With only a few weeks left in 2010, it’s a time not only of reflection on the past year’s accomplishments, but also a time to prepare your finances for the upcoming year. Here are a few things you can do to make 2010 a more profitable year, and put you on the right financial track for 2011.
For anyone planning to convert their traditional IRA(s) to a Roth IRA, executing the conversion in 2010 may be advantageous. The Tax Increase Prevention and Reconciliation Act of 2005 allows anyone, regardless of income, to convert a traditional IRA to a Roth IRA as long as they pay the tax on the converted amount. What’s special about 2010 is that the tax liability from conversions made this year can be spread over two years, which can be very beneficial if your IRA is large enough to push you up to a higher tax bracket.
Tax loss harvesting is the act of intentionally selling an asset at a loss to offset current and/or future capital gains. It is one of the few methods individuals can employ to manage their Adjusted Gross Income (AGI) and hence, reduce their taxes. To reduce their tax liability, many people rely solely on taking itemized deductions, such as mortgage-interest and charitable contributions. While itemized deductions can bring you modest tax benefits, they have no impact on one’s AGI. As the adage says, Don’t Lose the Forest For the Trees. In other words, be aware that there is a bigger tax benefit in tax loss harvesting and put it to work for you. It is important to note that tax loss harvesting only applies in your taxable accounts, not in your IRAs or 401ks. Each person’s tax situation is different, so investors should consult with their financial and tax advisors before engaging in such strategies.
The easiest way to reduce your tax liability immediately is to have less taxable income. Employer sponsored retirement plans are one of the best ways to accomplish this, because any contribution made to such plans reduces your taxable income. Whether you are self-employed or are an employee, the IRS has limitations on how much you can contribute to your retirement accounts each year. If you are an employee, the total amount you can put into your 401k in 2010 is $16,500. So for example: if you make $100,000 a year in salary, and contribute $16,500 into your 401k plan, you are then taxed on only $83,500. If you’re in the 28 percent tax bracket, that’s an immediate tax savings of $4,620! Check your year-to-date 401k contribution, and if you haven’t yet met the annual IRS limit, increase your contribution for the month of December.