Tax Planning

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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. -
If 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 ...
If 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.
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6 Tax Strategies That Will Have You Planning Ahead
6 Tax Strategies That Will Have You Planning Ahead Here are six tax tips you can follow now to help save money on your taxes now—and for years to come. Most people tend to think about taxes just once a year—usually March or April. But investors can save more in taxes each year by thinking ahead and strategizing about their taxes on an ongoing basis. Today, savvy investors aren’t beating the market day-to-day; instead, they’re focused on taking home more of their earnings by lowering taxes and fees across their portfolio. That means thinking about all of your tax-advantaged options—accounts you have now and selections you’ll make in the future—to make every move as tax-efficient as possible. You can think of accounts like IRAs, 401(k)s, 529 accounts, and HSAs as unique opportunities that if implemented strategically, can help you earn more over time. In this article, we’ll introduce six tax strategies that require ongoing planning, but if taken into consideration, can help you keep more of what you earn. 1. Shelter dividends in retirement accounts. By reorganizing your investments, you can shelter many dividends from being taxed. This strategy, called asset location, can not only reduce your annual tax bill, but also help to increase your after-tax investment returns. At Betterment, we have a service called Tax Coordination that does this automatically. It works by placing investments that are taxed more into traditional and Roth IRA accounts, which have big tax advantages. It places investments that are taxed less, such as municipal bonds, in your taxable accounts. This is a great way you can use your current investments to help reduce your taxes. Here’s a simple animation solely for illustrative purposes: Asset Location in Action 2. Start tax loss harvesting earlier. Another way to use your investments to help reduce your taxes is through tax loss harvesting. By selling investments at a loss, you can generate a tax deduction. You can use this deduction to offset other investment gains you earned during the year, or even to decrease your taxable income by up to $3,000. Most investors only view tax loss harvesting as a year-end strategy to get some last-minute deductions, and thus won’t be able to benefit from any other losses throughout the year. A better strategy to consider is monitoring your portfolio throughout the entire year for opportunities to harvest losses. This is especially effective if you are in a high tax bracket or have large capital gains this year. We automatically monitor for you on a daily basis here at Betterment if you use our Tax Loss Harvesting+ feature. 3. Contribute earlier to retirement accounts. It’s true that you have until each year’s tax filing date to contribute to your IRA for the previous year. However, if you’ve already maxed out your the previous year’s IRA contributions, consider maxing out this year’s IRA contributions as early in the year as possible—this can give you up to 15 extra months (January of this year to April of next year) in the market. Waiting until the last minute could cost you more than you think. In fact, funding your IRA in January every year could provide you with an average of $8,800 more over a ten-year period. So if you still haven’t funded your IRA for last year, consider doing it now instead of waiting until mid-April. 4. Execute Roth conversions in January, not December. A Roth conversion moves money from your traditional IRA to your Roth IRA and is sometimes referred to as a backdoor Roth IRA conversion. You may pay taxes when converting, but once inside your Roth IRA, future earnings and qualified withdrawals will be tax-free. You can convert your IRA at any point throughout the year, but most people wait until the last minute. Just like with procrastinating on your retirement account contributions, by waiting until December to convert, you’ll miss out on 11 months of potential tax-free growth. For this reason, consider doing your conversions early in the year to help maximize your tax-free growth. It may be worth speaking with a tax advisor if you’re worried about converting in January because you don’t have a clear enough picture of what your taxes for the year will look like, as the IRS recently removed the ability to undo Roth conversions. The tax code has been updated to reflect this change, which became effective January 1, 2018. This information is for educational purposes only and is not a substitute for the advice of a qualified tax advisor. Roth conversions can have significant tax implications and you should consult a tax professional to discuss any questions about your personal situation and whether a Roth conversion is right for you. 5. Put your tax refund to good use. If you’re like 72% of Americans, you receive a tax refund averaging around $2,825. That refund may sound great, but really that means, in this example, that you overpaid your taxes each month by about $236. That is money that could have been invested and growing for you throughout the year. To adjust how much money is withheld from each paycheck for taxes for the following year, you could consider resubmitting your Form W-4 to your employer. Making the change early in the year will allow it to take full effect, and filling it out properly can ensure the correct amount is taken out. The IRS has provided a Tax Withholding Estimator to help you set or adjust your W-4 to get your refund closer to $0 (meaning you aren’t giving Uncle Sam an interest free loan). Then, consider putting that money to work throughout the year. After adjusting your W-4, consider increasing your 401(k) contribution by that same amount. You won’t notice a difference in your paycheck, and that money will go toward your retirement instead of loaning it to the IRS. 6. Make tax-smart investment switches. You can likely benefit from reviewing your investment portfolio, but it’s important to minimize the tax consequences of making any adjustments. Rebalance your portfolio tax-efficiently. One example of a change you might consider is rebalancing your portfolio. Here’s how it works: As markets move up and down, your portfolio can drift away from its target allocation. Rebalancing allows you to realign the weight of stocks and bonds so that your asset allocation is appropriate for your goal’s time horizon. However, rebalancing by selling existing investments should generally be a last resort because this can cost you in taxes. Instead, consider using cash flows to rebalance; use new deposits, dividends you earn, and proceeds from tax loss harvesting to rebalance your portfolio on an ongoing basis. This will minimize the need to sell investments and thus can help reduce your taxes. At Betterment, we automate this entire process to help keep your portfolio properly balanced with every cash flow. Get out of high-cost investments. Another tax-smart change you might consider is getting out of high-cost investments. Look for losses you can use to offset any gains associated with swapping a high-cost fund for a low-cost one. Even if switching out of the high-cost fund will cause you taxes, consider doing a breakeven analysis to see if it still makes sense. For example, if selling a fund will cost you $1,000 in taxes, but you will save $500/year in fees, you can break even in just two years. If you plan to be invested for longer than that, it can still be a savvy investment move. Our calculator can help you with this decision. Rebalancing and reducing fees are both important, but make sure you don’t ignore taxes while executing these strategies. Think About It Now—And Later We all talk about tax season, but really, taxes are a topic we should think about throughout the year as we invest our savings. Sheltering your tax-inefficient investments in your retirement accounts can reduce dividend taxes and help keep more money in your pocket. Tax loss harvesting throughout the year, not just in December, can reduce your taxes and help increase your after-tax investment returns. Retirement contributions and conversions done early in the year are more effective because they allow your investments to grow for longer. Correcting your tax withholdings can allow you to save more throughout the year, instead of having to wait for your tax refund. Lastly, don’t ignore possible tax implications while rebalancing or adjusting your investment portfolio. Together, these strategies may significantly reduce your tax bill. And by automating them by using a service like Betterment, you can take advantage of these strategies without adding stress during tax season. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. -
What Is a Tax Advisor? Attributes to Look For
What Is a Tax Advisor? Attributes to Look For Since Betterment isn't a tax advisor, we often suggest that customers see a tax advisor regarding certain issues or decisions. Who exactly is a tax advisor and how should you think about picking one? Tax season is now upon us. Now that you’ve probably received all of your tax forms, you may be facing a choice for how to proceed with filing: do it yourself with tax software or hire a professional tax advisor? Although it certainly will be more expensive than using tax software, hiring a tax advisor makes sense for certain individuals, depending on their financial circumstances. Here are two important factors to consider when deciding if a tax advisor is right for you: Time: Even with tax software guiding you, filing your taxes yourself can be time consuming. You’ll need to make sure that you’ve entered or imported the data from your tax forms correctly, which often takes at least several hours, and your time is worth something. Complexity: The more complicated your financial situation, the more a tax advisor may be able to help you. Have partnership income, or income from an S corporation? Been subject to alternative minimum tax in past years? Received or exercised stock options this year? Tax software can handle these issues, but it will take time, and the risk of mistakes (and even an audit) increases. If you decide that your situation warrants professional assistance, some further questions are worth exploring: what exactly is a tax advisor and how should you think about picking one? Who counts as a tax advisor? Anyone with an IRS Prepare Tax Identification number (a “PTIN” for short) can be paid to file tax returns on behalf of others. But merely having a PTIN doesn’t tell you much about the tax preparer; tax preparers have different experience, skills, and expertise. What you really want is a tax advisor, a professional with a certification and experience level that qualifies her not only to prepare your return, but to use her knowledge of the tax code to provide advice on your financial situation. There are three different professional certifications to consider, each of which qualifies a tax advisor to practice with unlimited representation rights before the IRS. This means that in addition to preparing returns, they also are licensed to represent their clients on audits, payments and collection issues, and appeals. Certified Public Accountants (CPAs) CPAs have completed coursework in accounting, passed the Uniform CPA Examination, and are licensed by state boards of accountancy (which require that they meet experience and good character standards). Some, but not all, CPAs specialize in tax preparation and planning. You can find complaints about CPAs either by searching records with state boards of accountancy and at Better Business Bureaus. Enrolled Agents Enrolled agents are licensed by the Internal Revenue Service after they have passed a three-part examination and a background check. The IRS maintains complaints about enrolled agents on the website of its office for enrollment, and you can also find complaints on the National Association of Enrolled Agents website. Licensed Tax Attorneys Licensed attorneys have graduated from law school, passed a state bar exam, and are admitted to the bar in at least one state. Some, but not all, attorneys specialize in tax preparation and planning. Many tax attorneys have completed an additional year of law school study in a master’s program in tax (called a Tax LL.M. degree). Disciplinary actions against attorneys can be found by searching the state bar associations with which the attorney is registered. How to Select a Tax Advisor or Tax Consultant No tax advisor with one of the certifications described above is necessarily better than any of the others in all situations. Rather, what matters most is: How the advisor approaches the tax preparation process, including the specific experience the tax advisor has with issues relevant to your particular financial situation. Whether you feel comfortable with the tax advisor. How the advisor structures their fees. You may be able to screen potential advisors along several of these dimensions based on information you can find about them online; for others, an initial meeting will be critical to determine if the advisor is right for you. 1. Assess your confidence in the quality of a tax advisor's recommendations, as well as their experience. Here are a few specific factors to consider carefully when assessing the potential quality of a tax advisor's work. First, you should try to identify a tax advisor who will act ethically and with integrity. Before scheduling a meeting with a potential tax advisor, check to see if the advisor has been subject to any complaints, disciplinary actions, or other ethical infractions. When meeting with the advisor, be on the lookout for outlandish promises: if an advisor guarantees you a certain refund without having first looked at your returns, you should be wary (any promise that sounds too good to be true probably is). If the advisor suggests taking a position on a tax return that strikes you as overly aggressive (because it is not grounded in your actual financial situation) or if you simply do not understand something the advisor is saying, make sure to ask, and keep asking until you are satisfied with the answer. Having a tax advisor prepare your returns does not take away your responsibility for the accuracy of your tax return. Of course, an advisor who knowingly takes an improper position on a tax return will face consequences, but it is your return, and you can too. A good tax advisor also should provide more value than simply filling out your returns. She should help you to structure your finances in an optimal way from a tax perspective. Not every tax advisor has expertise with every nuance of the tax code, and so you’ll want to make sure that the advisor you select has significant experience with the particular issues for which you’re seeking expert advice. Of course, there are certain common issues that every good advisor should know: for example, how to maximize the value and efficacy of your charitable contributions, how to weigh the tax tradeoffs between renting and owning a home, or how to save money for or gift money to family members. For other less common situations, however, you’ll want an advisor with specific experience. If you own a business or are self-employed, if you work for a startup and own a significant number of stock options, or if some portion of your income is reported on a K-1 (because you are a partner in a business or own shares in an S corporation), you likely will be best served by finding an advisor who has worked with a significant number of clients with these tax issues. Finally, maintaining the security of your personal information is more important than ever these days, and the inputs for your taxes is some of the most sensitive information you have. There will always be some risk of data breaches, but a good tax advisor will take steps to safeguard your information. Make sure that you ask about how the tax advisor stores your personal information and what methods she uses to communicate with you regarding sensitive topics. You also should ask about whether the advisor has ever been subject to a data breach and what steps the advisor is taking to protect against future ones. 2. Assess your comfort level with the working relationship. You want to make sure you have a good rapport with your tax advisor, and that you feel like you understand each other. At your first meeting, make sure to bring three years’ worth of old tax returns for your advisor to review. Ask if you missed any deductions, and if your old returns raise any audit flags. Consider the advisor’s responses. Does the advisor seem willing to spend time with you to ask thorough questions to fully understand your situation? Or does she rush through in a way that makes you feel like she might be missing certain issues or nuances? Does the advisor explain herself in a way that is understandable to you, even though you don’t have a tax background? Or does the advisor leave you confused? A tax advisor may work by herself or be a member of a larger organization or practice. Each approach has its benefits and drawbacks. You can be sure that a solo practitioner will be the one who actually prepares your returns, but it may be harder to reach the advisor during the height of tax season, and the advisor may find it difficult to get a second opinion on tricky issues or issues outside her core areas of expertise. On the other hand, although the collective expertise of a larger practice may exceed that of even a very talented advisor practicing on her own, it may be more difficult to ensure that your return is prepared personally by your advisor. Finally, think about whether you want to work with a tax advisor who is already part of your social network, or who has been referred by a trusted family member or friend. On the one hand, having the seal of approval of someone you know and trust may help to assure you that the advisor is right for you. On the other hand, consider whether it will be harder to part ways with the advisor down the road if she fails to meet your standards. 3. Evaluate the cost of the tax advice. The final issue you’ll want to think about is cost. Tax preparation services are a low margin business (particularly with the competition that tax preparers face from low cost software), but you can expect to pay more for tax planning services or advice. The best cost structure is one where the tax advisor charges for her time or for the specific forms that the advisor completes and files. By paying for the advice itself and not a particular outcome, this cost arrangement properly aligns the incentives between your tax advisor and you. Be wary of compensation structures that create the potential for conflicts of interest between you and and your tax advisor. For example, some tax advisors may try to earn additional revenue from you by selling other services or financial products along with tax preparation. Ultimately, when it comes to cost, your goal should not be solely to minimize your combined out of pocket cost to the IRS and your advisor for this year’s tax return. Rather, you should take a longer term view, recognizing that good, personalized tax advice can help you to structure your financial life in a tax-efficient way that can pay dividends for years to come. -
How to Make a Tax-Smart Investment Switch
How to Make a Tax-Smart Investment Switch Calculate the value of realizing gains to move to a potentially better investment. A customer once called us to discuss moving significant assets from another provider to Betterment. He asked if he would have to pay a one-time tax cost to liquidate, and considering that cost, would the switch still be worth it? We thought we'd share with everyone a way to figure out the cost and benefits of switching. Depending on your particular circumstances, the answer is likely yes to both questions—selling off a long-established portfolio may trigger taxes, but in the long term, it can be worth it. As an example, you might want to move out of an actively managed mutual fund. Research has shown that a portfolio of actively managed funds is expected to underperform by 1.01% a year on average, after fees, compared to an all index-fund portfolio. Or perhaps you're interested in lowering your fees over the long term or diversifying your investments from a single stock to a multi-asset class portfolio. While nothing in this piece should be construed as tax advice, since individual circumstances can vary greatly, the following should serve as a general illustration of the cost and benefit of transitioning to a potentially better investment. Informed Trade-Offs The key here is making an informed trade-off—you may trigger a tax bill today by selling your current holdings, but if you're in it for the long haul, moving to a better portfolio consisting of all index ETFs should make up for that tax cost. The real question to ask yourself when looking to move your investments to Betterment is: How long do I intend to hold this investment for? If you’re a short-term investor and plan to hold assets for a couple of years, or less, there's not much to gain from transitioning to a more efficient portfolio (although it should be noted that under this scenario, you'll realize the capital gains very soon in any case.) And as a general rule, you should only consider moving appreciated investments that you've held for more than a year in order to qualify for long-term capital gains on liquidation. If your investments have not appreciated since you bought them, or if they are held in an IRA or 401(k), you can generally transition them tax-free.1 Tax Cost vs. Excessive Fees The process by which we pay tax versus fees on our investments subtly biases us to overestimate the impact of taxes, and underestimate the impact of fees. Fees are generally taken out of returns before they ever hit our accounts—it's money we never even see. Tax on realized capital gains is assessed for an entire year, and results in a clear and visible liability, paid out of funds that are already in your possession. It's no wonder that irrational tax aversion is a well-documented, widespread phenomenon, whereas millions of people unwittingly go on paying unnecessarily high fees year after year. Your key decision boils down to comparing the long-term benefit of switching to a potentially better investment and paying more upfront tax, versus staying put in a portfolio of less optimal investments with higher expenses (that might also be a drain on your time, which is worth something). It's also important to keep in mind that unless you gift or bequeath your portfolio, you will one day pay tax on these built-in gains. Tax deferral is worth something, but how much? The 3 Key Financial Drivers to Consider 1. You could be invested in better assets. Take a hard look at your investor returns in your current investments. Could they be better? If you’re invested in actively managed funds, you may be losing, on average, 1.01% in returns, compared to an all index-fund portfolio, research shows. Betterment’s portfolio is made up entirely of index-tracking ETFs. 2. Automation and good behavior drive returns. We automatically take care of maintaining your investments for you—including rebalancing, dividend reinvestment, diversifying, tax efficiency, free trades and more. If you’re handling your own investments, consider what you're missing (and also how you're spending your time.) We perform automatic, regular rebalancing, which is expected to add 0.4% to returns, on average; a global, diversified portfolio is expected to add 1.44% in returns as compared to a basic two-fund portfolio and the average Betterment customer has enjoyed a behavior gap that's narrower by 1.25% as compared to the average investor. All told, including the demonstrated benefit of index funds—these advantages are expected to contribute to returns over the long run. 3. If you're paying what a typical mutual fund charges, you could be paying much less in fees. The average expense ratio for a hybrid (stock and bond) mutual fund is 0.79%.2. Betterment’s underlying ETF portfolios have an average expense ratio of 0.06% to 0.17%, depending on your allocation. Note that the range is subject to change depending on current fund prices. Our management fee is either .25% or .40%, depending on your plan. Your all-in cost at Betterment is between 0.31% and 0.57%. As smart investors know, every basis point matters.3 Taxes are a cost, but generally a cost you'll eventually pay anyway. Meanwhile, the cost of being in a sub-optimal investment over the years can far outweigh any benefit of tax deferral. Need a second opinion? If you’re still not sure if transferring your taxable portfolio is worth the upfront costs, we can weigh in. If your taxable portfolio holds more than $250,000 in assets, stop stressing and simply reach out to our licensed transfer specialists at concierge@betterment.com. The team can review the specifics of your portfolio and provide you with a recommendation on how to best move—or not move—your assets to Betterment. 1 The discussion here only applies to taxable investment accounts. All types of IRAs (traditional and Roth) and 401(k)s don’t typically trigger taxes when rolling over from one provider to another. (An exception is converting from a traditional IRA to a Roth, which will trigger taxes. However, there are smart ways to lower these, too.) 2 2021 Investment Company Fact Book 3 We've updated our pricing structure since this article was published. Learn more at betterment.com/pricing. -
How Tax Impact Preview Works to Help Avoid Surprises
How Tax Impact Preview Works to Help Avoid Surprises Betterment continues to make investing more transparent and tax-efficient, and empowers you to make smarter financial decisions. Two words that don’t belong together: taxes and surprise. But all too often, a transaction made in your investment account has unexpected, costly consequences many months later. Selling securities has tax implications. Typically, these announce themselves the following year, when you get your tax statement. Today, we are changing that, with Tax Impact Preview. Betterment’s Tax Impact Preview feature provides a real-time tax estimate for a withdrawal or allocation change—before you confirm the transaction. Tax Impact Preview shows you exactly the information you should be focusing on to make an informed decision—potentially lowering your tax bill. Tax-Aware Investors Can Consider: Do the benefits outweigh the costs? Should I wait to avoid short-term capital gains? Is there another source of funds I could use that might have a lower or no tax impact? “Customers can become overly focused on short-term returns and change allocations or make withdrawals in reaction to fluctuations in the market,” says Alex Benke, CFP®, product manager for this new feature, “Tax Impact Preview will help these customers stay focused on the big picture and avoid unpleasant surprises on their tax bill.” Tax Impact Preview: An Industry First Betterment is the only investment platform to offer this kind of real-time tax information—and it joins a suite of tools which already helps investors minimize their taxes, including Tax Coordination™, Tax Loss Harvesting+, TaxMin, and more. Tax Impact Preview is available to all Betterment customers at no additional cost. Learn more about the suite of tax-efficiency features available for your portfolio. How It Works When you initiate a sale of securities (a withdrawal or allocation change), our algorithms first determine which ETFs to sell (rebalancing you in the process, by first selling the overweight components of your portfolio). Within each ETF, our lot selection algorithm, which we call TaxMin, will select the most tax-efficient lots, selling losses first, and short-term gains last. Transaction Timeline Table With Tax Impact Preview, you will now see an “Estimate tax impact” button when you initiate an allocation change or withdrawal, which will give you detailed estimates of expected gains and/or losses, breaking them down by short and long-term. Using this timely information, you can better decide if the tax result makes sense for you. If your transaction results in a net gain, we estimate the maximum tax you might owe. Why Estimated? The precise tax owed depends on many circumstances specific to you: not just your tax bracket, but also the presence of past and future capital gains or losses for the year across all of your investment accounts. We use the highest applicable rates, to give you an upper-bound estimate. You might ask—why are the gains and losses about to be realized not exact, even if the resulting tax is only an estimate? The gains and losses depend on the exact price that the various ETFs will sell at. If the estimate is done after market close, the prices are sure to move a bit by the time the market opens. Even during the day, a few minutes will pass between the preview and the trades, and prices will shift some, so the estimates will no longer be 100% accurate. Finally, while we are able to factor in wash sale implications from prior purchases in your Betterment account, the estimates could change substantially due to future purchases, and we do not factor in activity in non-Betterment accounts. That is why every number we show you, while useful, is an estimate. Tax Impact Preview is not tax advice, and you should consult a tax professional on how these estimates apply to your individual situation. Why You Should Avoid Short-Term Capital Gains Smart investors take every opportunity to defer a gain from short-term to long-term—it can make a substantive difference in the return from that investment. To demonstrate, let’s assume a long-term rate of 20% and a short-term rate of 40%. A $10,000 investment with a 10% return—or $1,000—will result in a $400 tax if you sell 360 days after you invested. But if you wait 370 days to sell, the tax will be only $200. That’s the difference between a 6% and 8% after-tax return. Until now, making the smart choice meant doing your own calculations for every trade you were about to make. This is the kind of stuff most people hate doing, and automation excels at, so we built it into our product. A Sample Scenario Betterment customer Jenny, 34, has been watching the recent market news and feels nervous about her "Build Wealth" goal, which has a balance of $95,290. She is currently at 90% stocks—the optimal allocation for an investor with more than a 20 year horizon. Jenny decides to temporarily move her allocation to 10% stocks to minimize her exposure to the roller coaster on Wall Street. What Jenny may not realize is that changing allocation will cost her very real money—in the form of a tax bill. And even if she suspects it, she cannot appreciate the extent of the cost. The taxes are abstract, but the anxiety from the rocky market is real. Before finalizing the allocation change, Jenny clicks “Estimate tax impact” and sees that she is about to realize $4,641 in capital gains, with $4,290 of that short-term, which could incur up to $2,304 in taxes if she goes through with the trades. Putting a real dollar cost on knee-jerk reactions to market volatility is exactly what we as investors need at the critical moment when we are about to deviate from our long-term plan. Market timing is not a good idea, and most of us know this. However, emotions can get the better of even the most sophisticated investors, and we can all use some help in making the right decisions. Smarter Design for Better Decisions, Lower Taxes We believe that unhelpful emotion can be mitigated by good product design, which emphasizes the right information at just the right time. For instance, we never show you the individual daily performance of the ETFs in your portfolio—you are more likely to see losses that way, even if your overall portfolio is up. Seeing losses causes stress, which leads to emotional behavior, which can hurt your long-term returns. And yet, every other investment platform shows you individual asset performance front and center. On the other hand, showing you the estimated tax impact of a transaction before you commit to it encourages better decisions, and yet nobody except Betterment shows you this information. This distinction is at the core of our mission. Building the perfect investment service is not just about a pretty web interface, or a slick mobile app (though these are nice too!). It means rethinking every convention from the ground up. We are very excited about Tax Impact Preview, because it’s already helping our customers make better choices, and lessen their tax burden. -
How to Estimate Your Tax Bracket When Investing
How to Estimate Your Tax Bracket When Investing Knowing your tax bracket opens up a huge number of planning opportunities that have the potential to save you taxes and increase your investment returns. If you’re an investor, knowing your tax bracket opens up a number of planning opportunities that can decrease your tax liability and increase your investment returns. Investing based on your tax bracket is something that good CPAs and financial advisors, including Betterment, do for customers. Because the IRS taxes different components of investment income (e.g., dividends, capital gains, retirement withdrawals) in different ways depending on your tax bracket, knowing your tax bracket is an important part of optimizing your investment strategy. In this article, I’ll show you how to estimate your tax bracket and begin making more strategic decisions about your investments with regards to your income taxes. First, what is a tax bracket? In the United States, federal income tax follows what policy experts call a progressive tax system. This means that people with higher incomes are generally subject to a higher tax rate than people with lower incomes. Currently there are seven different tax brackets, ranging from 10% up to 37%. Below are the 2021 federal tax brackets if you are single or married filing jointly. 2021 Federal Tax Brackets Taxable Income Bracket: Filing as Single Taxable Income Bracket: Filing as Married, Filing Jointly Tax Rate $0 to $9,950 $0 to $19,900 10% $9,951 to $40,525 $19,901 to $81,050 12% $40,526 to $86,375 $81,051 to $172,750 22% $86,376 to $164,925 $172,751 to $329,850 24% $164,926 to $209,425 $329,851 to $418,850 32% $209,426 to $523,600 $418,851 to $628,300 35% $523,601 or more $628,301 or more 37% For example, if you are single and have taxable income of $75,000 this year, you fall into the 22% tax bracket. However, that does not mean that all $75,000 of your income will be taxed at 22%. Instead, tax brackets apply to each portion of your income, building up like a staircase. Here’s a visual to help explain. U.S. Federal Tax Brackets for Single Filers If you are a single individual with a taxable income of $75,000, the first $9,950 of your income will be taxed at 10%, then dollars $9,951 - $40,525 will be taxed at 12%, and dollars $40,526 – $75,000 will be taxed at 22%. If your taxable income were to grow, then dollars $75,001 — $86,375 would still be taxed at 22%, but after that, the dollars would be taxed at higher tax rates. Filing status (single, married, head of household, etc.) also affects your tax bracket. See the tax brackets for each filing status. How difficult is it to estimate my tax bracket? Luckily, estimating your tax bracket is much easier than actually calculating your exact taxes, because U.S. tax brackets are fairly wide. Just look at the 22% tax bracket. If you are filing as single, any income between $40,526 and $86,375 falls within that same tax bracket. That’s a big margin of error for making an estimate. The wide tax brackets allow you to estimate your tax bracket fairly accurately even at the start of the year, before you know how big your bonus will be, or how much you will donate to charity. Of course, the more detailed you are in calculating your tax bracket, the more accurate your estimate will be. And if you are near the cutoff between one bracket and the next, you will want to be as precise as possible. How Do I Estimate My Tax Bracket? Estimating your tax bracket requires two main pieces of information: Your estimated annual income Tax deductions you expect to file These are the same pieces of information you or your accountant deals with every year when you file your taxes. Normally, if your personal situation has not changed very much from last year, the easiest way to estimate your tax bracket is to look at your last year’s tax return. However, with the passing of the Tax Cuts and Jobs Act in December 2017, a lot of the rules and brackets have changed. Thus, it is wise for most people to estimate their bracket by crunching new numbers. Estimating Your Tax Bracket with Last Year’s Tax Return If you expect your situation to be roughly similar to last year, then open up last year’s tax return. If you review Form 1040, you can see your taxable income on Page 2, Line 43, titled “Taxable Income.” As long as you don’t have any major changes in your income or personal situation this year, you can use that number as an estimate to find the appropriate tax bracket on the table above (or the full set of tables provided by the Tax Foundation). Estimating Your Tax Bracket by Predicting Income, Deductions, and Exemptions Estimating your bracket requires a bit more work if your personal situation has changed from last year. For example, if you got married, changed jobs, had a child or bought a house, those, and many more factors, can all affect your tax bracket. It’s important to point out that your taxable income, the number you need to estimate your tax bracket, is not the same as your gross income. The IRS generally allows you to reduce your gross income through various deductions, before arriving at your taxable income. When Betterment calculates your estimated tax bracket, we use the two factors above to arrive at your estimated taxable income. You can use the same process. 1. Add up your Income. Add up your income from all expected sources for the year. This includes salaries, bonuses, interest, business income, pensions, dividends and more. If you’re married, don’t forget to include your spouse’s income sources. 2. Subtract Your Deductions Tax deductions reduce your taxable income. Common examples include mortgage interest, property taxes and charity, but you can find a full list on Schedule A – Itemized Deductions. If you don’t know your deductions, or don’t expect to have very many, simply subtract the Standard Deduction instead. For 2020, the standard deduction is $12,400 if you are single, and $24,800 if you are married filing jointly. By default, Betterment assumes you take the standard deduction. If you know your actual deductions will be significantly higher than the standard deduction, you should not use this assumption when estimating your bracket, and our default estimation will likely be inaccurate. The number you arrive at after reducing your gross income by deductions and exemptions is called your taxable income. This is an estimate of the number that would go on line 11b of your 1040, and the number that determines your tax bracket. Look up this number on the appropriate tax bracket table and see where you land. Again, this is only an estimate. There are countless other factors that can affect your marginal tax bracket such as exclusions, phaseouts and the alternative minimum tax. But for planning purposes, this estimation is more than sufficient for most investors. If you have reason to think you need a more detailed calculation to help formulate your financial plan for the year, you can consult with a tax professional. How Can I Use My Tax Bracket to Optimize My Investment Options? Now that you have an estimate of your tax bracket, you can use that information in many aspects of your financial plan. Here are a few ways that Betterment uses a tax bracket estimate to give you better, more personalized advice. Tax-Loss Harvesting: This is a powerful strategy that seeks to use the ups/downs of your investments to save you taxes. However, it typically only makes sense if you are in the 22% tax bracket or higher. For those in the 10% & 12% tax brackets, capital gains are taxed differently, which could make this strategy not beneficial. Tax Coordination: This strategy reshuffles which investments you hold in which accounts to try to boost your after-tax returns. For the same reasons listed above, if you are in the 10% or 12% tax bracket, the benefits of this strategy are reduced significantly. Traditional vs. Roth Contributions: Choosing the proper retirement account to contribute to can also save you taxes both now and throughout your lifetime. Generally, if you expect to be in a higher tax bracket in the future, Roth accounts are best. If you expect to be in a lower tax bracket in the future, Traditional accounts are best. That’s why our automated retirement planning advice estimates your current tax bracket and where we expect you to be in the future, and uses that information to recommend which retirement accounts make the most sense for you.In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. Tax optimization is a critical part to your overall financial success, and knowing your tax bracket is a fundamental step toward optimizing your investment decisions. That’s why Betterment uses estimates of your bracket to recommend strategies tailored specifically to you. It’s just one way we partner with you to help maximize your money. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional. -
Tax Planning Happens Year Round, Not Just When You File
Tax Planning Happens Year Round, Not Just When You File Knowing how your investments affect your tax bill can help you save money not just when you file, but for years to come. Thinking about reducing your taxes may not be your favorite hobby, but the truth is that it can help you keep more of what you earn. While you can't control the stock market, you can control some of your tax obligations. To identify whether your long-term investment strategy is running efficiently, take a few minutes to review these year-round tax optimization tips. 1. Invest Your Tax Refund Would you have guessed that a smart place to invest your tax refund is in an IRA? Normally, investors might divert a portion of the refund into this account as part of a well-rounded investment strategy and claim the deductions on your taxes next year. Invest your refund, and you may get a portion of that back in tax savings. Stay in the habit of investing your refund as soon as you receive it, and over time you’ll feel good when you see your returns start to add up. The IRA contribution limits for 2020 and 2021 are the same. If you are under 50, you can contribute $6,000 to your Traditional or Roth IRA. If you are over 50, you can contribute $7,000 to your Traditional or Roth IRA. 2. Think Several Moves Ahead Investing is complex, and from time to time you might have to sell some of your investments. It might be to rebalance your portfolio, or maybe your goals have changed and your investments no longer match their intended purpose. Smart investors think ahead before blindly selling parts of their portfolio, because selling certain assets could potentially lead to capital gains taxes. By carefully choosing which investments to sell, you can help minimize hefty tax consequences. One way to do this is to partner with an investing company that has the tools to help make this process easy to access and understand. Here at Betterment, we are continuously rebalancing your portfolio as tax-efficiently as possible, using an automated method we call TaxMin. Further, our Tax Impact Preview tool lets you see the estimated potential taxes on a sale before making the trade. 3. Reorganize Your Investments Another way to potentially leverage small tax advantages for long-term growth is to organize your portfolio. Move tax-inefficient investments, like international stocks and other assets that are taxed at higher rates and more frequently, into a tax-deferred account, such as an IRA or a Roth IRA. That way, you can enjoy the potential for higher growth while also facing less of a tax burden. Similarly, you can also move tax-efficient assets, such as municipal bonds, into taxable accounts. For further guidance, we’ve outlined the tax implications that accompany each type of investment account. As part of your reorganization efforts, you may want to consider setting up Tax Coordination, which allows us to optimize this practice of asset location for you. 4. Benefit from Losses It’s never fun to watch your assets lose value, but did you know that in some cases, losses can actually benefit you? You can receive a tax deduction for your losses that can help cancel out the taxes you owe on assets that have gained value, or, you can use up to $3,000 worth of realized losses per year to lower your income—and excess losses can even be carried forward. The practice of selling assets that are currently at a loss in order to reduce your overall tax liability is called tax loss harvesting. You may want to consider our Tax Loss Harvesting+ feature (TLH+), which allows Betterment to automatically capture losses as the market fluctuates at the flip of a switch. Smart investors should always remember that investments involve risk and may result in loss. 5. Give to a Worthy Cause While it’s important to secure your own financial future, many investors see community support as an important additional goal. Consider donating to a nonprofit organization in your community. Not only are you helping to improve the quality of life in your locale, you can potentially claim a deduction from your income taxes. Fortunately, it sometimes can pay to do the right thing. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional for more information. -
Taking Time Off From Work Can Be A Secret Tax Opportunity
Taking 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. -
Put Your Tax Refund To Work—We’ll Show You How
Put 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. -
If You Live In Pennsylvania, These Tax Rules Might Help You Save On Taxes
If 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. -
State and Local Taxes Affect Your Wallet
State 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 December
3 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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