Though no one can predict the ultimate outcome of political campaigns and debates or control exactly how such events will impact a portfolio, there are several proactive tax planning strategies you can leverage to help protect and grow the value of your wealth.
These tips, poised for those who have end-of-year planning on their minds, will serve to guide your efforts and help you remain confident in your approach—regardless of potential policy changes that may develop over the near- or long-term.
Strategize your asset allocation
Tax planning for maximum benefit is one of the few aspects of investing you can control.
First things first: Max out your contributions to individual retirement accounts (IRAs) and 401(k)s, where investments can grow, tax-deferred.
Second, stack your tax-advantaged accounts with those investments that generate the most taxable income to offset their tax impact: Think stocks you’ll hold for the short-term and sell at a profit, taxable bonds, REITs, narrowly focused equity index funds, and most actively managed funds.
Other assets—such as individual stocks you hold for the long-term, municipal bonds, tax-managed funds, or broad market stock index funds—may fare best when held in taxable accounts. For example, long-term capital gains on the sale of a stock may be subject to a lower tax rate in a taxable account compared to the higher ordinary income tax rate that would apply if the same asset were placed in a tax-advantaged account such as an IRA.
Time when you buy, sell—and gift
In building an effective tax strategy, timing is key. Before you buy or sell any asset, consider the potential tax liabilities your actions could trigger for that year. If you plan to invest in mutual funds, for example, confirm the date the fund will distribute dividends—the value of shares will fall by the amount paid on that day. Savvy investors will want to wait to buy until after the payout happens so you’ll secure a lower price… and avoid the tax bill.
If you would like to sell stocks you’ve bought at different points in time, specify precisely which shares to sell so you’re not at the mercy of the “first in, first out” valuation, which may leave you subject to unintended taxes on short-term capital gains.
Aiming to gift your wealth to charity at year-end? Donate appreciated stock or mutual funds you’ve owned for more than a year, instead of cash. You’ll benefit from a charitable deduction equal to the fair market value of the security on the date you execute the gift—and you won’t pay taxes on the profit. If you own stocks or funds that could potentially allow you to claim capital losses, don’t donate stocks or fund shares. Instead, sell the asset so you can reap the tax benefits of the capital loss and donate cash to the charity.
Received a large bonus or have a significant amount of wealth you’ve earmarked for philanthropic purposes? A donor-advised fund (DAF) can manage tax liability and maximize the value of your charitable contributions over time. You can take the maximum deduction allowed in the year the donation is made, contributions to the DAF can be invested and grow tax-free, and you are empowered to allocate the money to charities of your choice over a period of time.
Leverage Your Health Savings Accounts
Health savings accounts often come under fire in political debates as a tool that benefits mostly high-income earners. If, however, you are eligible to contribute to an HSA because you have self-only coverage in a high deductible insurance plan, these vehicles are a triple-threat tax-efficient tool that can reduce your pre-tax income, allow you to grow money tax-deferred, and serve as a source for tax-free withdrawals to pay for qualified medical expenses.
Those eligible for an HSA can contribute up to $3,400 in pre-tax money in 2017 (or $6,750 for family coverage) to a tax-sheltered health savings account each year until age 55—at which point you can contribute an additional $1,000 a year for catch-up contributions. Withdrawals for qualified health care needs are tax-free and you can use the money to offset the costs of healthcare in retirement.
Wealth Building: A Family Affair
If you have children who are old enough to work and you own a business, you could reap tax benefits for your entire family by adding them to your staff. Not only can you deduct their pay to potentially reduce your own income, the “kiddie tax” applied to interest, dividends and capital gains associated with children under the age of 19 or college students under the age of 24 isn’t a factor because the child has earned the income him or herself. Plus, employees under the age of 18 aren’t required to pay Social Security tax on their earnings but can contribute income to an IRA.
If you plan to pay for your child’s college education, you and your spouse can also take advantage of the tax benefits inherent to your Roth account. Assuming you both contribute to your respective Roth accounts each year to fund future college tuition, the total amount of your contributions—less interest earned—can be withdrawn tax- and penalty-free to pay for qualified higher education-related expenses once your child is college-ready.
While certain tax planning strategies may become more or less popular over time as a result of developments in Washington, these concepts should be applied over the course of the year to ensure you are maximizing your opportunity for tax-advantaged wealth preservation.