You might not be used to thinking of your investments in terms of taxable, tax-deferred, and tax-free. Learn why you might want to.

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Diversifying your investments involves spreading your risks by investing in a variety of asset classes such as stocks, bonds, commodities, and real estate. But with a changing tax landscape, you might consider three more classes: taxable, tax-deferred, and tax-free.

 
Years ago, taxpayers often worked under the assumption that their tax bracket would be lower after they retire. Therefore, a common strategy was to defer as much taxable income as possible to the golden years. Now, however, with the possibility of higher tax rates in the future, it could be more efficient to pay those taxes today while rates remain lower. Since no one knows for sure what Washington will do, it might be time to hedge your tax risk and allocate your portfolio between accounts with differing tax consequences.

 
* Taxable accounts, such as savings or brokerage accounts, result in current taxation on earnings, but they also provide maximum flexibility. You can withdraw as much as you wish whenever you wish, with no IRS penalties. Keeping some of your nest egg in this type of account will provide immediate funds for major purchases, debt reduction, or emergencies.

 
* Tax-deferred accounts, such as IRAs or 401(k)s, only postpone the payment of taxes; eventually you will have to pay Uncle Sam when you withdraw the funds. But in the meantime, you generally receive a current-year tax deduction when you contribute, and the account can grow tax-deferred until you take it out at retirement.

 
* Tax-free accounts, such as Roth IRAs, are funded with after-tax dollars. What you put in, including any investment earnings, can be later withdrawn tax-free. The downside? You generally must wait until after age 59½ (and the account has to be open for five years) to make a tax-free withdrawal.

 
Diversifying your portfolio is only the first step. The next (and trickiest) step is properly investing in each tax class. For instance, your goal for a taxable account might be to generate growth while keeping taxable earnings to a minimum. This could be done by investing in tax-exempt municipal bonds or low-dividend yielding growth stocks.
In a tax-deferred account, investment income is not taxed until withdrawn, so earnings can come from any source without immediate tax implications. However, since you must start withdrawing funds from an IRA or 401(k) at age 70½, you might want to consider this in your planning.

 
Tax-free Roth IRAs offer the longest time horizon for investing since you are not required to make a withdrawal at any age.

 
In an era of high uncertainty and low-to-moderate economic growth forecasts, tax-efficient investing has never been more important. To review the tax implications of your investments, give our office a call today.

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Do You Owe Self-Employment Tax?

Did you work as a sole proprietor or independent contractor in 2016? If you earned more than $400 during 2016 from the work you did, you may owe self-employment tax. That’s true no matter what your age – even if you’re receiving social security benefits.

 
The tax is assessed on your earnings from self-employment. In this context, “earnings” generally means your self-employed income after deducting expenses incurred while operating your business. If you have multiple businesses, you combine the net income and losses. For your 2016 return, the self-employment tax rate is 15.3% on the first $118,500 that you earned.

 
What happens when you earn social security wages or tips from an employer and also have a side business? Your wages count toward the taxable base. Depending on how much you earn as an employee, your self-employment income may be subject to part or all of the tax.

 
You can pay self-employment tax on a quarterly basis as part of your estimated tax payments. One half of the total self-employment tax that you pay during the year is deductible on your income tax return, and you don’t have to itemize to claim the deduction.

 
Are you new to self-employment? Give us a call. We’re happy to help you make smart tax decisions.

FSA or HSA? Choosing between health accounts

 

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Are you confused about your choices for paying medical expenses under your employer’s benefit plan? Here are differences between two types of commonly offered accounts: a health savings account (HSA) and a health care flexible spending account (FSA).

 
Overview. An FSA is generally established under an employer’s benefit plan. You can set aside a portion of your salary on a pretax basis to pay out-of-pocket medical expenses. An HSA is a combination of a high-deductible health plan and a savings account in which you save pretax dollars to pay medical expenses not covered by the insurance.

 
Contributions. For 2016, you can contribute up to a maximum of $2,550 to an FSA. Typically, you have to use the funds by the end of the year. Why? Unused amounts are forfeited under what’s commonly called the “use it or lose it” rule. However, your employer can adopt one of two exceptions to the rule.
If you are single, the 2016 HSA contribution limit is $3,350 ($6,750 for a family). You can add a catch-up contribution of $1,000 if you are over age 55. You do not have to spend all the money you contribute to your HSA each year. You can leave the funds in the account and let the earnings grow.

 
Earnings. FSAs do not earn interest. Your employer holds your money until you request reimbursement for qualified expenses. HSAs are savings accounts, and the money in the account can be invested. Earnings held in the account are not included in your income.

 
Withdrawals. Distributions from both accounts are tax- and penalty-free as long as you use the funds for qualified medical expenses.

 
Portability. Normally, your FSA stays with your employer when you change jobs. Your HSA belongs to you, and you can take the account funds with you from job to job. That’s true even if your employer makes contributions to your HSA for you.

 
Because you generally can’t contribute to both accounts in the same year, understanding the differences can help you make a decision that best fits your circumstances. Contact us for help as you consider your benefit choices.