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End-of-year tax tips for the savvy investor

Where has 2019 gone?

It’s hard to believe the holidays are almost here, and that in less than 6 weeks, we’ll be ringing in 2020!

So, before December 31st arrives, here are a few tax planning items you might want to consider adding to your ‘to-do’ list.

Defer income to 2020

Are you an employee expecting a bonus this year? Are you a freelancer or contractor who has control over when clients are billed?

In both scenarios, take a look at this year’s total income and compare it to what you think it might be next year. If there’s a good chance you’ll earn less next year, shifting any year-end income from this year into 2020 can lower this year’s tax bill.

On the other hand, if you think you might make more next year, consider accelerating income into this year.

Max out your 401(k)

If you’re looking to lower your taxable income, one of the easiest ways is by saving as much as possible in your traditional 401(k). Anyone age 50 and older can contribute up to $25,000 in 2019.

Take note of how much you’ve contributed so far this year. Will you reach the max – or whatever goal you have – by the end of next month? If you won’t, massage your budget so you can siphon extra cash toward retirement.

And just keep in mind that you likely only have a few pay periods left before the end of the year, so if you want to adjust your contribution levels, do it ASAP.

Mind your RMDs 

If you have money in a traditional IRA or 401(k), you’ve been enjoying tax-deferred growth all these years. But, eventually, the government wants its tax revenue!

Starting at age 70 ½, the IRS requires you to start taking annual withdrawals, called Required Minimum Distributions (RMDs), from these tax-deferred accounts. The amount is different for everyone and is based off the account balance and your life expectancy.

In most cases, you must take your RMD before December 31st. The only instance in which this deadline is different is the year in which you turn 70 ½. In this case, you technically have until April 1st of the following year. (However, we generally recommend against waiting this long since you would then be taking two RMDs in the same tax year. This move could bump you into a higher tax bracket.)

If you fail to take your RMD by the deadline, the IRS will hit you with a pretty severe penalty: 50% of the amount you were supposed to withdraw.

Your advisor can help you figure out how much to withdraw. If you don’t have an advisor, you can use an IRS worksheet.

And here’s a tip ifyou’re younger than 70 ½: Since your RMD is based off your account balance, the larger the balance, the larger your RMD – and the more taxes you’ll likely pay. Therefore, consider pre-emptive planning to begin drawing down that balance before the government forces you to start.

Consider a Roth conversion

Currently, federal tax rates are at historically low levels. A ‘Roth conversion’ is one way to take advantage.

This strategy turns pre-tax money sitting in a traditional IRA into after-tax money that sits in a Roth IRA. While you’ll pay taxes on however much you would like to convert, the benefits can outweigh that initial tax hit:

  • A Roth IRA provides tax-free growth on earnings that can also be withdrawn tax-free once the account holder is age 59 ½ and has held the account for 5 years.
  • Roth IRAs do not have RMDs, making this a useful legacy planning tool.
  • Qualified distributions from a Roth IRA are not counted in your adjusted gross income (AGI), a component that’s used in calculating potential taxes on Social Security benefits and the Medicare surtax.

(A particularly savvy time to make a conversion is when you’re retired but before you turn 70 ½. It’s likely your income – and therefore your tax rate – will be fairly low during this timeframe).

Harvest losses or gains 

Have investment losses? ‘Tax-loss harvesting’ allows you to use capital losses to offset capital gains (as well as up to $3,000 in income from other sources). Just a caution, though: tax-loss harvesting rules can get fairly complicated.

If your income is low enough, the opposite holds true: consider ‘tax-gain harvesting.’ Currently in 2019, if your taxable income is less than $39,375 as a single tax filer (or $78,750 if married and filing jointly), your long-term capital gains rate is 0%.

That’s right. You would pay zero tax on investment gains you’ve held for longer than a year once you sell.

Don’t forget about your FSA or HSA

There are two types of tax-advantaged accounts specifically designed to help you save for healthcare expenses: a Flexible Spending Account (FSA) and a Health Savings Account (HSA).

Contributing to either of these accounts by the end of the year can lower your taxable income.

But if you have an FSA you shouldn’t just focus on contributing by the end of the year. You should also focus on spending. Because one of the biggest differences between an FSA and an HSA is that, in many cases, FSA money must be used by the end of the year or else you lose it (HSA money is yours forever).

Some FSA plans offer a carryover option that lasts for a few months into the next calendar year. Reach out to your HR department if you’re unsure of your plan’s specifics.

Wondering what to spend your FSA money on? There are hundreds – if not thousands – of different products and services that qualify as IRS-approved medical expenses.

As always, you shouldn’t make any tax moves without talking with a qualified financial professional, such as a CPA. But if you can put some of these strategies in place now, you’ll likely thank yourself once tax time rolls around early next year.

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