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10 Money Moves to Make Before Year's End
10 Money Moves to Make Before Year's End
By DAN KADLEC
If you're going about year-end tax and financial planning the same old way, you may be making some costly mistakes. The world has changed. Did you notice? Some tax laws are expiring while others are being ginned up; assets like housing and stocks that typically produce gains have delivered staggering losses. Smart planning in this environment means turning some traditional strategies on their head. But you only have a few weeks. So let's get started. Here are 10 money moves to make by Dec. 31.
1. Postpone your losses
That's right. This is the time of year when tax advisers typically advise "harvesting" your losses, which simply means selling enough stocks that have declined to offset the taxes owed on stocks you've sold at a gain this year and up to $3,000 of ordinary income. That strategy may still make sense — to the extent you have any taxable gains, say, from stock sales early this year. But with stocks having been cut in half this year it's a good bet that you are not staring at a capital gains tax liability just now. So put off selling until next year when, hopefully, the market will begin to recover and you'll stand a decent chance at getting a better price.
Another reason to wait: it's a reasonable bet that the capital gains tax rate will jump next year, though it probably won't happen until late in 2009 at the earliest due to the current economic crisis. On that chance, you might be better off paying any taxes on your gains this year in order to preserve your losses for next year, when those losses may be more valuable from a tax perspective. "Over the long haul you should have more gains than losses — or it doesn't make sense to invest," says William Jordan, president of Sentinel Group, a financial planner in Laguna Hills, Calif. "So you'll get the chance to use your losses." The choice, he says, is to pay a relatively low tax now, or a higher one later.
2. Accelerate income
Again, this runs counter to traditional planning. But just about everyone expects tax rates to go higher under President Obama. The top rate for ordinary income could shoot to 39.6% from 35%. That jump will either happen in 2009 or 2010, but it will most certainly happen. "We haven't seen tax rates this low since the 1930s," says Mary Ann Sisco, National Wealth Adviser for J.P. Morgan Private Wealth Management. These rates won't last much longer. True, the higher rates will probably only apply to those making more than $250,000, but some people will see their income shoot up to that level due to one-time events, such as lump-sum severance payments, bonus checks, incentive stock option transactions, 401 (k) distributions or freelance project payments. To the extent you are able, conduct those transactions by Dec. 31. Likewise, if you're selling a second home at a profit, try to close by Dec. 31. You only get the $250,000 exclusion ($500,000 for couples) on a primary residence. Other property is subject to capital gains rules.
3. Identify hidden income
You may be on the hook for taxable income from your mutual funds — even if they have plunged in value. This is one of the weird aspects of fund investing. They generate a tax liability anytime the fund sells more stocks at a gain than they sell at a loss during the year. Typically, funds manage this well, matching winners with losers for maximum tax efficiency. But scared investors have been fleeing the market en masse, forcing many funds to sell indiscriminately just to meet redemptions. In many cases they have had to sell long-held shares at a profit and have been unable to match them with losers. You'll be notified of any taxable distributions in a week or two — and they may be whoppers, up to 10% of fund assets, says Jordan. You can offset this tax liability with losses from your other holdings. You can also choose to sell the fund right away and avoid the distribution. Another painful source of phantom income is debt forgiveness, as with a repossessed car or foreclosure on your home, or even an agreed upon mortgage work-out plan with your bank. The amount you owe but do not pay is treated as income for tax purposes. Push that income into next year, if you can, by making it just one more month before cutting any deals with a creditor.
4. Defer expenses
Ordinarily, it's a good idea to accelerate deductible expenses like a mortgage or tax payment into the current year in order to reduce your taxable income, and that remains a sound strategy for anyone who expects their tax rate to stay the same or go lower. But high earners are likely to see higher income tax rates under President Obama. Expenses pushed into next year would provide a larger deduction.
5. Get invested for the times
No one knows what the near-term future holds for stocks. What we do know is that stocks almost always hit rock bottom long before a recession lifts. For now, it makes sense to invest for hard times — which means holding a lot of cash and cash equivalents, government bonds and recession-resistant stocks like food and beverage companies, pharmaceutical and health-care firms and businesses that make consumer staples like soap and paper towels. To the extent you do any tax selling, use the proceeds to adjust your holdings. While you're at it, rebalance your portfolio to a target mix of stocks, bonds and cash (60%, 30%, 10% is an all-weather guide). By mid or late next year, though, you should be thinking about buying recovery stocks like banks, homebuilders, construction firms and heavy equipment makers — all of which stand to benefit from the incoming administration's stimulus effort, which is likely to include a large infrastructure bill.
6. Look for bargains
December is almost always a great time to find stocks that have been beaten down beyond what their fundamentals dictate, and it's largely due to tax-loss harvesting. That's happening with a vengeance right now. So keep your eyes open for such stocks, which tend to outperform early in the New Year. How can you spot a bargain? A decent gauge is a company's price-to-earnings ratio, which is its share price divided by it earnings per share. Look at the P/E based on expected earnings for the coming year and actual earnings the past 12 months. You want the ratio in both cases to be below (but not more than three or four points below) the industry average. As a gauge, the market P/E is now about 13. Something less than that is a decent starting point.
7. Think green
Some consumer energy tax breaks expired last year, like the ones for new windows and insulation. But those will back next year, so don't buy that stuff now. The breaks for buying the most popular hybrid cars like the Toyota Prius and Ford Escort have all but vanished. But next year there will be new tax credits for certain new plug-in hybrid vehicles. For this year, you can still take a tax credit of up to $2,000 if you install in your home a solar-powered hot-water system or solar panels that produce electricity. Green breaks are a jumble. You can sort them out at dsire.org.
8. Claim your stimulus check
If you did not qualify for the government's stimulus check last summer based on your 2007 income, but have suffered a blow to your earnings, you may be eligible to apply for a recovery rebate credit on your 2008 return. The stimulus checks were for as much as $600 per person or $1,200 per couple and phased out at annual income of $75,000 per person ($150,000 for couples). You'll need to stay below those income thresholds, so think about that before accelerating any income. But if you do qualify the cash is yours through proper tax filing.
9. Give something away
Donations are tax deductible and, says Barbara Weltman, editor of J.K. Lasser's Your Income Tax 2009, "charitable organizations are really hurting this year." So you can do something good for the world and shave your tax bill at the same time. If your finances are temporarily tight, make a donation by credit card. You can take the deduction this year even though you make the payment next year. If you're not sure where to contribute, consider making a gift this year to a donor advised fund like those available at Fidelity, Vanguard and other big fund companies. You get an immediate tax deduction and can let the money grow for as long as you like before finally giving it away.
10. Convert to a Roth IRA
If you have adjusted gross income below $100,000 (that qualifier disappears in 2010), you are eligible to switch your traditional IRA to a Roth IRA. In a traditional IRA you make pre-tax contributions and pay ordinary income tax upon taking the distributions in retirement; in a Roth IRA, you make after-tax contributions but your money grows tax free and you owe no tax upon taking distributions. To convert, though, you must first pay income tax on the full amount being shifted. The ideal candidate for this move is someone who has lost a job or otherwise suffered a steep income drop but expects to get back on track and be earning much more in the near future — like, say, a mortgage broker or SUV salesman. Your temporary setback gives you a temporarily low tax rate. If you wait until next year, not only might you be earning more money and be in a higher tax bracket, but income tax rates may be higher too, pushing up the cost of the conversion.
If you converted to a Roth IRA earlier this year and since then have seen your assets plummet you can undo the conversion, advises Doris Merrick, tax director at Brinton Eaton Wealth Advisors. Simply send the assets back to a traditional IRA (what's left of them), and start the process all over again. It's worth the effort. A $100,000 conversion early last year triggers a $35,000 tax liability for someone in the highest bracket. But they may be able to cut that liability dramatically. Say IRA assets plunge by 40% to $60,000. Undoing the conversion, and then reconverting, would avoid tax on $40,000 — roughly a $14,000 savings in this example.
By DAN KADLEC
If you're going about year-end tax and financial planning the same old way, you may be making some costly mistakes. The world has changed. Did you notice? Some tax laws are expiring while others are being ginned up; assets like housing and stocks that typically produce gains have delivered staggering losses. Smart planning in this environment means turning some traditional strategies on their head. But you only have a few weeks. So let's get started. Here are 10 money moves to make by Dec. 31.
1. Postpone your losses
That's right. This is the time of year when tax advisers typically advise "harvesting" your losses, which simply means selling enough stocks that have declined to offset the taxes owed on stocks you've sold at a gain this year and up to $3,000 of ordinary income. That strategy may still make sense — to the extent you have any taxable gains, say, from stock sales early this year. But with stocks having been cut in half this year it's a good bet that you are not staring at a capital gains tax liability just now. So put off selling until next year when, hopefully, the market will begin to recover and you'll stand a decent chance at getting a better price.
Another reason to wait: it's a reasonable bet that the capital gains tax rate will jump next year, though it probably won't happen until late in 2009 at the earliest due to the current economic crisis. On that chance, you might be better off paying any taxes on your gains this year in order to preserve your losses for next year, when those losses may be more valuable from a tax perspective. "Over the long haul you should have more gains than losses — or it doesn't make sense to invest," says William Jordan, president of Sentinel Group, a financial planner in Laguna Hills, Calif. "So you'll get the chance to use your losses." The choice, he says, is to pay a relatively low tax now, or a higher one later.
2. Accelerate income
Again, this runs counter to traditional planning. But just about everyone expects tax rates to go higher under President Obama. The top rate for ordinary income could shoot to 39.6% from 35%. That jump will either happen in 2009 or 2010, but it will most certainly happen. "We haven't seen tax rates this low since the 1930s," says Mary Ann Sisco, National Wealth Adviser for J.P. Morgan Private Wealth Management. These rates won't last much longer. True, the higher rates will probably only apply to those making more than $250,000, but some people will see their income shoot up to that level due to one-time events, such as lump-sum severance payments, bonus checks, incentive stock option transactions, 401 (k) distributions or freelance project payments. To the extent you are able, conduct those transactions by Dec. 31. Likewise, if you're selling a second home at a profit, try to close by Dec. 31. You only get the $250,000 exclusion ($500,000 for couples) on a primary residence. Other property is subject to capital gains rules.
3. Identify hidden income
You may be on the hook for taxable income from your mutual funds — even if they have plunged in value. This is one of the weird aspects of fund investing. They generate a tax liability anytime the fund sells more stocks at a gain than they sell at a loss during the year. Typically, funds manage this well, matching winners with losers for maximum tax efficiency. But scared investors have been fleeing the market en masse, forcing many funds to sell indiscriminately just to meet redemptions. In many cases they have had to sell long-held shares at a profit and have been unable to match them with losers. You'll be notified of any taxable distributions in a week or two — and they may be whoppers, up to 10% of fund assets, says Jordan. You can offset this tax liability with losses from your other holdings. You can also choose to sell the fund right away and avoid the distribution. Another painful source of phantom income is debt forgiveness, as with a repossessed car or foreclosure on your home, or even an agreed upon mortgage work-out plan with your bank. The amount you owe but do not pay is treated as income for tax purposes. Push that income into next year, if you can, by making it just one more month before cutting any deals with a creditor.
4. Defer expenses
Ordinarily, it's a good idea to accelerate deductible expenses like a mortgage or tax payment into the current year in order to reduce your taxable income, and that remains a sound strategy for anyone who expects their tax rate to stay the same or go lower. But high earners are likely to see higher income tax rates under President Obama. Expenses pushed into next year would provide a larger deduction.
5. Get invested for the times
No one knows what the near-term future holds for stocks. What we do know is that stocks almost always hit rock bottom long before a recession lifts. For now, it makes sense to invest for hard times — which means holding a lot of cash and cash equivalents, government bonds and recession-resistant stocks like food and beverage companies, pharmaceutical and health-care firms and businesses that make consumer staples like soap and paper towels. To the extent you do any tax selling, use the proceeds to adjust your holdings. While you're at it, rebalance your portfolio to a target mix of stocks, bonds and cash (60%, 30%, 10% is an all-weather guide). By mid or late next year, though, you should be thinking about buying recovery stocks like banks, homebuilders, construction firms and heavy equipment makers — all of which stand to benefit from the incoming administration's stimulus effort, which is likely to include a large infrastructure bill.
6. Look for bargains
December is almost always a great time to find stocks that have been beaten down beyond what their fundamentals dictate, and it's largely due to tax-loss harvesting. That's happening with a vengeance right now. So keep your eyes open for such stocks, which tend to outperform early in the New Year. How can you spot a bargain? A decent gauge is a company's price-to-earnings ratio, which is its share price divided by it earnings per share. Look at the P/E based on expected earnings for the coming year and actual earnings the past 12 months. You want the ratio in both cases to be below (but not more than three or four points below) the industry average. As a gauge, the market P/E is now about 13. Something less than that is a decent starting point.
7. Think green
Some consumer energy tax breaks expired last year, like the ones for new windows and insulation. But those will back next year, so don't buy that stuff now. The breaks for buying the most popular hybrid cars like the Toyota Prius and Ford Escort have all but vanished. But next year there will be new tax credits for certain new plug-in hybrid vehicles. For this year, you can still take a tax credit of up to $2,000 if you install in your home a solar-powered hot-water system or solar panels that produce electricity. Green breaks are a jumble. You can sort them out at dsire.org.
8. Claim your stimulus check
If you did not qualify for the government's stimulus check last summer based on your 2007 income, but have suffered a blow to your earnings, you may be eligible to apply for a recovery rebate credit on your 2008 return. The stimulus checks were for as much as $600 per person or $1,200 per couple and phased out at annual income of $75,000 per person ($150,000 for couples). You'll need to stay below those income thresholds, so think about that before accelerating any income. But if you do qualify the cash is yours through proper tax filing.
9. Give something away
Donations are tax deductible and, says Barbara Weltman, editor of J.K. Lasser's Your Income Tax 2009, "charitable organizations are really hurting this year." So you can do something good for the world and shave your tax bill at the same time. If your finances are temporarily tight, make a donation by credit card. You can take the deduction this year even though you make the payment next year. If you're not sure where to contribute, consider making a gift this year to a donor advised fund like those available at Fidelity, Vanguard and other big fund companies. You get an immediate tax deduction and can let the money grow for as long as you like before finally giving it away.
10. Convert to a Roth IRA
If you have adjusted gross income below $100,000 (that qualifier disappears in 2010), you are eligible to switch your traditional IRA to a Roth IRA. In a traditional IRA you make pre-tax contributions and pay ordinary income tax upon taking the distributions in retirement; in a Roth IRA, you make after-tax contributions but your money grows tax free and you owe no tax upon taking distributions. To convert, though, you must first pay income tax on the full amount being shifted. The ideal candidate for this move is someone who has lost a job or otherwise suffered a steep income drop but expects to get back on track and be earning much more in the near future — like, say, a mortgage broker or SUV salesman. Your temporary setback gives you a temporarily low tax rate. If you wait until next year, not only might you be earning more money and be in a higher tax bracket, but income tax rates may be higher too, pushing up the cost of the conversion.
If you converted to a Roth IRA earlier this year and since then have seen your assets plummet you can undo the conversion, advises Doris Merrick, tax director at Brinton Eaton Wealth Advisors. Simply send the assets back to a traditional IRA (what's left of them), and start the process all over again. It's worth the effort. A $100,000 conversion early last year triggers a $35,000 tax liability for someone in the highest bracket. But they may be able to cut that liability dramatically. Say IRA assets plunge by 40% to $60,000. Undoing the conversion, and then reconverting, would avoid tax on $40,000 — roughly a $14,000 savings in this example.
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