As 2018 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 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 ideas 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 that 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,” says Lisa Greene-Lewis, a CPA and editor of the Intuit TurboTax blog.
For 2018, the maximum 401(k) salary contribution for an employee is $18,500 for those under 50, and $24,500 for those 50 and over. If you have an employee who receives a W-2 form, you should generally make any 2018 contributions by December 31. Other types of compensation may have different deadlines.
With traditional IRAs, contributions are typically made with pre-tax dollars, and grow tax-free. However, withdrawals are usually fully taxable. With a Roth IRA, money is contributed with after-tax dollars. If you’re over 59 1/2, you can make a qualified distribution that is tax-free.
For many investors, the tax savings from an immediate reduction in taxable income has to 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.
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. But if you don’t spend the funds, you lose not just 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 may include:
Since any losses from selling stocks, bonds, or mutual funds can be used to offset taxable capital gains, another approach 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 2018 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. While 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 says. “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, think about “bunching” deductions, particularly in categories where you have to cross a minimum threshold, Greene-Lewis says.
Consider bunching your deductions on alternating years. So, you’d take the standard deduction one year and the next year, if you carefully manage the timing of your purchases, 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 the years you plan to take the standard deduction.
December 31 is an important deadline in many ways for many people, retirees included.
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 will 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 year is a good time to reflect on your goals and resolve to improve. You can easily apply the same philosophy to your finances to start the new year on the right foot. Ask yourself if you are on track toward your goals. If not, some of these tax strategies can be a great opportunity to realign your finances.
If you have any tax questions, contact a reliable tax professional. Or, you can visit either the TD Ameritrade Tax Resources center or the Intuit TurboTax Tax Reform Hub.
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