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Last-Minute Tax Moves
Stewart H. Welch, III, CFP, AEP
Founder, The Welch Group, LLC — Birmingham, AL — E-mail: Stewart@WelchGroup.com
With April 15th looming, here are some last-minute tax moves, which can cut your tax bill and make money.
Make a Traditional Individual Retirement Account Contribution
You have until April 15th to contribute to an Individual Retirement Account (IRA). Below are two situations regarding Traditional IRAs.
You (or your spouse) are not an active participant in an employer’s qualified retirement plan. You and your spouse can contribute the lesser of $4,000 each ($4,500 if you are age 50 or older) or your adjusted gross income to a Traditional IRA and receive a full tax deduction. This is true even if one spouse has no income.
You (and/or your spouse) are an active participant in an employer’s qualified retirement plan. For couples filing jointly, you can contribute up to $4,000 each and receive a full tax deduction if your adjusted gross income is under $65,000 (under $45,000 for single filers). If your adjusted gross income is between $65,000 and $75,000 ($45,000 to $55,000 for single filers), you will receive a partial deduction. If you are an active participant in an employer’s plan but your spouse is not, he or she can contribute up to $4000 to a fully deductible IRA if your adjusted gross income is under $150,000. This is true even is he or she has no earned income at all.
Assuming you are in the 40% tax bracket and you each make a $4,000 contribution ($8,000 total), you will save about $3,200 in taxes. If you are a divorcee, your alimony is treated as “earned” income for the purpose of IRA contributions.
Make a Roth IRA Contribution
Although contributions to a Roth IRA are never deductible, they still make sense from a long-term planning perspective. One of the disadvantages of the Traditional IRA is that at retirement, all distributions from the IRA are subject to ordinary income taxes. However, with the Roth IRA, distributions at retirement are never subject to income taxes. This includes the interest, dividends, and capital appreciation, all of which can save you substantially later. For example, assume you and your spouse are age 30 and you each contribute $4,000 per year until age 65 to a Roth IRA. With a 10% return, your account would be worth $2,385,000 based on total contributions of $280,000. None of the $2,385,000 would be subject to income taxes.
To be eligible for a $4,000 Roth IRA, your adjusted gross income must be less than $150,000 ($95,000 for single filers). You can make a partial contribution if your adjusted gross income is between $150,000 and $160,000 ($95,000 and $110,000 for single filers). The deadline for making a contribution to a Roth IRA is April 15th.
Make a $500 “catch-up” contribution to a Traditional or Roth IRA
If you were age 50 or older in 2005, and you otherwise qualify to make either a Traditional or Roth IRA contribution, you are allowed to make an additional contribution of $500.
Set up a Simplified Employee Pension
If you own your own business, you can establish a simplified employee pension (SEP) and deduct up to 25% of net income, not to exceed $42,000. These plans are easy to set up, but some special rules apply (including the definition of net income), so contact your financial advisor before implementing. You have until the time you file your tax return, including any extensions, to set up your plan and make your contributions.
Some people question whether it’s still advisable to contribute to retirement plans since we now have lower income tax rates, which make the tax deduction less valuable. Our research suggests retirement plan investing is still one of your best choices. By providing active tax management for our retiree clients, we have found that often we are able to take out retirement distribution at an effective 15% tax rate, while most of them received a tax deduction for their contributions at marginal tax rates exceeding 40%. Tax-deferred earnings along the way provides icing on the cake. Dental practice owners face a more difficult decision because of the costs of contributing for eligible employees but a retirement plan is worth investigating.