By: Vanessa McElwrath, CFP®, Wealth Management Partner
For many, the fourth quarter is a hectic time of year. But as 2019 comes to a close, avoid treating year-end planning as an after-thought. By incorporating a few year-end tax planning tips into your fourth quarter routine, you can save on taxes and maximize the value of your retirement nest egg in the long run. Here are some tax planning strategies to consider before the year’s end:
Maximize Deferrals to Retirement Accounts:
Both tax-deferred retirement and healthcare savings contributions are subject to annual limits. Now is a good time to find out how much you have contributed to your employer-sponsored retirement plan and how much you can still contribute before December 31st to take advantage of year-end tax planning tips. If you make this move early enough, you may still be able to increase your salary deductions in order to make up for any shortfall below the maximum. And while you are reviewing deferral limits, it’s a good idea to get an update on new limits for 2020 and prepare for any salary adjustments that you may need to make in January.
Consider Roth Conversions:
While you’re looking at year-end tax planning tips, now is also a good time for those with large IRAs to evaluate whether it makes sense to convert assets to a Roth IRA. Investments in a Roth IRA have the potential to grow tax-free, and assuming certain provisions are met, participants in Roth IRAs don’t pay income tax when they withdraw those funds in retirement. While the conversion may increase taxes for 2019, it decreases potential future tax liabilities. This may be a particularly advantageous tax planning strategy if you find yourself in a relatively lower tax bracket in 2019 than you would expect during your retirement years. My fellow wealth advisor and colleague, Carli Smith, explored Roth IRA conversions in greater detail in her May 2019 blog post, “To Roth, or Not to Roth: A Practical Guide to Roth Conversions.”
Tax Loss Harvesting:
Given the volatility in markets seen in 2019, investors may be able to identify holdings in their taxable accounts that can be sold to recognize capital losses and save on taxes as part of their year-end tax planning tips strategy. These realized losses can then be used to offset capital gains that result from selling other investments at a profit. You can also use tax-loss harvesting to offset up to $3,000 in non-investment income. After selling the investment to recognize the loss, you should replace it with something similar so that you maintain your asset allocation for the market recovery and to avoid wash-sale rules.
The increase in the standard deduction from $12,200 to $24,400 has made it harder for taxpayers to itemize deductions and take advantage of charitable contributions as one of their usual tax planning strategies. If you are someone who regularly gives to charities and is on the cusp of itemizing deductions versus taking a standard deduction, you can consider combining several years’ worth of gifts in an effort to itemize in 2019.
Also, owners of individual retirement accounts who are 70 1/2 or older may consider specific year-end tax planning tips such as making charitable contributions through a Qualified Charitable Distribution, or QCD. A QCD is a direct transfer of funds from an IRA, payable to a qualified charity. The amounts distributed as a QCD can be counted toward satisfying Required Minimum Distributions for the year, up to $100,000, and can be excluded from your taxable income.
Withholding and Compensation:
Many taxpayers got an unpleasant surprise last April when they found they hadn’t withheld enough, and they got a big tax bill. To avoid unwanted surprises, make sure that withholding and estimated tax payments are enough to avoid penalties and interest to the IRS. Do that by covering 110% of your previous year’s income tax liability or 90% of your current-year liability.
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