Year End Tax Planning By Christina Mae Olson, CFP®
December is a good time to consider ways you can improve your financial situation. Many of those ways involve some simple and creative tax strategies.
Do you have a variety of health and other insurance benefits through your employer? December is “open enrollment” time. This is your opportunity to change insurance options and add or drop elective benefits. If you don’t make the changes now then you are stuck for another year.
Most employers offer a Section 125 Plan. The benefit to a 125 Plan is the ability to pay for many things on a tax-free basis. You divert a portion of each paycheck to a special account. You can spend this money on insurance deductibles, medical, dental, vision, prescription costs and a huge variety of over the counter medical items. If you are a parent you can also pay for child care this way. If you are in the 31.5% tax bracket (federal income over $31,850 taxed at 25%, Wisconsin taxed at 6.5%) then this is a full 31.5% discount! You have to calculate carefully how much you think you will spend each year. If you divert $500 into your 125 plan and only use $400 then the remaining $100 vanishes at the end of the year. On the other hand – if you elect to defer $500 – you can spend this all in January – even if you have not accumulated the full amount yet. If you quit your job you will not have to pay that money back.
Some employers are offering higher deductible health insurance as an option. You should really consider this. The $100 deductible health insurance plan will soon be extinct – it is very, VERY expensive for companies to offer this to their employees. Do you use your health insurance very much? Statistics show that a mere 10% of employees at public and private companies are responsible for 85% of the health insurance usage. The numbers are worse in government – 6% of government workers account for 95% of health plan spending. Most employees do not use their health plan during the year.
Employers offering a higher deductible health option usually pair this with what’s called an HSA (Health Savings Account). They deposit $1000 (equivalent of your new deductible) or more into a tax-free account on your behalf. You can use this for your deducible or for all the same liberal list of things just like with your Section 125 plan. The beauty of the HSA, unlike the 125 Plan, is that you can keep unspent money in this account. Every year, you get a new infusion of $1000+ (tax-free) from your employer. It is yours forever and you can roll it over every year, letting it grow and accumulate interest, until you need it. If you don’t use your insurance much this can grow to quite a nice sum over time. Believe it or not, HSA’s are saving both employers and employees a lot of money.
Are you retired and maybe on Medicare? You have until December 31st to make changes to your Medicare Part D (prescription drug) coverage.
There are four other MUST DO moves to take care of now. None of them are December only things but now is a good time to do them. First, fund your ROTH or Traditional IRA. Calculate the maximum amount you can tuck into your IRA and send off the money. You actually have until the day you file your 2007 taxes (well into 2008) to deposit the money. For new IRA accounts, however, you have to actually set up the account before 2007 is over.
Second, increase your 401(k), 457 or 403(b) salary deferrals at work. If you are under age 50 – you can defer up to $15,500 into your plan. If you are 50 +, the deferral limit increases to $20,500. Be sure you are contributing enough to get the full employer match on these funds, if offered!
Third, take a good hard look at the income tax withholding that is coming out of your paycheck. If you usually get a hefty income tax refund every year – then your employer is taking out too much withholding from your check. Tell personnel or HR that you want to increase your withholding exemptions. These exemptions have nothing to do with your family status. Most LGBT workers file as single tax payers. You can have as many exemptions for withholding as it takes! Each exemption is worth about $400 in tax refunds. That means if you get $2000 back each year – you can increase your withholding exemptions by 5 ($2000 ÷ $400 = 5). This will increase your paycheck by $83.33 if you get paid twice a month. An income tax refund is no way to save money. People tell me they like the refund because it is forced savings. Well, why can’t you set aside the extra $83.33 on your own? You don’t need to be lending your hard earned money to the government, interest free! It’s yours and you should get it when you earn it.
Finally, if there are children or grand children in your life – open and/or fund a Section 529 College Savings Plan for them. Wisconsin tax payers receive a nice $3000 state income tax deduction for each child! 529 Plans have a lot of flexibility and grow tax-deferred but can be used tax-free if spent on college costs later on.
Happy Holidays! I hope you’ve had a prosperous 2007 and wish an even richer year for you in 2008! Let me know if you want help with that!
Chris Olson is a Certified Financial Planner™ practitioner with a fee-only private practice. You can reach her at 608-525-9818 or CMOney@centurytel.net.