Taking Care of Year-End Business

Dec. 14, 2011— -- intro:As the end of the year approaches, there are some steps investors may want to take to keep Uncle Sam from taking too much of their hard-earned money, and to maximize their investment returns. Before you sing "Auld Lang Syne," consider these moves:

quicklist:title: Paying into your retirement plans. text:Contributions to 401(k) plans and IRA accounts are tax-deferred, meaning that you aren't taxed on this money until you withdraw it —preferably when you're retired and in a lower tax bracket. So contributing to these plans is an excellent way to get tax deductions while saving for retirement. Although you have until April 15 to make these contributions for the 2011 tax year, it's important to think about them now as part of your tax-planning strategy.

One advantage of the retroactive deadline is that investors who find after Dec. 31 that they have the wherewithal to contribute additional amounts to their plans can do so — and those who don't have accounts can establish them to cut their 2011 taxes.

quicklist:title: Converting assets to a Roth IRA.text:This means taking money out of a tax-deferred retirement account, such as a 401(k) plan or IRA, and putting it into a Roth IRA to take advantage of this investment's potential advantages. When you do this—called a Roth IRA conversion—you must pay taxes on the money that year. The good news is that the growth of assets in a Roth IRA is tax-free--subject to rules including penalties for early withdrawal.

Roth conversions this year can be a winner for people who anticipate substantially higher taxable income — or a likelihood of higher tax rates — in future years. Also, the longer you wait to tap these accounts, the more time there is for investments in your Roth IRA to grow tax-free.

One approach would be to convert some, but not all, money from IRAs and 401(k) accounts, and then maintain an IRA/401(k) bucket and a Roth bucket. In high-earning years, you could take money out of your Roth bucket tax-free. In lower-earning years, when your tax exposure is lower, you could take money out of your IRA/401(k) bucket.

quicklist:title: Taking gains or losses on investments for the 2011 tax year.

text: Gains result in taxable income while losses result in deductions in the year that investments are sold. Professional investors commonly speak of strategic loss "harvesting" to minimize taxes. This strategy is essential to maximizing net returns. But this shouldn't become an end in itself.

Instead, decisions should be driven by the goal of enhancing your portfolio, as opposed to just lowering taxes. Just because you have a loss on a stock that can get you a deduction in 2011, this doesn't mean you should sell the stock.

The question is: Is there a stock you'd like to buy that you believe would be an equal or superior investment?

For example, let's say you own Exxon and have lost money on it in 2011. Chevron looks better to you, so you sell Exxon and buy Chevron, maintaining your exposure to the energy sector and increasing your potential for gain. But if you don't have a replacement for Exxon, perhaps you shouldn't sell it this year — especially if it has potential to rebound and you expect to have more taxable income in 2012.