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When investing and growing wealth to secure your financial future, the most important thing is not how much you earn, but how much you keep. Yet, investors often overlook the important role that tax efficiency can play in successful retirement planning.
By strategically managing your investments, you can minimize what you owe, maximize what you earn (and keep), and build a nest egg that lasts longer for you and your heirs. can. But it takes active planning to make it work. This is not something you can worry about until each tax season and try to catch up. Proper tax planning means looking at the big picture, evaluating your goals, and finding opportunities to reduce your tax burden in the short and long term.
With that in mind, here are three steps you can take to help reduce your current and future taxes and keep more of your hard-earned money.
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1. Consider the Roth transformation.
One of the most powerful tools for tax-efficient investing is the Roth IRA, which offers several benefits in retirement. Contributions to a Roth account are made with after-tax dollars, but you don’t receive the upfront tax savings that other retirement accounts can offer. Earnings with a Roth grow tax-free, and qualified withdrawals are also tax-free. .
If you have most of your retirement savings in tax-deferred investment accounts such as traditional IRAs or 401(k)s, converting all or part of those funds to a Roth can reduce your future savings. It could be of great help. tax bill.
Of course, you’ll have to pay taxes on the money you cash out in the year you cash it out, so you’ll need to be careful with your withdrawals and be aware of your tax brackets. But the benefits of Roth are:
- There are no mandatory minimum distributions (RMDs), so you can continue to grow the funds in your account for as long as you like.
- Qualified withdrawals from a Roth IRA do not count toward the modified adjusted gross income (MAGI) standard used to determine Medicare surtax.
- A Roth IRA gives you more flexibility when it comes to paying taxes in retirement. For example, when used in conjunction with a tax-deferred account, you can manage your tax liability each year.
Another benefit is that if you pass your Roth IRA on to your heirs, they too can enjoy tax-free growth.
Let’s say you have a traditional IRA with a sizable balance and over time you want to convert some of those funds to a Roth IRA. Your heirs can wait up to 10 years after your death to withdraw the money, and the money can continue to grow during that time. According to the Rule of 72, an inherited Roth IRA could even double in his 10 years if the annualized return exceeds 7.2%.
2. Maximize your philanthropy by leveraging donor-advised funds.
If you like the idea of donating to charity and want to include it in your planning, there are several strategies that can provide significant tax breaks in the process. One of the most popular options is a donor-advised fund (DAF).
A DAF is like an investment account, except it’s specifically designed to grow funds for charitable giving. The benefits are twofold.
- A DAF allows you to “roll up” multiple years’ worth of gifts into one large gift (cash and/or assets) that exceeds the Tax Cuts and Jobs Act threshold for itemized charitable deductions in one year. It will be. This will give you an immediate tax deduction.
- The DAF’s sponsoring organization then invests the funds. It can continue to grow tax-free until it is paid tax-free to a qualified charity over time. A DAF sponsoring organization has legal title to the assets in your fund, but as a “donation advisor” they have some say in how the funds are invested and which charities receive donations and when. You can have
A DAF allows you to maintain your philanthropic commitment while optimizing your tax savings this year and over your lifetime.
3. Reduce capital gains tax through loss harvesting.
While it’s natural to root for winners in your portfolio, sometimes investments that are losing value can still contribute to your returns.
A strategy called tax loss harvesting allows you to sell a long-term position that has incurred a capital loss, replace it with a similar but not identical investment, and then use that loss to pay taxes on investment gains realized in the same year. Can be offset. If your losses exceed your profits, the excess can also be used to offset your ordinary income by up to $3,000 each year, with any remaining losses carried forward into the future.
By implementing this strategy regularly to minimize your taxes, you can keep more of your money invested longer and have more lasting impact.
Proactive planning is key
Strategies like Roth IRA conversions, donor-recommended funds, and tax loss capture can help you reduce taxes over your lifetime and leave a tax-efficient legacy for your heirs. If you can combine one or more strategies, you can increase your savings even more. (For example, an income tax deduction for contributions to a DAF can be used to offset the increased tax liability from a Roth conversion.)
However, you’ll probably need some help to get the most out of your investment. and Follow IRS regulations. Consulting with a financial advisor or tax professional can help you tailor these tax-saving strategies to your individual financial situation and increase your chances of achieving your family’s goals.
Kim Franke-Folstad contributed to this article.
The Kiplinger appearance was obtained through a PR program. The columnist received assistance from a public relations firm in preparing this article for publication on Kiplinger.com. No compensation was made to Mr. Kiplinger.
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