Year-End Tax Planning Opportunities
It’s nearly the end of the year and many people are still reeling from 2020. Can you believe 2022 will be here in just a few weeks?! Now, that we’ve come to grips with the end of the year approaching you’re probably thinking about the things that many others are regarding their finances. What’s my tax situation going to look like? Did I max out my 401k? Did I take advantage of my healthcare benefits?
Sit back, relax, grab a cup of coffee… today we’ll covering common areas to review before the end of the year to help with your wealth building and tax management strategies.
Maximize your Tax Deductions
Employer-Sponsored Retirement Accounts: Most commonly people think of the retirement accounts offered by their employer like 401(k), 403(b), 457, etc. Contribution limits for most plans in 2021 are $19.5k which means that that if you make $300k and contribute the max $19.5k to your retirement plan on a pre-tax basis, the IRS effectively sees your income as $280.5k Here’s how the math works out.
$300K (total income)
– $19.5k (401k contribution) =
__________________________
$280.5K (adjusted gross income)
You only pay taxes on $280.5k instead of your full $300k of income, and you’re saving a nice chunk of change for retirement.
Further, if you turned 50 this year, the IRS allows for what is called a “catch-up contribution” of $6.5k, thus increasing the amount you can deduct from your income from $19.5 to $26k!
*401(k) contributions for 2022 have increased to $20.5k. Catch-up remains at $6.5k.
Year–End Planning Checklist
Review your budget: I know, sooo exciting! We like to take our December annual statements from credit cards/checking/savings accounts and average out our yearly budget to a nice monthly number. It may surprise you. Was it higher/lower than expected?
Roth Conversions: During the pandemic many people changed jobs or even had a gap in employment. The lower income-earning year could be an opportune time to convert some of your pre-tax investments to Roth, allowing those assets to grow tax-free moving forward.
Review Insurance Coverage: Did you add a member to the family? Purchase a larger home? Earn a promotion? Life insurance is often overlooked and now may be a good time to ensure you have the proper protections in place for your family. We believe your insurance coverage should be fully audited every three years at minimum.
Required Minimum Distributions (RMD): If you’re age 72+ the IRS requires you take out a percentage of your tax-deferred accounts every year. After all, they did give you all those tax deductions years ago. If you fail to take your RMD, the IRS can penalize you 50% on any amount that was required to be taken on top of your ordinary income tax rate! RMDs must be taken by December 31st every year.
After-Tax 401(k) and Non-Deductible IRAs: Ok, this is a BIG ONE! You may have heard that the back-door Roth IRA and ability to convert after-tax 401k contributions to Roth (sometimes referred to as the mega back-door Roth) is going away in 2022. Roth conversions themselves are not going away, meaning that you can still convert pre-tax money to Roth. BUT, Roth conversions of money that has never been deducted (like your after-tax 401k contributions) cannot be converted to Roth starting on 01/01/2022.
If you’ve been contributing to your after-tax 401(k), make sure to check that you’ve elected to “convert my after-tax to Roth” and verify on a recent statement that your after-tax balance is zero and you can see that money being converted to your “in-plan Roth conversion” source. Most plans allow for an automatic, daily conversion. Some plans require a phone call to the custodian (e.g. Fidelity, Vanguard, Principal, etc.) to process a Roth conversion. If you’re unsure, call the number on the top of your 401(k) statement and ask.
Please note that this legislation is NOT final! It has passed the House but not the Senate. With that said, we feel it’s very unlikely that someone swoops in at the last second to ‘save’ the back-door Roth and would strongly encourage you to double check your statements before 12/31/2021.
Tax-Loss Harvesting: Individuals who own appreciated stock or who are compensated with stock by their employer, are familiar with capital gains. If the stock you own is “under-water” or below the price you purchased or received it at, your stock has an unrealized loss. The IRS allows you to sell the stock and book the loss which can either be deducted against other capital gains or even taken as a deduction against your income. Realized losses can be deducted against ordinary income up to a maximum of $3k per year, and if you have more losses that, they can be carried forward into future years indefinitely until completely used up.
For example - if you sold Company A stock and realized 50k in capital gains, and you also sold Company B with a capital loss of 20k, you could net those out. Resulting in only owing tax on the difference of 30k in capital gains! With this strategy you can turn an investment loser, into a tax winner.
Watch out for wash sale rules! Read more about that here.
Charitable Contributions: If you file your taxes using the standard deduction, individuals can deduct up to $300 in cash contributions made to charities in 2021 under the CARES act.
If you itemize your taxes, you can deduct much more. Typically, individuals can deduct up to 60% of their AGI for charitable contributions, however under the CARES act it’s been increased to 100% for 2021.
If charitable contributions are important to your family, you may also consider alternate donation strategies such as gift-bunching, using a donor-advised fund, making Qualified Charitable Distributions (QCD) directly from your IRA, or one of our favorites, giving low-basis, highly appreciated stock.
Health Savings Account: In another post, we go in depth on the many benefits of HSAs. Feel free to check it out here: Health Savings Accounts – Why everyone should use one! (if you’re eligible)
HSAs receive triple benefits—tax deductible, tax-free growth, and tax-free distribution for qualified medical expenses.
It’s the end of the year so if you’re unable to max out the contribution through your employer’s payroll deduction, you can still make a lump sum contribution to this account by the tax-filing deadline.
Further, the HSA’s have an awesome rule called “the last month rule.” This rule allows someone, who may not have been eligible for the entire year, to max out their full-year contribution based off December eligibility only. For example, if you started a new job that offered a high-deductible healthcare plan along with an HSA, the IRS allows you to contribute the maximum annual limit for having had coverage based on the last month of the year, December.
Stay at Home Parents: If you’re married and without any type of income, you may be eligible to contribute to an IRA based on your spouse’s income. This would allow someone to contribute up to $6,000 ($7,000 if you’re age 50+) into an IRA and take the deduction when filing jointly with your spouse’s income.
Note that there are income phaseouts on the deductibility of IRA contributions. For example, if you are married filing jointly with a spouse who has an employer-sponsored retirement plan (401k, 403b, etc.), you cannot take a deduction for your IRA contribution if your household income is higher than $208k in 2021.
If you or your spouse are doing the start-up life and don’t have a 401k at work, then each of you can contribute the max to an IRA and the full amount would be deductible at any income level. That’s a $12k deduction for anyone in this situation under age 50, 14k if you’re over 50. Not bad!
For more details, here’s a link to the IRS website.
Self-Employed Individuals: One of the most common gaps we see in a client’s financial plan often comes in the form of self-employed individuals with no retirement account! These individuals earn income as a 1099 or on a K-1 and don’t qualify to receive employer-sponsored retirement accounts. Further, many of them have not thought to seek out a Financial Advisor or CPA to learn more about what type of retirement accounts are available to them. After all, many self-employed individuals are running their own business. Do they have to do everything?
Self-employed Individuals are able to open a self-employed 401k (a solo 401k) which would allow you to contribute the same maximum amount that a regular 401k would ($19.5k), or a Self-Employed Pension (SEP) Individual Retirement Account (IRA) which allows you to contribute 25% of your net business income, up to a maximum amount of $58k in 2021.
We covered quite a few areas that may have provoked some thoughts or questions about you and your family's financial plan. If you’re ready to chat or have further questions, please don’t hesitate to reach out.
Disclosures:
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. This commentary is not meant to be tax advice. Please consult your CPA or tax advisor to understand if any of the above ideas are relevant for your unique situation.
Consilio Wealth Advisors, LLC ("CWA") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure. The information provided in this article is for educational and informational purposes only and does not constitute investment advice and should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.
