The end of a calendar year is a great opportunity to take a hard look at tax planning. Let’s face it, we’re all busy and most people don’t spend their days thinking about their financial plans or minimizing taxes.
However, there are tax-saving strategies that are time sensitive but must be accomplished by the end of the year—so much so in fact that end of year planning has become synonymous with tax planning. In this article, we’ll dive into strategies to maximize your tax savings in 2023, and into the new year.
For the next couple of years tax planning is particularly important, due to the upcoming sunset of the Tax Cuts and Jobs Act on December 31, 2025. This means that the window of opportunity to take advantage of lower marginal tax rates is quickly closing. This article will give you the details of how to get as much from the TCJA as possible before it sunsets.
If you’d like help implementing an effective tax strategy to save you money in 2024…
What is the Tax Cuts And Jobs Act and How Does it Affect Me?
The Tax Cuts and Jobs Act, commonly referred to as TCJA, is a piece of tax legislation that was passed back in 2017. Among other changes, it aimed to reduce the tax burden for a wide range of taxpayers. Discussing all the particulars of the TCJA is beyond the scope of this article, so we will focus on marginal tax rates.
2023 Federal Income Tax Brackets and Rates Vs. Pre-TCJA Rates for Married Couples Filing Jointly
Source: Internal Revenue Service
If Congress and the White House do not act, the TCJA will sunset at the end of 2025, and we will see a reversion to the tax structure that existed before the 2017 Act.
This is a meaningful impact as marginal rates will increase significantly. For instance, the current 22% bracket was previously 25%, and the 24% was 28%. And even though these tax brackets are adjusted for inflation many taxpayers will find themselves in a higher tax bracket at a lower income level.
How to Maximize Tax Savings Before the TCJA Sunsets
You’ve probably always been told to max out your 401(k) and TSP to benefit from the current tax deduction. But for investors that are in the 24% bracket or below, the conventional wisdom may not hold true. Due to our ballooning national debt, it is highly likely that marginal tax rates will be higher in 2026 and beyond.
So what should you do? I recommend determining whether or not the current deduction and deferral is the best choice over the long haul. Perhaps a Roth option, (if you’re eligible) or even saving more in non-qualified accounts may be a better way to go.
For those in or below the 24% tax bracket — (married couples filing jointly with up to $364,201) in taxable income Roth IRA conversions can be a good opportunity right now.
However, there are A LOT of considerations before you do this, and working with a good financial advisor can help you develop a strategic approach to do this in the wisest manner possible.
Employee Benefits, Tax Planning and Health Plan Deductions
Regardless of Roth or traditional 401k or TSP you should ensure you’re contributing enough to get your full employer match in your employer retirement plans. If you haven’t contributed enough to receive your full employer match, talk with your HR department about the possibility of deferring a larger percentage of your December pay. For example, if there’s a 6% match and you’ve only contributed 5% of your total salary throughout the year, you may be able to increase your contribution in December for a “true up” from your employer. This would qualify you for the full match.
My favorite account for tax planning is the health savings accounts (HSAs). And while these are only available to those with high deductible health plans, they offer the best of both the tax deductible and the tax free worlds. Maxing out your contributions to your Health Savings Accounts (HSAs) is ideal because you get a current year deduction for the amount contributed AND the amount you withdraw is tax free if used for qualified medical expenses. Many HSAs offer the ability to invest contributions in mutual funds and EFTs, thereby offering long-term growth potential .
The HSA contribution limits for 2023 are $3,850 for self-only coverage and $7,750 for family coverage. Those 55 and older can also contribute up to $1000 as a catch-up contribution.
It is important to note that HSAs are very different from their popular cousin, the FSA (Flexible Spending Account). Both are intended as a way to pay for medical expenses in a tax efficient manner. However, you should plan on spending your FSA contributions by the end of the year. While there are plan-specific exceptions to this deadline, it’s a best practice to abide by this timeline for planning purposes.
Why is this so important? If not spent, your money reverts back to the plan, and you lose the money. With an HSA, the money is yours, it does not revert back to the plan. This distinction creates a unique opportunity that can be a big benefit for investors. I recommend discussing this with your financial advisor during your benefits open enrollment period.
Tax-Loss Harvesting on Investments
In tax planning it is a well known fact that capital losses can offset capital gains.You can also carry forward these capital losses to future years. So what does this mean for investors?
Nobody likes down markets, like what we experienced in 2022 and parts of 2023. But down markets do set up an opportunity to proactively take action against taxes on future capital gains. Our strategy for clients involves continuous tax loss harvesting to counterbalance future capital gains.
For a successful tax loss strategy, you must have an actual loss and adhere to the wash sale rules. What does this mean? Here is an example. if you incur a loss on XYZ large value mutual funds and sell it, you can’t repurchase the same (or substantially identical) fund within 30 days.
Doing so would result in a disallowed loss or a wash sale, negating your ability to offset future capital gains with that loss. However, you could sell the XYZ fund, and immediately invest in a different large value fund, and then possibly repurchase XYZ fund after 30 days.
It is important to note that there are different interpretations of what substantially identical actually means, so it is a good idea to work with a financial advisor and a tax professional so you avoid triggering the wash sale rule.
Executed properly, a tax loss harvesting strategy locks in your loss on the XYZ fund but keeps you invested in that sector of the market. A similar approach can be applied to stocks and ETFs as well. You could harvest a tax loss from one dividend paying consumer stock into another similar stock or sector ETF thereby, securing the tax loss but maintaining sector exposure.
Another way we work to minimize client capital gains is by evaluating their mutual funds holdings for potential high capital gains distributions exposure. Where feasible, we will execute a tax loss harvest into a comparable strategy or sell the fund in a timely manner to avoid those capital gain distributions.
Please keep in mind that these strategies are only relevant in non-qualified, taxable accounts. They don’t apply to tax-advantaged accounts like TSPs, 401ks, IRAs, Roth IRAS, or any other sort of tax deferred or tax free accounts.
Charitable Giving and Qualified Charitable Distributions
Charitable giving is a passion of mine and I’ve written extensively about charitable giving in detail on my Forbes.com profile here. I remind my clients that giving money away for tax purposes doesn’t usually make sense, but if you’re already giving to charities, doing so in a tax-wise manner makes a ton of sense.
So, for those who are charitably inclined, donations must be made within the calendar year for which they are intended; they cannot be backdated. If you think you might be able to qualify for the standard deduction next year, you’re better off to lump your charitable contributions into staggering years so that you can itemize and maximize the value of your charitable giving.
For individuals over the age of 70.5, Qualified Charitable Distributions (QCDs) become relevant. This involves directing money from a traditional IRA to a qualified charity, a 501(c)(3) organization, which ensures the amount doesn’t become part of your taxable income. You’ll receive a 1099-R for this donation and a letter from the charity as a confirmation of your QCD. It is important to inform your tax preparer that you made this transaction as a qualified charitable distribution, as neither form will indicate this.
The beauty of QCDs lies in their ability to satisfy Required Minimum Distributions (RMDs) and charitable giving in the most tax-efficient way possible. They do not contribute to your Modified Adjusted Gross Income, which is critical for IRMAA — the Income-Related Monthly Adjustment Amount (higher Medicare part B and D premiums).
QCDs have become a standard point of conversation for our charitably inclined clients at Good Life Financial Advisors of NOVA for two reasons. First, the introduction of IRMAA in 2003 as part of the Medicare Modernization Act means that higher income individuals on Medicare pay higher Medicare premiums. Second, with the higher standard deductions applicable since the introduction of the TCJA of 2017, fewer clients are itemizing deductions unless they have given to charities. By utilizing QCDs, clients are able to reduce their taxable income even if they don’t itemize.
This strategy specifically pertains to traditional IRAs, it isn’t applicable to 401(k)s or TSPs.
End of Year Financial Checklist for 2024
To sum up, the complete checklist to go into 2024 with a successful tax saving strategy involves the following:
- Review Retirement Plan Contributions: As tax structures are expected to change post-2025, consider if it is best to contribute to a non-qualified account, a Roth IRA or traditional IRA, a traditional or Roth 401(k) or TSP or a combination of those. You may also want to consider converting some of your traditional IRA or 401(k) funds to a Roth before the tax rates increase.
- Maximize Roth IRA Contributions: If eligible, maximize contributions to your Roth IRA before the 2024 tax deadline, leveraging its tax-free growth potential.
- Ensure Full Employer Match: Discuss with HR the possibility of increasing your contributions if you haven’t met the threshold for a full employer match in your retirement plan. This is essentially free money that can boost your retirement savings.
- If eligible, optimize Health Savings Accounts (HSAs): Aim to max out HSAs, currently at about $7,750 for families, to enjoy the dual benefit of tax deductions and tax-free withdrawals for medical expenses.
- Plan for Flexible Spending Accounts (FSAs): Use any remaining FSA funds before the year-end to avoid losing them, as they don’t carry over like HSAs.
- Implement Tax-Loss Harvesting: Offset capital gains by selling securities at a loss, particularly in non-qualified, taxable accounts, while adhering to wash sale rules. This can help reduce your taxable income and lower your tax bill.
- Charitable Contributions: Ensure donations are completed before year-end, considering lumping contributions in certain years to maximize deductions. For individuals over 70.5, direct funds from IRAs to charities to reduce taxable income and satisfy RMDs efficiently.
As you can see, there’s a LOT that goes into the end of the year tax planning… which is why it usually makes sense to work with a professional who has the tools and experience necessary to bring it all together with the goal of reducing your tax bill.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
No strategy assures success or protects against loss.
All investing includes risks, including fluctuating prices and loss of principal.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Good Life Advisors, LLC, a registered investment advisor. Good Life Financial Advisors of NOVA and Good Life Advisors, LLC, are separate entities from LPL Financial.
