When it comes to your money, it’s not what you earn, it’s what you keep. Recent tax reform has made it easier to save money using certain strategies. Here are some ideas for 2018 that may help you keep more of your income in the long-run.
Consider a 529 Education Plan for K-12 and College Expenses
The recent tax reform produced a significant change regarding saving money for education expenses. Now, you are able to use money from a 529 account to pay for private school for your child in K-12 grade levels in addition to qualified college expenses.
One advantage of using a 529 plan is tax-free compounding since investment earnings in the account grow and won’t be taxed until you withdraw the funds. Additionally, taxpayers will be able to withdraw up to $10,000 per year tax-free for these expenses.
Another potential benefit is that over 30 states allow income tax deductions or credits when making 529 plan contributions. Alabama is currently one of these states. However, it is unclear whether amendments to current 529 plan state tax laws will be proposed, so that will be something to watch.
Invest for the long-term
Generally, income isn’t taxed until it is received, so you may find it beneficial to delay realizing gains by investing for the long-term. Try to hold an asset for more than a year; that way, earnings will be taxed at the lower long-term capital gains tax rate – 0%, 15% or 20%, depending on your tax bracket in 2018. If assets are held for a year or less, earnings are considered short-term capital gains and are taxed at ordinary income rates, which can be as high as 37% (that’s down from 39.6% under the old tax law).
You may be able to invest for the long-term and still receive current income from your investment in the form of dividends. If you receive “qualified” dividends, they are taxed at long-term capital gains rates, as long as you meet the holding period requirement. Generally, “qualified” dividends are those paid by domestic corporations or by foreign corporations whose stocks trade on an established U.S. stock exchange. Nonqualified dividends are taxed like short-term capital gains at your ordinary income tax rate.
Consider taxable versus tax-deferred vehicles
Another key to tax efficiency is the location of assets. You may want to keep investments that produce current income in a tax-deferred account, like an Individual Retirement Account (IRA), and hold investments that produce long-term gains or tax-free income in a taxable account. For example, you can hold corporate bonds and dividend-paying stock in an IRA, so you can defer paying taxes until distribution. Likewise, you can keep growth stock and municipal bonds in a non-retirement brokerage account to get long-term capital gain treatment on the stock and tax-free treatment on the municipal bond interest.
Tax-efficient distributions are also important. Distributions from traditional IRAs are taxable, and qualified distributions from Roth IRAs are tax-free. If you have more assets in traditional IRAs, you may consider converting some of those assets into a Roth IRA in a year in which you may have lower taxable income or when tax rates are low. Income limitations for Roth conversions no longer apply. Keep in mind, however, that tax reform no longer allows you to recharacterize, or undo, a Roth conversion so it’s wise to consult your tax advisor before deciding on this permanent transaction.
Finally, during retirement, you can choose from which vehicles you withdraw money (traditional IRA, Roth IRA, variable annuities, or non-retirement brokerage accounts) to keep from going into a higher tax bracket.
Tax Planning Advice
It’s always a good idea to consult a tax or legal professional about your own personal situation when considering various tax strategies. Additionally, having a financial advisor that understands how your investments may impact your income tax liability is extremely important. If I can help evaluate your investment strategy and whether it’s tax-efficient, please let me know. I would be happy to help!
This material has been provided for general informational purposes only and does not constitute either tax or legal advice.
This content originally appeared in the March issue of Hills & Castles magazine.