The financial climate during 2022 was active, volatile and unpredictable. Market declines can be a good thing when you’re looking to create opportunities to balance your portfolio. If you want to capitalize on the down market, it’s a good idea to start with an analysis of your financial situation that takes in a variety of considerations to determine a strategy to pay the right amount of taxes and possibly save money in the process. With only weeks away from the end of 2022, it’s now time to consider some year-end tax strategies.
There are several ways to help mitigate your tax responsibility:
The main goal of tax-loss harvesting is to defer income taxes years into the future, ideally when you retire, and potentially in a lower tax bracket. The strategy dictates you sell investment assets like stocks, bonds and mutual funds at a loss to lower your tax liability. When your capital losses are more than your gains, the IRS allows you to apply up to $3,000 in losses against your taxable income. Plus, you can carry over the remaining losses to offset income in future years.
Retirement Account Contributions
One strategy is to maximize your employer contributions to your retirement accounts, such as 401(k), Traditional IRA, Roth IRA and Health Savings Account (HSA). For this current tax year, the maximum allowable 401(k) contributions are: $20,500 up to age 49 and $27,000 for ages 50-plus along with a $6,500 catch-up contribution. The maximum IRA contributions are: $6,000 up to age 49 and $7,000 for ages 50-plus along with a $1,000 catch-up contribution. If you own an HSA, you may want to consider maxing out contributions as well — $7,300 for families, $3,650 for individuals and an additional $1,000 for individuals ages 55-plus.
It's also important to note that some states you can contribute a certain amount to your 529 plans for college and you’ll qualify for a tax deduction. It’s not only retirement accounts that may provide you with tax mitigation tools. Speak with your financial professional to learn more about account contributions.
Required Minimum Distributions (RMDs)
Traditional IRAs, SIMPLE IRAs and SEPs mandate RMDs on April 1st the year following your 72nd birthday. To avoid a penalty, you need to take your RMD by December 31st. If you don’t take your required minimum distribution by then, you would face a 50% excise tax on the withdrawal amount based on your age, life expectancy and beginning-of-year balance. If you don’t need the cash flow, consider a Qualified Charitable Distribution (QCD) pulled directly from your retirement account to a public charity of your choosing. Also, this will help keep your taxable income low.
Roth IRA Conversion
Our last newsletter article covered this topic in-depth. Essentially, it’s a great way to save you money in the long run, especially in this current down market. The conversion is considered a taxable event and any pre-tax contributions and earnings converted to a Roth IRA are added to your gross income and taxed as regular income. But earnings and contributions within the account grow tax-free and once an account has been opened for 5 years, when you reach the age 59½, you’re able to withdraw funds penalty-free.
Bunch Itemized Deductions
There are certain expense categories that the IRS will allow you to classify as itemized deductions. These categories are: Medical and dental, deductible taxes, Qualified mortgage interest (including points for buyers), Investment interest on net investment income, Charitable contributions and Casualty, disaster and theft losses. These expenses can only be itemized if they’re higher than a certain percentage of your AGI — Adjusted Gross Income.
For 2022 taxes, single filers may claim a $12,950 standard deduction, while married couples filing jointly can claim a $25,900 standard deduction.
There are plenty of charitable organizations doing great work and could use your financial help. Find a charity that aligns with your beliefs and take advantage of the tax break afforded for charitable donations. As stated above, you can bunch these donations into one standard deduction. For 2022, deduction limits for charitable gifts are 30% of adjusted gross income (AGI) for contributions of non-cash assets, if held more than one year, and 60% of AGI for contributions of cash.
There’s also the option of donor advised funds. This concept, which is becoming increasingly popular, allows you to group multiple years donations into one lump sum contribution. An effective strategy during years of a large financial windfall such as a bonus or an inheritance. The large, grouped contribution also provides the added benefit of a bigger tax deduction.
Flexible Spending Accounts (FSAs)
Most FSAs are bank accounts created specifically for healthcare costs, but there are also Dependent FSAs which are designed for childcare and adult care services. These accounts both contain pre-tax dollars for medical expenses, which would help lower your taxable income. Before the end of the year, it’s important to spend any extra funds within the account. Schedule any check-ups needed. Make sure your prescriptions are filled. Any money leftover in the account after December 31st will be taxed and, unless your employer allows a certain amount to rollover into the following year, you’ll lose these funds forever.
Rebalance Your Portfolio
Many people target the end of the year to review the current asset allocation of their investment portfolios. Over the course of a year, the market value of each security you hold earns a different return, often causing the weighting of each asset class to change. You want to make sure that your portfolio stays on or close to the asset allocation strategy that best aligns with your goals, time horizon, and tolerance for risk. This is true for IRAs, 401(k)s, and non-qualified investment accounts. A financial professional can help you look at your entire picture to determine if any changes should be made.
Remember, it’s important to speak with a tax-professional to answer any lingering questions you make have about any tax consequences deriving from the above options such as Roth conversion, itemized deductions, tax-loss harvesting and more. Your financial professional can help reduce your tax liability now or at some time in the future.
As always, Team SKG is at the ready to help you take the right actions for your personal situation and to put you in a strong position for 2023.
Neither MML Investors Services nor any of its subsidiaries, employees or agents are authorized to give legal or tax advice. Consult your own personal attorney, legal or tax counsel for advice on specific legal and tax matters.