All too often, taxpayers focus on only whether they get a refund or have to make a payment on April 15th. However, at this point there is little or nothing you can do to change your tax situation. Proper tax planning in advance, annually or even projecting out many years, is the best way to beat the tax trap.
Understanding your tax situation includes knowing the types of deductions and credits you are entitled to, but also investigating how potential future transactions can affect your taxes. Your marginal tax rate is an important figure to understand in order to plan for such events, because it translates into the tax impact of many of your financial decisions. Knowing your marginal tax rate can help you decide how to structure your investments, insurance, and even estate plan.
Capital Gains Marginal tax brackets also correspond with the eligibility of tax deductions and credits. For example, taxpayers in a tax bracket of 15% or lower pay no capital gains taxes in 2009. This can be a significant opportunity if you have long-term capital assets that have appreciated in value over the years. By selling or rebalancing them while this tax rule is in place you could avoid taxes on them altogether.
Annuities Along those lines, the recent surge in deferred annuity sales indicates investors are lured by the promises of tax advantages and guaranteed returns of annuity products. Interestingly enough, a Gallup Organization/Mathew Greenwald & Associates poll projects that about half of all annuity owners are in the 15% marginal tax bracket or less, who are not subject to capital gains and dividend taxes anyways. Generally, we recommend tax-deferred annuities only for those taxpayers in the top marginal tax brackets who have exhausted all other tax favorable investing options. While there can be tax advantages of annuities the restrictions and extra costs sometimes outweigh the tax benefits of them.
Individual Retirement Accounts A more economical and flexible route than an annuity may be a non-deductible traditional IRA. Investors in higher tax brackets often overlook the tax deferral benefits of the IRA, if they cannot get the immediate deduction in the year of the contribution. This can be a lost opportunity when it comes to planning for retirement and maintaining a tax diverse asset profile.
The Roth IRA strategy is perhaps the most debated tax opportunity for investors. The math tells you that if you are in the same marginal tax bracket when you contribute and withdraw the funds, the Traditional and Roth IRA will yield the same result. With that being said, most experts agree that taxes will have to increase in the future in order to pay for government deficits. But, does that translate into a higher marginal rate for you? Unfortunately, this question cannot be answered with certainty until later in your life.
But, for now you can plan to create a retirement portfolio that optimizes taxes while maintaining flexibility for the unknown ahead. Contact our office to learn more and discuss your unique circumstances.