Cut Taxes, Improve Planning and Your Portfolio

Anna K. Pfaehler, CFP

What you can still do by the end of 2012 to lower taxes and improve your planning and portfolio. Your financial institution won't always remind you, so it's good to keep these things on your mind.

Now’s the time to make year-end moves that can cut your taxes and help improve your planning and portfolio. Acting is especially important this year because tax rates will climb in January unless a deal is made. However with three weeks until the end of the year, Congress and the president remain deadlocked over a fiscal cliff deal.

There are still a couple of things to do before the year ends that can lower your taxes.

Sell mutual funds

Suppose you own ABC Fund, which has announced a large year-end distribution. By selling the fund before that, you’ll avoid the distribution and save on 2012 taxes. But first, find out your basis in the fund to make sure that selling wouldn’t trigger a gain bigger than the one you’re avoiding.

If you still like the fund, use the proceeds to buy it in one of your retirement accounts if you haven’t reached your 2012 contribution limit. You’ll avoid the tax hit while maintaining your portfolio’s investment profile.

Another possibility: use the proceeds to buy a similar fund in your taxable account that isn’t paying a big distribution.

Do year-end retirement-plan housekeeping

Roll over any retirement assets left at former employers to an IRA or an account at your new employer. Check that you have named beneficiaries and update them if necessary.

Consider increasing your contribution rate for your 401(k). If you’re not taking full advantage of your employer’s matching contribution, boost it to at least that level.

Make your Roth IRA conversion now

The amount you convert from a traditional IRA to a Roth counts as taxable income. With tax rates scheduled to jump in the new year, converting in 2012 can provide significant savings compared to waiting a few months.

But first you need to determine if converting the funds to a tax-free Roth is worth the extra tax you must pay by next April 15. If the answer is yes, then you need to decide on the amount.

Some people should not convert their entire IRA at once because that can bump them into a higher tax bracket. Instead, convert the portion you can without sparking a higher rate — assuming you have the money to pay the tax on it.

It’s different for those in the top tax bracket. If you are in the highest bracket already, converting now will not cause you to have a higher tax rate. But the top rate may be higher in 2013.

Take the required minimum distributions (RMDs)

If you’re over the age of 70-and-a-half years old, then you should take RMDs from IRAs and other retirement plans. The penalty for failing to take a RMD is one of the IRS’s steepest: 50% on the amount not withdrawn.

You can’t always count on your financial institution to remind you, and even if they do, the notice may not stand out. It’s best to put it on your calendar.

The year you turn 70-and-a-half, you have until April 1 of the following year to take the RMD. After that, the deadline is December 31.

The RMD is based on the value of your account at the end of the previous year and your age. If you haven’t gotten a letter from the financial institution giving you the figure, contact it.

Tip: You don’t have to take the RMD in cash. Instead, you can tell your IRA custodian to distribute securities in your plan to you.

Consider moving to a more conservative portfolio

If you’re retired or soon will be, then we typically recommend keeping assets you intend to spend in the next five years in conservative, less volatile fixed-income securities. As you move toward retirement, you should aim to reduce risk in your portfolio. December is a good time to take a fresh look at your portfolio.

Anna K. Pfaehler, CFP®, is a financial planner and portfolio manager with Palisades Hudson Financial Group, in Scarsdale, N.Y. Palisades Hudson is a fee-only financial planning firm and investment advisor with $1 billion under management. Branch offices are in Atlanta, Ga., Portland, Ore., and Fort Lauderdale, Fla. She can be reached at anna@palisadeshudson.com.