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Investing Specialists

2016 Taxes: What's on Deck for Your Investments

Higher HSA contribution limits, myRA introduction are among bigger tax changes this year.

Note: This article is part of Morningstar's February 2016 Tax Relief Week special report. An earlier version of this article appeared Jan. 7, 2016.

Compared with the "fiscal cliff" and other year-end escapades, the tax-related drama in Washington has been pretty subdued in recent years. Dividend and capital gains tax rates have stayed the same, and the federal estate tax will still only affect the uber-rich. (State estate taxes may kick in at much lower levels, however.) But that's not to suggest that investors can safely tune out tax considerations. The market's strong performance since 2009, combined with another nasty season for mutual fund capital gains distributions in 2015, accentuates the value of taking maximum advantage of tax-sheltered wrappers like 401(k)s and IRAs. It also highlights the virtues of carefully monitoring your taxable positions to help ensure that you're not paying more in dividend and capital gains taxes than you need to. 

Here's an overview of what has changed, tax-wise, in 2016, as well as what's staying the same. I've emphasized those tax items that have at least some connection to investments. 

Dividend and Capital Gains Taxes
Not too much to report here. Dividend and capital gains rates are the same for 2016 as they were last year, though the income tax brackets used to determine those rates have been adjusted for inflation. Investors who are in the 39.6% income tax bracket will pay a 20% tax rate on qualified dividends and long-term capital gains; investors in the 25% to 35% brackets will pay a 15% tax rate on qualified dividends and long-term gains; and investors in the 10% and 15% tax brackets for income tax will owe 0% tax on dividends and long-term capital gains. Nonqualified dividends, such as from REITs, and ordinary income from taxable bonds will be taxed at investors' ordinary income tax rates. 

For investors who are near the 15% tax bracket, the ability to avoid taxes on dividends and long-term capital gains provides a strong incentive to stay under that threshold. Taxpayers who are teetering on the edge of the 15% income tax bracket and who have at least some latitude to control their taxable income may want to take a few steps to land inside of it. For example, retired investors may take a greater percentage of their withdrawals from Roth accounts, as qualified Roth distributions don't count as taxable income. (Doing so, however, will reduce the long-term tax benefits of the Roth account; Roth assets are often considered the best "save for later" accounts because they can be the most valuable for your heirs to inherit.) Investors hovering around the 15% tax bracket might also "bunch" deductions together in years in which they plan to itemize, thereby receiving the biggest possible bang from those deductions. 

To help take maximum advantage of 0% capital gains rates, investors who are in the 15% tax bracket or below may also benefit from resetting their cost basis in appreciated securities they've held within their taxable accounts for at least one year. (If they've owned the securities for less than a year, they'd be on the hook for short-term capital gains, taxed at their ordinary income tax rates.) To do so, they would simply sell the security in question and rebuy it immediately thereafter, thereby resetting the cost basis to the new, higher level. That way, if they ever do owe long-term capital gains taxes, they'll owe them on a smaller amount than if they hadn't reset their cost basis.

IRA Contribution and Income Limits
IRA contribution limits are the same for 2016 as they were in 2015: $5,500 for investors under age 50 and $6,500 for those 50 or older. That limit is the same for both traditional and Roth IRA contributions. You have until April 18, 2016, to make an IRA contribution and have it count for the 2015 tax year.

The income limits to be able to deduct a traditional IRA contribution are also remaining the same for 2016. Individual filers who can make a retirement-plan contribution at work can make a fully deductible IRA contribution if their 2016 income is under $61,000; they cannot deduct their IRA contribution if their income is more than $71,000. (The amount of the contribution that is deductible is reduced--or phased out--for single taxpayers whose income lands between $61,000 and $71,000.) For married couples filing jointly in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, traditional IRA contributions are fully deductible if their income falls below $98,000; contributions aren't deductible if their income exceeds $118,000. (Contributions are partially deductible if income falls between those two thresholds.) 

Roth contributions aren't deductible, but income limits are increasing. Singles earnings less than $117,000 can make a full Roth contribution, but Roth IRA contributions are out of reach for single filers who earn more than $132,000. (Contributions are reduced if the single taxpayer's income falls between these two bands.) Married couples filing jointly can make a full Roth IRA contribution if their income is less than $184,000; they are ineligible to make a Roth contribution if their income exceeds $194,000. (Contributions are reduced for married couples filing jointly who earn between $184,000 and $194,000.) 

Investors at any income level can contribute to a traditional IRA, though they cannot deduct their contribution on their tax return if their income exceeds the deductible amounts outlined above. Instead, higher-income investors can take advantage of what's called a backdoor Roth IRA, converting their traditional IRA to Roth shortly after funding it. Note that this strategy won't generally make sense for investors with large traditional IRA balances, for reasons outlined here

401(k) Contribution and Income Limits
Contribution limits for 401(k), 403(b), and 457 plans are staying the same for 2016:  $18,000 for those under age 50 and $24,000 for those 50 and above. The contribution limit is the same for both traditional and Roth 401(k) contributions. No income limits apply. If you're maxing out and would like to space your contributions throughout the year, bump up your contribution rate as soon as possible. 

MyRA
MyRA is a relatively new retirement-savings plan conceived as a Roth IRA with training wheels. Aftertax monies go into the account, the money accumulates on a tax-free basis, and qualified distributions are tax-free. (As with any Roth account, investors can withdraw their contributions from myRA at any time and for any reason.) Designed for workers who do not have access to another retirement-savings plan, myRa allows investors to contribute very small sums on an ongoing basis. Assets are invested in holdings similar to the G Fund that federal-government workers can buy in their Thrift Savings Plan (TSP), the 401(k)-like plan for government workers. The G Fund is guaranteed to not lose money yet has historically paid a better yield than true cash instruments. That might sound enticing to yield-starved investors, but note that your combined contribution to an IRA--whether Roth, traditional, or myRA--cannot exceed the $5,500/$6,500 limits, and your maximum holdings in myRA cannot exceed $15,000. Thus, myRA won't make sense for most higher-income savers, but it looks like a fine multitasking emergency fund/starter long-term savings vehicle for young investors who are just getting started. 

Saver's Credit
This credit is designed to incentivize individuals and families with earnings under certain thresholds to put money into IRAs (or myRAs) or qualified company retirement plans. For 2016, married couples filing jointly are eligible for the credit if their modified adjusted gross income is less than $61,500; single filers can claim the credit if their adjusted gross income is less than $30,750. The lower the income, the higher the credit--up to a maximum level of $1,000 for single filers and $2,000 for married couples filing jointly. This IRS guide provides more detail on the credit. 

Health Savings Accounts
People who are covered by a high-deductible healthcare plan can contribute to a health savings account. A high-deductible plan is defined as one with at least a $1,300 deductible for individuals and a $2,600 deductible for families; the maximum out-of-pocket expenses that covered people can incur are $6,550 for individuals and $13,100 for families. For 2016, those with single coverage can contribute $3,350 to an HSA, while those with family coverage can contribute $6,750. (Investors age 55 and above can make an additional $1,000 catch-up contribution.) For those who are making the maximum allowable contributions to their company retirement plans and IRAs, the HSA provides another way to amass tax-advantaged savings. The investor makes pretax contributions, the money accumulates tax-free, and qualified withdrawals are also tax-free. 

Education Savings
Each individual can contribute up to $14,000 a year to a 529 college-savings plan on behalf of a specific individual without having that contribution count toward the gift tax. Additionally, investors who would like to make a large upfront contribution to a 529 can contribute up to $70,000 on behalf of a single individual in a given year; as long as he or she makes no future contributions on behalf of the same individual for the next five years, the contribution will not count toward the gift tax. 

Coverdell Education Savings Account contribution limits are more stringent; they are capped at $2,000 per beneficiary, and income limits apply. For 2016, single filers earning more than $110,000 cannot contribute to a Coverdell, and contributions are reduced for individuals earning between $95,000 and $110,000. Married couples filing jointly can contribute to a Coverdell if they earn less than $220,000; contributions are reduced if the couple's income falls between $190,000 and $220,000. 

Medicare Surtax
The income thresholds for the 3.8% Medicare surtax will remain unchanged from 2015 to 2016: $200,000 for single filers and $250,000 for married couples filing jointly.

Estate and Gift Tax
The annual gift tax exclusion amount is staying the same, at $14,000. However, the exclusion amount for the estate tax is jumping up slightly to $5.45 million per person in 2016.