How to Get the Most out of Your Tax Plan

Time the think about your tax plan. With the April 18th deadline to file your taxes fast approaching (thanks to Good Friday for the extra time), you’re likely ready to be done with thinking about taxes altogether. Another year to pretend the worst of our Nation's holidays isn’t swinging around to get us again. But even as you file last year’s tax return, it’s not too early to start planning for next April. Yes, plan. With some extra knowledge and help from a professional financial advisor, you can make a plan that takes advantage of strategies that can save you money — and headaches. The strategies that follow aren’t all going to work for every individual’s or family’s goals. Even with tips you read on the NEST blog, it’s important to remember that just because it sounds good doesn’t mean that it’s necessarily the right choice for you.And if you’re an entrepreneur or business owner, you might actually have access to even more tax-advantaged strategies. If you’re unsure of exactly which would work for you, your family, or your business, you should meet with NEST’s financial advisor to discuss tax planning strategies that meet your unique needs and goals.With that in mind, here are a few strategies for reducing or deferring your taxes to consider as you build a more tax-efficient financial plan. 

Using long-term gains and the 0% tax rate

If you fall within the 15% tax bracket, your long-term capital gains are tax-free. Holding onto taxable assets for longer periods could be beneficial in this situation. Always monitor your holding periods and consider potential tax liabilities as you decide whether to sell or hold investments.   

Tax-loss Harvesting

Tax-loss harvesting is “the timely selling of securities at a loss in order to offset the amount of capital gains tax due on the sale of other securities at a profit.”Here’s how it works: You sell investments at a loss, then you can deduct those losses on your taxes. Doing this can offset some or all of the gains taxes owed on other investments you sold at a profit.You then replace the asset you sold to offset those taxes with something similar. This allows you to maintain your diversified portfolio’s asset allocation and preserve your anticipated risk and return levels. Usually, harvesting is done in November or December, but it can be done anytime in the year before that as well. A few things to know:

1. Tax-loss harvesting only applies to investments stored in taxable accounts (i.e. not 401(k)s, IRAs, 529s, etc.)
2. It doesn’t work as well if you’re in a lower tax bracket
3. Harvesting for a given year must be done by the end of the calendar year, not the tax-filing deadline
4. It’s limited to $1,500 to $3,000 a year

Making IRA contributions

Unlike tax-loss harvesting, IRA contributions can be made for a given year until the April 15 deadline for filing your income taxes. This applies to both Roth and traditional IRAs. Contributing pre-tax dollars to a traditional IRA lowers your adjusted gross income by a dollar-for-dollar amount, potentially putting you into a lower tax bracket. And while Roth IRAs are funded with income that has already been taxed, when you withdraw the funds from the account (after you retire), you won’t have to pay income taxes on the funds. A combination of contributing to both types can reduce your tax bill now and down the line. Of course, there are limits to how much you can and who is able to contribute to IRAs, so make sure you are eligible before making IRAs part of your tax plan.    

Using the "backdoor" Roth

People at any income level can contribute to a traditional IRA, but those with an AGI over the limit (which is in the lower 6-figures) are ineligible to open and contribute to a Roth IRA. But, since 2010, the IRS hasn’t had income limits on who can convert a traditional IRA to a Roth IRA. Thus, the “backdoor.”People with incomes over the threshold can still make contributions to a traditional IRA using taxed income, and then convert it to a Roth. Since it’s funded with post-tax income, you won’t have to pay taxes when you withdraw the funds. You will, however, still pay taxes on any growth in the account between contribution and conversion from the traditional IRA.Because of this, the backdoor Roth IRA has become a useful tax planning tool for higher income earners. It’s worth noting that contributions on backdoor Roth IRAs retain the same limits as traditional IRAs. 

Exploring tax-deferred vehicles

No, I’m not talking about the car sitting in your driveway. I’m talking about vehicles like IRAs, 401(k)s that allow you to defer paying taxes on them until a later designated period. Tax-deferred vehicles can be either qualified, such as 401(k)s, or nonqualified, like Roth IRAs. This means they are funded pre-tax, as in the former, or post-tax, as in the later. Either way, by deferring taxes on dividends, interest, and capital gains, you get the triple compounding effect: 

1. Interest on the principle
2. Interest on the interest 
3. Interest on the taxes that you would have paid on an annually taxed investment

So, this year – or any year for that matter – don't wait until the end of the year to think about what you could've done to save on your tax return. Creating an optimal tax planning strategy that works for you depends on a number of factors as well as your personal or business goals. So, why not connect with our financial planning professionals by scheduling a no-obligation call? At NEST, we have the expertise, experience, and passion to help you make sure your finances work for you as hard as you work for them. 

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