While it’s traditional for you and your accountant to focus on tax planning tactics toward year-end, it may be less common to set aside time in a new year to leap on the freshly arrived opportunities. By getting a head start on some important retirement and healthcare saving incentives available from the Internal Revenue Service, you can make even greater leaps forward in keeping your hard-earned wealth for yourself. Why wait? Let’s get going.
Fund Your IRA Early in the Year
You can maximize your retirement savings by funding your IRA as early as possible for any given tax year. By contributing toward the start of the current year instead of waiting until tax day of the following year, your contribution can earn over a year’s worth of additional income that qualifies for tax advantages. This is a nice bonus that is overlooked by many investors, even when their circumstances warrant the early funding.
In 2014, the maximum annual IRA contribution is $5,500 per individual. If you’re 50 or older, your maximum contribution is $6,500, including a $1,000 “catch-up” amount. The limit that applies to you reflects the total annual amount you can contribute to all of your traditional and Roth IRAs combined.
Your maximum contribution to a Roth IRA and your maximum deductible contribution to a traditional IRA will be reduced if your Modified Adjusted Gross iIncome exceeds a given level based on your tax filing status.
Now More Than Ever, Consider a Roth IRA Conversion
Unlike a traditional IRA, a Roth does not offer a current-year tax deduction on contributions. However, under current legislation, the earnings on your Roth investments will never be taxed, not even upon withdrawal, provided certain conditions are met. Generally, those conditions require you to hold your Roth account at least five years and through age 59½.
Because only after-tax money can be held in a Roth IRA, any deductible (pre-tax) contributions you made to your old account, plus earnings on either deductible or nondeductible contributions, will be taxable upon the conversion.
Making an informed decision on whether to do a Roth IRA conversion requires a detailed analysis of your personal circumstances. Generally, a conversion works in your favor if you can reasonably project that the current-year taxes triggered by your action would be less than you would pay later if you were not to do a conversion.
In other words, if you think you’ll be in a higher tax bracket during retirement or anticipate higher tax rates by then, then doing a Roth conversion – getting the tax liability out of the way now – might be a smart move. On the other hand, if you expect to be in a lower tax bracket during retirement than you’re in now, the advantages of a conversion may be less substantial. Still, give some thought to a conversion anyway. The best decision is made by pushing the pencil around a bit to see where the line is drawn.
You also want to be certain you'll have enough funds to pay the additional current-year taxes that a conversion will entail, and ideally, you want to make sure a conversion won't bump you into a higher tax bracket in the year it’s made.
Maximize Deferrals to Your Workplace Retirement Savings Plan
By making pretax contributions to your 401(k), 403(b), 457 or similar work savings plan, you reduce your current income tax liability and pump up your retirement savings. The 2014 limit on employee pretax contributions is $17,500, or $23,000 (including a $5,500 “catch-up” amount) for people age 50 or older by the end of the year. Try to contribute at least enough to take full advantage of any match that your employer may offer, otherwise you’re leaving essentially free money sitting on the table. And if your plan allows for Roth 401(k) contributions, which like Roth IRA contributions are made with after-tax dollars, you may want to consider this option for some or all of your contributions. The limits are the same as pretax deferrals ($17,500 or $23,000), but you forgo a current tax benefit in exchange for tax-free growth.
Take Advantage of an HSA, FSA or HRA to Cover Out-of-Pocket Health Care Costs
When you use a Health Savings Account (HSA), health care Flexible Spending Account (FSA) or Health Reimbursement Account (HRA) to pay for qualified out-of-pocket medical expenses, you also get important tax advantages. And reimbursements from your account to pay for qualified expenses are tax-free.
These accounts, therefore, offer tax-savvy ways to cover out-of-pocket health care costs. Let's talk about how you can get maximum advantage from such an account in 2014 – and why there’s not much reason to wait to do your funding if you’ve got one available.
If you’re enrolled in an HSA (which is always paired with a High Deductible Health Plan, or HDHP), you have until April 15 of the following year – just like with an IRA – to make the full annual contribution. You’re allowed to contribute to the HSA in one lump sum or in multiple payments, although your account administrator may impose minimum deposit and balance requirements.
For 2014, the annual limit on tax-deductible contributions to an HSA is $3,300 for a person with individual coverage under an HDHP. For a person with family coverage, the limit is $6,550. Those 55 or older can contribute an additional $1,000. If your employer contributes to an HSA on your behalf, all contributions by you and your employer are combined to determine whether you’ve reached your maximum contribution level for the year.
You get to keep your HSA even if you change jobs, become unemployed, move to a new state or change marital status. And you can leave funds in the account indefinitely, so you can make tax-free withdrawals later, even after you retire, to cover qualified health care expenses at that time. You can withdraw funds for nonqualified reasons at any time, but such withdrawals are subject to regular income tax plus – in most cases, a 10% penalty.
If you’re enrolled in an FSA this year, money is already being automatically deducted from your paycheck according to an election you made last year. The issue now is to make sure you use the FSA throughout the year to reimburse yourself for qualified medical expenses not covered by insurance, including amounts you’ve paid out of pocket for deductibles and coinsurance.
With a health care FSA, you can reimburse yourself for a qualifying expense even if year-to-date contributions to your account are not yet enough to cover the full expense. Remember that FSAs are “use it or lose it” accounts. In other words, you will forfeit any money still remaining in your account as of a specified date. Check with your plan as to when that date occurs; it can be any time from the end of the plan year through 2 ½ months after the end of the plan year.
If you’re covered by an HRA, which is 100% employer-funded, don’t miss the opportunity to use the HRA to pay for qualified medical expenses not covered by insurance, including amounts you’ve paid out of pocket for deductibles and coinsurance. Check with your HRA administrator to find out whether leftover dollars can be carried over from year to year. Some HRAs, like FSAs, are “use it or lose it” accounts.
“Use It and Keep It” Planning
We’ve referenced some ideas for your “use it or lose it” accounts. Our greater goal for your overall wealth is to help you “use it and keep it.” At Grand Wealth Management, we help clients devise and implement personalized action plans for working toward their health care and retirement plan goals in 2014 and beyond.