The Countdown is On for Open Enrollment & Year-End Tax Planning
It’s hard to believe we’re already in the last three months of 2016, but here we are – and with more than enough to fill our thoughts between now and December 31. With distractions like the holiday season, a less-than-normal presidential election, and looming year-end deadlines, it would be easy to overlook two important planning times in your financial life: open enrollment and year-end tax planning. We want to ensure that doesn’t happen.
This will be a two-part series. Today, we’ll tackle open enrollment and tax-planning ideas around minimizing Medicare premiums. Let’s dive into company benefits first.
While every company offers a different array of benefit options, some of the most common offerings include: FSAs, HSAs, disability insurance, group life insurance, AD&D and 401(k) plans. Here’s a high-level overview of what you should know about each:
FSA (Flexible Spending Account) vs. HSA (Health Savings Account)
Although these accounts appear to be very similar to one another, there are significant differences between the two. Both accounts allow you to set money aside to use for qualified health care expenses and provide a tax benefit to the employee/account owner. Examples of qualified health care costs include health care deductibles, copayments or coinsurance, prescription medications, and dental procedures. For a complete list of qualified medical expenses and other details for FSAs and HSAs, visit these webpages:
In contrast, here the primary differences between these two types of accounts:
- Must be enrolled in the company insurance plan to be eligible to open an account.
- The 2017 contribution limit is $2,550.
- Contributions are pre-tax and generally deducted directly from your paycheck.
- Distributions are tax-free for qualified medical expenses.
- Contribution amounts are set at open enrollment and can only be adjusted during the year if there’s a change to your employment or family status.
- FSAs are either “use it or lose it” or allow for a $500 carry-over to the next year. If you have a balance over $500 at year end or any balance at all for plans that don’t allow for the $500 carry-over, you forfeit the unused account balance.
- If you leave your job, you’ll no longer have access to your FSA account (one exception is if you’re eligible for FSA continuation through COBRA).
- Must be enrolled in a high-deductible health insurance plan (HDHP) to be eligible.
- The 2017 contribution limit is $3,400 for individuals and $6,750 for families.
- Contributions are pre-tax or tax-deductible and can either be deducted directly from your paycheck or funded with a lump-sum payment.
- Distributions and any growth within the account are tax-free for qualified medical expenses.
- You can change contribution amounts throughout the year.
- Any remaining balance within the account at year end will roll over to the next year.
- You can take your HSA account with you if you leave your job.
Lastly, you cannot participate in both plans unless you’re able to initiate a HSA plan that also allows you to open a “limited purpose” FSA. (Most “limited purpose” FSAs only cover dental and vision expenses.)
There are a few key points to understanding the benefits of company-provided disability insurance:
- Disability insurance typically covers a percentage of your income and may not cover any income from commissions or bonus payments.
- Long-term disability insurance policies usually require a 60- to 120-day waiting period before paying any benefit, while most short-term disability policies require a 7- to 30-day waiting period.
- The cost of purchasing disability insurance tends to be more expensive outside of a company or group policy.
- It is not the same as worker’s compensation insurance. Disability insurance will provide income protection if you’re unable to work for an extended period of time due to an illness or injury that occurred outside of your job (e.g., car accident, falling from a ladder at home).
- If your company pays the policy premiums, your benefit payments will be taxed as ordinary income. If you pay the policy premiums, your benefit payments won’t be taxed.
Due to the increased cost of purchasing disability insurance outside of a group plan, we usually recommend electing the highest benefit amount available through your company plan.
Group Life Insurance and AD&D
Companies may offer group life insurance coverage for their employees along with coverage options for employees’ spouses and children. You also may see a life insurance option called AD&D (Accidental Death and Dismemberment). A few things to keep in mind when reviewing these two options:
- Depending on your age and health history, group life insurance coverage may be more expensive than an individual life insurance policy.
- If you’re unable to acquire individual life insurance coverage due to a preexisting condition or poor health history, you still may be eligible for life insurance coverage through a group life insurance plan.
- AD&D premiums tend to be much less than group life insurance because they only pay out if you’re dismembered or die from an accident (i.e., not due to an illness or natural cause).
One additional note when it comes to group life and disability insurance: if your company doesn’t provide these benefits or if you’re self-employed, you may be able to attain reduced-cost coverage through a professional association group policy.
The 2016 contribution limits for company-provided 401(k) plans are $18,000 plus an additional $5,500 catch-up contribution amount if you’re age 50 or older. (The 2017 limits haven’t been released yet.) These limits only apply to your plan contributions and don’t include any company contributions or matches.
Other plan components to review each year include:
- The company match – Make sure that, at a minimum, you’re contributing enough to receive the full company contribution.
- Your investment allocation – Is your account appropriately invested for your risk tolerance or should it be more or less conservative or aggressive?
- The vesting schedule – Know when you will have full ownership of all assets in the account. You’ll always be 100% vested (i.e., have full ownership) of any contributions you make into the plan, but there might be a waiting period before you’re fully vested for the company’s contributions.
If you have any questions while reviewing your 2017 company benefit election packet, don’t hesitate to contact our advisors for a personal review of your benefit options.
Medicare Tax Planning
Now let’s turn to some year-end tax planning ideas and, more specifically, tax planning around minimizing Medicare Part B premiums if you’re age 63 or older. (I say age 63 because your Medicare premium amounts are calculated based on the income you earned two years prior.) In 2015, 5.7% of Medicare Part B recipients owed premium surcharges due to their higher levels of income. In 2016, the combined Part B and Part D surcharges range from $737 to $4,090 per person on top of the base annual premium of $1,462 per person.
Below is a breakout of the 2016 Medicare Part B cost based on 2014 income:
|2014 MAGI* Individual Tax Filer||2014 MAGI* Joint Tax Filer||Part B Annual Premium Per Person|
|$85,000 or less||$170,000 or less||$1,461.60|
|$85,001 to $107,000||$170,001 to $214,000||$2,046.00|
|$107,001 to $160,000||$214,001 to $320,000||$2,923.20|
|$160,001 to $214,000||$320,001 to $428,000||$3,800.40|
|$214,001 and above||$428,001 and above||$4,677.60|
*Modified adjusted gross income
The additional premium charges are set based on your modified adjusted gross income or, more simply stated, your AGI (the number at the bottom of the first page of your tax return) plus any tax-exempt interest. Increasing your itemized deductions won’t help reduce your MAGI for Medicare premium surcharges; however, there are a few factors that can help minimize your MAGI and possibly lower your annual Medicare premium. They include:
- Capital gain and loss planning: Monitor your capital gains and look to utilize tax-planning options, such as tax-loss harvesting, to offset capital gains each year. Including broad-based index funds in your portfolio, which tend to have lower turnover, also could reduce your annual capital gains by decreasing your exposure to passive capital gains distributions.
- Increase Roth IRA savings: Withdrawals from Roth IRA accounts are tax free and aren’t included on your tax return (as long as you’re age 59½ or older and your initial deposit was made at least five years ago). Contributing to a Roth IRA or 401(k) can minimize the amount that must be withdrawn from your Traditional IRA or 401(k) accounts at age 70½. You also may convert Traditional IRA funds to a Roth IRA, but the amount converted would be considered income on that year’s tax return.
- Charitable contributions: I know I said that increasing your itemized deductions wouldn’t help reduce your MAGI for Medicare premium purposes, but there are other ways you can switch up your charitable contributions to decrease your annual income amount if you are so inclined. The first option is to donate highly appreciated stock to charities instead of cash. You are still able to deduct the amount of stock donated and you won’t have to pay taxes on any of the growth or gain of the stock donated to charity. Another option for those who are over age 70½ is to make direct donations of IRA funds to charity. You can donate up to $100,000 a year from IRA funds and, although the donation isn’t included as an itemized deduction, funds donated to charities can satisfy your annual required minimum distribution (RMD) and not be included as taxable income, which lowers your MAGI.
- Maximize savings options through work: If you’re eligible to save in a company-sponsored retirement plan or Traditional IRA, continuing to save funds in these accounts will reduce your MAGI. If you are self-employed, you often can deduct Medicare premiums for yourself and your spouse.
If you’d like to talk through some of these tax-planning options or if you anticipate large fluctuations in your retirement income, please contact your Redwood advisor to discuss it in more detail. Also, be sure to stay tuned for part two of our year-end tax planning Ideas.
Natalie Barber, CFP®
Director of Financial Planning