Taxes are Finally Done and Some Thoughts on What to Do Next
Well, I waited till the last minute to finish our taxes (thanks for the two extra days). Actually, I started the work in February, shortly after all the forms were in, but suspended it when I noticed that we had to send back a big check. I never rush when I need to pay money back. Since then I have made two payments through EFTPS so I don’t have to make all the payment at once.
I didn’t resume our tax filing process until yesterday and it took me almost the whole day to get it done. At the end, we owed about $6,000 in both federal and state taxes (. There are several factors contributed to our tax bills though we didn’t claim any dependent on our W-4s:
- We didn’t max out our 401(k) contributions: We were allowed to put $30,000 in our 401(k) accounts in 2006, however, our contributions only totaled at $23,730. That’s $6,270 short!
- We didn’t put money in child care account: The maximum pre-tax dollars we can set aside for child care is $5,000, but we didn’t put any because we didn’t send our baby to daycare.
- We pocketed more than $10,000 in interests, dividends, and capital gains from investments in our taxable accounts.
- We exceeded the income limit to make Roth IRA contributions, thus, have to withdraw almost all the $8,000 we made in 2006 and pay penalties.
Finally, our mortgage interests didn’t help too much in lowering our tax bills as the mortgage isn’t big. We paid a little more than $6,000 in interests in 2006.
Immediately after I wrote the checks, I logged on to my Fidelity 401(k) account and increased the deduction to 20%. This will guarantee that I contribute to the limit this year ($15,500 for 2007). Later on I may have to adjust the percentage so I don’t put too much in the account. My wife also made similar adjustment to her deduction. In addition, starting this year we contribute to the child care account, so this will help to lower our taxable income as well.
As for the incomes generated from our investments, I have a mixed feeling about them. On one hand, I love the idea of letting our money work for us without lifting a finger, but on the other, having to give a big chunk of the profit doesn’t make us happier. One way to deal with this situation is to reduce investments that pay lots of capital gains without scarifying the overall performance. I have already sold CSVFX, which alone distributed nearly $1,000 in capital gain last year. The next to target is CGMFX which has a turnover ratio of 300% in 2006.
For the excess contributions in our Roth IRA accounts, I have three options:
- Pay the 6% penalty on the excess contributions year after year until I correct it;
- Withdraw the money right away;
- Open a non-deductible traditional IRA account and move the money into that account (account recharacterizes).
I intend to go with the last approach with a traditional IRA account, but the process will take sometime to complete.
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