It’s hard to believe, but the New Year is getting close and that means it’s time to do some year-end financial planning to minimize any tax payments due to Uncle Sam on April 15.
Most people, it’s safe to say, don’t like paying taxes. While Benjamin Franklin was probably correct in saying, “In this world nothing can be said to be certain, except death and taxes,” careful and timely planning can soften or perhaps eliminate the blow of at least the taxes.
Some of the most effective planning strategies revolve around either intentionally pulling forward or pushing off the recognition of taxable income and gains. With the year-end just around the corner, now is the best time to review your planning options, seek the advice of a tax specialist and potentially save some money and a lot of stress.
Here are four tax planning tips to get your started:
1. Maximize contributions to your retirement account
Contributions to company retirement plans and most individual retirement accounts (IRAs) lower your taxable income. While the deadline to make 2019 contributions to an IRA is April 15, 2020, that’s not the case with an employer defined contribution plan, such as a 401(k) or 403(b), which have a calendar-plan year. The cut-off date for those contributions is December 31, so make sure you save as much as possible by the end of the year to help reduce your tax bill.
For your company retirement plan, carefully review your current tax rate and anticipated future rates to determine if you are better off making a pre-tax contribution (contributions are not taxed, but any gains are upon distribution), a Roth IRA contribution (pay taxes now and receive qualified distributions tax-free) or a mix of both. Similar considerations would apply as to whether to make a traditional IRA or Roth IRA contribution, subject to various income limitations.
2. Does a Roth IRA conversion make sense?
Unlike pre-tax contributions to 401(k) plans or deductible IRA contributions, Roth IRA contributions do not lower taxable wages. However, qualifying distributions, which are generally received after the age of 59 ½, are tax free. This explains the tremendous surge in popularity for Roth IRAs over the past 15 years.
In carefully reviewing your situation, it might make sense for you to consider a Roth IRA conversion if your anticipated tax rate today is lower than the anticipated rate after age 59 ½. This would trigger taxation on the converted amount now, but qualifying distributions – including any gains – would be received tax-free in retirement.
3. Minimize taxes by maximizing charitable donations
The Tax Cuts and Jobs Act of 2017 significantly changed standard deductions (now double previous levels) and federal deductions of state, local and property taxes (now capped at $10,000). Most taxpayers, therefore, will opt to take the standard deduction ($12,200 for individuals and $24,400 for married couples filing jointly) as opposed to itemizing various deductions. If your itemized deductions exceed those thresholds, then making financial gifts to charities/nonprofits will help lower your taxable income – but only if you act before December 31.
Whether you itemize or take the standard deduction, taxpayers making charitable gifts should consider donating appreciated stock – such as your Apple stock that has increased over the years – instead of cash. If you have owned the stock for more than one year, then you get to deduct the fair market value of the stock instead of what you paid for it (the cost basis).
Taxpayers over the age of 70 ½ might also consider a charitable contribution from their traditional IRA. This qualifying charitable distribution could also be used to satisfy annual required minimum distributions, thereby avoiding the recognition of the gifted amount as taxable income.
4. Save for healthcare and reduce taxes with an HSA
Healthcare is one of the biggest expenses for many families and individuals. To help make it more affordable – and possibly reduce your tax bill – you can open a health savings account (HSA). HSA contributions limits for 2019 are $3,500 for individuals and $7,000 for families, and you can use the money to pay for qualified medical expenses, such as doctor visits and prescription drugs.
Like a 401(k), the contributions are deducted from gross wages so you do not pay tax on the amount you put in the HSA. One of the great tax benefits that an HSA provides is that qualifying distributions are not taxed. So, with respect to Mr. Franklin, when used properly an HSA can help you escape the certainty of taxes.
Remember, in order to take advantage of these tax-saving ideas, you must act by December 31. And always consult with a tax advisor to make sure you are maximizing the benefits of these tax-saving strategies.
Matt Knight is vice president, financial advisor with First Horizon Advisors.
“Disclaimer: The information in this column is general in nature, and none of its contents should be construed as providing financial advice for your specific situation.”