Ah, mid-February- that time of year when my postman provides a daily barrage of tax documents, and scolds me for not retrieving them quickly enough. When it finally becomes apparent that he can no longer jam another rumpled envelope into my overflowing mail slot I know it’s time to file my taxes. While this annual ritual often yields a financial reward in the form of a tax refund, there is clearly a higher purpose for the enormous pile of paper. Note to self: my inner guilt will be quelled; this year I will make better use of tax time, and so can you.
Acknowledgement is the first step in my recovery: tax documents contain a lot of really useful information. Take an inventory of what you have and develop a game plan. A good place to begin is your W2 or 1099. These forms detail your wages and tax withholding, Social Security and Medicare contributions (aka taxes), as well as retirement plan contributions. If your employer offers a defined contribution retirement plan and you have failed to maximize your contribution- if you receive an unusually large refund, or worse yet you owe more in taxes than expected- make amends by contacting your payroll provider to adjust your retirement plan deferrals or tax withholding.
Investment account statements also provide a wealth of information. Take this opportunity to review your investment management fees and account performance. High fees and poor long-term performance, when compared with a relevant benchmark, might suggest that it’s time to have a tête-à-tête with your investment adviser. Investors with a long time horizon and significant taxable income may consider adjusting their asset allocation in favor of fewer income-producing investments. Do you invest in municipal bonds? Now is a great time to determine just how much benefit you derive from their tax-exempt interest. And most fundamentally: do you understand your investment strategy and is it appropriate for your needs and risk tolerance?
Deductions are another planning opportunity that is ripe for review. Each year I lovingly compile a list of expenses only to be told that I am not eligible to deduct many of them. Out-of-pocket medical and dental expenses must exceed either 7.5% or 10% of your adjusted gross income, depending on your age. Charitable contributions are limited to either 30% or 50% of adjusted gross income, depending on the charity. Gambling losses (not that I have any) cannot exceed winnings, and business and entertainment expenses are reduced by 50% of their total. Thankfully I am able to deduct all of my charitable gifts, but those pesky student loan interest payments offer me no tax benefit because of income-related phase-outs. You too may discover that you are deriving less benefit from tax deductions than you thought.
Finally, tax season is a great time to evaluate your retirement savings plan. More than ensuring that you save as much as you can afford, a good savings strategy considers how you allocate funds between different pre-tax, post-tax and tax-free savings plans, and the best asset allocation for each plan. Special opportunities like the Roth IRA conversion can help you diversify between account types. I’ve converted several pre-tax IRAs over the past few years and have a nice little pot of tax-free savings to show for my efforts. For retirees, tax season affords you the opportunity to confirm how Social Security and other incomes sources were taxed, and determine how best to structure withdrawals from your accounts to reduce the impact of income taxes.
As Lao Tzu said, “Do the difficult things while they are easy and do the great things while they are small. A journey of a thousand miles must begin with a single step.” Mine involves locating the key to my mail slot.