Does money really grow on trees

Someone recently asked me “how do you come up with so many varied topics to write about”? “It isn’t easy” I retorted. While one can be creative and find many obscure topics to elaborate on and keep things entertaining and educational, sometimes you need to go back to the basics and practice the tried and proven methods.

One such ‘basic’ is our perennial year-end financial planning exercise. As I constantly remind my classes, financial planning is not a one-time event; it’s a process that needs to be worked on regularly. The average person has a difficult enough time reviewing their financial state every quarter or every half a year, but the year-end process is so fundamental that I would be incredibly remiss if I didn’t remind my readers of its importance.

The purpose of a plan is to take into account foreseeable changes, and try to protect ourselves from unexpected events and changing realities. End of year planning has an added dimension over planning done at other times. Whereas financial planning always presents opportunities to hone in on your plan and finances, and reassess how your financial plan is working, in Israel it also offers you the chance to save a great deal of money via the Israeli taxation system.

Understanding the Israeli tax system is critical in order to verify that your taxes are being calculated correctly by your employer. This is particularly crucial in Israel since most Israeli employees rely on their employers to calculate their tax liability and then remit taxes to Mas Hachnasa on their behalf. Usually employees are not required to file annual tax returns in Israel. If mistakes are made (most likely when basic information is not entered correctly by the employer), money could be lost – and there is no easy way to follow the money flow if you don’t understand the system. So for instance, ensure that your employer has defined you accurately – as being a new immigrant (if applicable) or ensure that you are receiving all your tax credits for your children (if relevant).

The Israeli system is more complicated for people who work for multiple employers, because each employer needs to calculate how much tax they must pay on your behalf. In order to determine the correct amount, the employee applies to Mas Hachnasa based on the projected income earned from each employer. Mas Hachnasa will then calculate how much each employer should deduct in taxes from the employee. However, many times the amount earned will change over the course of the year, leaving the sum being remitted on your behalf as merely a best guess. To alleviate this problem, and make sure the right amount was paid, hire an accountant to do a mock-up of your tax return. If there was a mistake, file a year-end tax return and the money will be refunded – no strings attached.

There are other scenarios where you might want to file a year-end tax return, including if you weren’t employed for part of the year, if you were sick or disabled for a long period of time or if you made donations during the year, for which you are entitled to a tax credit of 35% of the donation made to approved charities. For this reason alone, it can pay to file an annual tax return, or alternatively you can also apply to Mas Hachnasa before the end of the year (but don’t wait for the last few days as they’ll likely stop processing these forms earlier) for a tax credit based on your donations. You will then receive a certificate to allow your employer to adjust the tax on your salary, and thus avoid the year-end tax return. If you are an employee, the Income Tax Authorities will give you a letter for your employer, instructing that your tax be reduced by the amount due to you. If you don’t manage to submit the report in time, you can file a tax return instead.

Those who are self-employed can reduce their tax exposure – in addition to the 35% reduction from donations – by contributing to kranot pensia (pension funds) and bituach menahalim (educational savings plans). Check with your accountant to determine the optimum contribution you can make to maximize your benefit. While some might recommend taking out a loan in order to contribute to savings plans, you need to be careful about taking loans against future income. Be realistic. If you haven’t managed to save each month, why would your reality change now that you have a loan? If you are not disciplined enough, this is not a good option for you.

End of year investment portfolios need to be evaluated before the end of the year. The process of offsetting gains vs losses is relatively easy in a calendar year. The gains you pay taxes on can be offset against any losses. If you have earned income or dividends, and have paid taxes on those gains (the tax rate in Israel is up to 25%), selling investments at a loss will reduce your taxable income. However, all this needs to be done before the end of the year otherwise the process becomes more complicated.

Americans need to consider the unclear American fiscal cliff issues, and to evaluate carefully whether they need to make changes in their portfolio before the end of the year. Capital gains for low income earners (singles earning less than $35,350 a year or $70,700 for couples filing jointly) will go up from the can’t beat rate of 0% in the USA this year. So if you can realize gains this year or gift your assets to someone in a lower tax bracket, you need to move fast. As I write these words, we have no idea how tax issues will play out. However, assuming that in most circumstances the tax rates will rise, bringing forward gains and postponing donations until next year may well be an advisable way to save a considerable amount of money.

Another recommended step is to defer expenses in order to pay a low tax rate this year and thus save money. However, tax issues should not be your only considerations. Too often I have seen people run around doing everything in their power to avoid taxes, and as a result not earn anything. Lowering your taxes is a valiant pursuit when it can be done without compromising your other goals. Evaluate your investment or retirement plans to ensure that your plan matches your risk profile to avoid unpleasant surprises. Having your investments inappropriately invested can leave you too exposed to the market, at just the wrong time (just ask those individuals who were planning on retiring at the end of 2008).

I was always taught that money doesn’t grow on trees, but with just a little foresight, you’d be surprised at how much of it is available to the average person, with some simple foresight and planning!