By: Sean Gallagher, CFP®
As the year draws to a close, it's the perfect time to look at your finances and implement year-end tax planning strategies. With careful planning, you can optimize your tax situation, reduce your tax liability, and save more money for the future. In this article, we'll explore various tax planning strategies that individuals and families can consider to maximize their financial situation before the year-end.
1) Review Your Income and Deductions
The first step in year-end tax planning is to review your income and deductions for the current year. This includes assessing your sources of income, such as salary, bonuses, dividends, and interest, to determine if there are any opportunities to defer or accelerate income. For example, if you expect a bonus in December, you might want to defer it until the following year to reduce your current tax liability.
On the deduction side, consider whether you can maximize itemized deductions like mortgage interest, property taxes, medical expenses, and charitable contributions. If you're close to meeting the threshold for itemizing deductions, you can strategically time these payments to optimize your deductions.
2) Contribute to Tax-Advantaged Accounts
Contributing to tax-advantaged accounts is an excellent year-end tax planning strategy. This includes funding retirement accounts such as a 401(k) or an Individual Retirement Account (IRA) for individuals. Contributions to these accounts can reduce your annual taxable income while helping you save for retirement.
For families, consider contributing to a Health Savings Account (HSA) or a Flexible Spending Account (FSA). HSAs offer a triple tax advantage: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. FSAs also provide pre-tax benefits for eligible medical and dependent care expenses.
3) Harvest Capital Gains and Losses
Capital gains and losses can significantly impact your tax liability. If you have investments, consider tax-loss harvesting, where you sell investments that have declined in value to offset capital gains. By doing this strategically, you can minimize your capital gains tax liability. Avoid wash sale transactions by waiting more than 30 days to repurchase the investments.
Conversely, if you're in a low tax bracket or have capital losses to offset, you might consider realizing capital gains by selling investments with appreciated value. Depending on your tax situation, you may pay little to no capital gains tax on these gains.
4) Explore Charitable Giving
Charitable giving allows you to support causes you care about and provides tax benefits. Consider making charitable contributions before the end of the year to take advantage of deductions. Remember to itemize deductions to claim charitable donations on your tax return.
If you are unsure of the charity you'd like to donate to, you may consider contributing to a Donor Advised Fund. These funds allow you to claim a tax deduction on the initial contribution to the account while making actual donations to charitable organizations in the future.
5) Plan for Education Expenses
If you have children or are pursuing higher education yourself, take advantage of tax-advantaged education savings accounts. 529 plans and Coverdell Education Savings Accounts (ESAs) allow you to save for education expenses while enjoying tax benefits. Contributions to 529 plans are not federally deductible, but earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses. Residents using state-sponsored 529 plans may be eligible for a state tax deduction in the year they contribute.
6) Roth Conversions
For those in a low tax bracket this year relative to future years, consider converting pre-tax retirement assets to tax-free Roth accounts. When you convert traditional retirement account funds, such as a traditional IRA or 401(k), into a Roth IRA, you pay income tax on the converted amount upfront. However, once the funds are in the Roth IRA, they can grow tax-free, and qualified withdrawals in retirement are entirely tax-free. This tax-free income can allow retirees more flexibility in managing their tax liabilities during retirement, as they won't be subject to required minimum distributions (RMDs) like traditional retirement accounts.
Additionally, Roth conversions can be a valuable estate planning tool, allowing individuals to pass on tax-free assets to their heirs, potentially creating a lasting legacy for their loved ones.
7) Consider Gifting Strategies
Year-end is an opportune time for gifting strategies to benefit your estate planning and reduce potential estate tax liabilities. The annual gift tax exclusion allows you to gift a certain amount of money or assets to individuals without incurring gift tax. In 2023, the annual exclusion is $17,000 per recipient. A married couple can gift up to $34,000 to a single recipient without incurring any gift tax liabilities.
Additionally, you can contribute to 529 plans for your loved ones, providing education funding and estate planning benefits.
8) Additional Year-End Planning Opportunities
Verify that Required Minimum Distributions have been taken correctly.
Increase withholding from income sources if you've underpaid on estimated taxes throughout the year.
Review Medicare open enrollment for any changes to your coverage, if applicable.
Ensure you meet the eligibility criteria to claim tax credits. Some common tax credits for individuals and families include the Child Tax Credit, the Earned Income Tax Credit, and the American Opportunity Tax Credit for education expenses.
If you maximize your retirement account contributions throughout the year, plan to increase your contributions in January to reflect the increased limits for 2024.
Year-end tax planning is an essential financial exercise for individuals and families. By carefully reviewing your income, deductions, and financial goals, you can implement strategies to optimize your tax situation, reduce your tax liability, and save more money for the future. At HIGHLAND, we proactively monitor our clients' situations for these opportunities and provide personalized guidance tailored to their specific circumstances.
Don't wait until the last minute; start your year-end tax planning now to make the most of the available tax-saving opportunities.
Sean Gallagher is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Sean graduated from Virginia Tech’s financial planning program in 2018 and successfully passed the CFP® national exam in 2019. As a Financial Planner at HIGHLAND Financial Advisors, Sean works on developing comprehensive financial plans and investment management for all clients.