As you focus on finishing your tax return for 2014, planning for the year ahead may be the last thing on your mind. However, getting an early start on planning for 2015 could result in greater tax savings (and less stress) for this time next year.
Here are five helpful techniques to keep in mind for 2015.
1. Employ Tax-Loss Harvesting
If you have already realized a large capital gain in 2015, or you are anticipating a large capital gain later in the year, you may consider tax-loss harvesting.
Tax-loss harvesting is an investment strategy that involves selling an investment at a loss and buying a similar, substitute investment simultaneously. By using this strategy, you can “lock in” an otherwise unrealized, paper loss to offset gains on your tax return, but the overall composition of your investment portfolio essentially remains the same.
For example, let’s assume that you purchased $10,000 worth of Oil Company #1 ABC stock last year. Due to recent concern over falling oil prices, that investment is now worth $7,000. If you don’t take action and oil prices rebound, thus raising the stock price, you will receive no tax benefit for the temporary, paper loss that you had in your stock.
However, if you sold your ABC stock and bought a substitute simultaneously (say, in Oil Company #2 XYZ stock), you would be able to use the $3,000 loss to offset gains on your tax return, and you would be able to participate in the stock price recovery that could accompany rising oil prices. This strategy can be used at the individual security level (i.e., stocks) or with diversified bundles of securities, like mutual funds and exchange-traded funds (ETFs).
By actively searching for tax-loss harvesting opportunities throughout the year, you can help minimize your capital gains tax liability and possibly achieve a greater, after-tax investment return.
2. Optimize Your Charitable Giving
Increasing your charitable contributions within the year that you realize a large capital gain (through the sale of stock options, a business or a second home, for example) can also help reduce your income tax liability. If you already have a favorite charity, deciding to make an additional contribution may be a no-brainer. However, if you don’t have a favorite charity and need more time to research organizations before making a contribution, you can consider creating a donor-advised fund (DAF).
A DAF allows you to take a charitable contribution deduction within the year that the contribution is made and make grants to your favorite charities in the future.
The funds contributed to a DAF can be invested and grow over time. In many cases, investors contribute to DAFs with appreciated securities so they can receive two tax breaks: on the charitable contribution and on the unrealized, capital gain in the investments. You can even create a board of advisors for your DAF to get other members of your family involved in grant-making decisions.
3. Boost Your Retirement Plan Contributions
For 2015, the maximum deferral to defined contribution plans increased to $18,000, and the catch-up contribution for those age 50 and older increased to $6,000 — a total of $24,000 in potential tax deferrals. To make the most out of your retirement savings, consider increasing your contributions to match the maximum limit. If you make traditional deferrals to your retirement account, you can also reduce your taxable income. Be sure to contact your plan administrator for more information.
4. Consider a Roth IRA Conversion
This gives you the ability to move assets from an existing IRA or employer-sponsored plan to a Roth IRA. Previously, Roth IRA conversions were only available to investors with a modified adjusted gross income (MAGI) below $100,000. However, Congress eliminated that restriction in 2010, making Roth IRA conversions available to nearly all investors, regardless of marital status or income level.1
While it may not be the best option for everyone, you can benefit from a Roth IRA conversion if:
— You expect your taxable income to be significantly lower in 2015.
— You expect your tax deductions to be significantly higher in 2015.
— You’re in a lower tax bracket now than your expected retirement tax bracket.
To make sure you’re getting the best tax advantages out of the conversion, it’s important to be proactive. Reach out to your tax advisor and ask them to prepare a tax projection to determine the optimal amount you should convert before December 2015. If necessary, you have until October 15, 2016 to recharacterize your Roth IRA back into a traditional IRA.
5. Maximize Your Company Stock Options
If you have an employer-sponsored stock option plan, it’s wise to start tax planning before the year in which the options mature, in order to retain the most flexibility and savings. If you have options that will mature or start vesting in 2015, meet with your advisor to start preparing tax projections. Planning ahead will help you prepare for income tax and alternative minimum tax (AMT) savings, as well as cash flow.
Remember that early tax planning is smart tax planning. Integrating tax planning with your investment management can optimize your after-tax return and enhance your financial plan, now and in the future.