***YEAR END FINANCIAL PLANNING***
The holidays are upon us, but you still have a couple of weeks to get your financial act together in 2006. Even if you've procrastinated all year (again!), you can still finish the year on a high note. As you check off each item in this list, your sense of accomplishment will grow and you'll gain confidence in your own ability to make smart financial decisions.
1. Supercharge Your Portfolio
The stock market is still setting new highs, and we've seen a slowdown in rising interest rates. Take advantage of that success as you take one more look at your portfolio before year-end.
__ Rebalance: With the market shooting up this year, your target allocations may be out of whack. Take a look at your Investment Policy Statement and see if you need to make any changes. You do have an Investment Policy Statement, don't you? (For more information, see How to Analyze Your Portfolio.)
__ Net gains and losses: So now that you're on a roll, let's take a closer look at what you can do to capitalize on your success. For example, if you've got paper losses (unrealized losses), you may want to sell some of your stocks or funds with big gains as well as the losers and net out the tax effect. Check Schedule D of your 2005 tax return to see if you have any losses from prior years that can be used to net out gains. (Take a look at How to Harvest Gains in Your Portfolio for more on this strategy. If you need help calculating gains and losses, click here.)
__ Check year-end fund distributions: If you plan to buy and/or sell mutual funds in the fourth quarter, pay attention to year-end capital gains distributions. Most people try to avoid these payouts because they can mess up your careful tax planning. If that's how you feel, don't buy a fund until after it makes its year-end payout. Conversely, if you were planning to sell a fund, consider doing so just before it makes its distribution. You can generally find out when a fund expects to make its distributions by going to the fund's Web site.
2. Shore Up Your Retirement Savings
You're not getting any younger. And I doubt you want to work indefinitely. So, take the initiative to sock away what you can now.
__ Contribute to your company retirement plan: If you have a 401(k) plan, a 403(b) plan, or a 457 plan at work, you can contribute $15,000 in 2006 (some of you may be limited in your contributions by plan "top-heavy" rules). For contribution limits for other types of retirement plans, click here.
__ Look at your contributions for the year to date to be sure you maximize your savings: Sometimes you think you're taking enough out of each paycheck to contribute the most you can to your company retirement plan, but for whatever reason you're falling short. Look online or at your last statement to make sure you're on track to contribute the most you can. If you see a problem, try to adjust your payroll deductions before year-end.
__ Make catch-up contributions: I joined the age 50-plus club this year, so I can put away $20,000 in 2006 (and so can you if you're older than age 50).
__ Make IRA contributions: You can contribute up to $4,000 to an IRA in 2006 ($5,000 if you're older than age 50). Anyone, regardless of income level, can make a nondeductible traditional IRA contribution, and now there's even more reason to do so. The Tax Increase Prevention and Reconciliation Act of 2005 (passed this year) allows anyone, regardless of income level, to convert a traditional IRA to a Roth IRA in 2010 and beyond. The two biggest advantages to a Roth IRA are that you don't have to ever pay tax on distributions once you've held the account for five years and are older than age 59 1/2, and you'll never have to take minimum distributions. For more on IRA contributions, see IRS Publication 590 at www.irs.gov.
__ If you're self-employed, make sure you have 401(k) or profit-sharing plans in place by year-end. For more on different types of plans and when contributions must be made, read Retirement Plans for Entrepreneurs.
3. Set a Holiday Budget
Most of us tend to overspend at the holidays. This year, before you head to the mall, why not spend some time thinking about how much you can really afford to give? The holidays are meant to be special, but sometimes we think that has to have a price tag. After working with lots of wealthy people for many years, I can tell you money won't buy happiness.
So, get creative about how you show your appreciation to loved ones. Make memories that can last much longer than a typical present. That takes some planning, so carve out some time to do just that. (If you've already overspent this year, plan to exercise more restraint next holiday season.)
__ Make a list of whom you want to give to and set a range of how much you plan to spend.
__ Add to that list holiday decorations, wrapping paper, travel expenses, postage on holiday cards, and so forth.
__ Create lasting memories by planning special times with family and friends.
4. Get Estate Documents in Place
Here's another area where people tend to procrastinate. After all, who really wants to think about death? The hardest part always seems to be whom you will name to be guardians for your kids or trustees for your assets.
Just do it.
__ Pick the best qualified person you can think of and "Git-R-Done" (as Larry the Cable Guy says). You can always amend your documents later if you find someone more suitable for the role of executor, guardian, or trustee or someone else to whom you want to leave the family heirlooms.
__ For what not to do, read Top 10 Estate-Planning Mistakes.
__ If you have estate documents, review them to make sure you're still happy with your current plan.
5. Earmark Money for the Kids' Education
Most of you are probably responsible parents. That's why it feels so good to bank some money for the kids' education. Whether you choose a 529 Savings Plan, a Coverdell Education Savings Account, a Uniform Gift/Transfer to Minors account, or something else, carve out some money from your next few paychecks or year-end bonus to invest in your child's future. Read Your Guide to College Savings Plans to find out more about different ways to save.
6. Plan Year-End Giving
You can give $12,000 each to as many people as you'd like this year without triggering gift tax. But that gift doesn't have to be cash. In fact, lots of people who have appreciated stocks in their portfolio give those instead.
The cost basis of the asset carries over to the person receiving the asset. If the person receiving the gift is in a lower tax bracket, he or she may pay less in capital gains tax when they sell the asset.
__ Identify to whom you want to give:
You can give as much as $12,000 each to any person without paying gift tax
You can give an unlimited amount to charity and get a deduction
__ Review your taxable investment accounts to identify appreciated assets you want to give away.
__ If you're older than age 70 1/2, consider making a gift directly from your IRA to avoid taxable income. (Read more about this new tax law opportunity by clicking here.)
7. Take Required Minimum Distributions
If you're older than age 70 1/2, you probably have to take at least the minimum required by Uncle Sam from your 401(k) (unless you're still working for that company) or traditional IRA.
Don't wait until the last minute. If you blow it, you'll owe 50% of the amount you should have taken plus ordinary income tax. I've seen lots of people cut it way too close at year-end.
Here's what you'll need:
__ Get the balance of your traditional IRA or company retirement plan as of Dec. 31, 2005.
__ Divide that by the IRS factor based on your age (click here for the factors for most of you).
__ Take your distribution from one or more of your IRAs. Distributions from company plans, like 401(k)s, must come from that account.
For more on taking required minimum distributions, read How to Manage Retirement-Account Distributions.
8. Do a Year-End Tax Projection
I don't know about you, but I hate nasty little tax surprises. I like to know what to expect long before I'm filling out my yearly tax forms. Doing tax projections throughout the year can help you gain the upper hand so that you have some control over what happens next April.
Not everyone will need to do this, but if you have to pay alternative minimum tax, exercise stock options, or have income from multiple sources, a tax projection at this time of year can be extremely helpful.
You can have your accountant do the projection or you can do it yourself with software like TurboTax. Be aware there are new rules regarding AMT (higher exemptions in 2006). Your projection can show you where you stand with year-to-date realized capital gains and losses from investment sales.
__ Gather pay stubs to project 2006 income.
__ Look at your 2005 1040 tax return to see if there are numbers that need to be carried forward (like capital losses)
__ Build in stock-option strategies, realized capital gains or losses, or year-end charitable giving.
__ Determine if you need to adjust your withholding.
__ Have your accountant review the projection for other 2006 action steps.
9. Consider a Roth Conversion
__ Do you meet the criteria? If you have adjusted gross income of less than $100,000 and you have a traditional IRA, you may want to think about converting to a Roth IRA.
You don't have to convert the whole thing--you can just use a portion. When you convert, you trigger ordinary income tax because you'll be paying tax on the portion of the traditional IRA that you convert.
Take a look at the top of your tax bracket. You can convert just enough of your IRA so that you don't push yourself into the next tax bracket. For example, if you are married filing jointly, the top of the 15% tax bracket is projected to be $61,300 for 2006. If you earned $20,000 and you had another $5,000 in investment income, that would still allow you to convert $36,300 without falling into the 25% tax bracket. (To see the 2006 tax tables, click here.)
__ Consider whether a Roth IRA makes sense for your situation. What's so great about a Roth IRA? For one thing, you are diversifying by tax effect (you hold a variety of assets that are taxed differently). Whereas you'll pay taxes on your 401(k) investments once you begin tapping your assets, Roth IRA distributions are not taxed once you have held them for five years and are older than age 59 1/2. (Your contributions can always be taken out tax-free.) And you aren't required to take RMDs.
That said, Roth IRAs are not for everyone. For starters, you do have to pay taxes sooner rather than later. Further, there is an element of tax risk involved with Roth IRAs--for example, you could decide to convert now based on current tax laws only to discover five years from now that the tax laws change, thereby making your conversion less beneficial. If your AGI is more than $100,000, you're ineligible to convert. Finally, if you are younger than age 59 1/2, you must pay the tax for a conversion with assets outside of your IRA or you'll get hit with a 10% penalty on top of income taxes.
__ Consider a Roth conversion in 2010. Even if you don't qualify for a Roth IRA conversion now, you will in 2010 and beyond. A recent tax law removes the income limitation then. So, if a Roth IRA appeals to you, you can always make nondeductible contributions until 2010 and convert then.
For more on Roth conversions and other IRA tips, read Five Strategies to Maximize Your IRA.
10. Plan Year-End Stock-Option Transactions
If you have stock options, you need to do some homework before year-end. Stock-option planning can be really complicated. In addition to gauging the tax consequences, you also have to dodge company blackout periods (when no one can sell stock). Here's what to do:
__ Check your pay stub to find out exactly where you stand with taxable income for the year.
__ Do a tax projection if you are trying to exercise incentive stock options that trigger AMT.
__ Consider exercising and selling nonqualified options to boost your regular taxable income above your AMT taxable income.
This is typically not the kind of planning you do on your own. Find an accountant or financial advisor who specializes in this area and get some assistance. If you save thousands of dollars in taxes, the accountant's fees will seem like a drop in the bucket.
From Morningstar.com
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