Taking Taxes Into Account When Saving & Investing

How many of us save and invest with an eye on tax implications? Not that many of us, according to a recent survey from Russell Investments. In the opening quarter of 2014, Russell polled financial services professionals and asked them how many of their clients had inquired about tax-sensitive investment strategies.

Just 35 percent of the polled financial professionals reported clients wanting information about them, and just 18 percent said their clients proactively wanted to discuss the matter.

Given some of the tax policies that went into effect in 2014, tax sensitivity has become an increasingly real issue. Whether you are in a phase where you are building wealth or a phase where you are working to preserve it, equal consideration should be given to the following key tax-saving strategies that may reduce future tax bills while allowing you to retain more after-tax wealth.

End-of-year planning presents an ideal time to address tax matters. The problem is that your time frame can be pretty short once December rolls around. You can’t always pull off that year-end charitable donation, gift of appreciated securities or extra retirement plan contribution. Sometimes your financial situation or sheer logistics get in the way.

It is better to think about these things before the holiday season, or even better, year-round.

Think about taxes as you contribute to your retirement accounts. Do you contribute to a qualified retirement plan at work? In doing so, you can lower your taxable income and your yearly tax liability. Why? Those contributions are made with pre-tax dollars. In 2014, you can contribute up to $17,500 to a 401(k), 403(b) or a 457 plan. If you are 50 or older this year, you can contribute an additional $5,500 for a total of $23,000. The same is true for most 457 plans.

Location matters when it comes to taxes in retirement. If you are wealthy and plan to retire in a state like California with high personal income tax rates, a Roth IRA may start to look pretty good versus a traditional IRA. Withdrawals from a Roth IRA aren’t taxed because contributions are made with after-tax dollars. Distributions from a traditional IRA in retirement will be taxed.

What capital gains tax rate will you face on a particular investment? In 2013 the long-term capital gains tax rate became 20 percent for high earners, up from 15 percent. On top of that, the Affordable Care Act Surtax of 3.8 percent effectively took the long-term capital gains tax rate to 23.8 percent for investors earning more than $200,000.

Even greater capital gains taxes can actually be levied in some cases. Take the case of real estate depreciation. If you sell real property that you have depreciated, part of your gain will be taxed at 25 percent.

Lastly, if you sell an asset you’ve held for less than a year, the money you realize from that sale will be taxed at the short-term rate (i.e., regular income), which could be as high as 39.6 percent.

Are you deducting all you can? Taxpayers do not always notice the mortgage interest deduction. Itemizing can be a pain, but if you itemize your deductions you will be able to also deduct the interest you pay on your home mortgage on loans up to $1.1 million.

Note: SEIA does not provide tax advice and should not be relied upon for counsel on tax matters.  You should consult with a tax professional.