Morgan Stanley
  • Wealth Management
  • Mar 11, 2016

Don’t Miss These 2016 Tax Strategies

Looking to lower your tax burden? As April 18th approaches, here are 10 strategies you may want to consider this year.

The good news for tax filers this year is that no major tax laws took place last year. The estate tax will stay at a maximum of 40% and has an exemption of $5.43 million in 2015 and $5.45 million in 2016. In addition, the annual exclusion from gift taxes remains at $14,000 per donee for 2015.

That said, the IRS did adjust federal income tax brackets and increased some tax exemptions, deductions and credits, so consult with your Financial Advisor and tax professional for possible tax savings strategies. With that in mind, here are 10 more tax strategies to consider this year:

1. Max out retirement plans.

The primary advantage of participating in a Traditional IRA is that the contribution may be tax deductible; similarly, a contribution to a 401(k) plan may be made on a pretax basis. If your taxable income is lower, the amount of income tax you owe for that year might also be reduced. And because these are tax-deferred accounts, you generally do not pay income taxes on any earnings on your investments until you withdraw funds.

2. Consider a Roth IRA conversion.

While income limits may preclude some investors from contributing to a Roth IRA, anyone can do a Roth Conversion by converting eligible funds from a Traditional IRA or employer-sponsored retirement plan to a Roth IRA. Roth IRA contributions are made with after-tax dollars, and qualified distributions are federal income tax free.1 When you convert, you must pay taxes on the amount converted as ordinary income for the year of conversion distribution (or deemed distribution), except to the extent the amount converted is treated as a return of your after-tax contributions, if any.

Subject to certain requirements, after-tax money in an employer-sponsored qualified retirement plan (e.g., 401(k)) may be directly converted to a Roth IRA tax-free. Taxpayers who have potentially taxable estates should consider the Roth IRA conversion option, as it could make a potentially significant future wealth transfer more tax efficient. Consult with your tax and/or legal advisor regarding your individual situation as a Roth IRA conversion may not be for everyone. A number of factors should be considered before converting, including (but not limited to) whether the cost of paying taxes today outweighs the benefit of income tax-free qualified distributions in the future.

3. Review highly appreciated assets.

The capital gains rates for most taxpayers are still significantly less than ordinary income tax rates. Consult your tax advisor about whether shifting to investments that generate capital gains instead of ordinary income would be a good strategy. Be sure to weigh the risks of having a large concentrated stock position or highly appreciated position. If gradual diversification is needed, trim before year-end to spread the capital gains impact over multiple years.

4. Give increased attention to buy-and-hold strategies.

With increased capital gains tax rates, buy-and-hold strategies may be attractive; the higher the tax rate, the more valuable the strategy. Similarly, it becomes more important to harvest tax losses to shelter gains that otherwise would be taxed at the higher rate.

5. Augment your tax-advantaged investments with municipal bonds.

Municipal bonds, the interest on which is typically free from federal, state and local taxes, are one of the most efficient investments available for defending against current and potentially higher tax rates. Even though income tax rates rose for high-income taxpayers, interest income earned on municipal bonds remains largely unaffected. (Capital gains from the sale or exchange of municipal bonds typically is not tax free.)

6. Consider redeploying assets to a variable annuity.

In a rising tax environment, the tax-deferral feature of annuities becomes increasingly attractive. Diversifying your retirement portfolio with a variable annuity may provide tax-deferred growth potential, guaranteed lifetime income, increased retirement savings, equity upside potential and a death benefit for named beneficiaries. Remember, though: withdrawals from variable annuities will be taxed as ordinary income and, if made before age 59½, may be subject to a 10% early distribution penalty tax. Please consult your tax advisor about whether variable annuities are appropriate for you.

7. Consider professionally managed and tax-advantaged investment strategies.

Now is a good time to evaluate the overall tax efficiency of your investments. Beyond municipal bonds, consider tax-efficient mutual funds or separately managed accounts that aim to limit the number of taxable events within your portfolio.

8. Review dividend distributions of your current portfolio.

Qualified dividend tax rates are still lower than ordinary income tax rates for most taxpayers, so consult with your financial and tax advisors about whether you should adjust your investment holdings to achieve greater income tax efficiency.

9. Engage in legacy planning and gifting.

All investors should have an estate plan that reflects their wealth-transfer goals and objectives. Taxpayers with taxable or potentially taxable estates who are in an economic position to do so and would like to benefit their heirs should consider making lifetime gifts to those heirs now, which may be a potentially more tax-efficient wealth-transfer strategy. Also, consider making gifts under the annual gift tax exclusion and charitable gifts before year-end. Please consult your tax and legal advisors to review your current estate plan and insure it reflects your goals and objectives.

10. Consider a securities-based loan or line of credit for tax obligations.

Using cash or liquidating assets could disrupt your investment strategy and trigger capital gains taxes or transaction fees. A securities-based loan or line of credit can be fast, easy to set up and may offer competitive rates with typically no fees while keeping your investment portfolio intact.2

These strategies might help minimize the impact of current tax laws on your portfolio. Contact a Financial Advisor or Private Wealth Advisor to determine which strategies might be appropriate for you.

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