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2016 Year-End Tax-Saving Strategies:
Maximizing Your Investments & Retirement Income
with Tax-Advantaged Planning
As the holiday season has quickly descended on us, so will a new tax-filing season. Have you
thought about the numerous effective tax-saving strategies you can deploy at year’s end?
Ensuring that you get to keep as much of your hard-earned money as possible instead of writing
a massive check to the government is one of the primary objectives of year-end tax plans.
Reviewing your use of qualified tax-deferred and tax-free accounts (both retirement assets and
non-retirement tax-deferred accounts, such as health savings accounts and educational savings
plans) should be part of your year-end financial checkup according to your financial goals and
priorities.
Considering the tax implications of your investments can be particularly crucial as you consider
your retirement assets. The Social Security Administration estimates that Social Security benefits
account for only 40% of retirees’ income1 and that personal savings accounts, such as IRAs and
401(k)s, will need to make up for the shortfall. Whether you are approaching retirement and
preparing to make the most of your final working years or have transitioned into retirement and
are drawing income from your investments, it’s prudent to take advantage of tax laws to keep as
much of your assets as possible. In doing so, you can both maximize what you keep for your
annual tax filing and enhance your long-term earning potential by considering new, taxadvantaged strategies, as we will explore within this white paper.
TAX-EFFICIENT INVESTMENT STRATEGIES
Your investments can fall into three essential tax categories: taxable, tax deferred, and tax free.
• Taxable accounts, also known as after-tax or non-qualified accounts, may include
personal savings, money markets, CDs, and brokerage accounts. These accounts generate
a 1099 or 1040 each year to show interest and capital gains and losses for your annual
taxes.
• Tax-deferred accounts may include traditional retirement accounts (IRAs, 401(k)s,
403(b)s, etc.) that are pre-tax dollars. This category also includes any kind of annuity,
whether it is a qualified or non-qualified account. Taxes are deferred on these accounts
until they are withdrawn from the account.
• Tax-free accounts may include municipal bonds, Roth IRAs, and life insurance benefits,
which can provide tax-free payouts.
Knowing how to fully utilize these types of investments can not only create significant tax
savings but also help you accomplish anything, from paying off your mortgage early to leaving a
legacy to provide for generations to come.
1. Consider a Roth IRA conversion.
In 2016, if your income exceeds $117,000 if you’re single or $184,000 if you’re married,2 you
are not eligible to contribute to a Roth IRA; however, there are currently no income limitations
or caps on how much you can convert to Roth. While legislation has been proposed in recent
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years to eliminate this conversion option—sometimes known as a “backdoor Roth conversion”—
under current law, a conversion allows you to pay income tax today on any amount converted so
that future growth and distributions will be tax free. As a part of your annual review, weighing
the pros, cons, and options of Roth conversion is often worth revisiting each year.
The future tax rates over the span of your retirement are one of the big unknowns in financial
planning; however, with a national debt nearing $20 trillion, many Americans are concerned that
rates have nowhere to go but up over the next several decades. To help remove this
consideration, converting your traditional IRA to a Roth could also be an efficient strategy.
When you convert your traditional IRA to a Roth, you will have to pay income tax at current tax
rates now, in exchange for tax-free growth in the future.
A common misconception about IRA conversions is that you need to convert your entire
balance. However, you can also utilize a multi-year conversion strategy by converting just
enough of the balance over the years until all or most of your traditional IRA balance has been
converted while you remain in your current tax bracket. Even if you have to pay additional taxes
throughout single or multi-year conversion, this move could potentially save thousands in taxes
during retirement.
2. Harvest capital losses on your investments and use them to your advantage.
Even though after-tax investment accounts are the least tax-advantaged option of the three, they
can provide an important role in a comprehensive financial plan. What they lack in tax benefits,
they often provide fewer restrictions and penalties for accessing the funds, which usually means
more liquidity than with tax-deferred and tax-free accounts.
That said, what are the tax considerations and opportunities of these accounts? Contributions are
not tax deductible, and earnings of interest and dividends are taxed in the current year they are
earned, regardless of whether they are reinvested. However, they do have some benefits you may
be able to utilize. For instance, they are free from penalties so you can cash them out at any time,
regardless of age and circumstances, and the same benefits will apply.
You may have capital losses to harvest in your brokerage accounts, as well as long-term capital
gains and qualified dividends that are subject to preferential tax rates. Depending on how your
investments are allocated, you may be able to take advantage of cashing in on appreciated assets
by netting them with your losses on the assets that didn’t perform so well and worthless
securities. Under normal circumstances, capital losses can be deducted up to only $3,000 per
year from your income. Any excess amount above that threshold can then be carried forward
until the balance is empty.
However, if you cash out assets that produced a loss in the same year as assets that significantly
appreciated, then you can net the loss with your capital gains. This is often referred to as tax-loss
harvesting because you can reap a great deal of benefits—that is, you not only get maximum
utility from capital losses but also avoid capital gains tax, net investment income tax (NIIT), and
being placed into a higher tax bracket.
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3. Avoid significant penalties by taking your required minimum distributions (RMDs) if
you are age 70.5 or older and own traditional retirement accounts.
If your retirement assets are parked in tax-deferred qualified plans, those assets can’t sit there
growing infinitely. You will need to start making withdrawals called RMDs3 after you reach age
70.5. With the oldest of the baby boomer generation reaching this landmark age, this will be a
new and important consideration for many.
RMDs are the absolute minimum you must take out from your tax-deferred retirement accounts
every year. The RMD calculation is based on last year’s ending account balance of all qualified
assets and a distribution period in the IRS’s Uniform Lifetime Table.
You must start taking distributions by April 1 of the year following the calendar year in which
you turn 70.5 if you have a traditional IRA. For defined-contribution plans, like 401(k)s and
403(b)s, you must take distributions according to the later of the two following scenarios: (1) by
April 1 of the year following the calendar year in which you turn 70.5 or (2) in some instances,
once you officially retire, if you are still actively employed by the plan’s provider. Plan terms
may vary, so be sure to speak with a financial professional or your plan provider to understand
the rules as they pertain to your situation.
The percentage of these accounts you are required to withdraw to meet RMDs also increases
every year thereafter, in some cases surpassing the amount of income you may need to take from
your investments otherwise. This factor is considerable if you have a large portion of your assets
in qualified retirement accounts, as you may find yourself forced to liquidate your retirement
assets at inconvenient times if your financial plan does not proactively anticipate them.
If you do not have your RMDs correctly calculated and distributed each year, you will be
required to pay a 50% excise tax on the entire or remaining RMD amount that was not
withdrawn from the account, above and beyond the income tax that will be due upon the
withdrawal. Other than those distributions in their first year of RMDs, this deadline is December
31 each year. If this is your first RMD and you choose to wait until April 1 next year, you will
also need to take an RMD for 2017 by December 31. This doubling up may be significant
enough to bump your tax bracket, so waiting until next year may not be in your best interest.
Another potential advantage or consideration for Roth conversions is that Roth accounts do not
require minimum distributions during the lifetime of the owner, as taxes have already been paid
on these accounts. It is not until Roth accounts pass on to beneficiaries that distributions may
become required, as they cannot grow indefinitely in their tax-free status for multiple
generations. You can take certain steps to extend their tax-free benefits for future generations.
Discuss them with your financial professional if this legacy planning is important to you.
4. Make catch-up contributions to your retirement plans and other tax-deferred plans if
you can.
While you can’t make contributions to traditional IRAs after age 70, you can make catch-up
contributions to your Roth IRA as long as you continue to have earned income. Regardless of
what plan type you have, you need to be mindful of the annual contribution limits.4
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In 2016, for Roth and traditional IRAs, you can contribute up to $5,500 per year ($6,500 if
you’re 50 or older.) 401(k)s have a contribution limit of up to $18,000 per year ($24,000 if
you’re 50 or older). You actually have until April 2017 to make these contributions if you need
to organize your finances first. However, putting off these contributions may mean lost earning
potential if dollars are waiting on the sidelines, so procrastination may not be in your best
interest.
Health savings accounts (HSAs) are another tax-advantaged account that may be worth
considering to fund annual contributions toward future medical costs. The 2016 annual limit is
$3,350 for individual plans and $6,750 for family plans, with an extra $1,000 if you are 55 or
older.5 So long as you use these funds for qualified medical bills over time, the money will
continue to grow tax free. Once you turn 65, you can withdraw any of the funds without penalty.
5. Self-employment after 65 and state-level tax benefits are bringing interesting changes to
retiree taxes.
Whether it’s out of economic necessity or passion for what they do for a living, 2016 has shown
that more people over the age of 65 are still working than during the pre-Medicare days.
According to the US Bureau of Labor, 27% of baby boomers are estimated to keep working as
long as they can, while 12% say they plan never to retire.6 With the onslaught of the freelance
revolution and having more time to act on their passions, more baby boomers are taking up selfemployment. Subsequently, they can deduct Medicare premiums by using the self-employed
health insurance adjustment deduction instead of taking an itemized deduction. This move
reduces adjusted gross income (AGI), which is more beneficial than taking an itemized
deduction because it will affect both federal and state tax benefits that hinge on AGI.
If you expect to spend more time volunteering during retirement, you can’t take a deduction for
the value of your time (such as providing legal services to a charity). However, take note of your
personal expenses, including travel, because this is a deduction that has potential to become
substantial.
You also need to pay attention to your state tax benefits. While there are no adjustments for longterm care premiums on the federal level, some states, such as New York, offer this benefit. States
such as Pennsylvania also fully exempt retirement income, while New York exempts the first
$20,000 of retirement income.
GIFTING STRATEGIES
It’s the season for giving, and you’re likely thinking of your loved ones, as well as causes you
support when pulling out your checkbook. Whether you want to save for your grandchildren’s
education or leave a legacy to a charity that you care about, there are many tax-advantaged ways
you can make a gift that keeps on giving.
1. Consider donor-advised funds.
Donor-advised funds (DAFs) are another tax-advantaged account that may be worth considering
for the charitably inclined. RenPSG Philanthropic Solutions Group compares these accounts as
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somewhat similar to the structure of HSAs; instead of letting funds perpetually grow so they can
be used to pay for qualified medical expenses, the funds withdrawn from DAFs are used to
donate to charities.7
DAFs are maintained by qualified public charities and created when donors want to make
substantial gifts. This way, the donor gets an immediate tax deduction (including the avoidance
of capital gains tax on highly appreciated assets, since the deduction is taken at fair market value
and not the purchase price) and the ability to make grant recommendations.
What makes DAFs unique compared to just setting up a gift plan or recurring donation with the
charity of your choice is that the ability to make grant recommendations continues throughout
not only the rest of your life but also future generations. If you want your children and
grandchildren to embrace the power of charitable giving and teach them these responsibilities,
DAFs may be an excellent fit for your gift strategy.
2. Donate through your retirement assets to make your RMDs.
Thanks to the Protecting Americans from Tax Hikes Act of 2015, the rules regarding qualified
charitable distributions (QCDs) have become permanent and enabled this strategy to help IRA
owners with proactive giving for years to come.
QCDs are payments made directly to charities (they cannot be paid to you or any other
beneficiaries) that help satisfy your RMD obligations if you don’t wish to withdraw the entirety
of your RMD.
In addition to being paid directly to the charity, there are a few other restrictions on QCDs. Only
gifts to public charities are allowable, so you can’t designate your QCDs to private foundations,
DAFs, or charitable trusts. You must be at least 70.5 years old to arrange for a QCD with a
maximum of $100,000 per year. This limit is on a per-taxpayer basis, so if you have multiple
IRAs, the limit is $100,000 regardless of which account the QCD is coming from. This strategy
also applies only to IRAs, not employer retirement plans.8
QCDs are an efficient way of helping charities you support because the charities receive all the
funds. In addition, even though you don’t get a charitable deduction, you don’t have to include
the QCD in your income, as you would if it were a normal RMD.
3. Be mindful of the gift limits for 2016 and 2017, as well as what constitutes a taxable gift,
to avoid paying the gift tax.
In 2016, you can give a gift of up to $14,000 to any individual throughout the year without
incurring gift tax.9 Taxable gifts are primarily cash and goods given to the intended person. The
only exception to this is your spouse; you can give unlimited gifts to one another because
married taxpayers are considered to be a singular taxpaying unit. If you want to make a large gift
to one individual and you are married, you can also make a gift-splitting election to avoid the gift
tax if your gift happens to be under $28,000.
Medical and educational expenses, however, are not considered taxable gifts, provided that the
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institutions are paid directly. If you have a friend who gets sick and sets up a GoFundMe page
and you’d like to make a significant contribution, you should see about paying his or her health
care provider directly because this would not trigger the gift tax.
The same goes for paying your child’s college tuition. If you write your child a check and tell
him or her to pay the tuition with it, one semester can easily wipe out the entire annual limit for
the gift tax. By paying the school directly, it does not constitute a taxable gift.
4. Consider your options for educational savings plans, especially 529 plans.
There are many options to save for future generations’ education, whether you are saving for
your children, grandchildren, or family friends. Your relationship to the beneficiary will play a
major role in whether the beneficiary will qualify for financial aid and whether distributions from
your account would be considered income or savings. In addition to these concerns, factors such
as access to the account, the contribution limits, flexibility, and state and federal tax savings can
help you determine which type of educational savings plan is the best choice.
If federal tax savings are a concern for you, 529 plans and educational savings accounts (ESAs)
offer tax-deferred growth, which is tax free when used to pay for qualified educational expenses.
If you live in a state with high income taxes, a 529 plan is more favorable because it also has
state-level benefits, whereas ESAs do not.
The lifetime contribution limit for 529 plan beneficiaries is $200,000 to $400,000, depending on
the specific type of plan, and you can contribute up to $70,000 ($140,000 if you’re married) to
one student in a single tax year without incurring gift taxes. ESAs come nowhere near this
contribution level; they are limited to $2,000 per year per beneficiary.10
There are other options for utilizing your investments to pay for higher education, such as taking
early distributions from IRAs. However, this is often not a good idea because the funds
withdrawn will still be subject to income taxes, only the premature distribution penalty will be
waived if you are younger than 59.5 years old for this scenario.
5. Fully leverage your life insurance policy for legacy planning.
Life insurance is another tax-advantaged vehicle that can provide a number of strategies and
options to provide tax-free legacy benefits to your loved ones, charities, or other organizations.
The proceeds are tax free to your beneficiaries and may also build up cash value that you can
access during your lifetime. Newer policies may also have hybrid benefits that may build in
some tax-free leverage to pay for long-term care or qualifying medical events but that pay out to
beneficiaries should you not ever need to access those benefits. Thus, life insurance is not “use it
or lose it,” as are many traditional long-term care policies.
The following is an example of a potential scenario of a life insurance strategy to leverage as a
tax-advantaged gifting tool. If you are married and a legacy is a primary goal, you may want to
consider a joint “second to die” policy. This is a life insurance policy set up for two people that
will pay out to the beneficiaries only when the last survivor dies. This can provide significantly
greater benefits to heirs than would a single life policy. The proceeds can also be designated to
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pay estate taxes, support charities, or keep an operational business intact for your heirs. This may
also be an option as an effective use of your after-tax RMDs, should you have excess income
from these withdrawals. You can turn after-tax dollars (the least tax-advantaged account type)
into tax-free dollars (the most tax-advantaged account type) by funding a life insurance policy.
6. Choose the timing of your gifts for maximum impact.
One of the major tenets of effective tax and wealth planning is that it’s not so much the amount
of money involved but the timing. A transfer made when you’re living is an inter vivos transfer,
whereas a transfer made in death (your estate) is testamentary. As an example of the latter, if you
have a highly appreciated asset subject to capital gains taxes, your beneficiary will receive what
is known as a step up in basis. He or she will owe tax only on the amount of growth from the
date of the inheritance.
Conversely, a transfer to your spouse may be better off as an inter vivos transfer because spouses
can make unlimited gifts to one another. Even though there is a marital deduction in estate taxes
that can reduce the federal estate tax, your state may not have reciprocity with this, and you’d be
best off making this transfer in life. States can also have far lower thresholds for taxable estates,
and just one asset—such as your home or 401(k)—can already put you at risk for paying statelevel estate taxes.
HOW CAN I MAXIMIZE THE TAX ADVANTAGES OF MY ACCOUNTS?
The secret to wealth management is focusing not just on what you have but also on what you
keep in your pocket at the end of the day. As such, a sound financial plan includes year-end taxplanning strategies and ongoing, proactive, tax-conscience advice.
Here are some final tips for maximizing your tax options as part of a financial plan:
•
Work with a qualified financial professional who understands the importance of tax planning
in your retirement- and legacy-planning processes.
•
Check in with your financial plan at least once a year or as major life events occur to make
sure that everything is still on course. Speak with your financial advisor if you have any
concerns about sudden volatility in asset value or how unexpected law or lifestyle changes
are going to affect your plan. Make any necessary updates and changes to your overall
strategy and, if applicable, where and how you’d like your estate to be distributed.
•
Frequently visit www.LangCapital.net or call our Charlotte location (803) 547-7853 or
Hilton Head location (843) 757-9400 to speak with one of our friendly and professional
financial professionals. Schedule a consultation to discuss the latest year-end tax-planning
strategies and how they will affect your retirement planning!
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DISCLOSURE
Calibre Investment Management, LLC is a registered investment adviser. Information presented is for educational
purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities,
investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be
sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy
discussed herein.
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any US
Federal Tax advice contained in this white paper, including any articles, links or text, is not intended or written to be
used, and cannot be used, for the purpose of: (i) avoiding penalties under the internal revenue code; or (ii)
promoting, marketing or recommending to another party any transaction or matter addressed herein.
SOURCES
1.
The Changing Impact of Social Security on Retirement Income in the United States, SSA.gov
http://www.ssa.gov/policy/docs/ssb/v65n3/v65n3p1.html
2.
IRS Retirement Topics, Amount of Roth IRA Contributions You Can Make for 2016
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
3.
IRS Retirement Topics, Required Minimum Distributions (RMDs)
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributionsrmds?_ga=1.50817646.674656059.1477020525
4.
IRS Retirement Topics, Contributions
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topicscontributions?_ga=1.17351166.674656059.1477020525
5.
IRS Publication 969: Health Savings Accounts (HSAs)
https://www.irs.gov/publications/p969/ar02.html#en_US_2015_publink1000204045
6.
“I’ll Never Retire”: Americans Break Record for Working Past 65, Bloomberg
http://www.bloomberg.com/news/articles/2016-05-13/-i-ll-never-retire-americans-break-record-for-working-past-65
7.
Donor-Advised Funds, RenPSG Philanthropic Solutions Group
https://www.reninc.com/gifttypes/donor-advised-funds/
8.
IRA FAQs—Distributions (Withdrawals)
https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-distributions-withdrawals
9.
IRS, Frequently Asked Questions on Gift Taxes
https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
10. IRS, 529 Plans: Questions and Answers
https://www.irs.gov/uac/529-plans-questions-and-answers
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