Have you started sipping on that holiday egg nog? How about thinking about your New Year’s resolutions? Not so fast! We know that there are a lot of exciting things happening this time of year to rivet our attention—from holiday parties to family get-togethers to making plans for the year ahead—but there are strategies you can potentially make before the end of the year that may help finish off 2021 with a few more financial wins!
- Tax-Gain Harvesting
Lucky for investors, we enjoyed another year of strong performance in the markets. It’s hard to believe this bull run has lasted twelve years. But, nonetheless, positive performance is always welcome and presents some unique tax-planning opportunities to take advantage of including tax-gain harvesting.
Tax-gain harvesting is the deliberate selling of assets that have increased in value in order to generate taxable income. But why would anyone want to do that? In order to take advantage of more favorable capital gains rates. As we have written and spoken about before, proposed legislation could bump up capital gains tax rates in the very near future.
Of course, selling appreciated assets now means paying taxes on them for the 2021 year, but aims to save you money over the course of your lifetime. This is especially beneficial for the times in the future when you will be tapping into your portfolio to generate income. It makes sense for many investors to pay the capital gains now while rates are lower and they are still accumulating income than in retirement when the income is more fixed and taxes may very well be much higher.
- Tax-Loss Harvesting
On the other hand, you may have some tax-loss harvesting opportunities to take advantage of, as well. This involves deliberately selling assets that have shown a loss in order to offset both taxable ordinary income and any reported capital gains realized throughout the year on other investments. Mutual funds, for example, are fairly consistent with capital gains distributions, so mutual fund holders may benefit from looking for other losses to sell prior to the year-end to reduce their overall liability.
Keep in mind, there are caveats to this strategy. Since the IRS will not allow you to buy an asset just to sell it for the purpose of owing less taxes, investors need to be wary of the “wash-sale” rule. The “wash-sale” rule indicates that you cannot claim capital loss if you re-purchase the same asset or a nearly identical asset again within thirty days of your loss-showing sale. However, you may want to purchase a similar (but not “nearly identical”) asset rather than being out of the market for thirty days altogether.
- Gifting Required Minimum Distributions (RMD) or Highly Appreciated Assets
Gifting is always popular this time of year for those who are philanthropically inclined, but there are specific gifting strategies that can help your financial bottom line in the process. Specifically, gifting “not-yet-needed” RMDs and/or highly appreciated assets.
If you are over age 72 and are not yet in need of the income generated from your Required Minimum Distributions, you can donate your RMD directly to charity in order to avoid paying taxes on the distribution. This is known as a Qualified Charitable Distribution (QCD) and is especially helpful for individuals who find themselves in receipt of more cash flow than they need to sustain their lifestyle.
Gifting highly appreciated assets is very similar in that doing so can help you to avoid paying capital gains if you were to sell the asset and then donate the cash. You may even wish to consider contributing multiple years’ worth of gifts into a Donor Advised Fund (DAF). Using a DAF allows you to take advantage of a larger tax break in the current year while still spreading the gifting out over several years into the future. Another perk? You don’t have to pick out your charity recipients up front. You have some flexibility to decide over time.
- Max Out Your Retirement Contributions
You always want to make sure you have maxed out your retirement plan contributions, not only to increase the amount of your retirement savings, but to potentially lower your taxable income. 401(k) plans with employer matches should be visited first in order to take advantage of the maximum employer contribution in the calendar year. Unlike 401(k) contributions which must be made before the close of the year for pre-tax purposes, IRAs have an extended deadline. Individuals have until April 15, 2022 to make IRA contributions that are eligible to count for 2021.
- Consider a Roth Conversion
A Roth conversion refers to the transfer of an Individual Retirement Account (IRA), either traditional, SIMPLE, or SEP-IRA, into a Roth IRA. Unlike traditional IRA accounts, Roth IRAs do not require individuals to take Required Minimum Distributions (RMDs) during their lifetime. The account continues to enjoy tax-deferred growth and ultimately, tax-free distributions. Not only does this allow for strategic tax planning and saving in retirement but can also be a wonderful way to leave a legacy gift for heirs to receive if the funds aren’t used during the account owner’s lifetime.
However, income limits on Roth IRAs exclude high-income earners from opening these accounts unless they are performed through a conversion or rollover. Although taxes will be due on the funds upon conversion, there are no taxes owed on the distributions in retirement. This creates a tax-free income reprieve for retirees—especially those who anticipate being in a higher tax bracket in retirement.
- Check In with Your Advisor
Of course, these tips are helpful for many investors, but you should never make any major money moves without first consulting with your financial professional. The end of the year is a great time to review your accounts, risk tolerance, and goals—especially during such a strong bull run!
Cheers to a fantastic 2021 and many more bull years ahead! Though none of us can predict what the markets will do or how tax legislation may change in the future, we can do our best to prepare and solidify our financial houses for whatever may come.
If you are in need of a trusted ally to guide you through these and life’s other major financial milestones, we’d love to chat with you. URS Advisory serves clients locally on the Treasure Coast and in the Palm Beaches. Schedule a conversation with us today to discuss your opportunities.
URS Advisory does not offer tax planning services but may provide references to tax services providers. URS Advisory may also work with your independent tax advisor. Please consult a qualified professional for assistance with these matters.