Are you ready? It’s officially tax season for your 2018 filing. While most financial professionals and Transamerica may not provide tax guidance, we can offer you some ideas to bring up with your own independent tax professional.
Most people generate taxable income in two ways: working (earned income) and with interest, dividends, and capital gains (investment income). To reduce your overall tax liability, you can reduce one or both of these sources of income when it isn’t needed.
Investment income such as stocks, bonds, and mutual funds, are held in a taxable account. Most interest, dividends, and capital gains distributions are taxable in the year they are received or realized, even if you reinvest them. But if your investments are in a tax-deferred vehicle such as an annuity, the income generated is excluded from current income until you take a distribution. This lowers your overall taxable income and in turn, your tax liability. Make sure you also consider the fees and charges associated with an annuity.
The difference between tax-deferred and tax-exempt
The term “tax-deferred” doesn’t mean you’ll never pay taxes on an investment like you would on “tax-exempt” ones. It simply means that taxes are merely deferred until your assets are withdrawn.
Advantages of tax-deferred investments
First, using a tax-deferred investment strategy may allow you to change investments among various subaccounts without triggering a taxable event. Instead of having to pay taxes on any capital gains distributions, you’re able to keep more of your money tax-deferred and working for you, which can make a significant difference in the long run.
Secondly, many investors choose tax-deferred investments and hold them until they find themselves in a lower tax bracket, such as in their retirement years. Then, the realized capital gains will be taxed at a lower rate. With taxable investments, you have no control over the amount of capital gains generated each year, lowering the predictability of your tax bill.
In addition, the amount of after-tax contributions for non-qualified tax-deferred investments is essentially unlimited. Contribute all you want. For 401(k)s and IRAs, individual contributions are limited in 2018 to $18,500 and $5,500, respectively.
Running the numbers
For illustration purposes only, let’s say Household A and Household B both have $400,000 in modified adjusted gross income each. Household A also has another $75,000 in investment income, whereas Household B has $75,000 in tax-deferred investment income. Household A’s estimated tax bill is $113,429 due to their higher tax bracket (35%), an additional 3.8% tax on net investment income (NIIT), and the potential loss of the child tax credit. Household B’s estimated tax bill is only $85,049 due to their lower tax bracket (32%), reduction in the amount subject to the 3.8% NIIT, and they get to keep their child tax credit.
A less taxing choice
Tax-deferred investments such as an annuity can be an attractive option for many investors looking to reduce their tax bill without illegally trying to write off “Fluffy” as a dependent. Talk to your tax and financial professionals to see if they make sense for your nest egg.
Tax Saver’s Credit
Another place to save taxes is the Tax Saver’s Credit, which is a non-refundable tax credit that may be applied up to the first $2,000 of voluntary contributions an eligible worker makes to a 401(k), 403(b) or similar employer-sponsored retirement plan, or a traditional or Roth IRA. The maximum credit for 2018 is $2,000 for single filers or individuals and $4,000 for married couples filing jointly.
It is available for workers 18 years or older who cannot be claimed as a dependent on someone else’s return and have contributed to a company-sponsored retirement plan or IRA in the past year and meet the Adjusted Gross Income (AGI) requirements:
- Single tax filers with an AGI of up to $31,500 in 2018 or $32,000 in 2019
- Head of a household with an AGI of up to $47,250 in 2018 or $48,000 in 2019
- Married couples who file a joint return with an AGI of up to $63,000 in 2018 or $64,000 in 2019.
Access this valuable resource that provides strategy to help you manage the amount of taxes you pay each year by significantly reducing your taxable income.
Things to Consider:
- Investigate different forms of tax-deferred investment options.
- Review your 1040 and see how much your investments cost you in taxes in 2018.
- Talk to your tax professional about whether a tax-deferred investment is right for your retirement strategy.
Neither Transamerica nor its agents or representatives may provide tax or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors regarding their particular situation and the concepts presented herein.