Post Tax Season Planning Using Prior Year’s Return
You may not
realize it, but you already have the snapshot in hand. The snapshot is the tax return you just
filed for last year. With a little
analysis of last year’s tax return and some comparison to prior year’s tax
returns, you can learn some important lessons about your financial well-being.
Look at the picture
Review your tax
return like you would reconcile your checkbook. Except, instead of balancing your monthly budget in your check
register, balance your annual budget in your life’s registry. You may already use your checkbook to
extrapolate one, three or five months into the future to ensure that your
income will cover the bills. Why not
use your tax return to extrapolate one, three or five years into the future to
develop a plan that will cover your life?
Investments
At some point in
your efforts over the years to accumulate a savings nest egg, you will need to
consider diversification, the process of putting your money in the right kind
of investment vehicles to satisfy your personal risk strategy and achieve your
goals. Looking at your tax return will
help you decide whether the investments you now have are the right ones for
you. If you are in a high tax bracket
and need to diversify away from common stocks, for example, looking into
tax-exempt bonds might help, especially if you have state income taxes to worry
about, too.
Reviewing the
Schedule D covering Capital Gains and Losses from last year’s return and from
the past three or four years can be an eye-opener for many people. Did you hold stocks long enough to be
entitled to the long-term capital gains rate?
Did you try to balance short-term gains with short-term losses? Are you bouncing from one investment trend
to another without a long-term investment plan that achieves long-term
needs? Are your mutual funds “tax
smart”? Become familiar with different
types of banking institutions and their products. Find out about CDs, money-market funds,
government securities, mutual funds, index funds, and sector funds and how they
interrelate with the determination of your tax liability each year. You may want to put that knowledge to work
in your investment strategy.
Trying to
implement this type of a five-year plan may seem difficult at first. However, just by looking at your tax return
you can start the critical planning that can lead you to financial independence
and a comfortable retirement.
Borrowing patterns
A look at your
interest deductions can also pinpoint ways for you to let Uncle Sam in effect
pay off some of your loans with tax deductions. Should you have more home-equity interest rather than credit card
debt? Are you maximizing or overusing the
advantages of borrowing on margin?
Consumer debt is a necessary way of life these days for many taxpayers,
but smart borrowing on an after-tax basis can help “tame that tiger”.
Medical Costs
Should you be
taking advantage of the medical expense deduction? Many people assume that with the 7.5 percent adjusted gross
income floor on medical expenses that it doesn’t pay for them to keep track of
expenses to test whether they are entitled to itemize. But with the premiums for long-term care
insurance now counted as a medical expense, some individuals are discovering
that along with other health insurance premiums, deductibles and timing of
elective treatments, the medical tax deduction is theirs for the taking.
Retirement planning
Don’t forget to
protect for eventualities. Are you
maximizing the amount that Uncle Sam allows you to save tax-free for
retirement? A look at your W-2 for the
year, and at the retirement contribution deductions allowed in determining
adjusted gross income should tell you a lot.
Should your spouse set up his or her own retirement fund, too? Are you over-invested in tax-deferred
retirement plans and therefore facing a large amount of tax each year after you
retire?
Remember, too,
that a defined amount of retirement income will only be available for a
definite amount of time after you retire.
If you are spending down your retirement savings at a rate of ten
percent per year, and they are only making a five percent return, those savings
will be exhausted in a finite number of years.
Do the analysis and try to save enough so that, between Social Security
and your savings, you can keep your annual withdrawals to under five percent
per year and still meet living expenses.
The Big Picture
Clients often
ask their accountants, “How long should I keep my tax returns?” It depends on how much of your own financial
history you want to see documented. The
tax code requires retention of tax returns for a minimum of three years but the
more history you have of your financial progress – or regress over the years,
the more information you will have for your analysis for the future.
When you are
reviewing last year’s tax return and learning how you have spent your money
during the last year, it may help to review some of what you’ve learned with
the accountant that prepared the return.
In fact, taking this step is very important to enable you and your
accountant to better plan your financial future. When you are reviewing your tax return, determine whether your
accountant just filled in your 1040 or whether he helped you make some progress
with a solid financial plan. It is
important to find an accountant or other tax professional who will help you see
the big picture.
If you would
like to review last year’s completed tax return with future planning in mind,
please feel free to give us a call and set up a time when we can meet and
discuss this matter.
