and secondary school costs. 2. Sell, convert, or gift your investment gains and losses, time shifting your taxable income. Time shifting taxable gains and losses on the sale of investments is another tax planning method to consider. When settling up your bill with Uncle Sam, it’s often a question of “pay me now or pay me later.” This strategy has you explicitly choosing now versus later depending on tax implications. Based off of your income this year, you might benefit from tax loss harvesting. This is the practice of deliberately selling losing investments in order to use the loss on that sale to help offset other income, thereby reducing taxes. Some services are even doing this automatically for you throughout the year. If you don’t use automatic tax loss harvesting, you have until year end to do it manually. If your taxable income is $38,600 or less ($77,200 for married couples), you might consider harvesting gains instead of losses. That’s because a portion of your profit may be subject to 0% long term capital gains tax rate. If you don’t qualify for the 0% rate and you have appreciated assets, your tax-planning options could involve transferring these investments to others. If you hold the assets for life, you could enable heirs to receive a step-up in basis. When they sell, they can avoid taxes on the gain the investments saw during your lifetime. Alternatively, you could donate the appreciated assets to a qualified charity or donor-advised fund, which may net you an immediate tax deduction. Since the charitable contribution is not subject to capital gains taxes, more of the value is preserved for the cause when the investments are sold. You may also want to consider doing a Roth conversion for time shifting taxes due on investment gains. Let’s say that over the years you’ve been contributing to tax-deferred retirement accounts. The usual course of action is to let these investments grow tax-free, and withdraw them in retirement when you expect to be in a lower tax bracket. But suppose your 2018 income is unusually low (e.g. you took unpaid leave). That—plus the generally lower rates of the tax reform bill—may mean you are subject to a low tax rate. This means that it may be to your advantage to convert some or all of your traditional retirement savings to Roth. It’s worth noting that in the past, investors had the option to change their minds and undo Roth conversions. With the new tax reform bill, however, Roth recharacterization is no longer permitted. 3. Shift your expenses to bunch your deductions. Investment gains and losses are not the only elements of the tax planning equation that can be time shifted. Delaying or accelerating other income and expenses is also a popular strategy. Examples include pushing bonuses to January, prepaying education expenses, and “bunching” itemized deductions. “Bunching” is the practice by which taxpayers consolidate as many deductible expenses as possible into a given year. The goal? To make the most of itemizing rather than taking the standard deduction. Historically, this meant controlling the timing of things like medical expenses, state and local taxes, mortgage interest, property taxes, and charitable giving. The new tax law is expected to change all of that since it nearly doubled the standard deduction. As a result, few will qualify to itemize going forward. Tax preparation may be simpler, but some taxpayers may end up owing more, including: Homeowners subject to new limitations on home mortgage interest deductions Residents with higher state and local tax rates, because the federal tax deduction for state and local taxes is now capped. Similarly, many miscellaneous itemized deductions have been disallowed. Bottom line: the benefit of bunching deductions has been severely curtailed. The exception, appropriately enough during this season of giving, is charitable contributions. Here, careful planning still has the potential to help ensure a happier holiday and tax time for you and the lucky recipient. Move quickly before the end of the year, but talk with a professional. It’s the most wonderful time of the year for income tax planning. But as we’ve seen, tax law changes, limitations, and interdependencies between provisions make it something of a tricky business. It’s crucial that you (or your tax advisor) run projections to help you see the intended benefits and quickly—like holiday sales, the window on this opportunity closes fast. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
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