Just when you may have thought that federal tax policy was set -- that January's "fiscal cliff" deal meant you could go about your financial life with multiyear certainty -- Washington is again talking of comprehensive tax reform.
The smart money is still betting against personal income-tax reform. The more Congress talks about it, the more those constituencies will pony up political contributions, but it's not clear whether anyone except politicians will benefit.
Taxpayers, meanwhile, have to plan their finances so they are protected under the new rules and under a radically reformed system, in the unlikely case one emerges.
Here are some ways to make the most of the income-tax system, now and later:
Max out your tax breaks. In general, a tax deduction is worth more now than later. That is especially true if tax rates get lowered in the future, even if your specific deduction is preserved. Direct as much of your money toward those items -- health savings account contributions, retirement-plan savings, charitable donations, energy-efficient appliances -- that will get you the break. Note that if you earn more than $250,000 ($300,000 for joint filers), your deductions will be limited, so learn how they work beforehand.
Keep your retirement savings tax-diversified. Even if you have a tax-deferred 401(k) account, put money into a Roth Individual Retirement Account if you qualify. (You have to make less than $112,000 as a single filer and under $178,000 as a couple filing jointly to contribute to a Roth.) If you make too much, you can still pay into a traditional but nondeductible IRA and then transfer the money to a Roth later. That will give you some flexibility to manage your tax hit when you get to the withdrawal stage of retirement.
- Make a multi-year charitable donation. If you normally give a set amount of money, consider doubling or tripling it this year and putting it into a donor-advised charitable fund. That will give you the donation this year but allow you to dole out the money over a few years. You can set up such a fund through one of the major investment companies like Fidelity Investments, Charles Schwab Corp, T. Rowe Price Group Inc or Vanguard. (Most community foundations - nonprofits designed to steer charitable contributions to local organizations - also will set up personal charitable funds.)
Be careful about your investments. Several categories of investments have long benefited from special tax breaks. That includes municipal bonds, which pay interest not subject to federal taxes, life insurance policies and annuities that allow tax deferral until the money in them is used, and good old-fashioned stocks and other securities that are subject to preferential tax treatment on their gains. Also be more judicious about buying annuities, permanent life insurance policies and other insurance products that charge high fees and might not be good investments without their tax benefits. That tax deferral could disappear or become worthless (if rates fall), so if you are using insurance as an investment, make sure it performs well and has low fees.
You can stick with muni bonds for now if you are in a high tax bracket and they make sense. But watch Washington carefully to make sure all the talk doesn't turn into fast tax reform action. If it does, be prepared to switch out of munis and other tax-protected investments and into other taxable choices.