Welcome to Casual Finance Friday: March Madness Edition!
Bracketology & Tax Brackets
Written By: Steven Higgins, Financial Advisor, Registered Principal
It’s Friday, March 21, and that means it’s the most wonderful time of the year—NCAA basketball tournament time. With my brackets completed, I eagerly anticipate a weekend full of hoops and my annual reminder of how bad I am at picking winners (in basketball terms, of course). I’ve got the Duke Blue Devils cutting down the nets on the men’s side and the UNC Tar Heels bringing the trophy back to Chapel Hill in the women’s tournament.
But with all this talk about “bracketology,” I’m reminded that it’s not only tournament season—it’s tax season. And since this is Casual Finance Friday, I thought I’d give two ideas to help you with another type of bracket: your tax bracket!
So, here are two tax savings ideas for you to take into the weekend:
State Tax Retirement Income Exclusion
Many states allow you to exclude some or all of your retirement income on your state income tax return. For example, here in Colorado, a person age 55 or older can exclude $20,000 of retirement income, and a person age 65 or older can exclude $24,000. Retirement income can include pension distributions, traditional IRA distributions, and Social Security, among other things. If your income is less than $75,000 as a single filer or $95,000 as a joint filer, 100% of your Social Security can be excluded.
Common mistake: Often a retired couple may be taking distributions from their IRAs. To make it easy, they may be taking the distributions from only one of their IRAs. This is a perfectly fine practice with respect to federal taxes; however, they may be leaving money on the table when it comes to state taxes. Be sure to take at least the amount that is allowed to be excluded from both spouses’ IRAs. In the case of Colorado, it may save you an easy $1,000 per year.
Of course, check with your own state to see what exclusion rules apply, and reach out if you have any specific questions.
Tax Loss Harvesting
As we discussed in last week’s episode, it’s absolutely normal for the stock market to go through periods of volatility. While the narrative of each episode may be unique, the outcomes tend to be pretty similar over time. Because of that, periods of market volatility can provide disciplined investors with tax savings opportunities. For our clients, we employ a strategy called Tax Loss Harvesting.
Tax loss harvesting is used in taxable accounts—single accounts, joint accounts, trust accounts, etc. This strategy can’t be used in retirement accounts like IRAs and 401(k)s. As is sometimes the case, an investment’s value may fall below what an investor paid for it.
Say you buy $100,000 worth of an Exchange-Traded Fund (ETF) representing many large, established publicly traded companies. The stock market corrects for whatever reason, and now your investment is worth $80,000. Again, this is a normal and regular occurrence in the stock market. You are able to sell the ETF and buy a different ETF, allowing you to capture the $20,000 loss for future tax benefits.
Tax losses never expire—they are carried forward on your tax return. The IRS allows you to write off $3,000 per year of ordinary income using tax losses, and there is no limit to how much you can use to offset capital gains. So, if you anticipate selling property or a business that will result in capital gains, it’s never too early to start harvesting tax losses when the opportunity presents itself.
There are two things an investor must know when using this strategy:
First, the new investment must not be “substantially identical” to the original investment. The IRS language is vague on this topic, but you can be assured that you can’t sell and immediately repurchase the same stock. The loss will be disallowed under what is referred to as the Wash Sale Rule.
Second, this should never be used as an excuse to sell an investment in a down market and think you can wait it out until the volatility subsides. When markets get nasty, our very natural threat response kicks in and tries to make the pain stop. This can lead to harmful short-term investment decisions that will almost certainly hurt your chances of reaching your long-term goals. The transactions should happen simultaneously.
At Higgins and Schmidt, we put these strategies into action for our clients. I strongly suggest you use a professional to do the same.
These are two practical tax strategies that can help keep more of your money in your pocket. But there’s so much more where these came from. At Higgins & Schmidt Wealth Strategies, we create long-term financial plans for our clients and invest our clients’ assets to help pursue their goals—all while emphasizing tax efficiency. No single strategy is right for everybody, and careful consideration and assistance from a qualified financial advisor are absolutely recommended.
Of course, reach out to us if you have any questions.
I hope your tournament brackets fare better than mine, and I hope you have a great weekend. Most of all… Happy Friday!
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Higgins & Schmidt Wealth Strategies, a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
No strategy ensures success or protects against loss.
