December is typically the time when advisors and clients scramble to make tax-saving moves before the calendar (and tax) year comes to an end. But the start of the New Year provides other opportunities for clients to save money, including finding money for college, cutting health care expenses and putting more away for retirement.
Here are some steps you and certain clients should take from the first of the year to the end of the first quarter:
1. Fill Out the FAFSA
Clients who have children going to college in the fall should start working on their Free Application for Federal Student Aid (FAFSA), available at www.fafsa.ed.gov.
The form is the key to obtaining subsidized loans, grants and other types of financial aid. And since some of that aid is awarded on a first-come, first-served basis, it’s better to submit the FAFSA sooner rather than later.
The form may ask for some financial information that the clients don’t have yet, such as figures from the previous year’s tax return. But that shouldn’t be an obstacle to completing and submitting the application. Applicants can estimate the value of any missing figures, submit the application and correct the estimates once they have the actual numbers.
2. Boost 401(k) Contributions
Working clients who didn’t make the most of their contributions to pretax at-work retirement plans in 2015 might want to start the New Year out by raising their deferral rates.
In 2016 the contribution limits remain the same—the lesser of the worker’s earnings or $18,000 ($24,000 if the worker is over 50). Clients who turn 50 during 2016 can contribute up to $24,000 beginning Jan. 1, even if they don’t reach that age until later in the calendar year.
If the clients need a little more motivation to contribute, point out how much lower their upcoming income tax bill would be if they had maxed out their contributions in 2015.
3. Make IRA and Roth IRA Contributions
For the 2015 tax year, IRA and Roth IRA contribution limits remain at the lesser of the actual earnings or $5,500 for those under 50 ($6,500 for the 50-and-over crowd).
Lower-income clients with earnings may want to use the Roth IRA, even if there is no tax break for deposits (other than the Saver’s Credit).
Middle-income clients may prefer a tax-deductible IRA, and depending on their modified adjusted gross income, they may be able to deduct the contributions even if they also contributed to a pretax retirement plan at work.
Those in the higher-income brackets should first maximize those same pretax at-work retirement plans, but if they have some money left over, they could still qualify to contribute to a Roth IRA.
Fidelity offers a breakdown of the income limits for IRA and Roth IRA contributions at tinyurl.com/fidira, along with a calculator that can determine if clients can deduct IRA contributions while participating in an employer-sponsored plan.
Married couples can make a spousal IRA or Roth IRA contribution for the non-earning spouse, up to the aforementioned limits.
Also, check with clients who are parents (or grandparents) of teenagers to see if the kids had any legitimate earned income for 2015. If so, the clients may want to help open and fund a Roth IRA for them.
4. Get a Roth via the Back Door?
High-income clients who have maxed out their contributions to at-work pretax retirement plans and are ineligible to make Roth IRA contributions may want to consider the “back door” Roth IRA.
They would make after-tax (i.e., non-deductible) contributions to an IRA and then convert the IRA to a Roth IRA. If they have no other IRA accounts, they would only owe taxes on the gains generated by the investments held in the IRA—which should be little or nothing if gains are invested in a money market account and converted quickly.
However, if the clients have other IRAs, the process gets more complex. The clients then add all their IRAs together and pay taxes on the portion represented by the converted amount.
For instance, if a client has $95,000 in IRAs, makes a $5,000 contribution to an after-tax IRA and then converts the $5,000 IRA to a Roth IRA, 95 percent of the converted amount ($4,750) would be taxed as ordinary income.
5. Make HSA Contributions
Another way eligible clients can cut their 2015 tax bill in 2016 is by making a tax-deductible contribution to a health savings account (HSA) by April 15. Unlike IRA and Roth IRA contributions, filing for an extension doesn’t give the client an extra six months to make the HSA contribution.
To contribute to an HSA, the client must be covered by a high-deductible health plan. For 2015 the deductible has to be at least $1,300 for individuals, and $2,600 for families.
The 2015 HSA contribution limits are $3,350 for singles and $6,650 for families. Clients over age 55 can add an additional $1,000 to these limits.
6. Undo a Roth Conversion?
If you helped a client convert some or all of an IRA to a Roth IRA in 2015, keep in touch as the clients prepare their income tax returns in the first quarter of 2016.
They might discover that the conversion is being taxed at a rate higher than they expected. Or, maybe the assets in the newly created Roth declined after the conversion.
Either way, they could benefit from a “recharacterization” of the conversion. This do-over allows the clients to retract some or all of the converted amount, owing no taxes on whatever they “undo.”
They can then do nothing, or wait 30 days and then reconvert the IRA to a Roth IRA. The deadline to recharacterize the conversion is Oct. 15 of the year after the conversion, but many clients may want to undo the conversion before they pay their income taxes on April 15. n