Year-End Tax-Planning Strategies

As we come to the end of another year, it is time once again to starting thinking about taxes.  And while most of us would prefer to put our head in the sand and not deal with taxes until the very last moment (if at all), that is likely a big mistake, and one that could be costly to both your financial well-being and your peace of mind.  Since taxes are a way of life (and even haunt us in death), it is best to get started thinking about them and planning your strategy as early as possible, so that you can make the best of your situation, whatever it may be.  With that in my mind, here are five tax-planning strategies to consider before the end of the year.

  1. Tax-Loss Harvesting – Nobody likes to see a loss on their investment portfolio.  However, even the best investors will suffer losses from time to time.  And when you do, you might as well make the most of it.  One way to accomplish this is through strategic “Tax-Loss Harvesting” in your taxable (non-retirement) accounts.When you have an unrealized loss (aka a “Paper Loss”) it often makes sense to realize it before December 31.  This loss could be on an individual stock, bond, mutual fund, or Exchange Traded Fund (ETF).  In order to turn an unrealized loss, which has no tax benefit, into a realized loss, which is likely to help reduce your overall tax burden, all you have to do is sell some or all of the losing position.  Since the IRS doesn’t allow you to buy back into the same security until 30 days have passed to avoid the ‘Wash-Sale” rule – and most of us do not want to be out of the market that long or have our asset allocation out of whack for 30 days – most people will find an ‘equivalent security’ to take its place in the meantime. Again, it is vitally important to remember this strategy has to be utilized in a taxable account in order for the loss to help reduce your taxes. Once the loss is realized, it can be used to offset realized gains from other sources and/or used to offset a portion of your ordinary income for the year, and potentially for many years to come. 
  2. Increasing Retirement-Plan Contributions – The end of the year is a great time to consider increasing your retirement-plan contributions for the coming year.  By getting this started early, you can often make relatively small increases to the amount you contribute to your retirement account each pay period and still see a significant positive impact on your eventual account balance.  This is because with the power of compounding, even small incremental changes can have a large effect when compounded over many years.  The maximum employee deferral limit into a work-place retirement-plan, such as a 401(k) or 403(b), is $19,500 for individuals under age 50 in 2021, and $26,000 for individuals age 50 and older.  Another consideration in determining the amount to contribute to your work-place retirement-plan each pay period, is whether you have a company match, and how it works. Though it may sound counterintuitive, with many retirement plans, you want to make sure you don’t contribute too fast.  If your employer offers a matching contribution, and their match is determined per pay period, you will not want to max out your retirement-plan contributions before the last pay period of the year.  If you do, you may miss out on a portion of the match your employer is offering.  This is one of the few cases in investing where funding too much too soon can actually cost you money.  In this situation, the perfect contribution amount is one that gets you to the maximum allowable contribution on the very last paycheck of the year.
  3. Roth IRA Conversions – In years when you have temporary or abnormally lower income than usual (perhaps after being laid-off during a pandemic?) you may have an opportunity for lifetime tax savings through Roth IRA conversions.  Converting assets from a Traditional IRA or Traditional 401(k) into a Roth IRA is basically a choice between being taxed now (converting to a Roth IRA), or being taxed later (keeping assets in Traditional plans).  While almost no one likes the idea of paying taxes any sooner than necessary, if you find yourself in a significantly lower tax bracket this year (or any year), and are unlikely to be in this low a bracket in the future when taking distributions from your retirement accounts, this strategy could significantly lower the overall amount of taxes you pay in the long run.  Unlike making contributions to a Roth IRA, there are no income limits to be able to convert from a Traditional IRA to a Roth IRA, so anyone can pursue this strategy.                                                                                                                                              As with all things financial, the decision of if, or when, to convert money from Traditional plans to Roth IRAs is not one that should be made in a vacuum.  You must look at all factors concerned and how they work together.  One of the biggest factors to consider, in addition to tax brackets now and in the future, is where the money will come from to pay the taxes due on conversion.  Often times, for this strategy to work to your advantage, you have to have the cash available outside of the IRAs to pay the taxes due on conversion.  If you are forced to use money from inside the retirement account to pay the taxes, this significantly decreases the advantage of using the strategy in the first place.  Another factor to be considered is that conversions from Traditional plans to Roth IRAs are considered taxable income for the year.  As such, this could affect the amount you pay for income-based programs such as Medicare, or the amount of education assistance your child receives when applying for federal student aid.  That is why it is so important that this decision be made as part of the bigger financial picture, and be discussed and confirmed with your tax advisor and financial planner before making any final moves.
  4. Timing of Income and Expenses – For self-employed individuals, or people with secondary sources of income such a rental income, the timing of income and expenses can be an important tax strategy to consider.  In general, you will want to accelerate expenses and defer income in years where you are in a higher tax bracket, and you will want to accelerate income and defer expenses in lower income tax bracket years.  Self-employed individuals often have some flexibility around the timing of a portion of their incomes and expenses, but still must make sure they are reporting these sources in a timely manner. With proper planning and forethought, beneficial timing of income and expenses can be accomplished while staying in the good graces of the IRS.
  5. Required Minimum Distributions – Individuals age 72 and older are usually required to start taking money from their Individual Retirement Accounts (IRAs) and work-place retirement accounts if they are no longer working.  These mandatory distributions are called “Required Minimum Distributions” (RMDs).  RMDs were eliminated for 2020, as part of the CARES Act that was passed by Congress in response to the financial hardship brought about due to the COVID-19 pandemic.  However, as it stands now, RMDs are back on the schedule for 2021 and beyond.  In normal years (NOT 2020), if you fail to take your RMD by December 31 each year, you are subject to an IRS penalty of 50% of the amount that was supposed to be taken.  As such, December is a great time to double-check that these distributions have been taken care of correctly and in a timely manner.Another tax-planning strategy around RMDs is centered around charitable giving.  The IRS now allows anyone age 70 ½ or older to give up to $100,000 to qualified charities from their IRAs, and avoid paying taxes on these distributions.  So, if you are subject to the RMD requirement, and are planning to give money to charity as well, giving directly from your IRA might make a lot of sense.  This is especially true now that the IRS has put significant limitations on what counts as a qualified charity and the amount of deduction you may receive for charitable donations.  Once you turn 70+ You should review this strategy with your tax consultant each year to see if it makes more sense for you to give from non-retirement accounts or directly from your IRAs.

Yes, we all hate thinking about taxes.  However, as we all know, taxes are very much a way of life and not something that can be avoided.  Since that is the case, we might as well take advantage of tax-savings strategies when and where we can, and make sure we are paying our fair share of taxes, but not overpaying due to bad planning or plain old laziness.


DisclaimerWe are not tax-experts and are not offering tax-advice. Please discuss all tax matters with your tax-consultant and/or attorney before making any decisions.The commentary on this website reflects the personal opinions, viewpoints and analyses of the Topel & DiStasi Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Topel & DiStasi Wealth Management, LLC or performance returns of any Topel & DiStasi Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Topel & DiStasi Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.