It wouldn’t be shocking if the next few years (or decades) provided investors with a low rate of return and a high degree of uncertainty—and that could be an optimistic scenario.
But there is still a reliable way for you to put more money in your clients’ pockets and portfolios each and every year. You just have to spend less time looking at stocks, bonds, and funds, and more of your time going over the clients’ 1040s.
We’ll spend the next few columns discussing how to cut your clients’ taxes at every age and stage of their lives, starting this month with working adults.
Save More, Pay Less
The most powerful tax-slashing tool available to most working clients is their employer-sponsored retirement savings plans, such as 401(k)s and 403(b)s.
In 2013 the annual contribution limits for these plans is the lesser of the employee’s earnings, or $17,500. Workers over age 50 can save an additional $5,500, for a total of $23,000.
Hopefully your clients can hit these maximums each and every year. But those who can’t hit the maximum should still try to save enough to lower their taxable income to a key level: the top of the 15 percent federal income tax bracket.
The number on Line 43 of their 1040 forms determines that figure. For 2013, it’s $72,500 for married couples filing jointly, and $36,250 for single filers. Any income over those amounts will be taxed by Uncle Sam at 25 percent or more.
Other Options
Clients who are able to maximize contributions to at-work retirement plans may still have other ways to save for retirement and cut taxes at the same time.
Those with qualifying income at low enough levels may be able to make a tax-deductible contribution to an individual retirement account (IRA). For the 2012 tax year, qualifying workers can contribute up to $5,000 to an IRA ($6,000 for those over 50), and the contribution is due by April 15, 2013. For the 2013 tax year, the contribution limit jumps up to $5,500, and again those over 50 can kick in another $1,000 on top of that.
Those clients who aren’t eligible to make a contribution to a regular IRA may still be able to fund a Roth IRA. You may also be able to establish and fund either a regular IRA or Roth IRA for the stay-at-home spouse of a working client.
The 2012 and 2013 income limits for contributions to Roth IRAs and deductible IRAs can be found at tinyurl.com/iradl.
Tax-Free Health Deductibles
Workers who have access to an employer-sponsored high-deductible health insurance plan and a health savings account (HSA) can use this option to save money on both health insurance premiums and current and future income taxes.
The higher deductible means that the worker usually pays a much lower premium on his health insurance. He then makes pre-tax deposits to an HSA, and whenever it’s time for him to pay his share of the deductible, he can withdraw the money tax-free from the HSA.
The HSA is not a “use it or lose it” proposition. The unused portion of the account rolls over into the next year for future use. Once the worker hits retirement at age 65, he can make tax-free withdrawals to cover other qualified medical expenses. Or, he can withdraw the money at retirement from the HSA for any reason, and it will be taxed as ordinary income (just like if it were an IRA).
Finding More Money
Many of your sharper clients will point out that increasing savings into the aforementioned retirement and health savings accounts may certainly reduce their current and future tax bills, but it will also reduce their take-home pay and spendable savings. You can rectify that dilemma by examining their monthly expenditures for areas that can be reduced without too much pain.
Clients might also want to slow down repayment of low-interest debt, such as student and vehicle loans. They could also benefit from redirecting money currently being saved for future college expenses, so that they get the bigger tax reduction now from saving for retirement.
Finally, homeowners who have some built-up equity in their homes should consider refinancing to the longest-possible mortgage for the most the lender will allow.
The cash-out proceeds and/or lower monthly payment from the new mortgage can be used to offset money that was going into the checking account but will be going to retirement accounts.
Delaying the Inevitable
Depending on their resources and circumstances, working clients may even have more tax- saving vehicles at their disposal.
Start by suggesting they move some of their rainy-day funds into United States savings bonds, specifically the “I” version. Those bonds pay 1.76 percent right now, although the rate is adjusted for inflation every May and November.
All of the interest is exempt from state taxes. As for federal taxes, the bond owner can either declare the interest and pay the taxes on it each year, or delay the taxes until the bonds are cashed in (or mature in 30 years).
Ideally, the clients will choose the latter method so that they can avoid the taxes now while in a higher bracket, and then in retirement redeem the bonds (and pay the taxes) while they are both in a lower tax bracket and more likely to need the money.
Parents with lots of money and little kids might also like to use 529 college savings plans to shelter future investment earnings from taxation. The parents keep total control over the accounts, but there are no taxes on withdrawals if the money is used for qualified higher education expenses. Even if 529 funds are eventually used for some purpose other than covering college costs, taxes and a relatively minor penalty will be applied—but only to the “earnings” portion of the withdrawal.
