TAX PREP & FILING


Purge Your Tax Files

I finished preparing my 2010 federal tax return, and I'd like to clean out my files. How long do I need to keep old tax records, investment statements and other documents? -- Gail Moeder, Great Bend, Kan.

This is a great time to get rid of outdated records and begin organizing your files for 2011. Review your year-end statements to make sure they accurately reflect the monthly statements you received from your bank, broker and other financial institutions. Toss the monthly statements, but keep the year-end statements in your tax files for at least three years after the due date of your return. That's how long the IRS generally has to audit your tax return, unless you've significantly understated your income.

You should keep records of your stock and fund purchases, however, for as long as you hold those investments. When you ultimately sell the shares, you'll need evidence of the price paid (your tax basis) and the date of purchase to settle up with the IRS. (Starting in 2011, brokers must track the tax basis of new stock purchases for you, and starting in 2012, fund companies must do the same for new fund-share purchases. But for investments made before then, you're still on your own.) Also hold on to year-end statements that show reinvested dividends and capital-gains distributions, so you don't pay taxes on the same money twice when you sell the shares.

It's a good time to declutter the rest of your financial files as well. You should keep tax returns for at least six years, but you can toss the supporting records, such as canceled checks and old receipts, three years after the due date of your return. Any year that you make nondeductible contributions to a traditional IRA, you must file Form 8606. Hold on to those forms until you withdraw all the money from your IRA so you can document that a portion of each distribution is tax-free.

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Don't skimp on home insurance

The value of my home has declined over the past few years. Can I save money by reducing my homeowners coverage? -- G. H., Germantown, Md.

No. The insurance value is based on the cost to rebuild the house, not to purchase it. Part of the home's sales price is based on the value of the land; your land can still be valuable, even if your home burns down. And although housing prices have dropped, rebuilding costs have not.

To calculate how much it might cost to rebuild your home, based on its size, building materials and any special features, try the calculator at AccuCoverage.com. For $7.95, you'll get an immediate estimate of your home's insurance value. See Save Money on Homeowners Insurance for more tips.

Stretch your tax refund

I'm anxiously awaiting my tax refund, but I don't want to blow this once-a-year windfall. Any suggestions on how to put it to good use? -- L.M., Indianapolis

First off, pay down high-interest credit card debt -- it's one of the best investments you can make right now. Using your refund to pay off a balance with an 18% interest rate is like earning 18% on your savings.

Your next priority is to build up your emergency fund so you'll be prepared to meet unexpected expenses. Try to keep at least six months' worth of essential expenses in a readily accessible money-market account or a savings account.

If you have refund money left over, use it to boost your retirement savings in an IRA or 401(k). Once you have your own financial situation under control, shift your attention to your kids (or grandkids). Contributions to a 529 college-savings plan may be tax-deductible in your state, and the money in the account can be used tax-free for college costs in the future.

Finally, use our tax-withholding calculator at Kiplinger.com to determine whether you can adjust your withholding and get more money in every paycheck right away.

Give kids a lesson in investing

I'd like to set up an investment account for my children, ages 11 and 13, to teach them about stocks, bonds and mutual funds by actually trading. Where can we go to get started? -- Richard Silber, Washington, D.C.

Open a custodial account at a brokerage firm with no or low fees or minimum investments to start your kids' investing education.

Several firms make it easy to set up a custodial account, even if you aren't already a customer. For example, TD Ameritrade offers custodial accounts with no fees or minimum investments; you'll pay $9.99 for each online stock trade, and $0 for exchange-traded funds and no-transaction-fee mutual funds.

Charles Schwab has a $100 minimum to open a custodial account, then charges its standard fees for trades: $8.95 for each online stock trade, and $0 for Schwab ETFs and OneSource funds.

Scottrade has a $500 minimum initial investment and no account fees; online trades are $7 each, or $0 for no-transaction-fee mutual funds.

Many parents like ING Direct's Sharebuilder program. There's no minimum and no maintenance fees, and if you sign up for regular monthly investments through the automatic investment plan, you'll pay $4 per trade.

Custodial accounts for children younger than 19, and students younger than 24, are generally subject to the kiddie-tax rules: The first $950 of the child's investment income is tax-free; the next $950 is taxed at the child's own, low rate. Any investment income that tops $1,900 is taxed at the parents' higher rate.

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