Tax-efficient investing has always been important. It will become even more so as the Bush tax cuts come to an end on Dec. 31. The top 2% of income earners with total family income above $250,000 will especially be hit hard. Some call it the largest tax increase in history. Here’s want you need to do to help your clients to prepare for 2011.
1) Tell clients to stop making 401(k) contributions once they have put in the maximum that their employer will match. Wait until 2011 to start maximizing 401(k) contributions again.
2) Switch clients to Roth 401(k) contributions if their employer offers the option.
3) Take long-term capital gains in 2010. The 15% capital gains rate is scheduled to increase to 20% next year.
4) Replace taxable bonds with tax-free bonds (municipals) in a client’s non-qualified (taxable) accounts. A municipal bond paying 3% is equal to a taxable bond paying 4.6% in the 35% bracket. It will be equal to 5% in a 39.6% bracket.
5) Use only tax-efficient or index funds in taxable accounts. Preferred tax treatment for qualified dividends is on the way out. The rate on long term capital gains is going up. Move any inefficient stock funds to your IRA and Roth. Taxable accounts should hold only low turnover or passively managed funds that minimize taxable distributions.
6) Convert IRAs to Roth IRAs. The $100,000 cap on adjusted gross income has been lifted. Anyone can convert an IRA to a Roth. Clients will have the choice of paying the tax on the conversion in 2010 or spreading it over 2011 and 2012. They may choose to spread the tax over the latter two years if the Bush tax cuts get extended. Otherwise, pay the tax in 2010 at the lower tax rates.
7) Hold off on charitable contributions until January 2011. Many people make the majority of their charitable contributions in December. The deduction may be more valuable to you in January.
8) Withdraw money from non-qualified annuities if you are over age 59 ½. Withdrawals from annuities are taxed as ordinary income. A withdrawal of $200,000 in taxable income will cost $9,200 less in 2010 than in 2011 at the top tax rate.
9) Encourage clients to vote for candidates that are in favor of lower taxes and lower spending. If lower taxes are really important to you, support the candidates for public office that feel the same way.
10) Accelerate earnings into 2010. Many business owners have some control over when they realize income. Push deductions into 2011 and move income into 2010. This isn’t the first time Americans have used this strategy. According to a 2004 U.S. Treasury report, "high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994."
In conclusion, get clients to consider strategies that reduce income taxes but not at the expense of greater earnings or diminishing your clients’ lifestyle. Unless you’re a tax expert, the wisest choice is to consult a tax professional who will consider your clients’ individual circumstances and council you on the best way to take advantage of current tax laws.
Rick Rodgers is founder and CEO of Rodgers & Associates, a planning firm in Lancaster, Pa.. Rick is also author of the book, The New Three-Legged Stool: A Tax Efficient Approach to Retirement Planning.