As 2019 winds down, investors of all ages can consider three general categories of year-end tax planning: Reducing taxable income, increasing deductions, and taking advantage of tax credits.
When it comes to year-end tax planning, many of us think in terms of the April filing deadline. But planning can begin much sooner, and some tax strategies require that you act before the end of the year.
As you review your finances, here are a few tax-planning strategies to consider before December 31 to help you potentially reduce your tax burden and perhaps get a larger refund.
Contributions you make to employer-sponsored retirement plans and other tax-deferred retirement accounts are taken out of your paycheck before taxes, which helps lower your taxable income. If your employer matches your contributions, increasing your 401(k) contributions can help you avoid leaving free money on the table.
With both you and your employer kicking money in every month, “you’re building your retirement funds, you’re reducing your taxable income, and you’re not being taxed,” explained Lisa Greene-Lewis, a CPA and editor of the Intuit TurboTax blog.
For 2019, the maximum 401(k) salary contribution for an employee is $19,000 for those under 50 and $25,000 for those 50 and older. If you have an employee who receives a W-2 form, you should generally make any 2019 contributions by December 31. Other types of compensation may have different deadlines.
With traditional IRAs, contributions are typically made with pretax dollars and grow tax-free. However, withdrawals are usually fully taxable. With a Roth IRA, money is contributed with after-tax dollars. you can take “qualified distributions” that are tax-free. In general, a qualified distribution is one made after you turn 59 1/2, or under certain exemptions such as to buy a first home, or if you were to become disabled. Also, Roth contributions are subject to a five-year holding period before they’re considered “qualified” for tax-free distribution.
The tax savings from an immediate reduction in taxable income should be compared to the alternative. Take a moment to calculate how much tax you would pay on those funds versus the tax you may face on the gains when you withdraw the money in the future. You may find that a Roth could offer significant savings, so it might be worth converting your IRA to a Roth IRA now. The deadline for a conversion is December 31. As of January 1, 2018, conversions are irrevocable and cannot be recharacterized, meaning their tax advantages cannot change (for example from traditional to Roth benefits).
You have until April 15, 2020 to make IRA contributions for 2019, but the sooner you get your money into the account, the sooner it can be invested. For the 2019 tax year, you can contribute a maximum of $6,000 to an IRA for 2019, plus an extra $1,000 if you’re 50 or older. Contributions must be cash, and the maximums apply to an individual, not each account. The IRS website provides more information on deductions and contributions to a Roth account.
Be diligent about submitting your FSA expenses by the end of the year, unless your FSA allows you to roll funds to the next year (check with your employer). An FSA allows you to set aside tax-free money to pay for certain out-of-pocket health care costs. Typically, the funds are a “use it or lose it” proposition with a deadline of December 31.
Spending these funds doesn’t directly lower your taxes, but keep in mind that the purpose of the FSA is to provide tax savings when you contribute. If you don’t spend the funds, you lose not only the tax benefit, but the funds set aside as well. The good news is that FSAs can apply to a broad array of expenses, although the IRS can change what expenses qualify.
Year-end tax-saving strategies:
Because any losses from selling stocks, bonds, or mutual funds can be used to offset taxable capital gains, another year-end tax strategy is tax-loss harvesting. The size of the potential benefit from tax-loss harvesting depends on your income level and the amount of your short- and long-term capital gains (minus any current losses that you may have already realized, or any losses carried forward from other years).
In addition, if you make a charitable donation before December 31, you may be able to write it off on your 2019 taxes. In addition to supporting causes you care about, you could gain a tax bill reduction. (Note: Charitable giving is one possible offset to the tax implications of a Roth conversion. Although a Roth conversion may increase your income, charitable contributions have the opposite effect if you can take the deduction.)
It’s also possible to combine tax-loss harvesting and charitable contributions.
“You may be able to donate your appreciated stock, which is a good way to increase your itemized deductions and save on your taxes,” Greene-Lewis said. “If you donate stock that’s increased in price, you don’t have to recognize the capital gain, as you would if you sold it.” If you keep the appreciated stock, the gains will normally be subject to taxation.
If your total deductions don’t justify itemizing by exceeding the standard deduction, Greene-Lewis said you can consider “bunching” deductions, particularly in categories where you have to cross a minimum threshold.
Suppose you decide to bunch your deductions on alternating years. You’d take the standard deduction one year and the next year, if you managed the timing of your purchases carefully, you would likely surpass the standard deduction.
You can also bunch charitable contributions by increasing donations in the years you plan to itemize and decreasing them in the years you plan to take the standard deduction.
December 31 is an important deadline for retirees as well.
When you reach age 70 1/2, your required minimum distribution, or RMD, must be taken out no later than December 31. You may delay taking your first RMD until April 1 of the year after you turn 70 1/2. If you delay your first RMD, you’ll have to take two that year: the first by April 1 and the second by December 31. Failure to take an RMD can be costly, as the IRS can assess a penalty of 50% of the amount not taken.
The end of the tax year is a good time to reflect on your personal goals and resolve to take action. You can easily apply the same philosophy to your finances to start the new year on the right foot. Ask yourself if you’re on track toward your goals. If not, consider these tax-planning strategies as a potential opportunity to realign your finances.
If you have any tax questions, contact a reliable tax professional. You can visit the TD Ameritrade Tax Resources center or the Intuit TurboTax Tax Reform Hub.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
Follow this year-end tax-planning checklist.
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