Tax Planning in December? 5 Tips for Now

Key Takeaways

Tax Plan Now With These 5 Tips

While your taxes typically don’t need to be filed until April, planning for it—and for possible ways to reduce what you owe—could happen right now or at least before the end of the year. We asked financial consultants Ryan Adams, Jimmy Merdian, Sarah Pedersen and Addison Tantillo for their top tips for investors to plan for tax time now. Here’s what they said.

1. Consider a Roth Conversion to Save on Taxes Later

Converting a traditional IRA to a Roth IRA can help you have future withdrawals that won’t be taxed. This could help you stay in a lower tax bracket in retirement.

“You will need to do Roth conversions by December 31,” says Ryan. “And you’ll want to leave yourself enough time to make sure you’re doing it in a way that makes sense for you and that doesn’t create unintended negative tax consequences.”

You also may want to consider what’s happening in the markets. “While we never encourage market timing, many people like to convert when markets are lower,” says Addison. “Then, when the market rebounds, their money is in a Roth tax-free account.”

Our consultants can help by using planning tools to help you see what timing makes sense and how a potential conversion will play into your retirement plan down the road.

What to Know Before You Convert

“There is a five-year rule on Roth conversions, meaning you cannot withdraw the money tax-free for five years,” says Jimmy. “However, if you convert at the end of this year, you get credit for the entire year because it is retroactive to January 1. Converting at year-end gives you one year down.”

Also, note that income taxes could be a pitfall. “Some people don’t understand you have to pay taxes on some or all of the amount you convert to a Roth IRA,” says Addison. “And you want to be careful about converting so much you fall into a higher tax bracket after the conversion.”

Some investors like to have taxes withheld and sent to the IRS as an early credit for the conversion. However, our consultants believe it may be better to set aside separate money to pay those taxes (if you can).

If you’re not age 59½, any amount withheld is considered taxable income and may incur an early withdrawal penalty.

Since Roth conversions mean you will owe additional taxes for the year you convert, you may also want to consider if a tax-loss harvesting strategy is right for you—also before year-end—especially if you are looking for a way to offset taxable capital gains.

2. Contribute to a 529 for Tax-Free Withdrawals

Adding money to a 529 education savings account helps a student and comes with tax benefits . The primary advantage is that neither you nor the student beneficiary pay taxes on qualified education withdrawals.

Contributions may also be tax deductible in some states and must be made by December 31 to get credit for that year. You may also qualify for educational credits at tax time, depending on your income. Anyone can contribute to a student’s 529, including parents, grandparents, aunts and uncles, and family friends.

New Flexibility Makes 529s More Appealing

Money from a 529 can now be rolled over to a Roth IRA to help kick-start retirement savings for the student named on the 529 account. That addresses the worry some may have about the “what ifs” about scholarships or if the child doesn’t attend college.

“With this provision, you do have to have the money in the 529 for 15 years to transfer it, so the sooner you start, the more flexibility you may have,” says Ryan.

“Although there are further restrictions on moving 529 money to a Roth that are not covered here, we think clients will be pleased with this new option,” says Sarah.

Those with student loans may also be happy to hear that students can use up to $10,000 from a 529 account to pay off that debt. “This makes adding to a 529 another good idea, and parents should know they aren’t past the point of contributing when their student is in college,” says Addison.

3. Put Strategy Behind Your RMD

Required minimum distributions (RMDs) from retirement accounts are due by December 31. Not taking one (or not taking enough) can result in hefty tax penalties. But beyond meeting the deadline, you may want to think about when to take money from a traditional IRA or other qualified retirement account and the associated tax implications.

“Many investors don’t want to touch their IRAs, so they don’t like taking money out of them, especially before they reach RMD age,” says Jimmy. “But you might not want to wait too long and end up with a huge forced RMD withdrawal in later years—and the additional taxes that come with it.”

Using the money to supplement your income earlier in and throughout retirement can help you reduce that risk.

“We can help clients develop an RMD strategy,” says Addison. “A strategy is essential when you start drawing Social Security and Medicare. You don’t want too much taxable income because of your RMD.”

Too much income can raise the premiums on Part B Medicare and make your Social Security benefits subject to income taxes. Consider talking to a consultant and tax advisor sooner rather than later about your RMDs.

4. Give Wisely—Don’t Sweat Gift Taxes

Many people think about charitable giving or giving to a loved one around the end of the year. Some of that may be due to being faced with a large tax bill and not utilizing tax strategies earlier. But there are also some benefits for the giver.

Qualified charitable donations (QCDs) can lower your adjusted gross income (which is more beneficial than making a tax-deductible charitable donation). “QCDs can help offset taxes while satisfying your RMD from an IRA,” says Sarah. “If you don’t need the RMD for living expenses, the donation can make your financial picture more tax efficient and help you save taxes at the end of the year.”

Sarah cautions to work closely with your investment company to follow the right process for charitable donations because the check needs to go directly to the charity. A cash donation you make directly to a charity, even if using the proceeds from your RMD, equates to a plain tax-deductible charitable donation, which is not treated as favorably tax-wise as a properly executed QCD.

Gifts and Gift Taxes

When giving to individuals, investors may be concerned about gift taxes. “I’ve had several clients concerned about giving too much and what the tax consequences may be, but most don’t have to worry,” says Ryan. That’s because most people will not come near the threshold allowed by the IRS.

Also, note that any amount you give will be added to your lifetime gift tax exclusion, so you’ll want to keep track of what you’ve given over the years. There are other considerations regarding gifting property to others, so please consult with your tax advisor for more guidance and information.

5. Stay on Top of Distributions

Most investors don’t think about capital gain distributions from their investments and what they may mean for them until tax time. Our consultants say to pay attention to estimated distributions, which we typically publish for our mutual funds by the end of October.

“A lot of larger funds tend to pay distributions, and being unprepared can cause headaches,” says Addison. You should also know that distributions can be paid on a fund, even if your mutual fund account has experienced a decrease in value during a calendar year.

“It can be confusing to understand distributions,” says Jimmy. “I remind clients that distributions aren’t necessarily based on fund performance; rather, it’s about gains from companies the fund invests in and movements within the fund’s portfolio.”

For most, mutual funds distributions will automatically be reinvested back into the fund. “Depending on an investor’s income situation, they may want to consider having these distributions paid or reinvested in a cash equivalent investment, like a money market,” says Ryan. “This allows an investor to take advantage of a taxable event that is unavoidable to free up cash for living expenses.” He suggests talking to a financial consultant to see if this strategy might be helpful.

Our consultants can also help you find ways to relieve some of the tax burdens that distributions can bring.

Talking Over Your Tax Plan Can Help

Taxes, in general and on your investments, can be complicated, so we encourage you to talk to a tax advisor before making any moves. Our consultants can also work with your tax professional to develop strategies to help make tax time less taxing for your investments.

“We’ll help with those investing strategies, including discussing some tax-efficient portfolios and investments that may help those particularly concerned about taxes,” says Ryan.