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As we approach the end of the year, there is still time to improve your financial position with a few well-placed year-end moves.
Maybe because we are working against a deadline, many year-end planning opportunities seem to be tax-related. Tax moves, however, should be made with your overall long-term financial and investment planning context in mind. So make sure to check in with your financial and tax advisors.
Here are seven important moves to focus your efforts on that will help you make the best of the rest of your financial year.
1) Harvest your Tax Losses in Your Taxable Accounts
As of October 22, the Dow Jones is up 16.57%, and the S&P500 is up just 21% for the year. Unfortunately, there are still stocks and mutual funds that are down for the year. Therefore you are likely to have some items in your portfolio that show up in red when you check the “unrealized gains and losses” column on your brokerage statement.
You can still make lemonade out of these lemons by harvesting your losses for tax purposes. However, the IRS individual deduction for capital losses is limited to a maximum of $3,000 for 2018. So, if you only dispose of your losers, you could end up with a tax loss carryforward, i.e., tax losses you would have to use in future years. This is not an ideal scenario!
However, you can also offset your losses against gains. For example, suppose you were to sell some losers and hypothetically accumulate $10,000 in losses. In that case, you could then also sell some winners. Then, if the gains in your winners sold add to $10,000, you have offset your gains with losses, and you will not owe capital gain taxes on that joint trade!
This could be a great tool to help you rebalance your portfolio with a low tax impact. Beware though, you have to wait 30 days before buying back the positions you have sold to stay clear of the wash sale rule.
2) Reassess your Investment Planning
Tax-loss harvesting is a great tactic to use for short-term advantage. However, as an important side benefit, it allows you to focus on more fundamental issues. So why did you buy these securities that you just sold? Presumably, they played an important role in your investing strategy. And now that you have accumulated cash, it’s important to re-invest mindfully.
You may be tempted to stay on the sideline for a while and see how the market shakes out. Although we may have been spoiled into complacency after the Great Recession, the last month has reminded us that volatility happens.
No one knows when the next bear market will happen if it has not started already. Therefore, it is high time to ask yourself whether you and your portfolio are ready for a significant potential downturn.
Take the opportunity to review your goals, ensure that your portfolio risk matches your goals, and your asset allocation matches your risk target. Then, reach out to your Wealth Strategist about that.
3) Check on your Retirement Planning
It is not too late to top out your retirement account! In 2021, you may contribute a maximum of $19,500 from your salary, including employer match to a 401(k), TSP, 403(b), or 457 retirement plan, subject to the terms of your plan. In addition, those who are age 50 or over may contribute an additional $6,500 for the year.
If you have contributed less than the limit to your plan, there may still be time! You have until December 31 to maximize contributions for 2021, reduce your 2021 taxable income (if you contribute to a Traditional plan), and give a boost to your retirement planning.
Alternatively to deferring a portion of your salary to your employer’s Traditional plan on a pretax basis, you may be able to contribute to a Roth account if that is a plan option for your employer. As with a Roth IRA, contributions to the Roth 401(k) are made after-tax, while distributions in retirement are tax-free.
Many employers have added the Roth feature to their employee retirement plans. If yours has not, have a chat with your HR department!
Although the media has popularized the Roth account as tax-free, bear in mind that it is not. Roth accounts are merely taxed differently. Check-in with your Certified Financial Planner practitioner to determine whether electing to defer a portion of your salary on a pretax basis or to a Roth account on a post-tax basis would suit your situation better.
4) Roth Conversions
The current tax environment is especially favorable to Roth conversions. Under the current law, income tax rates are scheduled to go back up in 2026; hence Roth conversions could be suitable for more people until then. And, of course, it is possible that Congress will vote for tax rates to go up before the end of the year.
With a Roth conversion, you withdraw money from a Traditional retirement account where assets grow tax-deferred, pay income taxes on the withdrawal, and roll the assets into a Roth account. Once in a Roth account, the assets can grow and be withdrawn tax-free, provided certain requirements are met. If you believe that your tax bracket will be higher in the future than it is now, you could be a good candidate for a Roth conversion.
Read more about the new tax law and Roth conversions
5) Pick your Health Plan Carefully
It is health insurance re-enrollment season! The annual ritual of picking a health insurance plan is on to us. This could be one of your more significant financial decisions for the short term. Not only is health insurance expensive, it is only getting more so.
First, you need to decide whether to subscribe to a traditional plan with a “low” deductible or a high deductible option. The tradeoff is that the high deductible option has a less expensive premium. However, should you have a lot of health issues, you might end up spending more. High deductible plans are paired with Health Savings Accounts (HSA).
The HSA is a unique instrument. It allows you to save money pretax and to pay for qualified healthcare expenses tax-free. In addition, unlike Flexible Spending Accounts (FSAs), balances in HSAs may be carried over to future years and invested to allow for potential earnings growth. This last feature is really exciting to wealth managers: in the right situation, clients could end up saving a lot of money.
If you pick a high deductible plan, make sure to fund your HSA to the maximum. Employers will often contribute also to encourage you to choose that option. If you select a low deductible plan, make sure to put the appropriate amount in your Flexible Spending Account. FSAs are used to pay for medical expenses on a pretax basis. Unlike with an HSA, you cannot roll over unspent amounts to future years.
6) If you are past 70, plan your RMDs
If you are past 70, make sure to take your Required Minimum Distributions (RMDs) each year. The 50% penalty for not taking the RMD is steep. You must withdraw your first minimum distribution by April 1 of the year following the year in which you turn 70 ½, and then by December 31 for each year after.
Perhaps you don’t need the RMD? Instead, you may want to redirect the money to another cause. For instance, you may want to fund a grandchild’s 529 educational account. 529 accounts are tax-advantaged accounts for education. Although contributions are post-tax, growth and distributions are tax-free if they are used for educational purposes.
Or, you may want to plan for a Qualified Charitable Distribution from the IRA. The distribution must be directly from the IRA to the charity. It is excluded from taxable income and can count towards your RMD under certain conditions.
7) Plan your charitable donations
Speaking of charitable donations, they can also reduce taxable income and provide financial planning benefits. However, due to the Tax Cut and Jobs Act of 2017 (TCJA), it may be more complicated than in previous years. One significant difference of the TCJA is that standard deductions are $12,550 for individuals and $25,100 for joint filers. So, practically, what that means is that you need to accumulate $12,550 or $25,100 of deductible items before you can feel the tax savings benefit.
In other words, if a married couple filing jointly has $8,000 in real estate taxes and $5,000 of state income taxes for a total of $13,000 of deductions, they are better off taking the standard $24,000 deduction. They would have to donate $7,000 before they could start to feel the tax benefit of their donation. One way to deal with that is to bundle your gifts in a given year instead of spreading them over many years. Or, within certain limits, to give directly from your IRA.
For instance, if you plan to give in 2021 and also in 2022, consider bundling your donations and giving just in 2021. In this way, you are more likely to be able to exceed the standard deduction limit.
If your thinking wheels are running after reading this article, you may want to check in with your Wealth Strategist or financial planner: there may be other things that you could or should do before the end of the year!
Check these other wealth management posts:
Is the TCJA an opportunity for Roth conversions?
How to Implement a New Year Resolution
Tax Season Dilemna: Invest ina Traditional IRA or a Roth IRA
Note: The information herein is general and educational in nature and should not be construed as legal, tax, or investment advice. We make no representation as to the accuracy or completeness of the information presented. To determine investments that may be appropriate for you, consult with your financial planner before investing. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions.We make no representation as to the completeness or accuracy of information provided at the websites linked in this newsletter. When you access one of these websites, you assume total responsibility and risk for your use of the websites to which you are linking. We are not liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, websites, information, and programs made available through this website.