Smart Financial Planning Moves to Make Before Year End – Part 1

Explore smart financial moves before year-end, from offsetting gains with losses to strategic IRA withdrawals, enhancing your financial outlook.

Kevin Zywna, Wealthway Financial Advisors: As is customary at this time of year for the US and in the show, we’ve come bearing some gifts. Some tips that you can use to hopefully enhance your financial situation before year end. So we have some smart financial planning moves to make before December 31. And yes, sure a lot of these are tax related. But tax planning does not happen. Well, at the end of the year, it might happen out of necessity. It might happen because of procrastination. But really good tax planning is year round and you start planning for the 2024 tax year now, or in January and February where you can make thoughtful, appropriate financial moves that can benefit you throughout the course of the year without waiting to the year end where your options start to get limited. But regardless, we have some things for you to think about tonight. Maybe some of these will help enhance your financial situation before the year is out.

Realize Investment Losses To Offset Tax Year Gains

So first of all, as it relates to some assets, your assets and your debts. So in your investment accounts and your taxable investment accounts, what we would call regular brokerage accounts. So these are not your IRAs, not Roth IRAs, not your 401 K plan, not your TSP or your 457 or 403B. Those are all tax sheltered accounts. But if you have investments, maybe directly with a mutual fund company like Vanguard or T. Rowe Price or Fidelity or something like that, if this is a regular brokerage type of account or a taxable mutual fund account, then do you have any unrealized investment losses in these taxable accounts? If so, you might consider realizing those losses to offset any gains for this tax year. Or write off up to $3,000 against ordinary income. So what you do is you sell the investment that’s in a loss position that books that loss, you’ve realized that loss, you’ll get a tax form at the end of the year that says that you have this loss. And that loss can be used to offset gain a little bit, $3,000, of ordinary income each year.

Now, if the loss is bigger than $3,000, if it’s $12,000, you get to use $3,000 against ordinary income for the next four years until it’s all used up. However, having said all that, generally speaking, just because you have an investment in a loss position, is no reason to go ahead and realize it just for tax purposes. Because sometimes, many times you can get caught holding the bag and you’ve sold your investment at a loss position. Say it’s an exchange traded fund, ETF mutual fund what have you before you buy back in, and you cannot buy back in without triggering the wash sale rule for at least 30 days. Sometimes the investment can improve in value and sometimes substantially so. So while you can selectively sell investments that are in a loss position, do so primarily because you generally want to get rid of that investment, or maybe rebalance your portfolio, or it’s part of a more thoughtful high level investment management strategy instead of just trying to recognize a tax loss. But it is an option.

Sell Funds Before Gains Distributions Are Paid

So something to consider, do you have any investments in taxable accounts that are subject to end of year capital gains distributions? This is primarily mutual funds. A mutual fund is a basket. And inside that mutual fund basket is typically anywhere between as low as maybe 25 individual securities, sometimes upwards of over 1000 individual securities in that one basket.

And so let’s say we’re talking about a stock mutual fund. So it’s made up of stocks of publicly traded companies. Those publicly traded companies spin off, they merge, they pay dividends. That activity that happens in the mutual fund basket has to be paid out at least once a year. Some mutual funds paid out quarterly are rare. Few payout monthly. Bond mutual funds typically pay out monthly. But stock mutual funds monthly, that’s rare. But quarterly, we do see that sometimes. But anyway, at least once a year, they have to distribute the capital gains activity that occurred in that basket by the active manager who manages that mutual fund. And so when those capital gains get distributed, that is a taxable event. And as long as you hold the fund on the day that the capital gains are distributed, that is a taxable event. So sometimes if you know that’s coming and in our world and we have relationships with the mutual fund companies, they are telling us in advance typically a month or so in advance, we’re starting to get activity now. They’re telling us approximately what their capital gains distributions will be, and approximately what date they’re going to pay out those capital gains. So sometimes those can be avoided by selling the fund before the distributions are paid out.

Now, if the fund is in a gain position, then you still have to pay capital gains tax on the sale, but you can avoid the capital gain distribution. And so you have to weigh the pros and cons on that. But just know that capital gains distributions are coming up here soon. Unlike 2022, we’ll probably see higher capital gains distributions than we did last year.

Aggregate Minimum Distribution from Multiple IRAs out of One IRA

Are you subject to taking required minimum distributions from IRAs, including inherited IRAs? If so, know that you can, in many cases, aggregate, the total required minimum distribution from multiple IRAs, and you can take that out of one. So for ease of administration, if you do have to take RMDs, or required minimum distributions this year, you don’t have to take a specific amount out of each IRA if you have multiple IRAs. And generally speaking, you should not have multiple types of IRAs of the same type. So you should not have multiple traditional IRAs. You should not have multiple Roth IRAs. Those can be consolidated into one. But we run into the case where plenty people do have that condition. So if that describes, you, just know that you don’t have to take your RMD pro rata out of each one, you, can add them all up, take a total amount from just one of the IRAs, and that counts.

Now, you can’t do that with inherited IRAs. But you can do that with traditional IRAs. You cannot do that also from 401K plans or most other company sponsored retirement plans. So if you’ve retired, but you still have your 401K account at your old employer, you have not rolled it out of the 401 K plan into an IRA, then that third party administrator handles the mechanics of the 401 K plan. You cannot aggregate multiple 401 K plans. You have to take out a pro rata amount of the required minimum distribution at each 401k provider because those third party administrators don’t know what else you have going on in your life. And so to make sure they comply with tax law, they’re going to kick out their portion and make sure that gets done right. Because if it doesn’t, the penalty for not doing so is steep.

Kevin Zywna, Wealthway Financial Advisors: Tonight, we’re talking about smart financial planning moves to make before year end. Let’s jump into some of the tax moves, that you still have time to make probably about another month or so. Some of these even extend into the next tax year as well, up to the tax filing deadline. So in most cases, April 15. But regardless, you don’t want to delay. Time is of the essence if you want to take advantage of some of these tax moves before year end.

Tax Moves

How To Invest In Highest Earning Years

Do you expect your income to increase in the future? Well, for most of us that is true. Our career trajectory is such that yes, in general, each year, we probably are going to make a little bit more than we did the year before us. And if we have a good long, successful career, then we’re going to be making a fair amount of money in the late stages of our career. So if that describes your current condition, consider making Roth IRA and Roth 401 K contributions also might be a good time to make Roth conversions under very strict, unique circumstances that I won’t go into tonight. And if eligible, you might want to consider electing the Roth employer matching contributions. Not all employers offer that, but some do a Roth employer matching contribution. And so the theory is you want to take your tax break when it’s most valuable.

How To Invest In Early Career Years

So let’s say, in a hypothetical, you’re in your 20s, or in your 30s. You’re relatively new to the workforce, you’re relatively new in your career. You are making, let’s say, entry level wages, the lowest portion, lowest wages that you might see in your career. That’s the time to make Roth contributions. Now you get no tax break on the contributions into the Roth. But you enjoy a lifetime of tax free growth on the investments in the Roth. And then when you take money out of the Roth, typically at retirement, it all comes out tax free. And if you do your financial planning well over your lifetime, then as you age, as your income increases, as you continue to save and invest wisely, then your income through the years is naturally going to increase and it’s going to push you into higher tax brackets.

When To Withdraw From Or Contribute To A Roth IRA

So what then is a great time to then withdraw tax free money out of a Roth, when I say you might be in the 32 or 35% tax bracket? And if you’re early on in your career and your income is relatively low, today, then you might only be in your 12 or 22% tax bracket. So forego the tax deduction today. Put it in the Roth, get your tax break later in life, when ostensibly your income will be higher, and you’ll be in a higher tax bracket. And when you do the math on all that, it really generates a lot of net worth over your lifetime by being smart about when to make Roth contributions. Also, if offered by your employer plan, consider making after tax 401 K contributions, if you think your income is going to be higher in the future season. You get no tax break for after tax contributions to your 401 K. If your employer allows it, not all do. But if they do, the strategy here is the after tax 401 K contributions can eventually be rolled over to a Roth IRA. So if you don’t have a Roth 401 K, you may be able to make after tax Roth 401 K contributions, and then convert that over to a Roth later on.

Also, if your income limits prevent you from qualifying for Roth IRA contributions, the after tax contributions of 401k may let you and get money into a Roth that you otherwise wouldn’t qualify for. Now, you take the money after tax contributions in the 401k. You roll them over into a Roth, you can roll over the contributions, but you can’t rollover the earnings portion of the after tax 401 K contributions, the earnings on those contributions, that that has to be if you want to keep it in tax protected wrapper that gets rolled over into a traditional IRA. And that’s a non-taxable event when that occurs. But when the money comes out of the traditional IRA, then it becomes taxable, but a little bit more sophisticated, clever way of working the tax code to advantage. Obviously, that’s a little bit more complex. You better know what you’re doing when you make those transactions work with a good custodian who can guide you through it, or of course, a good financial adviser who’s done this before.

If you are age 59 and a half or over, you might want to consider accelerating traditional IRA withdrawals to fill up lower tax brackets. If you’re not working, or you’re not earning much ordinary income. So 59 and a half, you can start taking withdrawals out of IRAs without penalty. But out of a traditional IRA, they will come out subject to ordinary income tax. So while you’re working, if you’re in your peak earning years forget about this, you do not want to do this. But let’s say you retire early, hypothetically at age 60. Okay, now your ordinary income has gone down to zero. That may be a great time to start purposely taking out large portions of your Traditional IRA, because they will come out at lower income tax rates than if you were currently working. And for those of you who have large balances in traditional IRAs that will eventually be subject to required minimum distributions in your 70s and force, sometimes 10s of 1000s sometimes over $100,000 a year of, of required minimum distributions subject to tax. If you get it out earlier, at a lower tax rate, you can lower your overall tax bill.

Kevin Zywna, Wealthway Financial Advisors: Tonight, we’re talking about smart financial planning moves to make before the year end. Running out of time here. We’re at the end of November. We’re looking down the barrel of 2023. Getting ready to turn the page. Here’s some moves that you can make before year end that might enhance your overall financial situation. I was talking about some tax planning moves that you could make to reduce your overall tax bill. If you expect your income to increase in the future, which generally speaking most of us are on that trajectory. Start out young, make entry level wages and work your way up. So in your early years of your career, probably a good chance, good opportunity to take advantage of Roth IRA types of investment vehicles. Now how about the opposite of that?

What if you expect your income to decrease in the future? What do you do then? Well, usually this applies most directly to people approaching retirement. You’re in your 60s, maybe early 70s peak earning years. You step off the treadmill into retirement, your earned income, your income, taxable income reduces substantially. So what would you do in that type of circumstance? Well, consider strategies to minimize your tax liability now, such as traditional IRAs and 401 K contributions instead of contributions to Roth. Remember what I said before the break, you won’t get the IRA contribution tax break wherever the tax rates are most favorable to you.

So if you are in the higher tax brackets because you are in your higher income earning years, then that is when you want to forego the Roth. Because you don’t get a tax break for contributions. You do want to take advantage of traditional IRA contributions and traditional 401 K contributions. That money comes out of your paycheck pretax, so you don’t pay tax. You get a tax deduction, on the money that goes into your 401 K plan. This also goes for your TSP, the 403B, the 457, all the other company sponsored retirement plans, simple IRA, contributions you make directly from payroll deduction. You get a tax break so when you’re in your higher earning years, that’s when you want to take advantage of those types of vehicles.

Understanding Tax Brackets

A little bit on tax brackets… Let’s say you are way up there in the 32% tax bracket, federal tax bracket that is, and then your income drops down to just the social security level, that might drop you down to into the 12% bracket. Now you want to start taking money out at 12%. You’re getting a tax break at 32. Now you take it out at 12. You win, the government loses. Just following the rules, being smart about which type of tax vehicle to take advantage of. Okay, so if you expect your income to decrease in the future, like most people, as they approach retirement, take advantage of those company sponsored retirement plans. They’ll set you up for a good net worth boost later on in life.

How about do you have any capital losses for this year, or carry forward from prior years? So like I said earlier, if you have some capital losses and taxable investment accounts, you can use those to offset capital gains in the same year. Capital losses can be carried forward until they’re all used up. But don’t take capital losses just to reduce your tax bill. We don’t want the tax tail to wag the investment dog. You can get some short term benefit, but usually, it’s to the long term detriment of the overall investment portfolio and to your overall net worth. So that has to be done very methodically, and very carefully.

Maximize Charitable Donations For Tax Purposes

Gift Appreciated Securities

How about are you charitably inclined? Okay, here’s some good tax strategies you can take advantage of if you’re going to give to charity anyway. So consider exploring tax efficient funding strategies such as gifting appreciated securities, or making qualified charitable donations. So those are two of our probably most favorite strategies that we use in our practice. Number one is gifting appreciated securities. So guess what, you don’t have to give cash to charities. They will take your mutual funds. They will take your exchange traded funds. They will take your shares of Apple or Procter and Gamble or Amazon. They will take most, most not all, but certainly the larger ones. And even churches and community based charities can accept appreciated shares of stock or mutual funds or ETFs. As a form of donation, the advantage to you, the giver, is if there’s an unrealized capital gain, (which means an appreciation and value of that stock or mutual fund). If you don’t sell it, you never incur a capital gain. So by directly gifting the shares to a charity (and letting the charity sell the appreciated shares of stock). They don’t pay a tax on it either because they’re a charity. So when you have a low cost basis, appreciated gain in the stock, instead of selling the stock or mutual fund to create cash to then give to charity. That’s tax inefficient. Because you have to pay capital gains tax on the sale, which is going to cost you money. And then you give something to charity, and maybe you get, you know a tax deduction for doing it but that really depends on the exemption limits as well. So donate appreciated stocks to charities, you never have to incur that capital gain. And you get to deduct it, if your tax works out right, but the entire value of the of the investments that you transfer to the charity, that you get to deduct the total amount on the day that it’s granted to the charity. So a very tax efficient way of donating to charities. And, like I said, more and more of them are set up to do this, it’s not really that exotic, but you always want check with the charity first, to see if it will work.

Gift IRA Required Minimum Distributions

The other one is making a qualified charitable donation. Now, this has to be done from an IRA. And you have to be 70 and a half or older in order to do that. But this is a great way for people who have to take required minimum distributions, who maybe don’t need the required minimum distribution. So the government is going to force you to take money out of your IRAs, at some point in your 70s, that age is shifting each year. So if you have to take it out, it’s going to be subject to ordinary income tax, unless you donate all or a portion of it directly to a charity. And that way, it never shows up as ordinary income. So it’s never taxable. And that’s a more tax efficient strategy than taking the money out, pay an ordinary income tax, then writing a check to the charity, and maybe the amount you contribute is tax deductible. So directly, donating money from your IRA from your traditional IRA that ordinarily would be subject to ordinary income tax can be avoided by doing qualified charitable donations. In our practice, we have special checkbooks that we give to our clients, that they write checks right out of their IRAs to the charities, and so it gets properly recorded. And when you do your taxes, there’s a little bit of additional administration involved. You do have to make sure you keep those check receipts. So that when you file your taxes, you make sure that you properly record the fact that all or a portion of the money that came out of your traditional IRA went directly to a charity. And if you do that, it never counts as ordinary income. So very tax efficient strategy, for those who are charitably inclined.

Roll Multi-Year Contributions Into One Year

And then one more for those who give to charity. Consider maybe bunching the contributions you give. So, you know, the standard deduction now is pretty darn high. $13,850, if you’re single, it’s $27,700. If you’re married filing joint, so that means your charitable contributions. And other deductions have to be higher than those limits before it even registers as a deduction. Otherwise, you just take the standard deduction. So if and only about the last statistic, I saw only about 10% of the population now itemizes their deductions because the standard deductions are so high. So that means most people aren’t really getting a tax break for their charitable contributions. However, let’s say you give $10,000 to your church every year, okay and you’re married, filing jointly. So you’re not able to really deduct that because the standard deduction is higher. So you’re just going to take that, well, if you go to church and say, “what do you think about this deal? I’m going to give you three years of my donations in one year, and then I’m going to give you nothing for the next two. Would you take that?” Most charities and churches will say, “Absolutely, we will take that,” because they’re getting a big chunk of money up front, and it goes into their coffers. And then they know they have instead of maybe, each week getting a little bit dribs and drabs and then maybe you forget or maybe you move out of the area, and maybe they don’t get as much. So $10,000 a year you branch out you give $30,000 in one year. Now you’re over the standard deduction. Now you have more that you can deduct from your taxes, and you lower your overall tax bill. So consider bunching regular, charitable contributions that you make in one tax year, and you might get over that threshold and pay lower taxes in that year. All right, and a pause here.

Tax Implications Of End Of Year Gifts

This might be volume, one of smart financial planning moves to make before year end. Maybe next show, which will be Tuesday, December 12, at 6pm will be Volume Two of smart financial planning moves to make before year end. Because there are a fair number of things you can do from a tax standpoint, from an asset standpoint, from a cash flow standpoint, from an income standpoint, to try to set you up for financial success going forward. More financial planning steps that you can take before the year end.

So this doesn’t apply to too many people here in Hampton Roads, but I think I’ll throw it out there anyway. Will you be receiving any significant windfalls that could impact your tax liabilities such as restricted stock units, vesting, stock options, or maybe a large bonus at the end of the year? If you are, if you’re expecting this type of activity, then one of them in most cases, then even in a bonus, even a straight paid out salary bonus, tax withholding is not typically set up sufficiently to accommodate the value of what you’re receiving. So restricted stock units, stock options, usually there’s no withholding setup on that at all, depending on the type of transaction. The bonus, you probably have your regular withholding set up for your paycheck, but then you get a big lump sum. And it turns out that the percentage you have withheld is not really enough to cover the entire federal and state tax bill. So what happens in these types of transactions is people get surprised with a really big tax bill at the end of the year. So number one, be mindful and number two, put away money to help pay your tax bill. If this applies to you. And or three, set up withholding or proper withholding on those vehicles where you can if your company will allow it or for you might need to make quarterly estimated tax payments or at least the fourth quarter estimated tax payments if you get a surprise stock option or stock grant or bonus. So if you pay a quarterly estimated tax, then you don’t have to pay a big tax bill when you file your taxes. Sometimes there can be a small penalty involved if you don’t pay the quarterly estimated tax. So something to keep on your radar.

Update Estate Plans For The New Year

How about some estate planning issues before the year ends? Any changes to your family situation? Marriage, second marriage, divorce, second divorce any heirs come into or out of your life that you would either like to inherit or disinherit? Have you bought or sold any assets this year that were a part of your estate plan that are now no longer part of your estate plan? Land that you have in the western part of the state, vacation home, something like that, that you had in your will, or trust, now is no longer there. Time for an update. Time for a refresh. Time to take a look at any of that activity through the year. And if it’s been meaningful enough, then we always recommend that you consult with a proper estate planning attorney to get your documents brought up to speed as well.

End Of Year Gifting Limitations

How about any gifts that still need to be made this year? You know, any one of us can gift any other one of us up to $17,000 this year, without any tax implications to either the giver or the receiver. $17,000 is the amount you can give to any friend, any family member, any relative that you want – no tax implications. And if you are a couple and you want to gift to, say, your children, each person in the couple can gift $17,000 to each child. So that’s a total of $34,000 that you could give to one of your children in this tax year without any tax implications. Next year it goes up to $18,000. So we’ll be happy to receive even more from mom and dad that year if you’re so inclined.

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