You are responsible for many of your own tax decisions. Small-business owners, independent contractors, and full-time employees at major corporations all have the right to make the most of their income. Yes, the government dips into your paycheck long before you get it, but there are things you can do to protect some of your income and put away for the future. All it takes is a few tax savvy investment tips to keep more of your hard-earned money.
Maximize Retirement Contributions
One of the most financially savvy things you can do for yourself, is to invest in your own retirement. Not only does it secure your financial future, but it boosts your financial situation in the near term by lowering your tax burden. Forbes has a complete rundown on the maximum contributions for personal retirement plans here, but the most important ones are the tax-advantaged retirement accounts.
Traditional IRA accounts retain a maximum level of $5,500 for 2016. That figure has now remained the same for four straight years. Annual contributions to 401(k) plans remain the same as 2015 as well, and are set at $18,000.
When you put away as much money as possible now, you enjoy a break on all pre-tax contributions you make. This allows you to enjoy tax-deferred earnings on those accounts that won't start until you begin withdrawing those assets.
Consider the 3 L's: Location, Location, Location
Asset allocation means devising the best mix of stocks, bonds, and cash investments to reach your retirement goals. Asset location is a similar process. If you want to minimize the impact of taxes on your investments, consider placing your most tax-efficient holdings in taxable accounts. Maintain your tax-inefficient holdings in your tax-advantaged accounts, such as your IRAs and employer-funded plans.
Harvest Your Losses with Your Gains
If you are selling securities this year to lock in gains, use that opportunity to harvest your portfolio for any losses that can offset those gains. The proceeds of a stock sale that results in a net gain are taxable, but they can be used to offset losses to add to a portion of your asset allocation that needs to be increased. This helps keep your target asset allocation in line with your investment objectives, and lowers your tax burden at the same time.
Reduce Net Investment Income to Avoid 3.8% Surtax
The 3.8% surtax on net investment income was introduced in 2013, and actually serves as a 3.8% Medicare surtax. Known as the NIIT, it primarily affects higher-income individuals who have investment income, but as Market Watch notes, it can also impact estates and trusts, so keep that in mind.
Now, the surtax usually just impacts those with consistently high incomes, but if you are your business has a really good year, it will likely come into play for your taxes. Examples include those who sell company stock for a big gain, receive a massive bonus at work, or even sell a home with a huge profit margin.
Here are a few strategies that can help you avoid the 3.8% surtax:
- If your net investment income is above the threshold for the surtax ($200,000 for individual, $250,000 for joint filers), focus on reducing your net investment income. Examples include selling some loser securities from your taxable brokerage accounts to offset gains.
- You could also lower your modified adjusted gross income, or MAGI. If your MAGI is lower than your net investment income, focus on lowering your MAGI to minimize the impact of the surtax. You could do this by maxing the contributions to your tax-favored retirement accounts.
Contact Manhattan Ridge Advisors for more help navigating through the complex movements that will help you make smart investment decisions in 2016. For specific tax advice please consult a qualified tax professional.