Planning For An Easy Tax Season...before the holiday rush

I don't know about you, but December has taken me by surprise again this year. And even while I get excited about the holiday parties and our traditional Christmas breakfast of strawberries and biscuits, I am also suddenly aware of those end-of-year deadlines. Unless you've been really diligent this fall, here are some simple tasks that will keep you from following up your holiday recovery with panic attacks:

1. If you are a business owner, you need to think about your annual reports for the state, as well as taxes. Here in Massachusetts the reports are often due in the fall. If you missed the deadline, the penalty is small, but you will want to get those in before they get lost in the taxes. Here is your link to the MA state filing forms & instructions.
2. Planning ahead can often save you on taxes. I know you've heard this before, but this is the moment to actually do something about it. Contact your financial planner or accountant now to see whether it makes sense for you to: sell some investments at a loss (to offset other income); sell some at a gain (if, for instance, you think your tax bracket will be higher for 2016 than it is for 2015, or you would rather pay this year); make some charitable donations or gifts to the family; make a big purchase for the business before December 1; set up a trust.
3. Put a little more in your retirement account. Now that you've reached the end of the year, you may find that you can afford to put a little more money into your 401k, IRA or other active retirement plan. The IRS allows many retirement contributions to be made anytime up until you pay your taxes, BUT your plan may well have an earlier deadline. Make your contribution by December 31st to be sure.
4. Set aside some cash if you've had any unexpected income this year. Most people count on the money deducted from their paychecks to cover the taxes that will be due on April 15th. But if you've received money from a side job, from shares in a business, from the sale of some investments, or if you just received a large gift or prize, you probably owe extra taxes. Plan now to keep some cash aside in your account to cover those. And, if this happens regularly, talk to your accountant about paying quarterly estimated taxes to avoid penalties.
5. Get those receipts together. You probably won't get all of the paperwork you need to file your taxes until January or even February. This stuff includes everything from W2 statements to health insurance coverage certificates and bank or investment tax statements. But you can get your tax receipts in order before the holiday and be ready to turn the whole mess over to your accountant as soon as the paperwork comes in. You will be especially glad you did if you are the tax preparer for your household.

Last but not least, make sure you know who is going to prepare the taxes for you and how. If you are one of those brave do-it-yourself tax filers, go ahead and purchase the tax software now. It's ready and waiting for you.

If you hope to turn this problem over to a professional, keep in mind that these folks get harder and harder to find as April approaches. Ask for referrals to a good accountant in your  area (your financial planner always keeps a list) and make contact now.

When the early spring finally hits, you could be enjoying warm sun and daffodils instead of a shoebox of fading receipts and late night caffeine fixes.

What Are Your Tax Dollars Paying For?

I am not sure why the first week in August became the week of quizzes on this blog, but I can't resist sharing a link to this one with you. It appears in Bloomberg Politics today and is meant to surprise us with some real information about where are tax dollars are going. To be sure, the methods are pretty crude—the authors looked up the annual costs of a number of our high-profile budget items and then divided each by the number of U.S. residents (321.4 million these days). But it's a pretty good way of understanding how easily we lose track of the costs of running an entire nation. I spend a lot of time thinking about politics (and a little too much time mouthing off about them, too). Still, I was caught out by a few of these questions. I figured the Supreme Court is not particularly expensive (there aren't that many of them, for one thing), but I had no idea how our law enforcement dollars were being spent. Give it a try—you don't have to confess your score afterword: http://www.bloomberg.com/politics/graphics/2015-budget-quiz/

Understanding Retirement Accounts

Of all of the topics that come up in my line of work, this has to be the one that creates the most confusion. We Americans are at the point where we have all heard about 401k's and pensions and probably about IRA's and Roth's. And for the most part, we are relying on these strange creatures to feed and house us in the last years (decades?) of our lives. But precious few of us really understand retirement accounts. This post is meant to give you a bit of a run-down on how retirement plans work with a  quick graphic at the end to get you thinking about the plans that might work for you.

The Magic of Tax Deferral

Let's start with the basics—anytime we call something a "retirement" account, we are actually saying that the account has some special mention in the IRS's regulations that will amount to a temporary tax break. You noticed the word "temporary", right? Except for the Roth, which I'll get to in a minute, retirement plans allow you to put a certain amount of your income into the account instead of paying taxes on it...for now. It's called tax deferral, and you not only get out of paying the taxes the year you earned them, you also don't have to pay any capital gains taxes when you sell investments in that account over the years. That gives you the ability to freely move in and out of investments without the usual tax consequences and lets the income you originally put in keep compounding—assuming those investments you chose are any good.

But you do have to pay taxes eventually. In the case of retirement accounts, this happens when you start taking money out— a process known as taking distributions. What's more, the IRS has something to say about when you will be doing this. In most cases, you will pay a penalty for "early withdrawal" if you take your first distribution before age 55. And you will be required to start taking your money at age 70 1/2, because after all, the IRS won't wait forever.

The Roth IRA (often just called a Roth) is a little different. Like 401k's and regular IRA's, your money can grow free of capital gains taxes over the years in a Roth. But if you open one of these accounts, you put your money in after paying the income taxes. This means you won't get that immediate tax break, but believe it or not, this might actually work out well for you. When you do go to take money out of the Roth account, you don't have to worry about the taxes on the money you first put in the account (you already paid those taxes, after all). This can reduce the strain of taxes in retirement and may even mean paying a lower tax rate on that money, say, if you are in a higher tax bracket in your mature years.

In reality, the most successful savers will use both Roths and whatever other accounts they can. The caps on how much you can contribute to a retirement account often mean layering accounts to the extent you are able.

Defined Benefit vs. Defined Contribution

This is the biggest change in the U.S. retirement system over the past 50 years. Defined benefit plans are exactly that—the plan defines in advance how much you will get in benefits. Most of us just call these pensions, and they were the most common type of retirement income for most of our history. Based on the length of time you've worked at a job and the amount you earned, your HR department will calculate how much you get in your monthly check during retirement. Nowadays, though, you are far more likely to be offered a defined contribution plan. These plans set terms for how much you can contribute and make no promises whatsoever about what you get back later.

This change is a big deal— and not just because people are less likely to contribute to the often-voluntary defined contribution plans. In the case of a pension (defined benefits) someone else is taking the risk that the markets will go down or that the beneficiaries (including you) will live longer than expected. If you have a defined contribution plan, that risk is all on you. This means that you need to do some careful calculating and some educated guessing to come up with a balance of investments that will grow enough to cover your needs and will likely be there when you need them. The change over from defined benefits to defined contributions has made it necessary for Americans to become smart investors.

The Magic of Timing

If you are worried about living for more than a few years after your retirement, you are going to want to focus on your timing when it comes to retirement accounts. I am not referring to when you start putting money away here—the earlier the better, of course. Honestly, though, most successful retirees started saving at the peak of their careers, not the beginning. Get started when you can and work from there.

But you should be strategic about which accounts you put money into first and which accounts you start withdrawing from when.

The timing of adding to accounts is relatively simple for most people. We always start by looking to see if a client's employer will "match" contributions. If so, we maximize that first (getting someone else to fund your retirement is always good). If the client has his or her own business, even if it is a "side" business, we have a lot more to play with and timing will often depend on the needs of the business, which is often itself part of the retirement solution.

Taking out the money is different matter. The trick here is to take advantage of the incentives that employers and the government give you and to recognize the requirements. Social security, for instance, gives you all sorts of incentives to wait until 70, so if you can draw from a 401k account or an IRA instead during your 60's, you probably should. Likewise, an old company pension might give you a much better monthly payment for waiting. But you can only wait so long on IRA's and 401k's—as I mentioned above, the IRS requires that you start taking at least some distributions when you reach 70 1/2. The Roth, always the exception, allows you to keep money in that account as long as you want. Choosing which accounts to draw from and when is a delicate game of knowing your income needs, getting the most you can from the incentives and keeping an eye on the taxes you will pay as your start taking that retirement income.

Which Retirement Accounts Should You Use?

Retirement accounts are only one piece of the puzzle when you are coming up with a plan for enjoying life after 65. But they are one of the most important pieces. Here is a quick graphic showing the most popular types of retirement accounts and which ones you might want to learn more about:

If Your Marriage Just Became Legal

Congratulations to everyone in the U.S. who became legally married thanks to our recent Supreme Court ruling! If this is you (or if you plan on getting married, regardless of court rulings), do a quick check on these financial issues:

1. Pay attention to your retirement account contributions this year. The amount you can put into a tax-deferred account often depends on whether you are married and what your spouse is earning and/or contributing. Make sure you review your retirement account contributions now, rather than at the rush at the end of the year!
2. Contact your lender if you have federal student loans and are on an Income Based Repayment (IBR) plan; if your spouse is also paying student loans, your IBR payments should decrease.
3. Revise (or create) your will and related documents to show your new status;
4. Check to see who the beneficiaries are on your life insurance policies;
5. Check on the beneficiaries listed on your retirement accounts;
6. Get ready for changes in your income taxes—we tax married couples more than we do two single people living together;
7. Feel free to give more—gift tax rules allow you to give to your spouse tax-free. And each spouse gets to use the gift tax exclusion on gifts you are jointly giving to someone else (that means you and your spouse can give $28,000 tax-free this year).
8. Revise those estate plans (if you had any to begin with). The Federal Estate tax for 2015 begins on estates valued at $5.43 million, so in all likelihood, this was not causing you any stress to begin with, but if it was, your new marital status may be reason to change everything (go talk to your Tax & Estates Attorney).

And if you had filed a marriage certificate that was not honored because of your same-sex status, you might be able to revise previous tax returns. Check with your accountant.