As a smart investor you should always consider the tax implications of any decision you make about your retirement savings. Over time, even an insignificant tax penalty can add up to a significant underperformance. Even worse, if you move assets the wrong way or at the wrong time, you could cause tax consequences that wipe out years of investment gains.
However, because your finances are all interconnected, how you handle your tax filing can affect how much you can afford to put away each year. That extra money you’re paying to Uncle Sam could have gone into your retirement account.
One of the clearest indicators you might have been able to save more for retirement during the previous tax year is…
if you receive a tax refund. Getting a chunk of money back from the IRS may feel good in the short run. But consider that getting money back from the IRS after you file your taxes is merely the return of the capital you loaned to the IRS over the last year or so at zero interest. Perhaps that money could have been put to use to enhance your own financial goals along the way.
The Difference Between “Above The Line” and “Below The Line”
You might have heard your CPA or other tax professional talk about “above the line” versus “below the line” deductions. They are both legitimate ways to lower your tax liability and simply refer to deductions you can take before or after calculating your Adjusted Gross Income (AGI).
The “line” in question is at the bottom of the first page of the federal form 1040 (line 37 for 2017).
You only take below-the-line deductions if you they total more than the standard deduction and you can itemize. These are things like mortgage interest and charitable deductions.
But you can take above-the-line deductions even if you don’t itemize, just as long as you meet their qualifications.
Above-the-line deductions include things like:
- Deposits into a qualifying Health Savings Account (HSA)
- Moving expenses
- Contributions to traditional IRAs and qualified plans such as a 401(k) or 403(b)
- Health insurance premiums, if you’re self employed
- Tuition and fees for school
- Student loan interest
Of course, the items above are not the entire list and there are rules governing each kind of deduction. Your CPA or tax professional will be able to identify all the above-the-line deductions you can legally take, but he or she won’t know unless you tell them about your spending in those areas. So be sure to let them know.
Also, if you’re self-employed, your tax advisor can help you determine if any of these would be better taken (if possible) as business deductions.
Taxes And Investing
It’s always smart to make the most of your deductible retirement contributions and then protect your gains from unnecessary taxation. Your trusted advisor can help you determine your best course of action for things like choosing between a Roth or traditional IRA, and help you design and maintain a long-term plan that addresses the potential for getting sidetracked or delayed by tax consequences.