My Favorite Year-End Financial Planning Strategies
Every year-end, my company holds a roundtable discussion event for our clients. It’s a great event that allows us to have an open discussion with many of our clients regarding markets, the economy, financial planning, etc. We have a few presentations and then open it to the room to discuss. In recent years, I’ve had the privilege of presenting on our financial planning topics at this event.
We held our Roundtable Discussion a few weeks ago. This year, I presented on Year-End Financial Planning Strategies. I thought it would be helpful to put this presentation into a blog and share with everyone as we are now in December and approaching year-end.
12/31 is a big date in financial planning. Largely because our tax schedule runs on a calendar basis. Because of this, many financial planning strategies that you’d like to implement need to be taken care of prior to the end of day, 12/31. Here are some of my favorite strategies to review and implement in the last month of the year:
Tax-Loss Harvesting
This is a term / strategy I find that a lot of people are familiar with. But, if you’re unfamiliar with Tax-Loss Harvesting, this is the action of intentionally selling positions at a capital loss, and then using that capital loss to either:
a.) Offset capital gains realized that year
b.) Use as an income deduction for that year (up to $3,000)
c.) Harvest those losses moving forward to use for a & b in future years
Because this deals with capital losses, this only pertains to taxable accounts (i.e., individual accounts, joint accounts, trust accounts). You cannot tax-loss harvest in a tax-advantaged account like an IRA, employer-sponsored retirement plan, or Roth account.
Commonly, after you sell your position and realize that capital loss, you would reinvest the proceeds into a similar, but not substantially identical security. This helps you keep your investment strategy intact while realizing that capital loss. If you reinvest the proceeds into the same or substantially identical security within 30 calendar days, you will inhibit the wash sale rule. Doing so, will eliminate your ability to realize that capital loss and negate the whole purpose of tax-loss harvesting.
Example:
This is a hypothetical / illustrative example. Your own tax situation may differ from this. The hypothetical performance does not represent actual performance, was not achieved by any investor, and actual results may vary substantially.
Tom has realized $50,000 in Capital Gains this year by using his taxable account to supplement his income in retirement. At 15% Long-Term Capital Gains rates, this may cause Tom additional taxes of $7,500. Nearing year-end, Tom decides to sell his ABC Mutual Fund that has a $20,000 loss and reinvest it into XYZ Mutual Fund. That $20,000 loss is used to offset part of his $50,000 in Capital Gains. Now, Tom only reports Capital Gains of $30,000, which may cause additional taxes of $4,500, saving Tom $3,000 in taxes paid this year.
Tax-Gain Harvesting
This is one of my favorite year-end planning strategies. And it seems to be much less known than its counterpart that we just reviewed. Tax-Gain Harvesting is the act of intentionally realizing Long-Term Capital Gains at a rate that is less than you’d pay on Long-Term Capital Gains in the future. The potential benefit of this action can best be realized by understanding how Long-Term Capital Gains are taxed. Here is the 2024 Tax Rates for Long-Term Capital Gains based on you Taxable Income:
2024 Long-Term Capital Gains Rates based on Taxable Income
These tax rates are based upon your taxable income. Meaning, your income after you’ve taken your standard deduction (or itemized deductions if you itemize).
The Long-Term part of this is very important. If you’re unfamiliar with the difference between Short-Term and Long-Term Capital Gains, it refers to the amount of time you’ve held that position. A capital gain becomes Long-Term when you’ve held the position for at least 1 year. When you hold a position for at least 1 year, it receives preferential tax treatment when you eventually sell that position. If you sell a position prior to holding it for 1 year, it is considered a Short-Term Capital Gain / Loss. Short-Term Capital Gains are realized as ordinary income and taxed just like your regular income. Long-Term Capital Gains are taxed in accordance with the table above.
As you’ll notice, there is a 0% tax rate for Long-Term Capital Gains. I will commonly find that households in their “gap” years (after retirement and before Required Minimum Distributions (RMDs) may fall in this 0% Long-Term Capital Gain bracket. If this is you, this is a great opportunity to intentionally sell (realize) Long-Term Capital Gains within your taxable account and increase your cost basis within that position. This can reduce the tax liability for that position in future years.
These tax rates are progressive, just like our ordinary income taxes. Meaning, if you fall in the 0% tax rate, that doesn’t mean any and all Long-Term Capital Gains are taxed at 0%. Just up till the point that your taxable income remains within the 0% rate. Should you exceed that tax rate, that doesn’t mean any and all Long-Term Capital gains are now taxed at 15% or 20%. Just the amount that went over the threshold.
As with anything tax related, it’s recommended that you conduct this strategy with the supervision of your financial planner or accountant. Anytime we are intentionally realizing income, we want to make sure we do it in a prudent manner. Realizing additional income may unknowingly increase our taxes elsewhere (i.e., social security). But when done correctly, this has the potential to have a positive impact on your overall retirement tax bill.
Example:
This is a hypothetical / illustrative example. Your own tax situation may differ from this. The hypothetical performance does not represent actual performance, was not achieved by any investor, and actual results may vary substantially.
Tom & Lisa are retired and their only income this year is their pension. Their taxable income is $50,000. Their joint account has ABC Mutual Fund that currently has a $200,000 long-term capital gain. Tom & Lisa could sell ABC Mutual Fund up to the point that it would realize $44,050 in long-term capital gains. That $44,050 in long-term capital gains would be taxed at 0%. Comparing this to a normal 15% potentially when they start Social Security and RMDs, that could save them $6,607 in taxes paid ($44,050 x 15%).
Roth Conversions
A Roth conversion is the act of moving (or converting) money from your pre-tax accounts into Roth accounts. The benefits of this action are:
Potential to take advantage of tax-arbitrage (realize the taxes during a lower tax year, versus higher tax year later in life).
Investments begin to grow tax-free.
Beneficiaries won’t have to pay income taxes.
Important note: Every dollar you convert is added to your ordinary income for that tax year. So, you want to make sure you have a plan to pay the additional taxes you’ll be realizing that year.
Similar to Tax-Gain Harvesting, with Roth conversions we are also attempting to take advantage of lower tax brackets by realizing income in a year where that income would be taxed at a lower rate than in the future.
This also is a common strategy for retirees in their “gap” years. Especially, if you’re anticipating that your RMDs will push you into higher tax brackets later in retirement.
When reviewing your financial plan, we’ll look at your current year tax situation, as well as project your future year tax brackets. This allows us to see if there are any opportunities to realize income at lower rates. Here is an example of tax bracket projection that would signal an opportunity for beneficial Roth conversions
(This chart is hypothetical and shown simply for illustrative purposes only)
As you’ll notice, in the above situation, this individual’s tax bracket is expected to increase once they begin RMDs at age 73. They would have the opportunity to begin converting a portion of their pre-tax accounts into Roth and realizing that income at 24% rates, instead of waiting for RMDs and being taxed at 32% rates.
Additionally, by converting money into Roth, that money will now grow tax-free and will not be subject to RMDs in the future. It can remain in the Roth account for the rest of their life if they’d like. Furthermore, it reduces their RMD obligation in the future, as they would now have less money in their pre-tax accounts.
So, there are a lot of benefits to Roth conversions. But again, it’s important to do this with the supervision of your financial planner or accountant. Because you will be realizing income, you want to make sure you don’t unknowingly go into higher brackets, phase yourself out of potential deductions, or increase other expenses like your Medicare premiums.
Example:
This is a hypothetical / illustrative example. Your own tax situation may differ from this. The hypothetical performance does not represent actual performance, was not achieved by any investor, and actual results may vary substantially.
Mary is 62 and she just retired. She is currently in the 22% marginal tax bracket. Most of her retirement nest egg is her Traditional IRA (pre-tax). She anticipates her IRA will lead to substantial required minimum distributions (RMDs) when she turns 75. She projects these RMDs may push her into the 35% marginal tax rate. Mary could benefit from converting part of her IRA each year into a Roth IRA, realizing that income this year at 22%, instead of 35% later in life.
Qualified Charitable Distributions (QCDs)
QCDs are a tax-free distribution from your pre-tax IRA to a qualified charity. You must be at least age 70 ½. The distribution proceeds must go directly to the qualified charity or Donor Advised Fund (DAF). In 2024, you can take a maximum QCD of $105,000.
One of the major benefits of a QCD is the fact that it counts towards your RMD for the year. Meaning, any QCD you take directly reduces your RMD obligation for that year by that amount. Because of this, it is a popular strategy for households that are in the RMD phase of retirement.
Additionally, the reason a QCD is more favorable than a regular charitable donation is that a QCD is added on top of your standard deduction (or itemized deductions). While a regular charitable donation is part of your itemized deductions.
QCDs are a beneficial strategy for charitably inclined retirees in a high marginal tax bracket or who have RMDs that push them into a higher marginal tax bracket.
Example:
This is a hypothetical / illustrative example. Your own tax situation may differ from this. The hypothetical performance does not represent actual performance, was not achieved by any investor, and actual results may vary substantially.
Michael is 75 years old. His RMD this year is $60,000. That $60,000 will push him from the 24% marginal rate into the 32% marginal rate. Michael does not need this money for his retirement. He decides to take a QCD and donate this $60,000 to charity. Doing this potentially saves him $19,200 in federal taxes due ($60,000 x 32%).
Taking Advantage of Retirement Plans and IRAs
Most of the strategies reviewed so far are for people in retirement. I wanted to make sure I review a strategy for accumulators as well (people still working and building up their savings).
Certainly, seems like a simple one, but this often goes overlooked. Your retirement plans (i.e., 401(k), 403(b), 457, etc.) have contribution deadlines of 12/31. IRAs do offer a grace period and will allow you to make a prior-year contribution up until Tax Day of the following year.
Elective deferral limits for 401(k)’s, 403(b)’s, and 457’s for 2024 are:
$23,000
$30,500 if age 50 or older
Contribution limits to IRAs and Roth IRAs for 2024 are:
$7,000
$8,000 if age 50 or older
Most people contribute to their employer sponsored retirement plans by selecting a percentage of their salary to be deferred into the plan. If you’re unsure of what your income for the year will be, this may leave you unsure of how much you’re contributing to your retirement plan. If you see that you’re not on pace to meet your eligible maximum for 2024 and you have discretionary savings from the year, this could be a great time to increase your salary deferral for December and maximize the retirement savings space available to you.
Keep in mind, retirement plans and IRAs have withdrawal restrictions. Unless you meet certain requirements, you usually cannot withdraw this money without a penalty until you reach age 59 ½. So, it’s important to make sure the money you’re deferring into these accounts is intended for long-term, retirement purposes, and won’t be relied on for an emergency or other shorter-term financial goals.
These are some of my favorite strategies to review with my clients as we near year-end. If you feel you may benefit from any of the above and would like assistance, please feel free to reach out.
Thank you,
Drew Schaffer, CFP®
Ellis Investment Partners, LLC (EIP) is an investment advisor in Berwyn, PA. EIP is registered with the Securities and Exchange Commission (SEC). Registration of an Investment Adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the commission. EIP only transacts business in states in which it is properly registered or is excluded from registration. A copy of EIP’s current written disclosure brochure filed with the SEC which discusses, among other things, EIP’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. The views expressed represent the opinion of Ellis Investment Partners, LLC (EIP) which are subject to change and are not intended as a forecast or guarantee of future results. Stated information is derived from proprietary and nonproprietary sources which have not been independently verified for accuracy or completeness. While EIP believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Past performance of various investment strategies, sectors, vehicles and indices are not indicative of future results. There is no guarantee that the investment objective will be attained. Results may vary. There is no guarantee that risk can be managed successfully. Investments in securities involve risk, including the possibility for loss of principal.
Additionally, many of the examples provided in this article pertain to tax. This article is not tax advice. Each individual’s tax situation may be different and not reflect the situations illustrated above. Incurring additional income may cause additional taxes or costs. It’s important to work with an experienced tax professional to guide your income and tax decisions.
Any indices and other financial benchmarks shown are provided for illustrative purposes only. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index.
Except where otherwise indicated, the information contained in this presentation is based on matters as they exist as of the date of preparation of such material and not as of the date of distribution or any future date. Recipients should not rely on this material in making any future investment decision.
EIP does not provide tax or legal advice. You should seek counsel from your tax or legal adviser for your specific situation. Drew Schaffer is an independent Investment Advisor Representative of Ellis Investment Partners, LLC (EIP). Financial Planning and Investment Advisory Services are offered solely by EIP, a registered Investment Advisor, 920 Cassatt Road, 200 Berwyn Park, Suite 115, Berwyn, PA 19312, 484-320-6300.
