Tax Efficiency: 4 Strategies To Consider
By Christopher R. English, President of Lumen Capital
Management, LLC
Back in April, we discussed charitable giving under the new tax code. I want to revisit the topic of taxes again this month. Again, I’ve turned to the good folks over at Indigo Marketing to help me summarize some basic strategies that may help us all lighten our tax burden next April. Through intentional planning, you may be able to mitigate the toll taxes take on your financial plan, minimizing your tax burden and maximizing the money you keep for yourself. Here, in general, are four ways you may be able to increase your tax efficiency.
1. Use Tax-Favored Investment Strategies
Tax benefits are available to investors who select specific investment strategies. Tax-favored investing is especially beneficial for professionals who are highly compensated. For tax-exempt alternatives, consider municipal bonds and Roth IRAs, and for tax-deferred options, pre-tax qualified plan investing is ideal. Your pre-tax contributions to qualified retirement plans can reduce your adjusted gross income, saving you on taxes now rather than in retirement. The most common employer-provided qualified plans are 401(k) and 403(b) plans. Everyone’s financial situation is unique, so the type of accounts that are most beneficial for you will depend on your circumstances.
Now let’s get into the details of these types of accounts to see how much they could decrease your tax burden. If you have a 401(k), you can defer up to $19,000 of your annual earned income on a pre-tax or after-tax basis. Participants over the age of 50 can also take advantage of the catch-up provision and contribute an additional $6,000.
If you are a business owner, you can lower your total taxable income even further. Solo 401(k)s and SEP IRAs are the two primary qualified plan types available. With a SEP IRA, you can contribute up to 25% of your compensation or up to $56,000. For solo 401(k)s, the annual plan contribution is the same as the traditional 401(k) plan ($19,000 for the 2019 tax year, or $25,000 for those over the age of 50). The company can also contribute a profit-sharing contribution of 25% of your income up to a maximum of $56,000.
2. Deduct Eligible Charitable Contributions
Annual gifts to qualified charitable organizations may be deemed an eligible itemized deduction. Under the new tax law, fewer taxpayers will itemize deductions due to the doubling of the standard deduction. The Tax Policy Center estimated that only 16 million people would claim an itemized deduction for charitable giving in 2018, down from 37 million. (1) Regardless, charitable giving is still a useful tax-minimization strategy. If you decide this is a viable route for you to go, you will need to note each gift on Schedule A of your 1040. If your yearly cash gifts exceed $500, you must also complete IRS Form 8323, which must be attached to your completed return. If you received benefits as a result of your charitable donation, only the amount over the benefit you received can be deducted.
You can also gift non-cash property and investment donations, which can be deducted at their fair market value. If you donate clothing or other household items, consider using available online value calculators to determine the total amount of your contribution, saving these records in the event of a tax audit. Records for all donations must be maintained, including bank records, payroll deduction notices, charitable donation receipts from the qualified organization, or phone records for text message donations.
You may also consider using a donor-advised fund to combine all charitable contributions in a year and then distribute the funds to various charities over several years. With this strategy, you may be able to itemize deductions in one year and take the standard deduction in the following years so you can achieve a tax benefit that you may not have received otherwise.
3. Invest In A College Savings Plan
Now, more than ever, may be an ideal time to invest in a 529 plan. This type of educational savings plan is a qualified tuition plan created so that families can receive tax benefits for saving toward qualified higher-education expenses. After-tax money is invested in a 529 plan, where it grows tax-free. When the money is later taken out for qualified expenses, there are no federal taxes due. Over 30 states also offer a deduction or tax credit for contributions to a 529 plan. (2)
And to increase the value 529 plans could add to your financial plan, as of January 1, 2018, 529 plans are no longer just for college. Up to $10,000 a year can be used for elementary and high school costs at public or private institutions. This provides a great opportunity for wealthier families who prefer to send their children to private schools.
Previously, the only tax-advantaged way to save for private primary and secondary school costs was through a Coverdell Education Savings Account. However, income limitations and a $2,000 annual contribution limit made them impractical or impossible for many families to use for K-12 expenses.
4. Consider A Roth Conversion
When it comes to your retirement, IRAs are one of the most widely used investment vehicles. IRAs are retirement accounts that are separate from your employment, which tends to simplify things considerably. Your IRA contributions can be invested in just about anything but life insurance and collectibles, so there aren’t as many restrictions as 401(k) plans, which limit you to a preselected group of investment choices.
Unlike the tax-deferred traditional IRA, a Roth IRA allows you to pay all taxes up front (your contributions are made with after-tax dollars). The perk is that you receive tax-free withdrawals in retirement after the age of 59½. When you decide to withdraw the money, you don’t have to pay taxes on any of the growth.
Another significant difference is that there are no required minimum distributions (RMDs). You can leave your money in the account to grow forever, instead of being required to start taking withdrawals (and stop contributions) at age 70½ as you would with a traditional IRA account. This allows you to use a Roth IRA as an estate planning tool to provide tax-free income for grandchildren and future generations.
The one caveat to a Roth IRA is that to qualify, you must fall in specific income categories. In 2019, singles making over $137,000 cannot contribute to a Roth, and the amount they can contribute begins phasing out after $122,000 of earnings. The phase-out period for married filing jointly is $193,000-$202,999. (3)
However, anyone can convert a traditional IRA into a Roth through a “backdoor conversion.” There are multiple reasons to consider a Roth conversion. For one, there are no income limitations when you convert. If you are not eligible for a Roth initially, you can pay the taxes to convert your traditional IRA to a Roth and still reap the benefits. Secondly, you can have all the benefits of a regular Roth IRA, such as no RMDs.
Roth IRAs are not necessarily for everybody. Not everybody wants to pay the taxes upfront. But they can be an important tool and the right fit for the right person. Please talk to me for some basic information on Roths, as well as your accountant to see if a conversion makes sense for you.
Getting Ahead With Tax Planning
Tax planning could potentially save you thousands, tens of thousands, and in some cases millions of dollars in taxes paid. Tax planning is incredibly beneficial, but taxes can also be complicated, so don’t go it alone. The IRS tax code is 72,536 pages long and filled with various opportunities and strategies for optimal tax efficiency. The key is understanding how each possible opportunity works and how it fits into your strategy and long-term goals. Professionals must implement these strategies in accordance with the law and on a foundation of honesty.
If you have questions about any of these tax strategies I encourage you to reach out to me. Call my office at 312.953.8825 or email me at lumencapital@hotmail.com.
About Chris
Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 312.953.8825 or emailing him at lumencapital@hotmail.com.
posted by CR English at 9:41 AM
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