Whether Congress will reach a resolution on the fiscal cliff by December 31st, or we’ll all be ringing in the new year with newer, higher tax rates is anyone’s guess.
But despite the stalemate in Washington, there are some simple actions you can take right now to help keep your money on high ground—come hell or higher (pre-Bush-era) taxes.
- Accelerate income. “You can be virtually certain that tax rates will not be going down anytime soon and, for higher earners, they will almost certainly go up,” notes Miami financial planner Cathy Pareto. Try to get any payouts due to you in January or Q1—like a bonus or consulting/self-employed income—paid to you now, so they fall under current tax rates.
- Harvest your profits. With the tax rate on capital gains poised to jump from 15% to 20% on January 1, talk to your portfolio manager about whether it makes sense to sell off any funds or stocks that have booked a substantial paper profit before year’s end. “This way you can realize those gains now while tax rates are lower,” says Pareto. This is particularly key if you’re a higher earner (over $200,000 for individuals, $250,000 for couples), since you’ll be hit with the 3.8% Obamacare surcharge on investment income starting January 1. No matter what happens in Congress—that’s a given.
- Consider going Roth. Now’s the time to convert a traditional IRAs, SEP IRAs or old 401(k) to a Roth, urges financial planner Galia Gichon, founder of Down-to-Earth Finance. Yes, it will trigger a bigger tax bill this April, she notes, “but it’ll be at this year’s tax rates and all the profits you earn from here on after will be tax-free.” If you don’t have the cash to cover the tax hit on a full switch-over right now, consider a partial conversion. (Nice for commitment phobes—you can reverse, or “re-characterize,” the switch before tax time, should you reconsider.)
- Think about relocating some assets. Barring Congressional action, taxes on dividends will be taxed as ordinary income (which, including the Obamacare surcharge, could spike as high as 40%) rather than the currently low 15% rate. Talk to your investment advisor about moving any dividend-paying stocks, bonds, or mutual funds currently held in a taxable account into your retirement account by year’s end, recommends Pareto. The process, known as “asset relocation,” is simply a matter of selling in one account, re-buying in another.
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