Don’t get caught flat-footed when it comes to year-end tax and investing moves.
The looming calendar flip means different things to different investors, depending on age, portfolio makeup, long-run goals, and more. It’s always best to check with your financial advisor and tax professional for specific year-end moves.
Here’s a quick list of last-minute investing and potentially tax-saving moves that might make sense.
1. Reminder: RMD
Chief among the late-year deadlines for some retirees is the December 31 cutoff for distributions in the current tax year. When you hit 70 1/2, your annual required minimum distribution (RMD) must be distributed from the account no later than December 31 (your very first RMD can generally be deferred until April 1 of the following year, if you prefer; remember, this applies only to the first year).
Importantly, unlike the April 15 tax-filing deadline, December 31 is not a postmark deadline. The assets must be out of the account by the end of the year to avoid a potentially steep penalty. We’re talking about 50% of the RMD. Read more on how to make late-year retirement account maintenance automatic.
2. Roth Conversion Time?
Your end-of-year tax checklist might include a deeper look at Individual Retirement Accounts (IRAs), including a conversion to a Roth IRA. With a traditional IRA, contributions are made with pre-tax dollars, deferring tax payments until withdrawal. With a Roth, after-tax dollars are contributed, allowing for withdrawals without paying taxes or penalties from age 59 1/2 and if the account was held for at least five years.
But, yes, you have to pay taxes on the conversion. The pre-tax balance of the traditional IRA you're converting will be considered taxable income, and the additional income might bump you into a higher tax bracket. That means you'll want to consider what any conversions might mean for your 2015 tax picture.
If you anticipate higher tax rates in the future or if you believe that you or your beneficiaries might move into a higher marginal tax bracket, paying a lower traditional-to-Roth conversion tax bill now versus a higher tax bill later can make sense for some. From there, you'll start the clock on the potential for tax-free growth that a Roth offers.
Don’t worry—not all hinges on that December 31 deadline. Taxpayers have up to 10 and a half months after the year end of the conversion to change their mind and re-convert some or all of the funds back to a traditional IRA.This is called a “recharacterization.”
3. Taxable Giving
If you make a charitable donation before December 31, you may be able to write it off on your 2015 taxes. Supporting the causes you care about is likely your primary motivation. An added bonus comes with the potential reduction to your tax bill—ask your tax professional.
Charitable giving is one potential offset to the tax implications of the Roth conversion discussed above. While the Roth conversion would increase your income, charitable contributions have the opposite effect. As you give more to causes you care about, the higher adjusted income could potentially raise your charitable deduction cap.
4. Harvesting Losses
If you follow the rules, you can turn 2015’s capital losses into potential tax savings by offsetting taxable capital gains. This move may make sense in 2015 in particular because of the late-summer stock sell-off, a short-term retreat in an otherwise positive year for the broader stock market.
The strategy is called tax-loss harvesting. It involves selling stocks, bonds, and mutual funds that have lost value to help reduce taxes on capital gains from winning investments. Most advisors caution against selling an investment that you otherwise remain bullish on simply for tax purposes, but these steps can play one part in a broad line-up of tax-reduction moves.
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.
Even if you don’t have gains, losses can be carried forward to offset gains in future years. Each year without gains, the maximum loss that can be taken is $3,000, until the total loss has been claimed. Always consult your tax professional for all the details and to determine what is appropriate in your situation.
5. Portfolio Check-Up
Even if you don’t take action before December 31, the closing of one year and the beginning of another can be a good time to assess short-, medium-, and long-term investing goals. It's also a good time to ask some big questions: Have market conditions changed? Has your risk tolerance shifted? Are your family’s needs different? Is it time to rebalance?
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