End-of-Year Tax Planning Strategies

October 13th, 2017 by B&C Financial Advisors

by Adam Oerther, CFP®

No matter your political leanings, paying taxes is a fact of life and an integral part of modern society. However, the federal government recognizes many different tax-advantaged strategies that lower your tax bill when the time to file comes around each year. This article will focus on a few of the more popular of these strategies: tax loss harvesting, increasing retirement plan contributions, and Roth IRA conversions.

Tax Loss Harvesting

If you own investments within a brokerage (non-retirement) account, you can offset taxes on both capital gains and income by selling a security that has experienced a loss. This is called tax loss harvesting, and it is a very common strategy used by investors to either save incrementally on their tax bills or receive a larger refund. If you are fortunate enough to find yourself in the highest marginal tax bracket (i.e. the 39.6% bracket), this strategy may be an important part of your tax planning, as the taxes on dividends and capital gains are higher for this group of investors.

While tax loss harvesting offers some tax advantages, you should be aware of some limitations that come with it. First, if you sell an asset for a loss, you must be careful not to be in violation of the “wash sale rule,” which states the tax advantage of a realized loss will be disallowed if you purchase a substantially identical asset within 30 days of selling the asset (e.g. selling one S&P 500 ETF and buying another S&P 500 ETF within 30 days). Next, only $3,000 of losses can be used to reduce your taxable income (or $1,500 each if married filing separately) in a given year. However, you can carry losses forward to be used to offset income in future years. Finally, you should consider the costs associated with selling one asset and buying another, such as the trading fee for each transaction. If the tax benefit of taking the loss exceeds the costs of doing so, you should take the loss.

Increasing Retirement Plan Contributions

Even if you do not have investments in taxable accounts, you can still take steps to either lower your taxable income or make use of tax advantages available, including contributing more to available retirement plans, either through your employer (401(k), 403(b), SEP IRA, etc.) or individually (Traditional or Roth IRA). Every pre-tax dollar you are able to contribute to an employer-sponsored plan, such as a 401(k), reduces your taxable income by the same amount, and these plans typically have higher contribution limits (you can currently contribute up to $18,000, or $23,000 if over 50 years old, in a 401(k) plan).

If you participate in a 401(k) or other employer-sponsored plan, you can still contribute to either a Traditional IRA or Roth IRA, but not both. The contribution limits for both of these types of retirement plans are $5,500, or $6,500 if over 50 years old. With a Traditional IRA, however, the tax deductibility of your contributions may be limited by your income and your participation in an employer-sponsored plan. Also, while contributions to a Roth IRA are not tax-deductible, the earnings are not taxable, and all withdrawals are tax-free and penalty-free if you are over 59 ½ years old. However, you may not be allowed to contribute to a Roth IRA if your income is above a certain level. Thus, it is important to check with your tax preparer about which strategy makes the most sense for your particular situation.

Roth IRA Conversions

If you own a Traditional IRA, there are certain times when converting that IRA into a Roth IRA (a.k.a. a “backdoor Roth”) for the tax benefits makes sense.

First, because withdrawals from a Traditional IRA are fully taxable in the year they are taken, it may be prudent to convert it to a Roth IRA in a year you expect your income to put you into a lower marginal tax bracket, saving you from having to pay a higher tax on the money in a later, higher-income year.

You may also consider converting to a Roth IRA if your income level excludes you from making a Roth IRA contribution directly. Single filers’ ability to contribute directly to a Roth IRA phases out between income levels of $118,000 and $133,000, and joint filers’ ability to contribute phases out between $186,000 and $196,000. Thus, if you and/or your spouse find yourself at these income levels but still want to partake in the tax advantages offered by a Roth IRA, a “backdoor Roth” is the only way to do so.

Finally, a conversion may make sense if tax rates are set to become higher, due to a change in the tax code by legislators. This is especially true if you are nearing the point when you will have to take Required Minimum Distributions from your Traditional IRA (at age 70 ½). By doing the conversion in the year in which the withdrawals will be taxed at the lower amount, you will ultimately pay fewer taxes come tax season.

Although these tax planning strategies are commonly used, it is important to discuss them with a tax or investment professional under the context of your individual financial situation. Please contact us to discuss how these strategies can be implemented for your financial plan – call us at (904) 273-9850 or email us at info@bandcfinancial.com.

The information presented in this article is for educational purposes only and is not meant to provide individual advice to the reader. There is no guarantee the information provided above relates to your personal situation. All financial situations are unique and should be advised as such.