Tax Free Opportunities

Lots of Americans are passionate about taxes. Many would like to pay fewer taxes, so they fervently embrace tax-free opportunities. You know you’re a tax-free fan if you:

· Always shop in the duty-free store when you come through customs.1

· Contribute to 529 plan accounts for all your grandchildren.2

· Hold off on purchases until your state’s sales tax holiday.3

· Have considered moving (or moved) to a state such as Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming that has no state income tax.4

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· Help subsidize family members by gifting each year.5

· Invest in municipal bonds for the tax-free income.6

· Really want to contribute to a Roth IRA.

Roth IRAs are tax-advantaged accounts that can hold many different types of assets and investments. Unlike Traditional IRAs, which offer pre-tax contributions and tax-deferred growth potential, Roth IRAs have taxable contributions with tax-free growth potential. Distributions are tax-free, too, as long as the investor is age 59½ or older and has owned the IRA for at least five years. As an added bonus, there is no minimum distribution requirement for Roth IRAs, so the money has the potential to grow and compound tax-free for decades.7

Earn too much to contribute to a Roth?

If you expect to be in the same or a higher income tax bracket during retirement, a Roth IRA may be a particularly attractive option. However, not everyone can make contributions to one. Roth IRAs have income limitations. For the 2015 tax year:8

Single individuals, heads of households, or married couples (filing separately) who earn $116,000 up to $131,000 can contribute a reduced amount to a Roth IRA. If they earn more than $131,000, they are not eligible to contribute to a Roth IRA.

Married couples, filing jointly, or qualifying widow(er) who earn $183,000 up to $193,000 can contribute a reduced amount to a Roth IRA. If they earn more than $193,000, they are not eligible to contribute to a Roth IRA.

While income determines whether a person can contribute to a Roth IRA, it has no bearing on Roth ownership. As a result, anyone of any income level can have a Roth IRA. And, because of that, there are ways for high-income earners to reap the benefits of Roth IRAs without making contributions directly.

Rollovers to Roth IRAs

In 2010, the income limits that prevented high earners from rolling assets out of Traditional IRAs and into Roth IRAs were removed. As a result, Americans can make contributions to Traditional IRAs and then rollover those assets into Roth IRAs. When this happens, the taxpayer will owe taxes on the amount of the rollover.9

For 2015, taxpayers can contribute up to a maximum of $5,500 to IRAs. If you are age 50 or older, you can contribute up to $6,500 for the year.10

Contribute to a Roth 401(k), 403(b), or 457(b) plan

Some companies and organizations allow participants in 401(k), 403(b), or 457(b) plans to make contributions to designated Roth accounts. The contributions are taxable, but any earnings grow tax-free and distributions are tax-free as long as certain requirements are met. A key difference between designated Roth accounts and Roth IRAs is required minimum distributions must be taken from Roth plan accounts at age 70½.11, 12

While it is permissible to divide your annual plan contribution between designated Roth 401(k) contributions and traditional pre-tax 401(k) contributions, the total contribution amount cannot exceed $18,000 for 2015. If you are age 50 or older, you may be able to contribute an additional $6,000 to an employer's plan this year.11

Make after-tax contributions to a 401(k) plan

If you have the option to make after-tax contributions to your retirement plan at work, you may want to take advantage of the opportunity. After-tax contributions are similar to non-deductible contributions to Traditional IRAs. The plan participant pays taxes on the contributions and any earnings grow tax-deferred until they are taken from the account. When a distribution is taken, the amount is taxable as ordinary income.13

The IRS recently ruled the after-tax portion of a distribution can be rolled over into a Roth IRA when a plan participant leaves an employer or retires. Forbes explained it like this:14

“There are new rules for taking after-tax money out of your 401(k), and they are taxpayer-friendly. Basically, if you have after-tax money in your 401(k) retirement account, you can roll it into a Roth IRA where it will then grow tax-free (as opposed to tax-deferred). You don’t have to pay pro rata taxes on the distribution, accounting for the percentage of the pre-tax money in your 401(k).”

Not all employer-sponsored plans include provisions making after-tax contributions possible. Check with your human resources department to find out whether your plan does.

If you’re passionate about taxes and would prefer to have tax-free income during retirement, ask your financial advisor about Roth strategies and how they may benefit you.

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Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

This is not intended to be a substitute for specific individualized tax advice. It is suggested you discuss your specific tax issues with a qualified tax advisor.

Sources:

1 http://www.worlddutyfree.com/information/tax-and-duty-free-shopping.html

2 http://www.sec.gov/investor/pubs/intro529.htm

3 http://www.taxadmin.org/fta/rate/sales_holiday.html

4 http://www.retirementliving.com/taxes-by-state

5 http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes

6 http://www.investinginbonds.com/learnmore.asp?catid=8&id=213

7 http://www.investopedia.com/university/retirementplans/rothira/

8 http://www.irs.gov/Retirement-Plans/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-For-2015

9 http://www.thinkadvisor.com/2015/03/09/4-key-questions-about-roth-iras-and-taxes

10 http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits

11 http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-on-Designated-Roth-Accounts

12 http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions

13 http://www.forbes.com/sites/robertberger/2014/02/24/3-stealth-retirement-savings-moves-for-the-wealthy/2/

14 http://www.forbes.com/sites/ashleaebeling/2014/09/19/irs-issues-401k-after-tax-rollover-rules/

Gardner Sherrill

After 16 years as a High Net Worth Private Banker I opened my firm in 2011 to create an unbiased and client-centered wealth management firm. As an independent advisor I can now solely focus on helping clients define and pursue their unique goals. Read More

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