12/31/98

Making the Best of Tax Time

Think of income tax season as a yearly financial check-up. If you’re like many Americans the last minute rush to finish your tax calculations and the eleventh hour dash to the post office adds a little stress to your life. However, tax time can provide an opportunity for you to assess your financial health.

For many, tax season provides the year’s only comprehensive look at personal finances. There’s much you can learn from the experience. To do so, devote some attention to the following issues when filing your taxes: taxes on investments, retirement plans, tax deferred growth, withholding, budgeting, and debt exposure.

Taxes on Investments: Is your investment strategy working? What are you going to pay in taxes on your interest, dividends and capital gains? Are you in mutual funds with high turnover ratios that induce higher than average capital gains and therefore a higher tax burden to you each year? Changes in your investment portfolio can be adjusted to maintain performance yet lower the tax liability. For example, you might want to:

• Move investments into "tax efficient" mutual funds that leave more after tax dollars in your pocket.
• Purchase municipal bonds or invest in a municipal bond fund in which the income generated is usually federal income tax free.
• Invest in state bonds or state bond funds that are generally federal and state income tax-free.

Tax Deferred Growth:

When filing taxes, you can see how your money is meeting your overall financial goals. In the process you may learn that you’re exposing yourself to additional taxes by putting long-term money in short-term investments. Obviously, you need some money to be liquid and accessible for near-term goals, but you may want to consider investments that defer or eliminate the needless tax "hit" altogether. One possibility is to invest in a variable annuity. In the annuity you will receive tax deferred growth on your investments which become completely accessible without penalty at age 59 1/2. Another significant advantage of an annuity is that you can change your investment mix in the annuity at any time without tax consequences and usually without a fee. IRA’s, and Educational IRA’s are other ways to achieve tax deferred growth. A new Roth IRA will give you tax free growth!

Your Retirement Plan : Take time to review your 401 (k), IRA, SEP, TSA or other plan and check on its performance this past year. With stock market fluctuations, your funds may not have performed as you expected. Do you need to change some of your investments or alter the balance in your portfolio? Perhaps it is time to take a more aggressive approach with your retirement plan if you are still young or to reduce your risk exposure if you are getting ready to retire. You should review the monthly amount you are contributing to ensure that your are taking full advantage of any company matching program and contributing the maximum amount allowed by law that you can afford. It is also a good time to ask yourself "Am I setting aside enough money in the right investments to reach my goal?"

Another retirement issue you want to consider if you did not in 1998, is the conversion of IRA’s and IRA Rollovers to Roth IRA’s. This remains an option after 1998 and the tax liability can still be spread over numerous years by simply converting a portion of your IRA each year, not the entire amount.

Review Your Withholding: The ideal situation is to not owe or get an income tax refund. If you have too much tax withheld each month from your paycheck, you are, in effect, giving Uncle Sam an interest-free loan and sacrificing potential returns that you could be earning from the money that’s withheld. If you are not withholding enough, you can end up owing a lot of money at the end of the year and having to pay a penalty as well. Projecting ahead to determine approximately how much tax you will owe next year will allow you to adjust your withholding accordingly.

Budgeting: Tax preparation shows you how much money you made and how you spent it. You can track how much you spent on mortgage interest, taxes and more. If you take the time to assess other regular expenses not required to complete a tax form, you can assemble a pretty complete picture of where your money is going. Then you can ask yourself if your current spending practices work. If not, it is a good time to set more realistic goals for the new year.

Debt: Finally, you can use the season of tax preparation to review your debt. Naturally, there is good debt and bad debt. For example, a home mortgage payment, in a sense, is an investment in your future and the interest is tax deductible. On the other hand, credit card debt is only costing you money and does nothing to reduce your taxes. This is a good time to develop a strategy for consolidating, reducing interest expenses on and/or paying off bad debt.

With some time, effort and perhaps some assistance, tax season can be instructive and advantageous to you.

Please send questions or comments to dcoffin46333@wradvisors.com.