5 tax moves to consider by the end of November
“Don’t wait until December 15th to do your year-end business.”
Have you ever found yourself in a store on December 23rd, looking at the bare shelves and cursing yourself for not shopping sooner? This can happen with your finances as well.
Every December, custodians - financial companies that hold your IRAs and 401ks - get flooded with requests with year-end deadlines. Unfortunately, not all requests are fulfilled.
In my first year in this business, I had a client ask me on December 15th to make a charitable distribution from his account. Despite my persistent calls to his custodian to expedite the process, the request was not fulfilled until the new year. Now, I tell clients every year to avoid the rush and to get your business done in November.
Some tax items have a deadline in 2025; specifically, IRA and HSA contributions for tax year 2024 can be made until April 15th, 2025.
But many items must occur in the calendar year to be effective for 2024. Below is a list of the most common of these items, and a little bit about why you should consider them.
Before you read further, know that this is not tax advice or a recommendation to buy or sell anything. Beyond that, know that there is no “free lunch”, and even the “good” ideas I discuss come with downsides (or potential downsides).
It’s also important to note that these items are all related, and sometimes contradictory. For example, harvesting gains at 0% and then offsetting those gains with losses leaves you no better than when you started; you may as well have done nothing. Thus, it’s important to speak to an expert before implementing these tactics.
Schedule a free consultation with 402 Financial.
In general, these tactics have the effect of raising or lowering your taxable income. You might think lowering your taxable income is always the right move, but there are times when it makes sense to increase your income in the current year. Specifically, if you project your tax rate will be higher in the future than it is today, it may be a good idea to accelerate your income today.
Reducing income
529 Plan (College Savings) Contributions
A 529 account is one of the best ways to save for college, and legislation passed in 2022 makes the account even more versatile. Money in a 529 account grows tax free, and can be withdrawn tax-free
Contributions (up to $10,000) made to a Nebraska-sponsored (NEST) 529 account that you own are deductible from Nebraska state income tax.
Contributions to a non-owned account – e.g. to your grandchild’s account owned by your child – are not deductible. If you wish to contribute to an account owned by your child, consider making a gift to your child so they can make the contribution and take the deduction.
Charitable contributions
It’s fundraising season, and you may be wondering how to give to charity without paying taxes.
Charitable contributions are an itemized deduction. And since the new tax law in 2018, most taxpayers use the standard deduction instead.
However, even if you can’t use the itemized deduction, charitable contributions can be used to dispose of assets with large unrealized capital gains, as the charity can sell the asset without paying taxes.
Most stock indexes have had big returns for the past few years. If you have investments outside of your retirement accounts, you may be sitting on large amounts of unrealized capital gains.
Contact the office of your church or charity to find out how to donate non-cash assets.
Additionally, if you are over 70 1/2 (born before June 30, 1954), you are eligible to make a Qualified Charitable Distribution (QCD) from your IRA. This distribution, sent directly from your IRA to the charity of your choice, is not included in your taxable income.
Tax loss harvesting
A diversified investment portfolio has historically increased in value over the course of many years. However, in any given year, there is a good chance that one or more investments within your portfolio has actually lost value.
This is not a time to panic or change your strategy. Instead, you can capitalize the loss and use it to offset gains from other portions of your portfolio, including mutual fund distributions.
If your total losses exceed your total gains, you can offset up to $3,000 of ordinary income with your remaining losses. Any losses above $3,000 can be carried forward to offset gains in future years.
There are two things to be aware of when harvesting tax losses. One, the wash sale rule will disallow the loss if you buy the same or a similar stock within 30 days of the sale. In other words, when you sell, you have to wait 30 days before you buy the stock again.
The other thing to remember is that losses harvested today will increase your potential for taxable gains in the future. For this reason, it’s usually only smart to harvest losses if you believe your tax rate will be lower in the future.
Increasing income
Roth conversion
The dollars in your pre-tax IRA and 401(k) do not belong entirely to you; the federal (and state) government have a claim. Unless distributed as a QCD for charitable purposes, your distribution will be taxed.
If you pay taxes on the government’s schedule, you may end up in a situation where required minimum distributions (RMD) force you to recognize income at a higher tax bracket and/or pay taxes on some of your Social Security retirement benefits.
Roth conversions allow you to buy out the government’s share on your schedule. They are a great tactic to fill up your precious lower tax brackets, particularly in the years after you retire and before you collect Social Security retirement benefits. An effective Roth conversion strategy is one where you pay taxes at a lower rate than you would if you had waited.
Roth IRAs are inherited free from income tax. If you hope to leave a gift to your children, consider Roth conversions.
Tax gain harvesting
When you invest outside of retirement accounts, you will be taxed on any appreciation (gain in value) when you sell the asset. The amount of the tax depends on your tax bracket in the year you sell the asset, or “realize the gain”.
Long-term capital gains have a lower tax rate than ordinary income. A married couple taking the standard deduction can have up to $123,250 in gross income and still pay 0% on capital gains. Thus, harvesting capital gains is a way to realize gains and pay 0% in taxes.
The applications for this tactic are somewhat limited, as it competes with Roth conversions for the precious low tax bracket space. Still, in certain situations, it is a sneaky - and perfectly legal! -way to remove potential future taxes from your portfolio.
Unlike with tax loss harvesting, there is no wash sale rule, so you can sell the asset and immediately buy it back again and still reap the benefit.
If you have any questions about these concepts or want to know if they are right for you, please send me a text (phone number is at the bottom of this page).
About the Author
Joseph Fowler, CFP® is a financial planner and co-owner of 402 Financial in Lincoln, NE.
402 Financial provides financial planning and investment management services to people approaching or in retirement. Joe always acts as a fiduciary and never takes commissions on product sales.
Click this link to schedule a free consultation with Joe.
