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Expert retirement advice ... in plain English.

Controlling Your Taxes While Working

April 15th is usually the last day to pay federal and state income taxes. Wouldn’t it be great if you could control how much that is going forward? Well, you can, to a certain extent, regardless of whether you are a highly compensated executive or a business owner. The higher your earned income, the more control you could have, even after the recent loss and reduction of some personal tax deductions.

Realize that you can only use pre-tax or after-tax dollars to save and spend money, but there are three ways your money can come out: either by paying taxes now, later or never. Managing each of these properly is where income tax control comes into play. I’m going to focus on taxes now for today.

There are some forms of compensation over which corporate executives have no control, such as restricted stock and stock appreciation rights. The dying breed of stock and tradable options at least afford the award recipient some flexibility in when they pull the trigger, but it is usually during a high income year. You may have some flexibility if you retire at the end of the year and have any remaining stock awards become taxable the following year when your income may be lower.

If you are saving after-tax dollars in cash, stocks, bonds, mutual funds, exchange traded funds, and other investments, you pay taxes on the interest and gains you earn each year. Of course, you can defer the gain on the growth of stocks and bonds that you don’t sell. It doesn’t matter if you spend what you earn or not. The taxes are still due based on the 1099s you receive. What fun!

If you have a lot of dividends, interest and capital gains reported on the front page of your tax return and you’re not spending that money, then you’re paying unnecessary taxes and could be missing out on ways to keep these off of your tax return.

First, you could do some tax optimizing by matching taxable gains with the losers that have gone down in value by the same amount. Note that you have to match long-term gains with long-term losses, and short-term gains with short term losses. Prudent planning can help you to control this part of your taxes.

Some people purchase annuities to defer the growth on their earnings until some point in retirement, instead of incurring taxable interest, dividends and capital gains along the way. Annuities are not the evil asset some pundits would have you believe, but there are some things that are important to know.

ANNUITY CAVEATS: They are taxed on the earnings first when you take money out of them, most variable annuities have very high fees, there is a penalty if you take the money out before age 59½ (as with any retirement account), they typically have surrender charges if you take out too much of your money too soon, there are some costly riders to avoid, and some annuity providers may require you to start taking money out at some point (in your 80’s).

There’s one more strategy where you pay the taxes now, but I’ll cover that in the last of this three part series.