Now that it’s officially tax season all of us are looking to the not so pleasant task of filing their income taxes. I want to start out by pointing out the differences between advisors that assist in tax planning and tax preparers.
A financial advisor such as myself can assist their clients in laying out future tax savings strategies. A tax preparer such as an accountant or CPA is a historian who takes what a client did in the past and compiles their tax returns based on that information. Some accountants perform both tasks in advising their clients on future strategies and then at the end of the tax year compiling returns based on the results of those strategies. However, most of the time it’s one or the other but it is critical to have both. Whether you file your taxes on your own or hire a specialist, future tax planning is critical but often overlooked.
As such I want to cover in this month’s column one tax saving strategy that is widely known but very much misunderstood, the humble IRA or Individual Retirement Account. IRA’s were originally created under President Nixon’s administration back in the early 1970’s. At the time they were very cumbersome and limited in their ability to save on taxes. Back then you could only have one if your employer did not have a retirement plan that covered you, was not deductible and you were limited to a maximum contribution of $1,000 per year.
When President Ronald Reagan took office, he revamped the IRA and made it available to all wage earners regardless of whether they had a company retirement plan or not. He also made them fully deductible and doubled the amount of the annual contribution to $2,000. In addition, he also made the investment choices you could use to fund them almost unlimited. It was then that the popularity of IRA’s really took off.
Today I believe the IRA is the cornerstone of a well planned tax strategy with almost unlimited contribution and funding options. There are too many to list in this column, as such I’ll limit my discussion to what tax deductibility and tax deferral are in relation to the IRA. Tax deductibility means you can reduce your overall income that is reported to the Internal Revenue Service by the amount you contribute to an IRA. For example, if you earn $40,000 in one year and put $2,000 into a deductible IRA you only have to report $38,000 of income on your taxes. However, these deductions are subject to phase out limitations based on income and contributions are subject to an annual cap. Tax deferral is just that, putting off paying a tax until a later date so that hopefully you will be in a lower tax bracket when you have to pay the bill.
In my opinion, a common misconception is that tax deductibility is better than tax deferral. It is actually the other way around. But both are excellent strategies. Just because you may not be able to deduct your contribution doesn’t mean you shouldn’t contribute. However, sadly, many of my clients do exactly that. Tax deferral while not immediately realized can potentially save you tens of thousands of dollars in taxes just as deducibility can. However deductibility can be seen quickly and deferral can take years to realize.
Now there is the subject of Roth IRA’s. These are a relatively recent development in the IRA universe. If you qualify, you can make after tax contributions that can potentially generate tax free earnings!
Keep in mind not everyone qualifies but I can assist you with determining if you are or not.
Lastly, the government allows for the funding of your IRA anytime during the current tax year up until April 15th of the following year. So if you haven’t opened or funded your IRA for last year, you have until the April 15th tax filing deadline to get it done. In other words, if you haven’t filed your taxes for 2016 yet, you can still contribute for the 2016 tax year and potentially save money on your taxes with an extra deduction.
As with all investment/retirement issues, I am qualified to work with you in assessing your needs to secure your financial future. I can be reached at 480-307-9909 (office) or 480-296-9556 (cell).
Any opinions are those of Rudy Eidenbock and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.