31 October 2008
Over the last couple week’s people across America have been opening account statements that, at best, would make a grown man cry. I think this market drop has been harder than past ones because it hit closer to home – from the homes we live in to the credit we need for a new car. And it is hard on us because we are in a country that likes the take-charge attitude. Sitting around and waiting for the market is tough on us. But there are things that we can all proactively do to better our situation.
First, if gifting to charity is still in the cards before year-end, whenever possible, gift appreciated assets instead of cash (many still have appreciated assets). Gifting a stock/mutual fund that has done well over the past couple years allows you to give away the appreciation without paying taxes. If you still like the investment, buy it back with cash and increase your cost basis.
Second, if you are 70 ½ or will turn 70 ½ before year-end, consider making charitable gifts out of your IRA. In the Emergency Economic Stabilization Act of 2008, congress extended this popular law through 2009. Instead of taking required minimum distributions (RMDs) as taxable income, you can send those RMDs to your favorite charity (public charities only; no charitable gift funds or private foundations). You must do this only after turning 70 ½, the custodian of your IRA must send the check directly to the charity, and you still must get a receipt from the charity to show the gift was made. When done correctly, the part of your RMD given to charity is not taxable but it counts towards your RMD for 2008 and thus, will reduce your taxable income. Note that you do not get to take a charitable deduction since you never were taxed on the income to begin with. Also, since this law was passed so late in the year, if you have already taken your RMDs for 2008, you cannot unwind them and do this instead. Keep this in mind, however, for 2009.
Third, review your portfolio for any losses that you can use to offset gains. Within that, look at mutual fund distributions that are typically made in November/December and understand if they will be considered short-term (taxed heavier) or long-term (taxed less). Also consider if it makes more sense to sell the mutual fund and pay taxes on your gains versus paying taxes on the distributions. While reviewing mutual funds, look them up on www.morningstar.com and understand that funds with higher turnover should go in tax-deferred accounts like IRA’s since higher turnover funds tend to make more taxable distributions each year. And if you are investing in fixed income (bonds, CDs), look at whether it makes more sense to use municipal bonds to get more tax-free income (be careful of this if you pay the alternative minimum tax – AMT).
Fourth, if you are over 59 ½ and retired, but not taking money out of IRAs/401(k)s yet, now is the time to consider this. A tax projection by your accountant can help you understand what tax bracket you are in and whether it makes sense to take money out of retirement plans in your current tax bracket, without moving you into a higher bracket. Sometimes paying taxes now at a lower bracket makes more sense than waiting until 70 ½ and taking RMDs since that might push you into a higher bracket. This might work especially well this year since you would be taking money out at depressed prices and reinvesting it for future growth and thus, lowering future RMDs.
Finally, if you are so inclined, 2008 might be a good year to consider converting your normal IRAs to Roth IRAs while the stock market is down. In the long run this could help re-configure your assets so that more are in a non-taxable bucket and again, away from forced RMDs.
I recommend you have your accountant review these moves before you do anything on your own since there are a lot of pitfalls that can hurt you even more than the market already has. But doing it now will also give you some control back in your life.