Investment Insights

Jeff Benjamin

Investing strategies as taxes rise

Dec 9, 2012 @ 12:01 am

By Jeff Benjamin

Attempting to manage client portfolios based on the chess match unfolding in Washington is probably a waste of time.

But there are a few areas with enough certainty for a financial adviser to add value right away.

No matter how you slice it, and whether you like it or not, taxes eventually are going up for individuals making more than $200,000 a year and families making more than $250,000.


Even as the debate rages over Bush-era tax cuts and tax loopholes aimed at taking more from those pesky “rich” folks, there is little disputing the reality of the 0.9% tax on ordinary income and the 3.8% unearned-income tax from Obamacare that will apply to those high earners.

One strategy that can work for anyone with access to a health savings account is to max out the allowable contribution, which is $6,250 per family this year and climbs to $6,450 next year. For those 55 and older, a catch-up provision increases the annual contribution limit by $1,000 each year.

No contributions are allowed after 65, but annual maximum contributions can and should be met until that time.

Karen DeRose, managing partner at DeRose Financial Planning Group, sees the HSA as one of the hidden and underutilized gifts of the tax code.

“Taxes are going up, so if you have a health savings account, you want to stuff it every year,” she said.

Under current rules, money goes into an HSA pretax, and isn't taxed on the way out as long as it's used for medical expenses.

Thus, the annual contributions lower a client's tax base, and the assets in the account can be invested like any other qualified account, creating a significant medical-expense nest egg for retirement.

“I tell clients to contribute, but don't use it now; just let it roll over every year,” Ms. DeRose said.


With higher tax rates most likely right around the corner, anyone on the fence about converting a traditional IRA to a Roth IRA should make the leap before year-end.

“Converting to a Roth is going to make a lot of sense this year,” said Scott Winget, senior managing director at Ascent Private Capital Management, a unit of U.S. Bank Wealth Management.

Weighing the pros and cons of a Roth conversion can be tricky in any environment because it involves assumptions about where taxes will be down the road, versus where they are now.

Part of the analysis has to include the dicey outlook for state and local tax policies. For instance, nine states don't charge income tax, which could make a traditional individual retirement account seem more appealing when it comes time to take taxable distributions.

Considering the growing fiscal challenges facing state and local governments, however, it is anyone's guess where income tax levels could go and how many states will forgo collecting income taxes.

Although it could be argued that allowing Roth IRA distributions tax-free in retirement is just a promise from Congress, it still carries more weight than no promise, or even rough guidance, on future state and federal income taxes.


The taxes coming in January from the health care law help make the case for converting this year as opposed to next.

Depending on the size of the conversion and overall financial status of a client, converting a traditional IRA to a Roth next year could trigger the 3.8% health-care-related tax on unearned income, Ms. DeRose said.

“The taxable conversion may bring your modified adjusted gross income above the relevant dollar threshold of $250,000 for joint filers,” she said.

Another wrinkle is the tax implication of converting this year. That means paying close attention to the impact on 2012 adjusted gross income, because the taxable event that comes with a conversion could bump a client into a higher bracket.

According to Ms. DeRose, this is particularly important for anyone who converted an IRA in 2010, when it was allowable to count the income from the conversion over a two-year period for tax purposes.

From its origination in 1997, the Roth IRA has included income limits to establish eligibility, which tops out this year at $183,000 for a married couple.

But access to the Roth wrapper became available to all income levels a few years ago, when the limit on conversions from nondeductible IRAs was lifted.

All anyone has to do now is open a nondeductible IRA and immediately convert it to a Roth.

Questions, observations, stock tips? E-mail Jeff Benjamin at Twitter: @jeff_benjamin


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