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Dollars & Sense: Taxes and Investments

Imagine if your Doctor sent you to see a specialist and the specialist put you on medication but neglected to inform your primary physician? Then, when you go back to your primary he doesn’t ask about the visit to the specialist and is unaware of your new medications. When one specialist doesn’t talk to another, it puts you at risk. The same is true with your investments and your taxes, lack of tax advice when it comes to your investments can be very costly to you, the taxpayer.

When you think about it, nearly everything you do with your investments impacts your taxes. Contributions to your retirement plans, 529 College Savings Plans, premiums paid for long term care insurance, management fees you may pay your financial advisor, converting traditional IRAs to ROTH IRAs, non-deductible or deductible IRA contributions, IRA transfers and withdrawals, rollovers and inherited IRAs…the list goes on and on.

These are common pitfalls when your financial advisor doesn’t communicate with your tax advisor and when your tax advisor doesn’t communicate with your financial advisor.

  1. You have been contributing to a ROTH IRA each year and haven’t ever told your tax preparer since it isn’t part of your tax return. It comes up in conversation and your tax preparer informs you that you are ineligible to make ROTH contributions because your AGI exceeds IRS limits. Outcome: Excess contributions to a traditional IRA or ROTH IRA that are not withdrawn before April 15th will incur a 10% penalty on the entire excess contribution in addition to taxes on any earnings.
  2. Your financial advisor believes you are over-weighted in tax deferral and recommends you change your 401k contributions to be 100% ROTH instead of continuing pre-tax contributions. You agree and make the change. Next year, when you get your taxes prepared, your tax advisor informs you that owe a substantial amount of money to the IRS because you never adjusted the amount being withheld for federal taxes.
  3. You have your taxes done and unexpectedly owe federal tax. Your tax preparer tells you it is because of the mutual funds you own. Your financial advisor should explain the difference in taxation between ordinary dividends and qualifying dividends, as well as taxation on capital gain distributions and realized capital gains. Your investments could be adjusted to be more tax efficient, but nothing will change unless your tax advisor communicates the specifics to your financial advisor.
  4. Each year for the past 5 years you have contributed $10,000 to the CHET 529 College Savings Plan for your grandchild and you are the owner of the account. Your tax advisor, knowing you do not have college age children does not ask if you have made any CHET 529 contributions. Contributions to the CT CHET 529 plan are deductible on your CT state income tax return, up to a maximum of $10,000.
  5. You inherit an IRA account and your financial advisor puts the IRA into a beneficial IRA account for you. You receive a tax document that shows the transfer and give it to your tax preparer and they ask if you took the Required Minimum Distribution (RMD). You don’t remember taking a withdrawal and you never received a 1099. Your tax preparer informs you of the steep IRS penalty you will incur for not taking out the RMD. The penalty is 50% of the amount you should have withdrawn. Note that Inherited ROTH IRAs also have IRS requirements for required withdrawals, even though they are not taxable, they are still subject to the penalty if you don’t take out your RMD.

All of these situations are less than ideal and in some form will result in money coming out of your pocket. What can you do? Insist on collaborative planning and communication between your financial professionals. See your financial advisor before your tax appointment and make sure you have the needed documents and information on any transactions you may have made that affect your income tax return. After tax season, you might want to sit down with your tax preparer and ask if they have any recommendations or changes you should consider with your investments that would benefit you on your taxes.

Roberta L. Nestor is a financial advisor practicing at 491 New Haven Avenue in Milford, CT offering retirement, long term care, investment and tax planning services. She also offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network – a member FINRA/SIPC and a Registered Investment Adviser. Fixed insurance products offered through Nestor Financial Network are separate and unrelated to Commonwealth. Commonwealth Financial Network or Nestor Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation. Roberta can be reached at Nestor Financial Network, 203-876-8066 or roberta@nestorfinancial.com.

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