Tax season is over and you’ve filed either your return or your extension. But before you put away \ those documents, take some time to look at it as a financial planning tool. There’s a wealth of information there that can be very useful to you… if only you know where to look.
Here are some of the clues you can find in your tax return and what they might reveal about your financial situation.
Your Investment Gains and Losses
Excessive investment gains and losses might be an indication that you are buying and selling stocks, ETFs and mutual funds too frequently. While there are certainly reasons to trade, for most of us, a long-term focus is the best course.
Gains and other taxable distributions can also be triggered via distributions from mutual funds and ETFs held in taxable accounts. There’s nothing inherently wrong with this, but you might want to take a look at your overall portfolio and your various accounts with an eye toward asset location (which types of investments are held in which accounts).
Funds and ETFs that consistently throw off distributions — including many fixed-income funds –might be better housed in a tax-deferred account like an IRA. Stock-based investments that generate long-term capital gains, which are taxed at lower, preferential rates, should be housed in taxable accounts.
The various forms used in compiling your return contain a lot of information.
For example, if you are self-employed as a sole proprietor and filed a Schedule C, you might look at whether forming a different type of entity for your business makes sense. Options include S-Corporations and LLCs taxed as S-Corps. These make a difference both from the standpoint of limiting your personal liability from your business activities and from a tax savings perspective.
Were you able to take a deduction for a retirement plan for your business? If not, or if the amount was minimal, look to fund a SEP IRA, a Solo 401(k), or some other type of plan. This can bump up your savings for retirement as well as letting you deduct the contributions.
Savings and Investment Accounts
Speaking of retirement plans, did you contribute to your employer’s retirement plan such as a 401(k) or a 403(b)? How much did you contribute? As an employee, these can be great retirement savings vehicles and provide a way to reduce your taxable income to boot.
Your W-2 forms will tell you how much you contributed and whether the contributions were made via a traditional pre-tax account, a Roth, or a combination of the two. If you didn’t contribute the maximum amount of $18,000 ($24,000 if 50 or over), then there is room to increase your contributions.
Schedule A, Itemized Deductions
If you deducted mortgage interest, this is a good time to review your rate and the term of the loan. Can or should you refinance? Does it make sense to go to a 15-year loan if this shortens the time left on the loan, allowing you to pay it off sooner?
If you make charitable contributions, you might consider using appreciated investments such as mutual funds, ETFs, or individual stocks. By giving appreciated investments, not only do you receive a deduction for the value of investment on the date of the gift, but you avoid paying tax on any capital gains on the investment.
If you are taking required minimum distributions (RMDs) from one or more retirement accounts and you also donate to charity, consider directing some or all of your RMD to charity. The advantage is that, while you won’t receive a charitable deduction, that portion of the RMD will not be added to your taxable income for the year. This reduces your income, saving taxes. Additionally, this may be enough to keep your income below the thresholds for higher Medicare premiums.
Other Items of Note
Filing status. Did your filing status change due to a life change like getting married, getting divorced, or the death of a spouse? If so, are your beneficiary designations on retirement accounts and insurance policies up to date? How about wills and other estate-planning documents?
Dependents. Besides claiming them as dependents, is there a need to save for college or other planning for them? If your kids are minors, have you made arrangements for a guardian to care for them in the event that you and your spouse die prematurely? Do you have adequate life insurance to provide for their financial needs?
Alimony. Did you receive alimony during the year? Alimony is taxable, but child-support payments are not. Be sure that you are having taxes properly withheld during the year or are making estimated payments as needed.
These are general observations. Of course, any financial planning decisions should be made in light of your unique situation. The items cited above are not a complete list by any means.
Your tax return is a story of your financial life. A thorough review with financial planning in mind can be beneficial to you. Many financial advisors like to review client tax returns each year, and especially at the start of a new client relationship for just that reason. Take a tip from the pros and look at yours with an eye toward what it tells you about the current state of your finances.