INVESTMENTS AND TAX DEFERRALS

Winter, 2009

There are many ways to defer income taxes on investments.  With the exception of bank savings accounts, certificate of deposits, and money market accounts, etc. which have no potential for gains but only generate interest income which are taxed at ordinary tax rates, most investments have potential for gains which are not taxed until sold and usually at favorable tax rates.  Investments, if held more than a year when sold, will get a very favorable tax rate of no more than 15% unless depreciation is involved.

Interest on bonds are taxed at ordinary tax rates unless they are municipal bonds in which interest is federally tax exempt and possibly state tax exempt.  However, gains on disposition of all bonds are subject to capital gains tax whether exempt or not.  The fact that tax isn’t paid until the bonds are sold is a form of tax deferral. Dividends on qualified stocks are now taxed at a maximum of 15%.  Again, any gains you have in stocks, the tax is not paid until they are sold, tax deferral.

But what about tax deferral on all the income generated by an investment?  Here are some methods of which the taxpayer can take advantage.

• Roth IRA’s are not only tax deferred but also tax exempt.  If your earned income is $5,000 or more ($6,000 if 50 years old or older), a contribution of $5,000 ($6,000 if 50 years old or older) may be made and no tax is ever paid.  There are income limitations, so not everyone qualifies and there are restrictions on distributions.
• Traditional IRA’s, are tax deferred and in some cases, contributions are tax deductible.  Those not qualifying for Roth IRA’s can still make a tradition IRA contribution as long as there is sufficient earned income. Everyone with earned income should be investing in one of these IRA’s.
• 401(k) is another deferral investment tool.  Any employee who’s company provides a 401(k) should participate because it not only defers tax on contributions to the plan, it also defers the tax on earnings in the plan.  Plus, many employers offer a matching program by which a certain percentage of employee contributions are matched by employer contributions into the 401(k).
• Annuities are tax deferred.  Investments in annuities also are unlimited, so in theory all investment income could be deferred.
• Coverdell Education Savings Accounts formally known as Education IRA’s, defer income on earnings and if used to educate your children is also tax free. Contributions up to $2,000 per year per child can be made but income limitations apply.
• Section 529 Plans are also tax deferred and, if used for education, are also tax free.  These plans are state sponsored and allow a tax deduction on the states tax returns for contributions made with limitations.  There is no income limitation for contribution.
• Qualified Retirement Plans not only provide tax deferral but also provide tax deductions.  If you own a business, there are many types of plans to choose from.
• Life Insurance that offers cash or account values can also provide tax deferrals.  These deferrals could be used to fund education or even retirement and if handled properly can be tax free.

As you can see, there are many ways to defer and/or even avoid income tax.  Give us a call and let us help you to determine what works best for you.