Year-End Tax Planning: Smart Moves Before the New Year
As the year draws to a close, it's a great time to take a proactive approach to your finances. A few strategic moves before December 31 can help you lower your taxable income, reduce your tax bill, and set yourself up for a stronger financial future.
Here are some key year-end tax planning strategies to consider.
Maximize Retirement Contributions
One of the most effective ways to reduce your taxable income is to increase your contributions to tax-advantaged retirement accounts.
401(k)s and 403(b)s: If you haven't yet reached the annual contribution limit, you may be able to increase your contributions from your final paychecks of the year. Every dollar you contribute to a traditional 401(k) reduces your taxable income, saving you money on your current tax bill.
Traditional IRAs: You have until the tax-filing deadline (typically April 15 of the following year) to contribute to a traditional IRA for the current tax year. Contributions may be tax-deductible, depending on your income and whether you have a retirement plan at work.
Health Savings Accounts (HSAs): If you're enrolled in a high-deductible health plan, an HSA offers a "triple-tax advantage." Contributions are tax-deductible, the money grows tax-free, and withdrawals are tax-free when used for qualified medical expenses. You can often make a lump-sum contribution before the end of the year to reach the annual limit.
Review Your Roth IRA Contributions
While Roth IRAs offer tax-free growth and withdrawals in retirement, they come with a strict income eligibility requirement. This is a critical point to review at year-end, as a bump in income could disqualify you from making a full or even partial Roth contribution.
Income Limits: The IRS sets specific Modified Adjusted Gross Income (MAGI) limits for Roth IRA contributions. If your income for the year exceeds these limits, your contribution may be considered an "excess contribution" and could be subject to penalties.
Recharacterization: If you discover that your income is too high to qualify for a Roth IRA, don't panic. You can "recharacterize" your contribution by moving it and any associated earnings to a traditional IRA. This process effectively treats the contribution as if it were made to the traditional IRA from the start, helping you avoid penalties. It’s a key move to make before the tax filing deadline to correct an over-contribution.
Harvest Investment Losses
If you have a taxable investment account, a down market can present a unique opportunity. Tax-loss harvesting involves selling investments that have lost value to offset capital gains you've realized from other sales during the year.
Offsetting Gains: You can use your investment losses to offset any capital gains. If your losses exceed your gains, you can even use up to $3,000 of those losses to reduce your ordinary income.
The Wash-Sale Rule: Be aware of the IRS wash-sale rule, which prevents you from claiming a loss if you buy a "substantially identical" security within 30 days before or after the sale. You can still maintain your portfolio's market exposure by selling one fund and immediately buying another similar, but not identical, fund.
Consider Charitable Giving
Charitable contributions can provide a valuable tax deduction, especially if you itemize your deductions.
Donating Cash or Property: A cash donation to a qualified charity is a straightforward way to get a deduction. If you have appreciated assets like stocks that you've held for more than a year, donating them directly to a charity can be even more beneficial. You may be able to deduct the full market value of the stock and avoid paying capital gains tax on the appreciation.
Donor-Advised Funds (DAFs): A DAF allows you to make a charitable contribution, receive an immediate tax deduction, and then recommend grants to your favorite charities over time. This is a great strategy if you want to bunch multiple years of charitable giving into a single tax year to exceed the standard deduction threshold.
Final Thoughts
The end of the year is a perfect time for a financial check-up. By taking the time to review your retirement contributions, manage your investment portfolio, and plan your charitable giving, you can make a significant impact on your tax situation. Have questions or need some assistance? Set up a free 30-minute consultation to see how Legs Financial can help.
