Planning for year-end amid a market decline

2022 was tough for stocks and bonds. Year-end is a good time to think about some financial planning opportunities that have long been available, but that might look even more attractive than usual given the market decline.

Roth conversions

The 2017 Tax Cuts and Jobs Act lowered tax rates on a temporary basis — rates are set to return to higher levels starting in 2026 and will do so at lower income amounts.¹ While the lower rates are still around, it could be beneficial to convert pre-tax retirement dollars to a Roth IRA if you are projected to be in a higher tax bracket in the future. Converting assets in the current down market could be especially attractive if those assets can recover while in their new tax-free Roth status.

Charitable giving

Year-end is when most Americans tend to make their charitable gifts.² A taxpayer who is age 70½ or older can give up to $100,000 from their retirement account directly to a qualified 501(c)(3) charitable organization.³ If you are subject to required minimum distributions, this qualified charitable distribution can go toward satisfying the required distribution amount without needing to pay the income tax on it.

Another option is to gift appreciated securities, such as stocks — doing so allows you to receive a tax deduction while also avoiding paying capital gains tax on those appreciated securities. Since the 2017 Tax Cuts and Jobs Act passed and raised the standard deduction — now at $12,950 for an individual and $25,900 for a family in 2022 — it is important to ensure that you are itemizing deductions to receive the full tax benefit of your gift to charity.⁴ As a result, it may make sense to consider bunching together your contributions by using a Donor Advised Fund to try to ensure maximum tax savings.

Retirement plan funding

While retirement plan contributions generally do not have to be completed until tax filing time, in my opinion, with the market trading at more attractive levels than where we started the year, it may be a suitable time to start putting those contributions to work a bit earlier.

Many individuals would love to be able to contribute to a Roth IRA, but have too much income to do so. These taxpayers can still make a traditional IRA contribution, but due to their high income, it is likely non-deductible. If you have no other traditional IRA assets, this non-deductible IRA contribution can be converted to a Roth with potentially little or no tax due.

In my view, this opportunistic Roth IRA strategy is a terrific way for higher-income taxpayers to build up tax-free Roth IRA assets. Those with Roth 401(k) options at their employer plans may want to consider making “mega backdoor” Roth contributions if their plans allow. This strategy is a bit complicated, but it could result in an added $40,500 in Roth IRAs annually.⁵

Fund your 529s

Many states provide tax deductions for contributions to their 529 plans. Sending in a contribution before December 31 may help save on state-level taxes. In my opinion, 529 plans are great accounts, as they are triple tax-advantaged — contributions into the account are tax-deductible, the assets in the account grow tax-deferred and, if the assets are used for qualified education expenses, distributions are tax-free. In addition, 529s can be front-loaded with up to five years of the annual gift exclusion of $16,000 ($80,000 total) to amplify the impact of the 529.⁶

Tax-loss harvesting

When life hands you lemons, they say to make lemonade. When an investment declines in value, there can be an opportunity to sell that investment and take the capital loss for tax purposes, while swapping into another investment that provides similar market exposure. This gives you a tax loss that can be used to offset capital gains while allowing you to remain invested in the market so you can capture any bounce-back that might occur. While tough to look at, these capital losses result in real dollars saved in the form of a lower tax bill without actually having to change the outlook on your portfolio’s returns.

Rebalancing

While reviewing your portfolio for tax losses, it is also important to consider your current allocation compared to your target allocation. Market volatility can be disjointed, and not all assets move up or down simultaneously — or at the same rate. It is my view that efficiently rebalancing your target allocation when parts of your portfolio become over- or under-weight is the tried-and-true way to ‘buy low and sell high’ and can contribute to your long-term results.

Estate and annual exemption gifting

The current federal lifetime gift and estate tax exemption amounts are $12.06 million per person ($24.12 million per married couple) in 2022, though these exemption amounts are scheduled to sunset and revert to half of the current exemption.⁷ Estates exceeding the federal exemption amount are currently subject to a 40% estate tax, so significant tax savings can be had by implementing the right planning strategies today and locking in the higher exemption rates. For those that have already used their lifetime exemption, another opportunity awaits in January 2023 as the exemption amount increases to $12.92 million, supplying an added $860,000 of available exemption to everyone.⁸

In addition to the lifetime gift and estate tax exemption, there is an annual exclusion amount of $16,000 that you can gift to any individual without it counting against the lifetime exemption mentioned above. This amount is scheduled to increase to $17,000 starting in the 2023 tax year.⁹

¹ https://barberfinancialgroup.com/tax-rates-sunset-in-2026-and-why-that-matters
² https://neonone.com/resources/blog/year-end-giving-statistics
³ https://www.irs.gov/newsroom/reminder-to-ira-owners-age-70-and-a-half-or-over-qualified-charitable-distributions-are-great-options-for-making-tax-free-gifts-to-charity
⁴ https://www.forbes.com/advisor/taxes/standard-deduction
⁵ https://www.fool.com/retirement/plans/roth-ira/mega-backdoor
⁶ https://www.savingforcollege.com/article/dont-worry-too-much-about-the-annual-gift-tax-limit
⁷ https://www.elliottdavis.com/gift-and-estate-tax-planning-methods
⁸ https://www.forbes.com/sites/matthewerskine/2022/11/04/irs-announces-estate-and-gift-tax-exemption-amounts-for-2023
⁹ https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes

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