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5 Simple Strategies to Lowering Your Tax Bill

AUTHORS NOTE

Creating a custom financial model of your future gives you the framework and lens to make important financial decisions.

How to best mitigate and manage your tax burden is just one of the important decisions to consider.

At Divergent Wealth we are state-of-the-art financial planners and investment professionals who specialize in simplifying complicated things.

To create a complimentary customized financial plan, call us at 385-CFP-4000. For information, visit us at www.divergentwealth.com.

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“In this world, nothing can be said to be certain except death and taxes.” – Benjamin Franklin.

Tax avoidance can be legal. However, tax evasion is not legal. So what’s the difference? Tax avoidance is simply minimizing the impact taxes have on your bottom line.

While every scenario is unique, the goal of tax planning is to arrange your financial affairs to minimize tax impact.

There are three broad ways to reduce your taxes. You can reduce your taxable income, increase your tax deductions, and/or take advantage of tax credits.

Below we’ll cover 5 strategies to consider.

1 |    TAX-LOSS HARVESTING

Selling an investment for MORE than you paid for it will incur a capital gain. Selling an investment for LESS than you paid for it will incur a capital loss.

Capital gains are taxable in the year they are incurred.

As of 2018, most taxpayers are subject to a 15% capital gains rate, while higher earners may be subject to a 20% capital gains tax plus 3.8% net investment income surtax.

The IRS allows investors to use capital losses to “off-set” or “net against” capital gains. Realizing these losses is commonly referred to as Tax Loss Harvesting.

When realizing a loss in a security, you can consider whether or not to invest the proceeds in a similar security to keep your exposure to that asset class.  

You simply sell the security when it was low to realize the loss for offsetting capital gains… ultimately allowing you to reap a little benefit from the security that may be ailing you.

Here’s a quick example:

Imagine you invest $100,000 in the U.S. stock market via an S&P 500 ETF. Let's now assume this investment drops by 10%, falling to a market value of $90,000.

Rather than doing nothing, you can sell the ETF and reinvest the $90,000 back into a similar position that can closely mirror your previous position.

Although you’re keeping your market exposure constant, for IRS tax purposes, you just realized a loss of $10,000. You can use this loss to offset other capital gains. You can even use $3,000 of the loss to offset your earned income ($3,000 if married, $1,500 if single). Since you kept your market exposure constant, there hasn't been a change in your investment allocations, just a potential cash benefit on the tax return.

In summary, tax-loss harvesting is a way investors can take an active role in managing their portfolios with a strategy that is based on opportunity created by tax law, not market speculation. In some cases, after-tax returns could be enhanced, putting the investor well on the road to quicker asset accumulation.

2 |   RETIREMENT ACCOUNT CONTRIBUTIONS

One of the best ways to lower your tax bill is to set money aside in a tax-deferred retirement account.

Contributions to a tax-deferred retirement account may reduce your income by the exact amount you contribute.

Retirement accounts come in two main forms:

The first is an individual retirement account (Traditional IRA). IRAs allow eligible investors with earned income the ability save for retirement using tax-deferral. As of 2018, the maximum amount you can contribute to an IRA is $5,500 if you under age 50 and $6,500 if you are over age 50. There are some income limitations for the tax deductibility of the contribution. See a tax adviser to review your situation.

The second form is a retirement account through an employer. There are many different types of employer plans each with its own contribution rules and limits. Employer plans generally allow you to contribute more than your personal IRA allows you to.

Can you contribute to both?

Maybe. There are income and coverage limitations. Depending on how much money you make and if you are already covered through an employer’s retirement plan, will determine if or how much you can contribute to your personal IRA.

Note: Roth accounts are becoming more common options for individuals and employer-sponsored plans. Roth retirement accounts do not provide a reduction of income on the front-end like traditional retirement accounts do. However, the account grows tax-free the rest of your life. You may not be taxed when you take the money out of the account, and it can be passed to beneficiaries with the same tax benefit. This is a very viable option to consider and may be more appropriate than a traditional IRA.

Consult with a fiduciary financial adviser to weigh the pros and cons.

3 | MAKE CHARITABLE CONTRIBUTIONS WITH APPRECIATED INVESTMENTS AND RETIREMENT ACCOUNTS

With the standard deduction doubling, you may find it less advantageous to itemize your taxes. However, through a process called “bunching” you can contribute multiple years of charitable giving in one year to take advantage of itemizing. This process is then repeated, creating the opportunity to receive the full tax benefit of planned donations every few years, and a standard deduction in years where itemized deductions are lower than the standard deduction.

Two of the best ways to fund charitable giving are through donating appreciated assets from taxable accounts and/or using retirement assets (for those age 70.5 and older).

Instead of selling positions in taxable accounts and donating the proceeds, the IRS allows a direct donation of the appreciated asset to take place. This eliminates the eventual tax of capital gains.

If you’re over 70.5 you can donate to a charity from your IRA (or another tax deferred account), up to $100,000 per year. This is known as a Qualified Charitable Distribution or QCD.

4 | CONTRIBUTE TO HSA

From time to time congress creates new types of tax-favored accounts to help with different needs. One of those accounts is called a Health Savings Account (HSA).

With rising health care expenses, the HSA was designed to alleviate some of the burden on families by giving them a resource to pay for those medical expenses tax-free.

The HSA allows for tax deductible contributions, tax-free growth, and lastly tax free distributions if used for permitted health care expenses.

If you want an HSA, you will need a qualifying high-deductible health plan to go with it. Deductibles must be a minimum of $1350 for individuals and $2,700 for a family policy.

If you’re younger than age 55 the contribution limits for an individual are $3,450 and those for a family are $6,850. For those individuals older than age 55 you may add an additional $1,000 to the corresponding figure that applies to your situation.

5 | TAX-FREE BONDS

Lastly, one the best ways to lower taxable income is to invest in Municipal Bonds. Although interest in municipal bonds may not be as high as taxable investments, the income paid is exempt from federal tax. If you also own municipal bonds issued within your state, the interest income can also be free of state (and often local) tax. A great way to determine if the tax savings outweigh the forgone higher rates through taxable investments is through a simple taxable equivalent yield calculation.

An example of the tax equivalent yield formula would be an investor who must decide between an investment that pays 7% and is taxed vs a municipal bond that pays 4.5% but earnings are tax free. In this example, the investors marginal tax rate is 37%. To compare the yield of these two investments, the equation for this example using the tax equivalent yield formula would be 4.5% / (1 -.37) = 7.14%. Assuming investment risks remain constant you can see that once taxes are considered, investing the municipal bond would yield a higher after-tax return.

CONCLUSION

Creating a custom financial model of your future gives you the framework and lens to make important financial decisions. Tax Planning is just one of the important decisions. At DivergentWealth®we are state-of-the-art financial planners and investment professionals who specialize in simplifying complicated things. To create a customized complimentary financial plan, call us at 385-CFP-4000. For information, visit us at www.divergentwealth.com.

The SCT Library’s mission is to cut through the clutter and the spin to deliver financial straight talk -- to simplify complicated things. These short guides will reduce complex topics to their core issues to assist in making the best financial decisions for your family.

DIVERGENTWEALTH® is changing the way people engage with advisors. They are a competent, dedicated, and credentialed financial partner should you ever decide that’s what you need. Experience the difference at www.divergentwealth.com or call to interview us at 385.CFP.4000.


Divergent Wealth Advisors LLC is registered as an investment adviser with the SEC and only transacts business in state where it is property registered or is excluded or exempted from registration requirements. SEC registration in an of itself does not constitute an endorsement of the firm by the commission nor does it indicate that the adviser has attained an adequate level of skill or ability.

The information contained in this material is given for information purposes only, and no statements contained herein shall constitute tax, legal, or investment advice. The information is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the needs of an individual’s situation. You should seek advice on legal and tax questions from an independent attorney or tax advisor.

Individual clients should review with their adviser the terms, conditions, and risks involved with specific product or services. Neither the information provided, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.

 



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