Money Sense


Tax Planning Has No Season

Most of us think about our taxes at two points during the year – April 15 and December 31. However, planning for your taxes is something to consider all year long as the decisions you make now can affect every piece of your financial life. Here are some year-round tips and strategies you can discuss with your financial advisor to ensure your tax planning helps you achieve your yearround financial goals.

Maximize the Effectiveness  of Your Tax-Deferred Accounts
Make sure that you fully fund and invest your taxdeferred retirement and education savings accounts. Tax-deferred accounts present opportunities for you to reduce your overall taxable income and therefore, reduce your tax bill. Some strategies to consider include:

  • Make the maximum annual contribution of $15,000 ($20,000 if age 50 or above) to your 401(k) or 403(b) or other workplace savings plan. If you or your spouse currently participates in an employer-sponsored retirement plan, the amount of your tax deduction for your contribution will depend on several factors, including your taxfiling status, your modified adjusted gross income (MAGI), and whether you, or your spouse or both of you are active plan participants. Even if you’re limited in the tax deduction you claim, you still can make nondeductible IRA contributions if you are under the age of 70 ? with earned income.
  • Contribute up to the annual maximum of $4,000 ($5,000 if age 50 or above) to a traditional IRA, if you are eligible. Earnings in traditional IRAs grow tax-deferred but distributions may be taxable.
  • Business owners should continue to defer as much income as they can (up to the lesser of $44,000 or 25% of a maximum of $220,000 compensation) in profit-sharing plans and Simplified Employee Pension (SEP) programs.
  • Contribute to Roth IRAs, as earnings in Roth IRAs grow free from federal tax and qualified distributions are also federal tax-free.2.
  • Invest savings in a Section 529 college savings plan, which allows a current annual maximum contribution of $12,000 ($24,000 per married couple) per beneficiary. Another benefit is that you may be able to take contributions as deductions on your state income taxes depending on the 529 plan in which you invest and the state in which you live.
  • Be sure to stay on course when withdrawing funds from certain retirement accounts. When you turn 59?, you can begin taking penalty-free withdrawals and earnings and deductible contributions will be taxed as ordinary income. At age 70?, you can generally no longer make contributions and you’re required to take your required minimum distributions (RMD).

Take Advantage of Tax-Deferral Strategies
If you have control over how and when you receive income, you have a unique opportunity to generate tax savings. By delaying income and accelerating deductions, you can defer taxes from one year to the next, allowing you to use that money in the interim. This will also give you taxfree use of your money during the deferral.

Make Sure You Have the Right Mix of Investments
There are several tax-efficient equity investments and tax-exempt securities available. These include, but are not limited to, municipal bonds and exchange-traded funds. It is important to identify the appropriate allocation and diversification of investments unique to you to minimize tax liabilities and to alleviate risk. Pay special attention to the quality of your investments, especially during volatile market conditions.

Make Deductions Count
If your income is high, it may be difficult for you to take deductions for items that have an initial threshold, such as medical or miscellaneous itemized expenses. Therefore, it is important to maximize other deductions, such as those for interest paid, taxes paid and charitable contributions.

Unique planned giving strategies might help as well. For example, take advantage of preferential treatment for employer stock held in your retirement account and donate those shares to a charitable remainder trust. If you roll over your company stock to an IRA, withdrawals from your IRA will be taxed at ordinary income tax rates.

If you have children or grandchildren who will be attending college in the next few years, consider gifting appreciated securities. Capital gains and qualified dividend taxes for taxpayers in the lowest brackets (most minors) are five percent until 2008—when they fall to zero percent.

You may also be eligible to make a special gift-tax election for 529 plan contributions (which must in cash not securities) of $120,000 per couple or $60,000 per individual for each beneficiary in just one year (as long as no additional gifts are made to the same beneficiary during the five-year period thereafter). This can be an effective way to reduce taxes on your estate while making a generous gift to a child. Finally, married couples may make gifts totaling $24,000 annually to anyone without any gift tax consequences.

Consolidate Your Finances
Making decisions that will impact your total financial portfolio requires a lot of coordination. That’s why you may find it simpler to consolidate all aspects of your financial life under one advisor.

A financial advisor who can see all aspects of your finances can help you make more informed investment and wealth transfer decisions, and it offers convenience as a result of having all your finances in one location.

These are just some of the steps you can take to reduce your tax liability throughout the year, but remember that over the long-term, a comprehensive wealth management plan that includes specific measures for tax efficiency can enhance your overall investment performance. It is important to discuss these tax issues with your financial, tax and legal advisors so that you can determine how to integrate tax strategies into all aspects of your financial life. Together, you can determine which strategies are most appropriate to help you generate tax savings and reach your personal and financial goals and dreams.

Michael Falcon is a Managing Director and Head of the Retirement Group at Merrill Lynch. Before you invest in a Section 529 College Savings Plan, request an official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the Section 529 College Savings Plan, which you should consider. Merrill Lynch does not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S., federal, state or local tax penalties. Please consult your advisor as to any tax, accounting or legal statements made herein.