Many financial decisions made prior to the end of the year can have a positive impact. As you approach the end of the year, it is often a great time to address your financial and life goals. There are a number of moves that may help in achieving these objectives. Here are some questions you may wish to ask yourself:
When should I give to charity?
The decision to make a charitable gift, while primarily intended to benefit the cause at hand, may also have financial implications. Determine if your charitable deduction may be more of an advantage in the current or following tax year and then decide the specific date to gift. Keep in mind that when making a contribution, you will need to give to a qualified charity, usually a 501c3. You’ll need to receive documentation of your gift in order to make a deduction as well.
Those with highly appreciated assets (stocks that have increased in value, for example) may wish to give the asset rather than the same amount of cash. Doing so can often kill two birds with one stone. You can not only deduct the full value of the gift but avoid capital gains taxes on the increased value or your asset when gifted directed as opposed to selling and then gifting cash.
Should I start contributing to my company plan or increase my contribution?
If you have the opportunity to participate in a company plan (a 401k or other option, for example) you may wish to begin contributing or increase your contribution. Check with your company to see when you are able to make changes to your current election.
Many participants find it convenient to increase their contribution by 1% annually or whenever they receive a raise. While you’re at it, if you are going to look into your current company plan allocations, check to see if your plan gives an option for both traditional and Roth contribution, then decide on a mix that works for you.
Should I max out my IRA?
You may be able to make contributions to a traditional Individual Retirement Account (IRA) and receive a tax deduction. Your eligibility will depend on your income as well as your eligibility to participate in any company plan. IRA accounts give you the flexibility to invest as you choose and defer taxes on any earnings in the account until funds are withdrawn during retirement. Be sure you can consider these contributions as long-term investment funds since amounts withdrawn without an exemption (first time home purchase or certain medical expenses, for example) may be subject to a 10% penalty.
What about a Roth account?
Roth accounts are an excellent option for those who wish to eventually withdraw tax-free funds in retirement. You won’t get a deduction for your contribution, but you’ll be able to make withdrawals without being taxed on the contributions or growth. Another advantage of the Roth is flexibility. During the account owner’s life there are no required minimum distributions (“RMDs”) and like traditional IRA accounts, you can own most investments. Collectibles and life insurance are the only major restrictions.
Sold on the idea of Roth accounts? Consider converting some of your funds in traditional accounts to Roth status. You can convert an unlimited amount of funds from traditional to Roth regardless of your income level but will have to include the amount included as taxable income for the year. Many who convert large sums choose to do so over multiple tax years to avoid a large amount of taxable income in a single year. Others whose income varies from year to year will wait for the best opportunity to convert sums in years when they have less taxable income.
How does tax loss harvesting work?
No one likes to take a loss, but it can often provide an advantage from a tax standpoint. You can use losses that you take to offset capital gains in the current or future year as well as a limited amount of ordinary income which can be carried forward to future tax years.
Be sure you do not purchase the same security within 30 days or you will have engaged in a “wash sale.” Get something similar but different instead. You’ll maintain the overall balance you desire in your portfolio while still being able to claim the loss.
What about gain harvesting?
Similar to tax loss harvesting, tax gain harvesting involves the strategic sale of a security for tax purposes. Instead of selling at a loss and purchasing a similar security in order to use the loss for a deduction against either other gains or a limited amount of ordinary income, an investor sells securities that have appreciated, buying the same or similar security afterward. But why would someone wish to take their gain any sooner than they have to?
This depends on that investor’s tax situation and where they expect to be in the future. While long-term capital gains (profit on the sale of items held longer than one year) are taxed at a more favorable rate in general than your ordinary income tax (the tax on wages, for example), they can be as low as 0% for investors whose income is low enough. Depending on income, the investment rate (applicable for capital gains and dividends) would apply. This can be either 0%, 15% or 20%. If you happen to fall into the range where your gains would be taxed at the lowest rate of 0% it makes sense for you to take some gains and reestablish a higher cost basis, paying tax on a lower amount of gain in future years when you may be at one of the higher investment rates. One of the advantages of this strategy is that there is no wash sale rule for taking gains similar to the requirement to wait more 30 days to before repurchasing the same security to claim a loss. Those employing a gain harvesting strategy can repurchase the security immediately.
What is asset location?
Put simply, asset location is where you hold your assets. Two investors may own the same exact stocks, bonds, and mutual funds, but they may be held in different taxable, tax-free and tax-deferred accounts. You’ll want to consider not only what you own, but where you have your assets.
Do I have a home office and can I deduct it?
Those who use part their home to conduct business may qualify for the home office deduction, which is based on the percentage of your home used for business purposes. You may also be able to deduct related expenses such as utilities or insurance.
Can I open a Health Savings Account?
In order to qualify for a Health Savings Account (“HSA”), you need to be enrolled in a qualified high deductible medical insurance plan. Your contributions will go in pre-tax and any amounts that are withdrawn (including growth) that are used for qualified medical expenses can be tax-free.
How does my withholding status affect my return?
Do you find yourself usually short on cash during the year but then receiving a large refund? You may wish to adjust your withholdings to receive a larger check throughout the year. Don’t need the money? In that case, adjust your withholding and then save or invest the money elsewhere instead of giving the government an interest-free loan until your tax refund is received. Those who recently married or divorced will also wish to adjust their withholding to reflect this.
Do I have to take a required minimum distribution or “RMD?”
You will need to take a required minimum distribution from your qualified retirement accounts if over 70 ½ years of age. If you reached 70 ½ during the tax year, you may take your first RMD by April 1st of the following year rather than December 31st of the tax year, although you will still need to take your RMD for the following year as well. This gives you additional flexibility to time your first RMD but could create lead to a higher rate of tax by receiving your first two distributions in the same tax year.
You will not need to take distributions from your company plan while still employed or from your own Roth accounts. (Those who have inherited retirement accounts may experience different requirements depending on the type of account and if the decedent was a spouse or non-spouse.)
Make your decision based on your overall financial situation since you may need to take into account other aspects such as the tax implications on Social Security benefits. Withdrawals from traditional accounts may affect your “provisional income” which determines how much of (if any) of your Social Security benefit is taxable.
What other transactions can affect my taxes?
Consider the tax implications before buying or selling a home, exercising stock options, selling your business or performing other transactions.
Those who meet the length of ownership requirements may be able to receive an exemption of $250,000 of capital gain ($500,000 if married filing jointly) on the sale of their primary residence. It can sometimes make sense for those with gains to delay their sale to meet these requirements.
Those with stock options should take special care when deciding not only when to exercise the option, but also when to sell the underlying shares. There are different tax implications for Incentive Stock Options (ISOs) as well as Non-Qualified Stock Options (NSOs) so be sure you fully understand the nature of your contracts before making any decisions.
There are several ways to sell a business which can be as simple as a straight cash sale to more advanced strategies such as using an ESOP (employee stock ownership plan) to unlock equity for business owners. Your options will vary based on the size of your business and nature of your industry, but don’t just focus on the sale price alone. Make sure you examine all of your available exit or transition strategies to make sure you’re also taking into account the tax consequences of the sale.
Should I pay my mortgage faster or make extra payments?
Your mortgage interest can be deductible up to federal limits. Sometimes it makes sense to make your January payment in December to use the deduction in the current tax year and sometimes homeowners opt to make an extra payment entirely in order to pay down principal quicker. Consider this option if your emergency fund and retirement accounts are in good shape already.
What if I’m returning from military active duty?
Be sure to revoke any powers of attorney that you may have granted to others and also check your credit for any errors. Be sure you’ve decided what to do with the balance of your SDP (Savings Deposit Plan) once no longer eligible after return from active duty and that you are aware of some additional financial rights you have such as additional time to file a tax return and a maximum interest rate on your credit cards while deployed of no more than 6%. This protection, granted under the Service Members Civil Relief Act (SCRA) is an important benefit since many cards charge double-digit rates, but you will need to notify the card company.
How does my recent marriage affect things?
You’ll want to review your withholding status at work in order reflect this as well and potentially changing your beneficiary designations for company retirement accounts and life insurance. You may also want to consider purchasing additional life insurance and determine if some other benefits are more advantageous no that you are married. You may, for example, determine that adding one spouse as a dependent on the other’s employer-based plan is a less expensive option. You may also find that certain types of insurance (long-term care and Medicare supplement policies, for example) offer a spousal discount when both members of a couple get their policies from the same company.
The end of the year is a great time to take stock of your financial situation and see if any of the actions discussed make sense for your situation. Consider a free assessment with Pure Financial Advisors.