Planning NOW: 3 Questions to Ask Before the End of the Year

By Jeffery Levine, IRA Technical Expert  

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Thanksgiving is here – and the end of 2012 (believe it or not) is right around the corner. That means “year-end planning” time, and below we offer 3 questions you should ask (and find answers to) before year-end.

1) Should I convert all or a portion of my IRA to Roth IRA in 2012?

Right now, in 2012, the highest federal income tax rate is just 35%. In 2013, the highest rate is scheduled to be 39.6%, or roughly 5% higher. Of course, the highest rates are just for those lucky enough to enjoy incomes substantial enough to get to that point. In 2012, that meant close to $400,000 of taxable income, which is your income after all of your deductions and exemptions have been factored in.

So what if you’re in a lower bracket? No big deal right? Not so fast. Although President Obama campaigned on a platform that called for the Bush-era tax cuts to remain in effect for married couples with incomes less than $250,000 and single filers with incomes less than $200,000, those extensions still require Congressional approval. While both parties agree that they would like to see these cuts extended, they disagree about other aspects of the Tax Code, and thus, a deal on those cuts is far from guaranteed.

If Congress does not extend the Bush tax-cuts for those with incomes below the aforementioned limits, pretty much everyone will be impacted. Even those with the lowest levels of taxable income would see their tax bill rise, as the lowest bracket that currently exists, 10%, is set to be eliminated altogether and replaced with a 15% rate. Meanwhile, the 25% tax rate that many middle income Americans enjoy would be replaced with a 28% rate. Those who are currently in the 28% and 33% marginal brackets would see those rates increase to 31% and 36% respectively. Bottom line… If nothing changes, no one is safe from higher taxes. So regardless of whether your income is high, moderate or low, now is a good time to consider a Roth conversion, locking in today’s “low” tax rates for your hard-earned retirement funds.

What happens if you convert now and Congress acts late this year – or even early next year – to extend your current tax rates? That’s a good, no wait – great – problem! Maybe the conversion is still right for you, but if not, don’t forget the Roth recharacterization. Remember, as long as you file your return or your extension on time, you can recharacterize, or undo, your 2012 Roth conversion until October 15, 2013 and get all the tax you paid on the conversion back.

2) What can I do to minimize my exposure to the 3.8% health care surtax?

Beginning in 2013, a new 3.8% surtax on net investment income is set to kick in for certain taxpayers. If you are a single filer and have income of more than $200,000 or are married and have income of more than $250,000, you could be hit with the surtax. The tax is only going to be assessed on the income above your applicable threshold that’s attributable to net investment income. That means there are two ways you reduce your exposure to the surtax if you are likely to be impacted.

Strategy #1 – Reduce your overall income so that your total income drops below your applicable threshold

Strategy #2 – Reduce your net investment income

Approaches to these strategies include transitioning taxable bonds to tax-free municipal bonds, increasing the use of life insurance, using non-qualified annuities to help “shield” capital gains, dividends and interest from being taxable and, of course, Roth conversions.

#3 – Should I sell any of my taxable investments before the end of the year?

Right now, in 2012, the maximum tax rate you can pay on most long-term capital gain investments is 15%. Next year, the maximum rate on the same investments is scheduled to be as high as 23.8% when you factor in both the scheduled increase in long-term capital gains rates and the health care surtax (see question #2). That means that you could pay nearly 60% more in taxes if you sell appreciated long-term gain property next year, or after, instead of 2012.

Normally, when you sell investments at a gain, it’s also a good idea to see if you can sell some investments at a loss to offset those gains, resulting in a lower, possibility $0 tax bill on your sales.

This is commonly known as tax-loss harvesting, a strategy frequently employed by many tax professionals and portfolio managers. While tax-loss harvesting is still worth considering before the end of the year, it may also pay to “keep losers in the till” until next year, when they will be “worth” more since they could cancel out gains that would be taxed as high as 23.8%, as opposed to canceling out gains taxed at a maximum of 15% this year. Long-term and short-term capital gains and losses are first netted separately, and then against each other.

Article Highlights

  • Have the Roth conversion conversation because taxes are on the rise in 2013
  • Plan to combat the 3.8% surtax on net investment income due from the implementation of Obamacare
  • Think about whether you should sell any of your taxable investments before the end of the year


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