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Why You Should Begin Year-End Retirement Planning

10 things to check and consider as 2014 winds down


(This article previously appeared on MarketWatch.com.)

October marks the start of the fourth quarter: the perfect time to think about year-end planning strategies and tactics that can help save or make a buck or two. Though not an exhaustive list, here are 10 things experts say you should consider or do now:

 
1. Put your financial house in order. The last quarter of the year is a great time to review how much money you’ve spent during the past 12 months and track your annual expenses for the coming year, said Randy Bruns, a certified financial planner with HighPoint Planning Partners.

“Understanding your annual expenses is crucial for calculating how much should be set aside in savings in the case of a job loss, how much term life (insurance) is needed to protect your family should you die, and … to help calculate a target nest egg,” said Bruns.

 
Consider purchasing Quicken or using free online tools such as Mint.com to track your income and expenses.

(MORE: New Apps and Sites to Manage Your Money)

 
2. Project your tax bill. Once you get a handle on your income and expenses, it's a good time to estimate your 2014 tax bill, especially if there have been or will be large differences from previous years.

Items to look for, according to Joseph Clemens, a certified financial planner and owner of Wisdom Wealth Strategies, include:

 
Increased medical expenses “Since medical mileage/travel is potentially deductible, did you travel a lot for medical purposes?” he asked. “This can be especially important since those 65 and over have through 2016 before their threshold jumps up to the rest of the population from 7.5 percent to 10 percent.”
 
Have you made large purchases such as a vehicle and the funding came from a taxable account? If so, this could increase tax liability, said Clemens.

(MORE: 7 Key Changes to the 1040 Form)
 

Are you making enough in estimated payments? “If you think you won’t be, one trick is to do a withdrawal from an IRA to cover the difference and withhold 100 percent,” Clemens said. “Since IRA withholdings are treated as being contributed to throughout the year, this trick can help avoid the underpayment of tax penalty.”

FYI: If you don’t want the income from the IRA that is required to do this, you could replace the money into the IRA account from your bank as a “once per year 60-day replacement” or take the funds from a Roth, Clemens said.


“Once you get a tax projection, then a retiree will be in a better position to analyze the usual year-end strategies, such as charitable stock gifting and tax harvesting,” said Clemens.
 
3. Consider a Roth IRA conversion. Part of getting a handle on your potential tax bill means getting a sense of what your taxable income will be for 2014, said Scot Hanson, a certified financial planner with EFS Advisors. That would be line 43 on Form 1040.
 
One possible tactic: Taxpayers who expect to land in the 15 percent tax bracket or less (married couples filing jointly in 2014 with taxable income of $73,800 or less, for example) might consider converting part (or all) of their traditional IRA into a Roth IRA, but not so much that they move into the 25 percent tax bracket.
 
“It is no fun to report income and pay the extra taxes, but at 15 percent, you are most likely never to be in a lower tax bracket for the rest of your life,” said Hanson.

(MORE: The Pros and Cons of a Roth IRA)

 
One benefit: “Any amount you convert now and move to Roth IRA will not have required minimum distributions (RMDs) that start at age 70½ with most other retirement accounts, so you are blunting that future impact,” Hanson said.
 
And the worst of it is this: You’re prepaying taxes so that children inheriting your Roth IRA will not have to pay any taxes, Hanson said.
 
Also, consider asking your children to help pay whatever tax you might owe on the Roth IRA conversion. “If I am your son or daughter and can expect the future IRA at death, I would be willing to help with those taxes at 15 percent, because I would not want to pay those same taxes at a much higher tax bracket if in a higher tax bracket,” Hanson said.
 
Another benefit: By converting to a Roth IRA before reaching age 70½ you might be able to reduce how much your Social Security benefit is taxed. “RMDs (from your traditional IRA) often cause more of your Social Security to be taxed,” said Hanson.
 
How so? If you’re married and filing a joint return, and you and your spouse have a combined income between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits and if you have combined income more than $44,000, up to 85 percent of your benefits may be taxable.(Combined income equals your adjusted gross income, plus nontaxable interest, plus one-half of your Social Security benefits. RMDs would be included in your adjusted gross income.)
 
By contrast, you won’t ever have to take an RMD from your Roth IRA. And if you do take a distribution from a Roth IRA, it won’t be included in your adjusted gross income.
 
Mark Luscombe, a principal analyst with Wolters Kluwer, CCH, said Roth conversions can also be a good strategy, especially if IRA distributions might push the taxpayer into a higher tax bracket or push adjusted gross income (AGI) up sufficiently to make the taxpayer subject to the 3.8 percent tax on net investment income. “The taxpayer might want to spread out the conversions over several years, again to keep AGI as low as possible,” he said.
 
And, Luscombe said, “Roth conversions also make more sense for taxpayers who do not anticipate needing the converted funds in retirement, at least not right away, and if the taxpayer has other funds to pay the tax on conversion.”
 
Speaking of what planners often refer to as tax-bracket planning, consider this tactic too. Long-term capital gains are taxed at 0 percent if you are in the 10 percent or 15 percent federal income tax brackets. So, if you fall into those tax brackets, Ryan Pace, a certified financial planner with D3 Financial Counselors, recommends realizing enough long-term capital gains to take you to the top of the 15 percent tax bracket.
 
4. Maximize retirement contributions. Another way to trim your tax bill? Make sure you’re on pace to contribute as much as possible, even the maximum allowed, to your retirement accounts, such as your 401(k) and the like, as well as, if you have one, your Health Savings Account (HSA), said Pace.
 
In 2014, you can contribute up to $17,500 in your 401(k) plus an additional $5,500 if you are age 50 or older.
 
Read IRS Announces 2014 Pension Plan Limitations; Taxpayers May Contribute up to $17,500 to their 401(k) plans in 2014 for the contribution limits for all the various types of retirement plan accounts and the IRS’ Revenue Procedure 2013-25 for the inflation-adjusted HSA contribution and high deductible health plan minimum deductible and out-of-pocket limits for 2014.
 
As part of this exercise, Bruns recommends reviewing your financial plan to determine whether you’re saving enough for retirement, and then making the appropriate changes to your contribution rates for this and next year.
 
Pace also recommends: contributing to a 529 college savings plan if your state offers an income tax deduction for contributions and enrolling in a Flexible Spending Account (FSA) if your employer offers one. FYI: The government changed modified the “use-it-or-lose-it” rule for health Flexible Spending Arrangements. Participants now can carry over up to $500 of their unused balances remaining at the end of a plan year. So make sure to spend as much as you need to bring your balance down to $500. Otherwise, you’ll lose any amount over $500.
 
What’s the benefit of maximizing your contributions to 401(k)s, HSAs and the like? You’ll lower your income tax bill.
 
5. Maximize tax deductions and credits. You might be able to reduce your tax bill by increasing your charitable contributions. Pace recommends the following: cleaning out your garage and closets to make non-cash donations to charity; donating your most appreciated assets to charity (by doing so you avoid realizing capital gains); and front-loading charitable contributions by gifting cash or stock into a donor-advised fund.
 
Also, if a family member has higher education expenses, Pace recommends taking advantage — if possible — of the American Opportunity Credit (it’s a tax credit of up to $2,500 of the cost of tuition, fees and course materials paid during the taxable year) or the Lifetime Learning Credit (it’s a tax credit of up to $2,000). Read American Opportunity Tax Credit: Questions and Answers and also, Lifetime Learning Credit.
 
6. Look for ways to deduct losses. For some, tax-loss harvesting might be another way to keep your tax bill in check. “Tax-loss harvesting is a way to reduce your taxes by selling an investment that is trading a significant loss and replacing it with a comparable investment,” said Dustin Obhas, a certified financial planner with CLA Financial Advisors.
 
Two caveats: One, the IRS will disallow the loss if the same or substantially identical asset is purchased within 30 days. That’s called the “wash-sale rule.” And two, only up to $3,000 of loss can be used to reduce your taxable income ($1,500 each if married filing separately). Given these caveats, consider talking with a qualified tax professional who can determine in advance whether tax-loss harvesting makes sense for you.
 
7. Rebalance your portfolio. Consider the pros and cons of tax-loss harvesting in the context of your overall portfolio. You might be able to accomplish two goals — rebalance your portfolio to its intended target and tax-loss harvest — at the same time.
 
“If the stock market is booming and the bond market is flat, chances are you’ve now got more exposure to stocks than you did when the year began, which adds risk to your portfolio,” Bruns said. “A disciplined rebalancing strategy is a simple and easy way to remove emotion from your investment decisions by forcing you to sell high and buy low.”
 
Examine, too, the fees you’re paying for your investments. “Review your mutual fund expenses at year-end and dump those with unnecessarily high fees,” said Bruns. “Decades of academic research has shown that high mutual fund expenses are a major headwind to future performance.”
 
What to do: Own mutual funds with expense ratios well below 1 percent. “Low-cost providers such as Vanguard offer mutual funds with expense ratios below 0.10 percent,” said Bruns.
 
Also, as part of this process, update your investment policy statement — your blueprint for your investments. “You want to make sure your investment match your risk tolerance and goals,” said Obhas. “Ask yourself if you’re taking on too much risk or being too conservative.”
 
8. Take your required IRA distributions. If you’re over age 70½ and you own traditional IRAs and/or 401(k)s don’t forget to take your required minimum distributions (RMDs). “Miss the Dec. 31 deadline and you’ll face a steep penalty of 50 percent of the amount that you should have taken,” said Bruns.
 
Remember, too, that taking your RMD is taxable income, said Obhas.
 
9. Update your estate plan. Use the final three months of the year to update your estate plan, including your will, trusts, and powers of attorney. Make sure they reflect any material changes such as divorce, or children leaving your home, or a sibling who was listed as your executor or trustee dying.
 
“Also make sure the beneficiaries are up-to-date on your various financial accounts,” Bruns said. “A lot can change after you open an account.”
 
Others agree with the need to review your estate documents. “Chances are it’s been years since you updated your estate planning documents,” said Obhas. “Life happens, things change.”
 
10. Keep an eye on Congress. Taxpayers already in retirement, Luscombe said, should watch whether Congress extends expired provisions, particularly the provision that permits taxpayers over age 70½ to make IRA distributions directly to a charity without taking the distributions into income.
 
“This keeps AGI lower which could help reduce tax on Social Security benefits and perhaps also help the taxpayer qualify for other tax breaks that phase-out as AGI increases,” said Luscombe.
 
Of note: Luscombe said the last time Congress waited until the end of the year to extend this provision, they let required minimum distributions made in December be treated as if they were made directly to a charity and allowed distributions to charity made in January of the following year to be treated as if made on Dec. 31. “It is not certain what Congress might do this time around,” he said.

Robert Powell is editor of Retirement Weekly, published by MarketWatch. Follow his tweets at RJPIII. Got questions about retirement? Get answers. Send Bob an email here.

By Robert Powell
Robert Powell writes about retirement issues for MarketWatch.com and produces the Retirement Weekly subscription newsletter.@RJPIII

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