How State Income Taxes Work When You Live Or Work In Multiple States

February 06, 2019

For people who travel a lot for work or live close to a state line, state income tax withholding and filing is often a bit confusing. Maybe you earned income in more than one state during the year or in some cases, you may not even live in the state where your employer has an office.

We get a lot of questions about this stuff and while we’re not tax professionals nor is this intended to be tax advice, I’m hoping to provide some clarity around how it all works. There are several moving pieces, and everyone’s situation can be a bit different, so consider consulting with a tax professional if you’re unsure so that you don’t end up with any unwanted tax surprises.

How multi-state income taxes work

The default rule for determining state income tax withholding is to withhold tax for the state in which you actually provided a service – you pay first to where you work, then possibly also to where you live. It gets a bit more complicated when you earn income in more than one state or if you earn the income in a state but live in another. Other withholding rules come into play.

Where are you actually a resident?

Typically, the state where you’re considered a resident governs how you’ll ultimately be taxed on your income. States have their own rules around how to treat income you earn there as either:

  1. A resident, who had income from another state, OR
  2. A non-resident who had income from within that state.

Check the rules of your state here.

TIP: A common misconception is that if your employer’s home office is in New York for instance, that your employer has to withhold New York state income tax from your pay, even if you did not earn any income in New York for the year. That’s actually not true – I live in Florida (where there are no income taxes!) and Financial Finesse is headquartered in California – thankfully I don’t have to pay California taxes.

If however, your employer’s home office is located in the state where you’re considered a resident, your employer would have to adhere to that state’s laws. In addition to withholding income tax for other states where you earned income, your employer may have to withhold that state’s income tax from your pay though you did not earn income there. It depends on what the state’s law says.

Does your home state have a reciprocal agreement with any of the states you worked in?

A reciprocal agreement, also called reciprocity, is an agreement between two states that allows residents of one state to request exemption from tax withholding in the other (reciprocal) state. So for example, if you’re a resident of Michigan who works in Ohio, your employer only has to withhold Michigan taxes and you don’t have to worry about Ohio, even though that’s where you earned all of your income.

If an agreement exists, you’d reach out to your payroll department to request the exemption form. This can save you the trouble of having to file multiple state tax returns at least for each of the states that have the agreement.

How do you know if an agreement exists or not? This website lists all the states along with the necessary forms you have to supply to payroll to avoid the tax withholding from the state where you work. 

TIP: If there is an agreement and A) You don’t submit an exemption to avoid having income tax withheld from states where you are not a resident, and/or B) Your employer withheld the tax either inadvertently or due to state law, you can file a non-resident tax return in the applicable states and apply for a refund.

If there is NOT a reciprocal agreement, then the laws of each state have to be considered

I have had several New York residents who work in other states throughout the year inquire about this, as New York does not have a reciprocal agreement with any other states at this time. In that case, there are two steps here:

Step 1: If you’re a resident of New York or if the state where you’re considered a resident is not listed, you’ll need to check with your state to confirm your residency status and its withholding requirements based on that status. For instance, you may be considered a resident or a part-year resident and each of those could require a different set of tax forms to be completed or steps to be taken.

Step 2: For all other states in which you earned income, confirm your residency status (likely a non-resident in this case) and follow their tax filing guidelines for a non-resident.

Check the rules of each state here. For those unlucky New Yorkers, they may work out of the state every day of the year, but if they call NY home, they will still have to pay some of their income to their state.

At the end of the day, having an idea of what happens when you earn income in more than one state is already a positive. You may need to reach out to your payroll department to make sure they are aware of your residency status and are applying the rules per that state as well as the other guidelines mentioned here.

Then when it comes time to filing and ensuring you don’t overpay, it may be worth it to hire a tax pro – most DIY softwares are not equipped to file multiple non-resident returns in a way that can ensure you’re not over (or under) paying one state or the other.

3 Common Myths You Probably Believe About Taxes

February 04, 2019

One of the areas that I find to have the most misconceptions is taxes. After all, Einstein is quoted as saying that the hardest thing to understand is the income tax…and that’s when it was a lot simpler than it is now! Here are the biggest ones I’ve seen as a financial planner:

Myth 1: Your goal should be to minimize your taxes above all else.

No one likes to pay taxes, but making the goal solely about minimizing what you pay implies you should earn no income so you have no tax liability. More realistically, this idea comes up most frequently when people are reluctant to pay off their mortgages because they’ll lose the tax deduction

Reality: There are good reasons not to pay down your mortgage early, but the mortgage interest deduction isn’t one of them. While the mortgage interest deduction can reduce the cost of interest, it’s still a cost. The deduction simply makes mortgage debt cheaper than non-deductible debt with the same interest rate. Don’t let the tax tail wag the dog and instead focus on maximizing after-tax returns.

Myth 2: Your marginal tax rate is the percentage of your income that you pay in taxes.

In other words, if you’re in the 24% federal tax bracket the thought is often that it means you pay about 24% of your income in federal taxes. In my experience this is how most people think about tax rates.

Reality: You only owe the marginal tax rate on income in that bracket. So, you would only owe 24% on any income over that amount and the rest would be taxed at lower rates. This is why you’ll probably end up paying a lower average tax rate on your 401(k) withdrawals in retirement even if you retire in the same tax bracket. (Your contributions come off the top and avoid that marginal rate, while a lot of the withdrawals will be taxed at the lower rates.)

Myth 3: You need a tax accountant to take advantage of various loopholes to reduce your taxes.

This is probably one of the main reasons people hire tax preparers. It’s also true for anyone who doesn’t feel comfortable using tax software.

Reality: Tax accountants can be helpful if you own a business or investment property since many of the deductible expenses are ambiguous, but tax software should do the job for the average person. The reality is that most of what you can do to reduce your taxes is in the planning before the taxes are prepared. That mostly means contributing to tax-advantaged accounts like 401(k) plans, IRAs, and HSAs. A good financial advisor can also help you minimize taxes on your non-sheltered investments.

What Happens When You Inherit An IRA?

January 31, 2019

You’ve inherited an individual retirement account (IRA) – now what? Should you spend that money or save it for later? What are the consequences of either choice? Although there are several rules to follow regarding the method and timing of distributions from inherited IRAs, it is important to understand that distributions from inherited IRAs are not subject to the usual 10% penalty for distributions received before you reach age 59 ½. The IRS rules for distribution of inherited IRA funds are different depending upon several conditions:

  • Whether the IRA owner died before his or her beginning date for required minimum distributions (RMDs).
  • Your relationship with the deceased IRA owner (spousal or non-spousal)
  • Whether the inherited account is a traditional IRA or a Roth IRA

Spousal beneficiary of traditional IRA

If you inherited a traditional IRA from your spouse and were named the sole beneficiary, you may choose any of these options:

  • Own it. Treat the IRA as your own, even rolling it into an existing traditional IRA in your own name. Electing this option means the same rules and penalties apply to amounts withdrawn prior to you reaching age 59½. Assets will continue to grow tax-deferred.
  • Lifetime distributions. Open an inherited IRA (make sure it’s labeled “inherited”), transfer the inherited assets into it, and take annual distributions over your lifetime. Distributions need not begin immediately, but they must start no later than December 31 of the year in which your spouse would have turned 70 ½ or December 31 of the year following the year of death, whichever is later. If your spouse was age 70 ½ or older upon death, then distributions must begin no later than December 31 of the year following the year of death. These lifetime distributions are taxable, but they are not subject to a 10% penalty for early distribution if you are under age 59 ½.
  • Five year spend down. Open an inherited IRA, transfer the inherited assets into it, and take distributions of the full amount over a five year period. By the end of the fifth year, all inherited IRA assets must be distributed to you. These distributions are taxable, but they are not subject to a 10% penalty for early distribution if you are under age 59 ½.
  • Lump sum. Take a taxable lump sum distribution. As with the lifetime or five-year distribution options, a lump sum distribution to you is subject to income tax, but a 10% penalty for early distribution prior to age 59 ½ does not apply.

Non-spousal beneficiary of traditional IRA

If you are named as the beneficiary of an IRA from a parent, grandparent, sibling, aunt/uncle, friend, etc. (aka anyone you weren’t married to when they died) then the rules are different – you may not treat the inherited funds as your own. However, the other options available to a spouse are also available to a non-spouse. A non-spouse traditional IRA beneficiary may:

  • Open an inherited IRA in the deceased’s name, transfer the inherited assets into it, and take annual distributions over your lifetime. These distributions must begin no later than December 31 of the year following the account holder’s death. These lifetime distributions are taxable, but they are not subject to a 10% penalty for early distribution if you are under age 59 ½.
  • Instead, you may elect taxable distributions of the full amount over a five-year period without incurring a 10% penalty for distributions received prior to turning age 59 ½.
  • Finally, you could also take a taxable lump sum distribution immediately and without paying a 10% early withdrawal penalty if you’re under age 59 ½.

Spousal beneficiary of a Roth IRA

  • Treat the inherited Roth IRA as your own, including rolling it into a new or existing Roth IRA.
  • Elect lifetime tax-free distributions.
  • Elect tax-free distributions of the full amount over a five-year period. However, if the account is less than five years old when distributions occur, earnings will be taxable.
  • Take a lump sum distribution. However, if the Roth IRA was less than five years old at the time of the owner’s death, earnings are taxable when distributed.

Non-spousal beneficiary of a Roth IRA

With the exception of treating the inherited Roth IRA as your own (not an option in this instance), a non-spouse beneficiary of a Roth IRA has the same remaining options as does a spousal beneficiary:

  • Elect lifetime tax-free distributions.
  • Elect tax-free distributions of the full amount over a five-year period. However, if the account is less than five years old, earnings will be taxable.
  • Take a lump sum distribution. However, if the Roth IRA was less than five years old, earnings are taxable when distributed

Inheriting an IRA is, of course, a bittersweet occasion where we have to simultaneously deal with the physical and emotional loss of someone we care about and also face some critical financial decisions. For more information and details regarding this important topic, refer to IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). You might also want to consult with a qualified financial or tax advisor for advice on your particular situation.

The IRS Will Never Call You Out Of The Blue (& Other Scams To Watch Out For)

January 30, 2019

In order to avoid becoming a victim of scammers, it’s more important than ever to be aware of a few rules that the IRS follows so that you know when you can ignore calls or letters.

That’s not the IRS demanding payment via gift card

One of the more lucrative scams for criminals in recent times has been to prey on people who are already afraid of the IRS or the government, particularly elderly citizens or immigrants who may fear random deportation. They call and demand immediate payment via gift card such as Google Play or iTunes, threatening arrest if you don’t comply.

Here’s the thing to know: the IRS will NEVER initiate contact with you via email or phone. They always start their tax collection process via mail. If the IRS is calling you, it’s because you’ve either requested a call via written correspondence or you haven’t been paying attention to the mail they’re sending you. And they’ll never ask for a gift card, that’s not an acceptable way to pay your taxes.

It’s time to stop fearing the IRS

As a CPA, I’m required to complete an average of 40 hours per year of continuing education, so I’ve had the opportunity to attend a few seminars presented by IRS agents. I’ve learned a ton of technical stuff, but there are some key take-aways that I wish I could scream from a mountain top for all to hear:

  • The IRS is very slow and prefers to correspond with taxpayers via US Mail – this plays to our advantage as taxpayers because we have everything in writing.
  • No one ever went to jail over their taxes who wasn’t expecting it – even Willie Nelson knew he wasn’t paying his taxes, he just chose to ignore it. Making a mistake on your return will not suddenly escalate to being arrested unless you respond to the IRS with some type of threat (not a good idea).
  • The IRS always gives you a chance to appeal any tax they levy against you – those notices you receive for underpayment are based on information they likely received from another source, but that doesn’t mean it’s correct and they know that. This is why keeping good records is so important.
  • You can call the IRS to pay your taxes via credit card, but they will not call you to demand that information. If someone is asking you for a credit or debit card number, they are NOT representing the IRS. Hang up and report the call.
  • The IRS will not ask you to verify or provide information via email – that’s a scam. If you receive such an email, forward it to [email protected] then delete it.

What if you think you might owe taxes and you get a call or email?

If you think there may be a reason that the IRS is trying to contact you, the same information above applies, but here are a few other steps to take to ensure it’s truly the IRS reaching out to you and not a scammer:

  • Don’t answer calls from numbers you don’t know. If it’s truly the IRS, they will leave you a message with a number to call back, and they WON’T be threatening.
  • To verify that it really is the IRS trying to contact you, follow these steps, which are copied directly from this website:

The bottom line – don’t be a victim

The most important thing to know from the above is that the IRS is never going to irately demand via phone that you resolve an incident immediately, nor will they threaten arrest or other action if you don’t immediately comply. So if someone is doing these things, hang up, close the door, delete the email – it’s a scam.

How Child And Dependent Care Tax Breaks Work

January 29, 2019

During tax time, do you ever get to the section about child care expenses for the year and get confused about what’s really allowed and if you made the right decision? If you have been contributing to a Dependent Care FSA, does that mean that you are NOT able to take advantage of the Dependent Care Tax Credit? Let’s review how it works.

What are the tax breaks exactly?

Dependent care flexible spending account

The Dependent Care FSA (DCFSA for short) is an account where you choose to automatically have money deducted from each of your paychecks BEFORE TAX is taken out, which you can then use to pay for child care expenses that year. The IRS allows you to set aside up to $5,000 each year, regardless of how many kids you have.

How it works

In other words, you use pre-tax money to pay for the eligible child and dependent care expenses, so that $5,000 is not included in your taxable income for the year.

Child and dependent care tax credit

The Child and Dependent Care tax credit is not tied to your work, but is something that allows you to claim a credit against your taxes for the year. The credit is equal to 20% up to a maximum of 35% of your total child care expenses, limited to $3,000 for one dependent OR $6,000 for two or more dependents. So for example, if you have one child and paid $5,000 in child care expenses for the year, the most you can claim toward your credit would be $3,000, and your credit would be a percentage of that amount (20% up to 35%, depending on your total income).

If you have more than one child, it doesn’t matter how your costs are divided between the dependents either. You can pay $1,000 for one dependent and $4,000 for the other dependents and it doesn’t matter since the credit is simply based on the total cost.

How it works

A tax credit essentially reduces your tax bill, dollar for dollar, rather that just reducing your taxable income like a tax deduction. So if you owe $2,000 in taxes and your credit is worth $1,000, you would only owe $1,000 in taxes. This credit is not considered “refundable” though. So if you owe $900 in taxes and the credit is worth $1,000, you simply won’t owe anything. You don’t get to pocket the extra $100.

Sounds like a no brainer to go with the credit, right?

It’s true that at first look, the credit seems to be the obvious choice because it goes dollar for dollar against your actual taxes and not just your taxable income. However, the more money you make, the lower the percentage of eligible expenses you can claim as a credit, so there becomes a certain point where the DCFSA (aka the deduction) makes more sense.

 1) Your income matters. Did you make $43,000 or less during the year?

  • YES – You’ll typically have a better tax savings if you claim the credit, REGARDLESS of how many dependents you pay child care expenses for.
  • NO, I make more than that – You’ll likely benefit more by contributing to the Dependent Care FSA

You can dig into the math on that here. 

2) Can you get the credit AND contribute to the Dependent Care FSA in the same year?

Per IRS, the maximum credit you can take for child care expenses is reduced by whatever amount you contribute to a Dependent Care FSA. Remember, if you answered YES to # 1 above, taking the max credit for eligible expenses (up to $3,000 for one dependent or $6,000 for two or more dependents) typically gives you a bigger tax break.

Benefiting from both usually works out when the below is true:

  1. Your income is higher than $43,000 AND
  2. You have child care expenses for two or more dependents AND
  3. The expenses exceed $5,000 (which is the maximum you can contribute to the Dependent Care FSA)

3) If you fit into 1, 2, and 3 above and want the benefit of both tax breaks, how do you do it?

  • 1st – Contribute $5,000 to a Dependent Care FSA
  • 2nd – Take the credit for any remaining expenses up to another $1,000

Child care can be expensive, but we can do our best to budget for it and take advantage of tax breaks like these to help shave off some of the cost and use that extra money towards other goals like traveling and saving for retirement.

How To Withdraw Over $100k From Your 401(k) Tax-Free During Retirement

January 11, 2019

Do you know how your retirement accounts will be taxed at retirement? If not, you might want to get up to speed with the IRS tax code (or work with an advisor who is) otherwise you may be missing out on some significant tax savings. Let’s start with the basics of how different sources of retirement income are taxed:

Common retirement income sources taxed as ordinary income

Traditional retirement accounts, including deductible IRAs, pre-tax 401(k)s, and inherited traditional retirement accounts are taxed as ordinary income in the year of distribution and pension benefits are taxed as ordinary income in the year received. (which means it will be taxed as if you earned it working during that year.)

Another source of taxable ordinary income during retirement is Social Security, but only a portion depending on the amount of total income from other sources. To estimate the taxable portion of Social Security benefits, check out this helpful calculator.

Common retirement income sources taxed as capital gains

Some sources of income during retirement may be taxed at preferential capital gains tax rates (basically lower rates than you pay on income that you earn working, aka “ordinary income”.) These sources include proceeds from the sale of stocks and mutual funds that are NOT held in a retirement account, which are subject to long-term capital gains tax treatment if held for over one year prior to sale. (Losses may be used to offset gains in the same year. Up to $3,000 in net losses may be deducted from income and losses that exceed $3,000 may be carried forward.)

Qualified dividends are a special type of dividend that also receives capital gains tax treatment (aka most people only pay 15% tax on dividends, even if they are in, say, the 32% tax bracket.)

Real estate is also subject to capital gains tax treatment when sold. There is, however, a special exclusion that applies to the sale of a primary residence. If a taxpayer lives in a primary residence for at least 2 of the previous 5 years before sale, the taxpayer may exclude up to $250,000 ($500,000 if married filing jointly) in capital gains from tax.

Common tax-free sources of retirement income

Not all sources of retirement income are taxable. Roth IRAs and Roth 401(k)s are tax-free when the account has been open for at least five years and the owner is at least age 59½. This is referred to as a qualified distribution. Inherited Roth accounts are also tax free as long as the deceased owned the account for at least five years.

Health Savings Accounts (HSA) are tax-free if funds are used for qualified expenses. Funds used for non-qualified expenses are taxed as ordinary income and subject to a 20% penalty tax if withdrawn before age 65 (after age 65, it’s just taxed as income when not spent on medical expenses.)

Finally, withdrawals from your regular savings account may be spent without incurring additional tax liability, although as you probably know, you pay taxes on any interest as you earn it.

Running a few ‘what if’ scenarios

Once you have a general understanding of how your different income sources will be taxed during retirement, you can run a few different “what if” scenarios. For example, let’s assume Hank and Cindy each are age 61 and recently retired at the beginning of the year. They would like to delay the start of their Social Security benefits until full retirement age or later (66 since they were born in 1954). They both have retirement plans from their former employers and can start making distributions penalty-free now that they are over 59½.

Their goal is to minimize taxes as much as possible and to take out just enough from their 401(k) accounts to stay in the safe zone of not outliving their money during retirement. Here is a quick snapshot of their retirement savings:

  • Hank’s 401(k) = $325,000
  • Cindy’s 403(b) = $275,000
  • Emergency savings/“rainy day” fund (checking, savings, CDs) = $150,000

Now, let’s assume that Hank and Cindy have an annual retirement spending goal of $42,000 per year ($3,500 per month). The mortgage is paid off and they are completely debt-free. Based on a generally accepted but widely debated 4% “safe withdrawal rate” rule, they could actually withdraw up to $24,000 in Year 1 of retirement. In this example we’ll stick with a $20,000 withdrawal from Hank’s 401(k), which is realistic based on this How Long Will it Last Calculator. The remaining $22,000 in annual income would come from their checking and savings accounts.

Looking at how their withdrawals will be taxed

How will Hank and Cindy be taxed using the 2018 income tax tables? The $20,000 retirement plan distributions are included as taxable income. The $22,000 coming from their regular checking and savings is after-tax return of principal and would not be taxed. (Only interest earned would be included as taxable income).

Hank and Cindy choose a married filing jointly tax status and their total income tax for 2018 will be a grand total of $0. Yes, that is zero. Here is how they will be taxed:

A quick review of the current Income Tax Rate Table shows us that a married couple filing jointly is taxed at the 12% marginal tax bracket for income over $19,050 but less than $77,400. But keep in mind that your total deductions and exemptions are subtracted from your income to determine your taxable income. The total deductions amount is either your standard deduction or your itemized deductions, whichever amount is greater.

The standard deduction is a fixed amount based on your age and filing status (e.g., $24,000 for married couples filing jointly in 2018). Hank and Cindy’s taxable income will look something like this:

Total Income: $20,000

–        Total Deductions: $24,000

=       Taxable Income: $0

Note: Hank and Cindy benefited from maintaining an emergency savings account that eventually transitioned into their short-term retirement income bucket. Most financial planners would suggest keeping assets that will be needed within a 3 to 5 year time horizon in safe, conservative investments such as cash equivalents, savings, CDs, or short-term fixed income instruments. This is sometimes referred to as the “safety bucket.

Using a Roth account instead of a savings account

In this example, a similar result could be obtained if the additional $22,000 retirement income was funded through tax-free sources such as a Roth IRA or Roth 401(k).

A similar result with taxable investments

If this couple held taxable investments in a brokerage account, they could also take advantage of historically low long-term capital gains rates (currently 0% for the 10% and 12% marginal tax brackets).

In essence, they could “fill up” the 12% income tax bracket with long-term capital gains up to the marginal tax bracket cap of $77,400 and not have to pay a dime of federal income taxes on that growth. But they would still want to invest that money in tax-efficient investments such as passively managed mutual funds or ETFs with relatively low turnover and low costs.

Remaining tax-free until Social Security starts

In summary, this type of retirement funding strategy could be replicated for the next 5 years until this couple has reached full retirement age for Social Security purposes. By that time, they could realistically take out over $100,000 from their retirement nest egg completely tax-free.

The secret is found within a simple concept known as tax diversification. Having multiple retirement income sources that are each taxed in a different manner can help you legally use the complicated IRS tax code to your advantage.

This is an example of just one of many different ways to minimize taxes during retirement. As you approach retirement, go ahead and run a few different “what-if” scenarios to examine your projected taxes. You can use this simple TaxCaster tool from TurboTax if you want to run a quick estimate using the current tax tables.

Keep taking full advantage of your retirement plan at work, especially up to the max to get the match. But take a second look at Roth IRAs, taxable accounts, HSAs, and good old-fashioned savings as well to help you obtain optimal tax diversification.

Important Reminders To Help You Prepare Your Taxes This Year

January 10, 2019

In the coming weeks, Americans will begin preparing their tax returns for 2018 under the tax reform changes that went into effect on January 1, 2018. While many of the changes are intended to simplify tax preparation, the very idea of change can cause anxiety. Here are some reminders to help make your tax season flow smoothly.

Don’t procrastinate

Fortunately, several people I spoke to throughout the past year took advantage of the IRS W-4 calculator and other tax estimators to monitor their withholdings and make adjustments, if needed. Still, there’s nervousness about how the numbers will all shake out.

Ideally, you’re due a refund and you want to get that in your pocket sooner rather than later, right? On the flip side, if you owe, there may be steps you can take to reduce your liability before the tax filing deadline of April 15th or to come up with the cash needed. Either way, just knowing where things stand will reduce your anxiety. Then you can plan your next step.

Understand that there is only one Form 1040 now

To help streamline things, the IRS re-worked the 1040 into a shorter form so that everyone will use the same baseline for their return. The new approach uses a shortened, simplified 1040 that can be supplemented with additional schedules if needed. In addition, they have eliminated the 1040A and 1040EZ forms altogether, so don’t spend valuable time searching for these if you’ve used them in previous years. All of the new forms are available here from the IRS.

Seek assistance if needed

Some of the anxiety associated with tax prep is the fear of making an unintentional error that comes back to bite us. Or maybe it’s just overwhelming or your to-do list just keeps growing. There are a number of options to consider to get that return finished and (fingers crossed) get your refund in your pocket ASAP.

Free filing and resources

The IRS site offers Free File software for households with income below $66,000, including state returns. If your income is greater, you can still download free fillable forms that will do the math for you, but you must know how to prepare your federal taxes. You also don’t get help with your state forms if your income exceeds the threshold, but check your state’s revenue website as they likely offer the fillable forms there.

If you don’t qualify for the IRS resources or want face-to-face help, check your community for pro bono or free tax filing services. For example, the United Way has partnered with tax prep software providers to provide free software to households earning less than $66,000 last year (go to MyFreeTaxes.com to learn more).

For people who generally make $54,000 or less, persons with disabilities, or limited English speaking taxpayers, there’s the Volunteer Income Tax Assistance (VITA) program.

Folks who are age 60 or older can seek guidance through the Tax Counseling for the Elderly (TCE) program, which typically operates through AARP locations, including your local library (search this site for locations in your area).

DIY tax prep

For those who don’t qualify for the free services above or feel comfortable with online apps, there are a number of tools available to reduce anxiety by guiding your through the process and helping to ensure you don’t miss anything. This might be especially helpful in light of the new tax laws.

For those of you who like CreditKarma for monitoring their credit score, they offer free tax prep on their website and recently added free audit defense as part of the service. Reviews indicate they’ve worked out several of the kinks from early years, so it might be worth checking out if your situation is fairly straight forward with W-2 or 1099 income. It’s not a good fit for active traders, real estate investors, or if you have to file in multiple states.

For more complex situations and apps with more bells and whistles, check out this recent comparison of online tax filing services.

Hire a professional

Finally, if your situation is too complex, overwhelming, or you find yourself in an unexpected pickle, you might consider hiring a tax professional. Although the thought of paying for a pro isn’t appealing, they can often pay for themselves by identifying tax-savings opportunities, avoiding minefields, and keeping you informed of the latest tax laws and strategies.

My colleague, Kelley Long, provides some helpful tips on finding a good tax preparer to fit your needs. If you do hire a pro, work with them to help estimate your 2019 taxes and adjust your W-4 for this year if needed as well.

 

5 Common Tax Myths About Gifts

January 04, 2019

Did you receive or give any large monetary gifts to family or friends this holiday season? We often get questions about the tax implications of gift-giving this time of year, so let’s take a look at some of the most common tax myths about gifts:

Myth: You have to pay tax on gifts you receive

Reality: You don’t owe tax on gifts that you receive. Instead, the giver of the gift may owe tax. This may seem counter-intuitive but the whole point of the gift tax is to prevent people from using lifetime gifts to avoid paying the estate tax.

Possible caveats

There are a few caveats to this though. The first is that gifts from your employer or in appreciation of your work may be taxable as income. That’s why tips are technically taxable even though they’re usually a voluntary gift rather than a required payment for service. (Don’t worry. Small de minimus gifts like a holiday turkey from your employer are excluded from tax.)

Second, if you’re given property that appreciated in value since the giver purchased it, you get the giver’s cost basis. That means that if you later sell it, you’ll have to pay a tax on the difference between what you sell it for and what the giver purchased it for. It’s kind of like a delayed tax on part of the gift’s value.

For example: Your grandfather gives you 50 shares of stock worth $20/share, and he paid $1/share for it long ago. You’ll be responsible for the capital gains tax on the $19/share gain when you sell the stock.

The final caveat is that if you’re fortunate enough to receive over $100k in gifts from one or more related foreign individuals or trusts or more than $16,076 from a foreign corporation or partnership, then you’ll have to file Form 3520 with the IRS. That’s not because foreign gifts are taxable. The IRS just wants to make sure that you’re not claiming what would otherwise be taxable foreign income as a nontaxable gift.

Myth: You have to pay a tax on gifts you make that are over $14k per year

Reality: First, the annual gift tax exclusion is now $15k per year. There are several other things to keep in mind too. One is that you can give an unlimited amount to a qualified charity or to your spouse without owing tax (unless your spouse is a non-citizen, in which case the annual exclusion is $152k in 2018 and $155k in 2019). You can also give an unlimited amount if you send a gift directly to a medical or educational institution. That’s one reason (I’m sure you can think of more) that it may make more sense to write a check directly to junior’s college rather than writing him a check for that purpose.

The $15k is also per person, so you can theoretically give $15k gifts to a virtually unlimited number of people each year tax-free. (If this is your intention, don’t forget the person you heard this from.) You and your spouse can also combine your $15k exemptions to give a $30k tax-free gift.

Finally, even if you go over the exclusion limit, you still probably won’t owe anything to the IRS, at least not yet. That’s because the amount you go over the limit just reduces the $11.18 million (going up to $11.4 million in 2019) that you can give tax-free over your entire life or at death. Even if you don’t owe anything right now, you still have to file a gift tax return for going over the limit though.

Myth: You can avoid the gift tax by loaning money at no interest and than forgiving the loan

Reality: To be considered a loan, you have to treat it like a real loan. That means putting the terms in writing, including the repayment schedule, and charging a fair market interest rate. If you forgive the loan, it will be considered a gift at that point. If you want to stay under the $15,000 annual limit, you can forgive the 1st $15,000 of payments each year.

Myth: Charitable contributions can always be deducted from your taxable income

Reality: First, the gift must be to a qualified tax-exempt charitable organization. You can ask the charity if they qualify or search for the charity on this IRS site. If you receive something of value for your gift, you can only deduct the difference between what you gave and what you got in return. Finally, the charitable deduction has to be itemized. That means if your total itemized deductions (which includes your mortgage deductions) are less than your standard deduction, the charitable donation won’t reduce your taxes. (more on that here)

Myth: This is all you need to worry about

Reality: Certain states have their own gift taxes and other states may treat charitable deductions differently, so you may need to file in your state even if you don’t have federal tax implications for your gift. Be sure to check what your own state’s laws are.

How To Make Sure Your Charitable Donations Are Most Effective

December 12, 2018

It is said that it is better to give than receive. There’s even research that shows that giving is psychologically and financially beneficial. For many Americans, giving to charity has made a material difference in terms of reducing their tax liability (approximately 25% of Americans report charitable donations as itemized deductions to their income each year.) Charitable giving is a key component of tax planning for many taxpayers and it is important to make those gifts in time to count for 2018.

Last year’s Tax Cuts and Jobs Act left most charitable deduction rules the same but there have been some additional changes that may make it more difficult to reap the same tax benefits. If you are in the habit of making a lot of donations toward year-end in order to get the tax deduction, keep reading – you may not see as much benefit as in years past.

Is it deductible?

First, a quick review of the rules of charitable giving. You can count a gift as a charitable tax deduction ONLY if you make that gift to a qualified organization as defined by IRS section 170(c) – most of these are 501(c)(3) organizations.

Outside of that, you may make donations to people or organizations, such as helping a local family in need, but those donations are considered gifts and are not deductible from your taxes. That means those charitable individuals paying off Walmart layaways aren’t likely to see a tax benefit (although I still think it’s really cool!). One of the more common misconceptions is that crowd-sourced giving, like GoFundMe campaigns, are tax deductions, but they are not.

Will charitable giving actually reduce your tax?

Due to the recent tax changes, people who make charitable gifts strictly to lower their income tax burden may need to re-think their strategy. One major change to the tax code is the increase in the standard deduction, which basically doubled for each filing status. This doubling means that many Americans who previously itemized deductions will likely use their standard deduction this year because their itemized deductions will not measure up. To determine if you have enough itemized deductions, total them up and compare them to your standard deduction ($12,000 for single, $24,000 for married). You’ll claim whichever one is higher.

One way to make it count for tax purposes

If you are falling just short, one idea is to accelerate some charitable contributions for next year into this year to get you over the standard limit. If you are falling well short of reaching your deduction level this year, you could hold off on some end of the year giving to boost your itemized deduction for the following year.

If you have a large amount of funds to donate this year but want to spread out the disbursement of those funds over several years, consider a donor advised fund. You can make a gift to the donor advised fund upfront and claim it for the current year and then disperse the gifts over time.

Making sure your gift is going to a worthy cause

Your charitable gift can help an organization achieve its cause, but you want to make sure the organization you are giving to is managing your gift correctly. There are many organizations that offer rosy promises but how can you be sure they are doing what they say? Take some time to investigate the organization’s mission and find out what percentage of donations actually go toward the mission. You may want to tour the operations or even volunteer with the organization to see how your gift is making a difference.

If you are looking for a third party assessment of an organization’s stewardship, online resources like Charity Navigator rate hundreds of organizations on their accountability measures and transparency. If you are considering giving to a smaller or local organization that may not show up on these national search engines, check in with resources like a local community foundation to determine if they have vetted that organization’s efficacy.

The bottom line

I have witnessed the ability of a well-run charity to change individual lives and whole communities for the better. Whether you will receive a tax deduction for a gift does not have to be the determining factor in whether to make a gift, but consider these strategies when you do give to maximize the potential tax benefits. Doing so can give you additional assurance that your hard-earned dollars are being effective in helping others, while also leaving you with more money to be generous in the future.

7 Tax Moves You Might Want To Make Before Year-End

December 05, 2018

The new tax law that was enacted earlier this year could mean big changes for your personal tax situation. Before we wind down 2018, it’s wise to take a moment and check that you’re making all the best moves. Here are 7 things to check:

1. Double check your deductions

In previous years, taxpayers were encouraged to accelerate any deductions to the current year to make the most of them, but that wisdom may not make sense with the new tax law. For example, for people who pay estimated taxes, it’s common to pay the 4th quarter state estimate on December 31st so that you can deduct that payment in the current year. Now that the total deduction for state and local taxes is limited to $10,000, that might not be the best move anymore.

First of all, the standard deduction was increased to $12,000 for single filers and $24,000 for married, which means that you may not even be itemizing deductions anymore — only if your mortgage interest (on the first $750,000 of a mortgage) plus taxes (limited to $10,000) and charitable contributions (limited as well, depending on what you’re giving) exceeds $24,000. In other words, if your property taxes and state/local income taxes are $10,000 or more, you also have to have $14,000 of mortgage interest and charitable contributions to even need to itemize.

What does that mean to you? Before you make tax-saving moves like you have in years past such as giving to charity just for the deduction or accelerating paying taxes, make sure you’ll even be deducting those things for 2018.

2. Make up a tax shortfall with increased withholding

If you’ve had a change in marital status, a change in the number of dependents in your household, or a substantial change in income, you may have had too much or too little income tax withheld this year. Run an estimate of your tax liability and compare it to how much tax you have paid either directly to the IRS or through withholdings on your paycheck. If it doesn’t look like enough, make extra payments now while there’s still time – you can adjust your W-4 if there’s enough time, or just make an estimated payment using the proper forms. It may not save you from an underpayment penalty for prior quarters, but it should help for the last quarter.

3. Leverage retirement account tax savings

If you have a 401(k) at work, you are eligible to contribute up to $18,500 for the year (plus an extra $6,000 if you turned age 50 or older this year). If you have not reached this limit yet and anticipate higher taxes this year, consider increasing your pre-tax contributions before year-end to get closer. You can also contribute to a traditional IRA (which is deductible if your income is low enough), but you have up until April 15, 2019 to make that contribution so you don’t have to be in as much of a hurry.

4. Look into Roth conversion options

While most of these suggestions are ways to help reduce your 2018 taxable income, due to lower rates you may actually wish to convert pre-tax retirement savings to Roth either using an IRA or in your 401(k). Any funds you roll from a traditional IRA to a Roth IRA or convert in your 401(k) are treated as taxable income for the year, but depending on where you are in your tax bracket, you may find it worthwhile to lock in a possibly lower tax rate if you have many years to go until retirement or just simply think that tax rates will be higher when you do retire.

What to watch out for

  • Know where you are in your tax bracket and make sure any conversions don’t push you into a higher bracket.
  • This can be an especially smart move if you do this when the market is down.
  • Be aware that the new tax law took away the ability to change your mind on this, so once you flip the switch to Roth, it’s done.
  • Make sure you can pay any resulting taxes with funds outside your IRA or 401(k).

5. Maximize “above-the-line” deductions

While these are technically just adjustments to income, above-the-line deductions are a great way to reduce your taxable income without the requirement to itemize. Some of the more common deductions include traditional IRA and health savings account (HSA) contributions, self-employed health insurance costs, and alimony payments (although that particular deduction ends this year). Keep in mind that you can make HSA contributions via lump sum up until the tax filing deadline in April.

6. Look into tax-loss harvesting with any brokerage investments

If you own any stocks or mutual funds in a taxable brokerage account, this strategy is for you. Investments held more than one year are taxed at more favorable long-term capital gains tax rates, while investments sold that have been held for one year or less after purchase are subject to the higher ordinary income tax rates.

If you have capital gains to report for the year, consider selling other securities that may generate a loss in order to offset some or all of the gain. In addition, up to $3,000 of capital losses not offset by capital gains can be taken off ordinary income taxes annually. The remaining losses can be carried forward indefinitely. Just take care that you are only selling securities you truly no longer wish to hold anymore – if you buy the same thing back within 30 days, the IRS will disallow the loss due to the wash sale rule.

7. Don’t squander your gift tax exclusion

Any taxpayer may give cash and noncash gifts totaling up to $15,000 in value to as many people as they wish without incurring a gift tax in 2018. (Couples can combine their gift and give up to $30,000 per recipient.) If you have a sizeable estate and are feeling extra jolly this year, be sure to take advantage of this annual tax break.

As we often say at Financial Finesse, financial planning is a process, not an event. The same is true of tax planning. Begin the process today so that you can have a happy and prosperous tomorrow.

 

Note that Financial Finesse does not provide tax or investment advice. This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, investing or accounting advice. You should consult your own tax professional before engaging in any transaction.

How To Use Tax Loss Harvesting To Reduce Capital Gains Taxes

December 03, 2018

No one invests to lose money, but there can be times when selling investments at a loss can be helpful. It’s a process called “tax loss harvesting,” but it’s nowhere near as complicated as it sounds.

When does tax loss harvesting make sense?

First of all, this strategy only works for investments that are NOT held in a qualified retirement account like a 401(k) or a Roth IRA. So if you have stocks, bonds, mutual funds or exchange traded funds (ETFs) held in a regular brokerage or mutual fund account you may want to consider this.

How does it work?

When I was a financial advisor, one of my favorite clients was Hugh (not his real name). He had a lot of stocks in his portfolio that he was hesitant to sell because he didn’t want to pay taxes on his gains, even when he was ready to get rid of them. We got around that by helping him take advantage of his stocks that were down.

First, we looked for any investments he had that were down since they had been purchased (aka they were trading at a loss). Sometimes he had stock that he had purchased multiple times, so some were at a gain and others at a loss. We focused on the shares that were purchased at a higher cost and were negative at the moment and sold everything we could that had lost money since they were purchased.

Paying attention to short-term versus long-term

After selling everything we could at a loss, we started looking at what type of losses they were. Anything that we had sold that Hugh had owned for less than a year were short term losses. That meant that if we had stocks that we wanted to sell that had made money in the short term (less than a year), we could generate the same amount of short-term gain and not have to pay any taxes because the short-term losses canceled them out.

Then we looked at the losses where the shares had been held for more than one year. Those losses were used to cancel out the profits that he had from stocks that he owned for more than one year. So again, that meant no taxes on those profits.

How a market downturn actually helped

Then 2008 happened. For several years leading up to that market crash, we had helped Hugh reduce the taxes on his investments by using tax loss harvesting, but during 2008 and the years before the market came back, unfortunately he had a lot of stocks he could sell for a loss.

The good news is that when you “harvest” a loss (aka you sell something for less than you paid for it), you get to carry forward anything you don’t use that year. So we were able to harvest a lot of losses in 2008 that Hugh was able to use in the following years of the market recovering while making money for him without paying taxes on those gains.

Getting a deduction for some of your losses

It gets even better though. If you have more losses than gains in any single year, you can use up to $3,000 of those losses as a tax write-off against your regular income. So Hugh was able to claim a tax deduction in 2008 and a few more years after that in addition to avoiding capital gains taxes, all while being able to sell the stocks he wanted to sell anyway!

Beware wash sale rules

One last thing that’s important to know. Like most things with the IRS, there is a catch. Since you are allowed to use losses to offset gains, the IRS wants to make sure you’re not taking advantage of the rules so they made a rule that says you cannot repurchase the same investment within 30 days of selling it for a loss, or you won’t be able to claim the loss. It’s called a “wash sale,” as in your loss is a wash aka it’s treated like you never even sold and re-bought the stock.

So if you’re really just looking to take the loss and “reset” your cost basis on a stock you ultimately want to keep holding, you have two choices:

  1. Leave the money in cash for 30 days and then repurchase the same stock or fund; or
  2. Buy a different but similar investment.

For example, if you are selling a tech stock to claim the loss, but you really want to still hold that stock, you could use that money to buy a technology ETF that includes the stock you sold. Or if you are selling a fund, consider a slightly different fund in the same category.

I hope that you make a ton of money on your investments, but when you have those inevitable losses, remember that a loss today could be your best friend on April 15th!

NUA – One Overlooked Benefit Of Employer Stock In Your 401(k)

October 03, 2018

Should you own stock in your current or former employer? There are mixed opinions out there regarding the risk of holding too much stock in the same company that provides your paycheck, but before you liquidate a large holding in your 401(k), keep reading.

One little known benefit of holding company stock in a 401(k) plan is the ability to have the “net unrealized appreciation” of the stock or “NUA” taxed at a lower tax rate. Normally, when you take money out of a traditional 401(k), it’s taxed at your ordinary income tax rate. However, the gain in employer stock can be taxed at the lower long term capital gains rate if you meet several conditions:

Here’s how NUA works

1) You have to reach a triggering event. This can be death, disability, separation from service, or reaching age 59 ½. You can’t take advantage of this at any time. Most people take advantage of it upon retirement or after.

2) You have to take a lump sum distribution of the entire account. You can’t just withdraw the shares of stock. However, you can choose to roll the rest of the money into an IRA or another retirement account, while moving the company stock shares to a regular brokerage account.

3) The employer stock has to be distributed “in kind.” Basically, this means you can’t sell the shares and then withdraw the cash as you would typically withdraw money from a 401(k). Instead, you have to transfer the shares of stock into a brokerage firm.

If you meet the criteria above, then when you do a withdrawal of the company stock, you would pay ordinary income taxes on the cost basis of the stock (essentially the value of the stock when you purchased or received it) at that time. You may choose to hold the stock or liquidate some or all of it at that point. When you do so, you’ll pay taxes at the lower long term capital gains rate on any growth in the value of the shares beyond what you paid for them (regardless of how long you actually held them).

Be aware that withdrawing a large amount of stock could push you into a higher tax bracket for that year, so you’ll want to be strategic about when you make this move. However, removing the stock from your retirement account would also reduce the amount of required minimum distributions you’d have to take starting at age 70 ½. (Incidentally, the capital gain would not be subject to the 3.8% Medicare surtax on investment income, but the stock would not benefit from a step-up in basis when you pass away.)

It’s about more than just the taxes

As I always like to say, don’t let the tax tail wag the dog though. This is not a reason to load up on company stock. After all, individual stocks are always a lot riskier than diversified mutual funds since an individual stock can go to zero and never recover. This is even more true when it’s the company that your job is tied to. A good rule of thumb is to never have more than 10-15% of your portfolio in any one stock, especially your employer’s.

That being said, it could be a good reason to keep some money in company stock, especially if you already have shares that have appreciated quite a bit. In fact, this is one of the main reasons I would suggest someone not roll a former employer’s retirement plan into an IRA or a new retirement plan while they are still working.

How to decide whether NUA is right for you

You can calculate the value of doing an NUA distribution vs an IRA rollover here. If you’re still not sure whether this makes sense for you, see if your employer offers access to an unbiased financial planner who can help you with what can be a complex decision, or consult your own financial advisor if not.

Working In The U.S. Temporarily? Here’s What You Need To Know About Retirement

August 17, 2018

We get many retirement benefits questions on our Financial Helpline from professionals who are working in the United States now but plan to return eventually to their home countries or take another ex-pat assignment. Frequent questions include: should I participate in my company’s 401(k) plan, and if so, should I choose to make a pre-tax, Roth or after-tax voluntary contribution? How can I access my savings when I leave the U.S.?

Get professional tax advice

If you’re a professional from another country working legally in the United States and do not have permanent resident status (e.g., a “green card”), the U.S. system of taxation can seem like a maze: one wrong move and you’re stuck in a corner. Do not try and navigate this yourself. Seek professional tax advice from a tax preparer who is experienced in ex-pat/non-citizen issues. You’ll need guidance on tax withholding, tax filing, benefits choices and what to do when you leave the U.S.

Ask ex-pat colleagues first for referrals to a tax professional who has experience working with people like you. It’s not expensive and could save you from financial and legal problems later. For a basic overview of types of U.S. tax preparers, see this post on How to Find a Good Tax Preparer.

What do I need to know about U.S. retirement savings programs?

The U.S. retirement savings system is made up of Social Security, defined contribution plans (401(k), 403(b) or 457), traditional pension plans (defined benefit), and individual retirement accounts (IRA and Roth IRA).

Social Security

This is the government-sponsored retirement system, similar to what’s often called a “public pension” in other countries. As a non-citizen employee, you will likely pay a mandatory 6.2% of your pay on the first $128,400 of your 2018 wages into the system while you are working in the U.S. You’ll also pay 1.45% of your wages into Medicare, which you will not recoup unless you continue to be a U.S. resident. Your employer will also make contributions on your behalf.

If you do not plan to live in the U.S. when you retire, you may or may not be able to receive Social Security retirement benefits. It depends on how long you paid into the system, your immigration status, your country of residence, and whether you started receiving payments before you left the U.S. See this Social Security Administration Guide for Your Payments While You Are Outside The United States as well as Can I Still Receive Social Security If I Move Abroad?

401(k), 403(b) and 457 plans

Most large employers offer employer-sponsored retirement savings plans, such as 401(k) and 403(b) plans. An employee may contribute a percentage of their gross pay each period to a tax-advantaged account. Frequently, the employer will match up to a set percentage of what you contribute or will sometimes make contributions regardless of whether you make your own contributions. You’ll get to choose how your contributions are invested from a menu of mutual funds or other investing vehicles.

You may also get to choose whether you contribute your money into a pre-tax (traditional), after-tax (Roth), or after-tax voluntary account. See tips below for choosing what works for you. In 2018, you may typically contribute up to $18,500 to your employer’s plan annually plus another $6,000 if you’re 50 or older.

IRA and Roth IRA

If you are considered a resident for U.S. tax purposes (have U.S. earned income, have a Social Security number and meet the substantial presence test), you may open a traditional or Roth IRA. However, if you are a non-citizen and don’t plan to seek U.S. citizenship or permanent residency, you may not be able to reap all the benefits of an IRA or Roth. If you’re eligible, you may contribute up to $5,500 annually to a traditional or Roth IRA plus an extra $1,000 if you’re 50 or older.

Traditional pension plans

These are no longer widely available to new employees, but some larger companies and state/local government jobs still offer them. A pension may be fully funded by employer contributions or with a combination of employer and employee contributions. Typically, it takes 10-20 years to be “vested” in a pension, where the employee is eligible to receive a fixed monthly payout at retirement.

Should I enroll in my 401(k)?

Saving in your employer-sponsored retirement plan has multiple benefits, even if you don’t plan to continue working and living in the U.S. later in your career. If there’s a match on your contributions, that’s like earning additional income. There’s the potential for tax-deferred or tax-free growth, depending on the type of contributions you make. Plus you really can’t beat the ease of contributions deducted automatically from your paycheck!

Always consider your future taxes

For non-citizens making decisions about which retirement contribution type to choose, you’ll need to consider where you will be living when you withdraw the money, how old you will be when you plan to withdraw it, and whether you think you’ll be a U.S. permanent resident or citizen at that time.

If you expect to still be a non-citizen when you withdraw the money, note that you are required to file a U.S. tax return in any year in which you have U.S. income, which includes retirement plan withdrawals. Additionally, according to the IRS, “Most types of U.S.-source income paid to a foreign person are subject to a withholding tax of 30%, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty.” You may or may not owe that rate in taxes, but the funds will be withheld from the distribution regardless.

If you’ve overpaid through the withholding, you would get a refund after you’ve filed your tax return for that year.  See this IRS U.S. Tax Guide for Aliens for in-depth reading. Now do you see why I say you need a tax advisor if you’re an ex-pat working in the U.S.?

If by the time you withdraw the money, you have become a U.S. citizen or a permanent resident – but are living overseas – you won’t be subject to the 30 percent withholding. You will, however, have to file a U.S. income tax return every year, regardless of your income. This blog post reviews the rules for U.S. citizens or permanent residents living outside the U.S.

Pre-tax, Roth or After-tax voluntary contributions?

The financial planning goal, then, is to minimize taxes and penalties on your future retirement plan distributions. Remember – you’re going to pay income taxes on whatever has not been taxed before. Your company’s matching or profit-sharing contributions to your retirement plan are always pre-tax, so they will be taxed when you withdraw them. How much of your own retirement contributions will be taxed depends on how you contribute:

Traditional pre-tax contributions: They are deducted from your taxable income, so you’ll pay less in income taxes today. Earnings grow tax-deferred for retirement. After age 59 1/2, you may withdraw them without penalty, paying US income taxes on whatever you take out. Prior to that, you may withdraw them only if you a) retire b) leave the firm or c) have an extreme financial hardship. Pre-tax contributions up to your plan’s percentage are generally eligible to receive the match, which is also in pre-tax dollars.  See this blog post for more details.

Roth contributions: Roth 401(k) contributions are made after-tax and grow tax-free for retirement if withdrawn 1) after 5 years and 2) after age 59 ½. If you meet those requirements for a distribution, your Roth distribution would not be included in your taxable U.S. income. See this IRS tool to see if your Roth distribution could be taxable. However, your home country (or country of residence) could tax it, depending on the tax treaty with the U.S.

If your plan allows, you can leave the funds in the account until after age 59 ½. If you must take an earlier distribution after you’ve left the firm, you will only be taxed and penalized on the related growth and any company contributions, not your original contributions. See this IRS Guide to Roth 401(k)s for more information and this blog post for when a Roth 401(k) works best.

After-tax voluntary contributions: Many employer-sponsored plans permit after-tax voluntary contributions in excess of, or as a substitute for, Roth or pre-tax contributions. This will give you some flexibility, as you may withdraw those contributions at any time (although growth of your funds will be subject to tax). If you plan to withdraw contributions after leaving the firm, taxation is similar to the Roth 401(k). Your retirement plan may also permit you to convert after-tax voluntary contributions to the Roth account, which could come in handy if you end up staying in the U.S., or roll them over to a combination of a traditional IRA and Roth IRA when you leave the firm. (See this blog post for strategies.)

On the down side, you won’t receive an employer match on voluntary contributions. Your original contributions can be withdrawn at any time tax-free, but any earnings or growth made in the account will be taxed when withdrawn. (That means earnings which are withdrawn before 59 ½ will be taxed and subject to an additional 10 percent penalty.)

If you leave the U.S., are you required to take distributions?

If you leave to work and reside overseas, you would be able to take a distribution from your company’s retirement plan but are generally not obliged to take any until age 70 1/2.  If possible, leave it where it can continue to grow protected from taxes. Pre-tax contributions that are later distributed are included in your taxable income, and if taken prior to age 59 1/2, may be subject to an additional 10% penalty.

Ask for guidance

If your company offers a workplace financial wellness benefit, talk through the pros and cons of your choices with a financial coach. Your financial coach can help you understand the implications of your choices given your personal situation. Also, while you’re working in the U.S., don’t forget to use a tax advisor experienced in non-resident taxation., such as a certified public accountant or an enrolled agent. This is well worth the relatively low cost to get good tax advice.

 

A version of this post was originally published on Forbes.

How Will Your Social Security Income Be Taxed In Retirement?

August 13, 2018

Many of us dreamily envision the possibility of retiring someday; you know, making work optional, taking a permanent vacation, etc. While we can retire from the world of work, retiring from the world of taxes is typically not an option, as many retirees are surprised to learn.

Tax obligations may not be part of our retirement dreams, but perhaps they should be. The decisions we make about saving and investing for our retirement dreams while we are still working can help prevent a tax nightmare after we retire.

Your retirement income tax bite

As you might imagine, retirement is a popular reason for people to chat with a financial planner, and I have the pleasure of talking almost daily with people from all walks of life about their retirement concerns. Most people understand that pension income and distributions from traditional 401(k) and traditional IRA accounts will be taxed as ordinary income. One thing that surprises me though, is how many people are not aware that a significant portion of their Social Security retirement benefits will most likely be subjected to ordinary income tax as well.

Social Security is not (always) tax-free

If Social Security is your only or primary source of income in retirement, your benefit may not be taxable. However, if you have income from other sources as well (e.g., pension, distributions from a pre-tax IRA or 401(k), part-time work, self-employment, interest, dividends, etc.) that add up to a certain amount, then a portion of your Social Security will also be subject to income tax. Just how much of your Social Security is taxable will be determined by your combined income.

How to calculate whether you hit the income limits

Sometimes referred to as “provisional income,” your combined income figure is calculated as the sum total of adjusted gross income plus nontaxable interest (yes, that’s your municipal bond income) plus ½ of your Social Security income. Your combined income determines how much of your Social Security income is taxable, and the amount subject to income tax could be 0%, 50% or 85% (or even 100% in one special case). (Don’t panic – it’s not a 100% TAX, that’s the percentage of your SS that will be taxable!)

Adjusted gross income (line 37 on Form 1040)
+
Non-taxable interest (line 8b on Form 1040)
+
1/2 of what you received in Social Security (from Form SSA-1099)
_______________________________________________
Income for Social Security taxation purposes

A good rule of thumb is that if your other income is more than $44,000, you’ll be paying taxes on Social Security no matter what. Less than that (or if you’re not married), refer to the chart below.

 

Combined Income Limits for Taxation of Social Security Retirement Benefits

Taxable SS Amount Single, Head of HH, Widowed, Married Filing Separately IF apart entire year Married Filing Jointly
0% Less than $25,000 Less than $32,000
50% Between $25,000 – $34,000 Between $32,000 – $44,000
85% More than $34,000 More than $44,000

Note: If you are married and filing separately but you lived with your spouse even one day out of the year, all of your Social Security retirement benefit will be taxable for that tax year.

 

Roth to the rescue

If you think there isn’t much you can do about your taxes in retirement, you might be surprised to know that you have more control than you think. If you still have a few years to go until retirement, or if you plan to work part-time after you retire, a tax-free Roth IRA can help you keep the tax man at bay.

Here’s why: although the combined income calculation for determining Social Security benefit taxation includes non-taxable interest income (e.g., municipal bond interest), the calculation does not include Roth IRA or Roth 401(k) distributions.

You read that correctly.

Money you take out of a Roth account (assuming it has been in there at least five years) is not subject to income tax, nor does it affect how much of your Social Security is taxable. Accumulating Roth assets during your working years, including converting some traditional IRA/401(k) dollars to Roth accounts, can pay off hugely in retirement by giving you a source of tax-free income that reduces your combined income for Social Security purposes and potentially lessens the tax bite on that benefit.

Remember, you can even convert traditional/pre-tax retirement dollars to Roth IN RETIREMENT, although you’ll have to pay taxes on the amount you convert. However, that’s one way to plan ahead to hopefully avoid taxation of your Social Security in the future. If you want to read about more strategies for reducing your taxes in retirement, my colleague Erik Carter wrote about several strategies in one of his Forbes articles.

Can You Contribute To A 401(k) And SEP-IRA At The Same Time?

July 13, 2018

One trend I’ve noticed in recent years is people with full-time jobs starting a business on the side. Some folks are looking to earn some extra cash and some are passionate about a hobby or pursuit and want to try to make a business from that passion.

If you have a side gig such as catering, photography, or blogging in addition to your “real job,” it’s important to know that there are distinct types of retirement plans that you can use for each. Being aware of how they work together can allow you to save more for retirement, while possibly saving on taxes today.

What is a SEP?

First, a quick review of what a SEP-IRA is. Most of us are familiar with our 401(k) plans at work – in order to contribute, you have to work for the company that’s providing it. Similarly, a SEP-IRA is a retirement plan tied to a company, but it’s specifically designed for self-employed individuals and small businesses.

How do contributions work?

Unlike the 401(k), where both the employer and employee are able to contribute to the account, all contributions to a SEP-IRA are considered employer contributions. For 2018, you can contribute the lesser of 25% of your gross salary (or 20% of your net adjusted annual self-employment income) up to a maximum of $55,000. You have until your tax filing deadline to make your contribution, so many people with SEPs choose to wait until then so that they know exactly how much they can put in (your CPA and most tax prep softwares will calculate this amount for you).

Keep in mind that if you employ anyone to help out with your business, you also have to put the same amount in their account as you save for yourself. You can adjust your contributions each year, so if your business is having a great year, you can save more. You can also save less (or not at all) in years that are tight. However, you do have to have self-employed income to make any contributions.

Can I use a SEP-IRA if I also contribute to my 401(k)?

If you are an employee of the company you work for (aka you receive a W-2 at tax time) and you also have a side business that you own, you can actually make contributions to your employer’s 401(k) plan and contribute to a SEP-IRA for your business. That means that having a side gig can allow you to save beyond the 401(k) annual limit of $18,500 (or $24,500 if you’re over age 50)!

Here’s an example of how it might work:

  • Let’s say you are already maxing out your 401(k) at work.
  • Now let’s say you also do a little wedding photography on the weekends, which brings in another $20,000 this year.
  • You could open a SEP-IRA and contribute $5,000 (25% of $20,000) for this year.
  • Because the 401(k) and SEP-IRA are with two different companies with no common control, saving in your 401(k) does not impact how much you can save into a SEP-IRA.
  • It’s important to note that if you have two jobs where you work for someone else and have 401(k)’s at both, that the $18,500/$24,500 limit applies to both across the board; the SEP-IRA, however, could be in addition to the 401(k).

As you can see, the potential to reduce your taxable income and save for retirement becomes very powerful!

Other things to consider

  • It is crucial to run your situation by your tax professional to make sure your strategy is best suited to you.
  • I also suggest reviewing this FAQ site from the IRS to get additional information.
  • My colleague, Scott has also written a great piece about SEP IRAs that can help if you’re looking to set one up.

Understanding your options and having a well-coordinated plan can help you manage your taxes and do some serious savings for retirement!

3 Things To Know About The Kiddie Tax

May 10, 2018

I have four children who all have custodial accounts. By definition, those custodial accounts belong to my children, and when they reach the age of majority—18 in most states—they technically can take that money and use it for whatever their hearts desire (case in point: my daughter, who is using hers to pay college expenses). Until then, I’m the custodian of the account, and as the custodian, it is my responsibility to make sure the money is managed properly. Not only does that mean making sure the assets are invested wisely, but also making sure that any taxes associated with the account are reported accurately.

Rather than keep the money in a bank account earning next to nothing in interest, I decided to invest the money in mutual funds, which distribute interest and capital gains each year. The question is how do I report this information, if at all, to the IRS? Here are a few things the IRS would like us parents to know as it relates to reporting a child’s investment income:

1. Investment income includes interest, dividends and capital gains

Whether it is interest earned in a bank savings account, dividends from stock, or capital gains distributed from a mutual fund, a child’s investment income falls under a set of tax rules commonly referred to as the “Kiddie Tax.” Under these rules, any investment income in excess of $2,100 is taxed at the same tax rates that trusts use.

2. If your child’s investment income is above this threshold, your child must file their own tax return

Once your child’s investment income is above the limit, you will complete a tax return on behalf of your child as though he or she were just like any other taxpayer. You’ll need to include Form 8615, Tax for Certain Children Who Have Unearned Income, when you file your child’s federal tax return. This is especially important for children who also have earned income, like from a summer job.

3. Be aware of the Net Investment Income Tax (NIIT), which may require one more form

NIIT is a 3.8% tax on the lesser of either net investment income or the excess of your child’s modified adjusted gross income over a certain threshold. If your child is subject to this tax, you will complete Form 8960, Net Investment Income Tax, and include it with your child’s return.

When I first set up these accounts, my children were too young to have a job, so the only income I had to deal with was investment income. Now that my oldest are starting to work part-time jobs, they are also reporting that income as well. I’ve used this as an opportunity to teach them how taxes work, by working with them to complete and file each of their tax returns. To learn more about the filing requirements and tax implications of a child’s earned income, see Publication 929, Tax Rules for Children and Dependents.

 

Please note that this article is not intended to be taken as tax advice — as a financial education company, Financial Finesse does not provide any tax, legal, investing or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Should You Pay Off Your Mortgage Or Keep The Tax Deduction?

May 09, 2018

One of the more common questions we receive as people prepare for retirement or just get close to paying off their homes is whether they should pay it all off early or keep paying on it to keep the tax deduction. Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1) The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest so it’s mostly deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal. And with the new higher standard deduction amounts, a lot more homeowners may find themselves no longer itemizing their deductions even if they have many years to go on their mortgage (see reason #2).

2) The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction ($12,000 per person in 2018) since you only get whichever one is higher. If your standard deduction is higher, you don’t deduct your mortgage interest at all.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100. You can use this calculator to see exactly how much your mortgage interest is really saving you in taxes.

3) The cost of the interest is always more than the tax savings. Let’s assume that you have $10,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $3,700 in federal income taxes. Does it really make sense to pay $10,000 to save $3,700?

When it doesn’t make sense to pay your mortgage off early

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

1) You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2) You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3) You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan debt is also deductible up to $2,500 per year assuming you don’t exceed the income limits.)

4) You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute.

5) You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. But it’s seldom because of the tax deduction.

4 Myths About Filing Your Taxes After April 15th

April 13, 2018

Every year around tax time when I’m talking with people about filing their taxes on time, I’m reminded of an old friend of mine who, no matter what, always extended his taxes. He was always due a refund, but he just never got it together in time to file by the April deadline. It confounded me — why wouldn’t he want to get his refund ASAP? He just laughed it off and chalked it up to procrastination. I chalk it up to diff’rent strokes for diff’rent folks.

Most people who delay filing have better reasons than procrastination: they’re still waiting on something, they thought they could do their own but realized too late they needed a pro, etc. Whatever the reason, here are a few myths I’ve heard about the US tax deadline, along with the truth.

Myth #1: Extending your return due date means you’re filing late

This is decidedly untrue — as long as you let the IRS know by filing Form 4868 that you’re putting it off, you’re not considered late. It’s like the difference between an excused absence and unexcused — often an excused absence just means you made sure the authority keeping attendance knew you wouldn’t be there, and then you’re excused.

You’re considered late (and therefore could be assessed a late filing penalty) if:

  • You don’t file Form 4868 by midnight on the April filing deadline
  • You file 4868 on time, but then fail to actually file your return by October 15th, which is the final deadline, no matter what

Myth #2: Extending your return due date means you don’t have to pay until later

This is probably the biggest mistake people make. Filing an extension request gives you 6 more months to turn your form in, but if you end up owing anything at that point, you’ll pay a late fee and interest.

How do you know how much you’ll owe if you don’t have all the information?

Great question. You’ll need to make your best estimate, erring on the side of over-paying, in order to avoid the penalties. Let’s say, for example, you’re extending because you’re still waiting on a corrected W-2 from your employer. You can use your last paycheck stub of the prior year to fill out a draft of your tax return, while using all of the other information you have, to see what your projected payment due might be.

The bad news is that while the IRS expects you to pay them on time even if you file late, they won’t be sending you your refund until you send in your final return.

Myth #3: You have to have a valid reason to request an extension

Nope, you can extend just because you like to be late. But you do have to submit that form to formally request it.

Myth #4: Filing later is a red flag for audit

Untrue. In fact, it’s a commonly held belief in the CPA world that filing an extension may actually reduce your chances for a random audit, since those types of audit can be determined on a first-come, first-served basis. That doesn’t mean you won’t ever be audited, particularly if you have other potential red flags on your return, but requesting an extension does not rouse suspicion with the IRS.

The most important point about filing after the April tax deadline

If you only remember one thing when it comes to filing and paying your taxes, it’s that any balance you may owe the IRS on taxes for the prior year will always be due by April 15th (or whatever date you’re required to file that year), no matter when you submit the supporting tax return. Beyond that, if you’re expecting a refund and decide to delay your filing until after the April due date, that’s fine, just make sure you submit the form. The IRS will assess a late filing penalty if you didn’t officially notify them of your need for extension (in other words, you’ll suffer for unexcused absences).

How To Use Tax Time To Proactively Plan Ahead

March 30, 2018

Whether you are still trying to get your tax information organized to meet this year’s income tax filing deadline or using this time of year as a proactive start to your tax planning efforts based on the new tax law, here are a few tips to help make the most of that time.

When you’re not sure about DIY software vs. using a tax pro

Online tax preparation software is relatively inexpensive and fairly easy to use if you take the time to go through the step-by-step guidance and Q&As — which one is best is open for debate in our industry. However, the key is that you have to be committed to getting it right — if you are more interested in finishing your return than finishing it accurately, your tax software may create a “garbage in, garbage out” situation according to my colleague Greg Ward.

How you should do your taxes generally depends on the complexity of your financial situation and the amount of time you are willing to devote to trying to complete your return on your own. If you are not sure if you are cut out to prepare your own returns with some guidance, check to see if you qualify for free income tax preparation services (generally for lower income people) or at least kick the tires and give online tax preparation software a free spin. Most tax software packages allow you to start for free and do not require payment until you are ready to file.

If you know you want to use a tax pro, check out these tips from my colleague Kelley on finding one in your area.

When you’re worried about being able to file on time

When time is running out to stay off of Uncle Sam’s naughty list and complete your income tax returns prior to the April deadline, the good news is that you can request a six month extension to wait until October to file. The most important thing to know here is that while you can push back your filing deadline, you still have to pay any taxes due by the April deadline. Expecting a refund? You’ll have to wait until you file to get that… If you’re not sure what you’ll have due, you’ll have to do your best to estimate — any underpayment will be subject to interest and penalties.

I have worked with many people that need the extra time to overcome the procrastination demons or simply pull together financial records for rental properties, investments, and small businesses. Some small business owners even use those extra six months to allow for more time to set aside money for last minute SEP IRA or other self-employed retirement plan contributions. If you decide to extend, you do have to file a Form 4868 to let the IRS know that you’re on it.

When you need last minute tax-savings tips

If you find yourself owing for the year and want to find a few ways to reduce the balance due, there are some steps you can take, although you’ll have to come up with more money in total.

  • Contributing to a deductible IRA is an option if you are working but not covered by a qualified plan (like a 401k) at work or if you are participating in a plan and have income below certain limits.
  • If you have a nonworking spouse under age 70 1/2 and enough earned income, you can make a deductible contribution to a spousal IRA too, subjected to higher income limits.
  • Health savings account (HSA) contributions are another excellent way to save on taxes today and for health care expenses now or later in life if you are covered by a high deductible health plan, assuming you didn’t max out your contributions for the prior year already. Remember that if you are age 55 or older, there is an additional $1,000 catch-up contribution beyond the annual limits.
  • Contact your HSA custodian to see how to make your contribution via direct deposit and verify that it is assigned as a previous year contribution — you don’t have to do it through payroll.
  • For both IRA and HSA contributions, the April deadline still stands even if you file an extension, so be sure to take action soon.

When you want to get to owe/refund: $0

It is essential to go beyond focusing on the amount you overpaid or the amount you owe on IRS Form 1040 when trying to get both numbers to zero. Determining if you are on track to receive a tax refund or will end up owing the IRS in the current year is a good place to start with a proactive income tax plan.

Update your paycheck withholdings

In order to make changes to your withholding, you will need to fill out a new Form W-4 and provide this form to your payroll department. However, prior to making any changes to the W-4, you might want to review the IRS withholding calculator to estimate the correct withholding for you and your family’s situation. If you are looking for a second opinion or just want to double check your entries, try the TurboTax W-4 withholding calculator.

When you want to reduce your taxes for the current year

Filing your tax return should not be the end of your tax planning efforts but should mark the next step in your current year plans. This process of planning ahead requires a quick assessment of where you stand today. To get started with your income tax planning, take some time to get your important financial documents together. Organize your financial statements and have a copy of your most recent tax return on hand.

Maximizing all tax savings options

Remember that the goal should not be to just “get it right” in the eyes of the IRS or just minimize the amount of taxes owed. You will still want to make sure you maximize all potential tax exemptions, deductions, and credits but also consider reallocating investments in taxable accounts to more tax-efficient options. Plan ahead so you can contribute as much as possible to your employer’s retirement plan, IRAs, HSAs, and possibly 529 college savings plans.

Give with purpose and meaning to charitable organizations with an added bonus of tax benefits from Uncle Sam for your good deeds. If you start the planning today, you will not have to scramble at the end of the year to find last minute techniques to lower your taxes.

A final word about tax planning

Whether you prepare your taxes using tax preparation software or use the help and guidance of a tax preparer, you should review your tax return and look beyond the bottom line of owing money or getting back a refund. Be sure to make a note of anything on the return that you do not completely understand and use it as motivation to educate yourself about these specific items. The more familiar you become with the information that appears on your tax return, the better positioned you will be to plan to minimize your taxes in the future.

Should You Pay Your Mortgage Off Early Or Keep The Tax Deduction?

March 27, 2018

I recently received a question after one of my workshops from a woman who was wondering if she made a mistake paying her mortgage off early because she no longer has the mortgage interest deduction. I can’t tell you how many times I’ve gotten different versions of that same question (including after a later workshop session that same day). Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1. The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest, so most of what you pay is deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal anyway.

2. The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction since you only get whichever one is higher. Considering that the standard deduction is now $12,000 per person (or $24,000 for a married couple), AND the income and property tax deduction is limited to $10k per year, many people will fail to qualify for itemized deductions going forward, even if you have many years to go on your mortgage.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100.

3. The cost of the interest is always more than the tax savings. Let’s assume that you have $15,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $5,550 in federal income taxes. Does it really make sense to pay $15,000 to save $5,550?

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

Reasons NOT to pay down your mortgage early

1. You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2. You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3. You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan interest is also deductible up to $2,500 per year.)

4. You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute (although you can still spend the funds if you switch to a lower deductible plan in the future).

5. You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. (At retirement is a different story.) But it’s seldom because of the tax deduction.