Tax planning can feel like a buzz word to so many at the end of the year. But what does it mean? Am I doing everything I “should” be? And what happens when the clock strikes twelve, ringing in the new year? Is all hope lost for efficient tax strategy until the following December?
The new year can be a time of resolutions and new commitments for many. Implementing an efficient tax strategy now can help make year-end planning conversations run smoothly.
A great strategy is to set retirement goals and begin implementing them. Here are some great options to consider.
1. Efficient Contributions: Saving for retirement can provide tax benefits today and income for tomorrow. Comprehensive tax planning looks at more than just maximizing today’s savings. In a taxpayer’s highest earning years, maximizing 401(k) contributions can reduce current income and tax. In periods where income is only anticipated to rise, Roth 401(k) and Roth IRAs make great tools to save for future retirement with tax free growth and earnings. Roth vehicles do not provide the same current year tax benefits and instead allow focus to be on future tax savings. Roth 401(k)s are very beneficial for young workers, those early in their careers and those working reduced hours nearing retirement.
2. Roth Conversions: What if you don’t anticipate a dip in income until the early years of retirement, where income is driven by Social Security and an investment portfolio but required distributions from IRAs and 401(k)s have not yet begun? Roth conversions are a great tool to smooth income, slightly increasing tax brackets today to lower tax brackets in the future.
3. Additional Retirement Contributions: If you have outlined your retirement goals and see the availability for additional contributions, there are plans that allow contributions up until tax returns are filed. Self-Employed Pension Plans (SEP), Profit Sharing Plans (pass-through entities only), and Nondeductible and Deductible IRA contributions all remain possible options for prior year contributions, where applicable, for those who missed contributing before the close of the year.
4. 529 Plans: Moving assets to young children can often result in more tax then anticipated due to Kiddie Tax, or tax for dependent children being calculated at the rates of the parents. 529 Plans allow assets to be gifted to children with growth and exempt from Federal tax if the funds are used for qualified education expenses (expanded to include K-12 in 2017). What not everyone knows is there may be state tax benefits available as well.
In the mid-Atlantic region, Pennsylvania, New Jersey (beginning 2022), Maryland, DC and Virginia allow tax benefits and/or deductions for contributions to 529 plans (at the time of this writing, Delaware does not). 529 plans are state sponsored programs, and every state has different requirements. Always speak to an advisor knowledgeable in your state of residence to ensure the plan you have invested in conforms with state requirements.
There are many reasons funding 529 Plans may not be appropriate, such as account balance limitations or the restricted use to receive tax free growth. For wealthy individuals looking for alternative investment strategies, I redirect you back to #1. Retirement contributions for children can be an efficient strategy for multiple taxpayers at once.
5. Maximize Tax-efficient Charitable Giving: When it comes to charitable giving, not all donations are created equal. Qualified Charitable Deductions or directing a required distribution to a charitable organization provides a reduction to ordinary income (up to $100,000 annually). Reducing ordinary income carries a greater impact in tax reduction then charitable giving, characterized as an itemized deduction. When taxpayers are not required to draw from an IRA, gifting appreciated stock held for greater than one year can be more beneficial than cash. This is because when appreciated stock is transferred to a charitable organization, the unrealized gain is not recognized. The donation results in both a reduction of income on the non-recognized capital gain as well as an itemized deduction for the Fair Market Value (FMV) of the stock.
Recommendations can change from one taxpayer to another and annually as facts and circumstances change. Always consult an advisor or a tax professional when making any large changes to tax planning strategy and understanding new law.
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