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It Is Never Too Early To Start Year-End Planning

wealth management retirement planning taxes charitable giving

The best time to start year-end planning is really April 15th, after you complete or sign your tax return and realize how the taxes could have been changed, had certain action been taken in the prior year.  People always accuse me of being impatient, so I have waited until July to write this blog with the intention that many items can be acted on prior to year-end.

Among the many areas we review with clients is proactive year-end planning in many financial areas.  Although we coordinate extensively with our clients’ other advisors, the following are certain areas that we recommend for all taxpayers regardless of whether they are our clients or not.  We offer this as a “gift of knowledge” and hope that you find it helpful in your situation. Any one of these ideas could be a unique blog topic.  Be mindful that this is not meant to be all-inclusive in these matters; rather, it’s intended to trigger your thinking and action in these relevant areas.  If, after reading, this article triggers questions about your situation, please feel free to contact us.

 

Reducing taxable income is always a powerful driver each year.  Taxes are paid eventually, but having the capacity to modify the timing to a time better suited to you is always a better way to manage your situation. 

The 10 techniques listed below can help control cash flow for taxes and future retirement planning:

1. Defer your income

The individual top tax rate is 39.6% on taxable income of more than $415,050 for single taxpayers; $466,950 for married couples filing joint returns ($233,475 if filing separately); and $441,000 for head-of-household taxpayers.  If your remaining pay will push you into a higher tax bracket, defer receipt of money where you can, or increase deductions so that taxable income is minimized.

Some ideas:

  • Some employers may allow deferral of year-end bonus and other payouts until the following year.
  • Put more money into your tax-deferred workplace retirement plan.
  • Hold off selling assets that will produce a capital gain.
  • If you're self-employed and on the cash basis accounting, don't send out invoices for year-end jobs until early 2017.
 
2. Add to your 401(k)

Generally, even if you're nowhere near the top tax bracket, putting as much money as you can into your company's 401(k) or similar workplace retirement savings plan is good, especially if the company matches a portion of the contribution.  Since most contributions are made before taxes are taken out, it will reduce your taxable income.  (Exceptions are contributions to Roth 401(k) plans, where you put away after-tax money and get tax-free growth.)  The sooner you put the money into the tax deferred account, the longer the earnings will grow tax-deferred.

It would be ideal if we could contribute the maximum yearly amount of $18,000 that employees can invest in a 401(k) in 2016, but any amount you can contribute is a great way to plan for the future.  If you are age 50 or older, you can put in an extra $6,000 for 2016.

In many cases, you can modify your 401(k) contributions, but many plans allow periodic quarterly changes.  Your company’s benefits administrator would have this specific information.

3. Review your FSA amounts

Another workplace benefit, the medical flexible spending account (FSA), also requires year-end attention so you don't lose money.  You can contribute up to $2,550 to an FSA via payroll deductions.

As with 401(k) plans, money goes into an FSA before your taxes are calculated, saving you some taxes.  But if you leave any money in your FSA, you may lose it at the end of the year.  Some companies, however, allow a grace period into the next year to use the untouched FSA funds, but not all.  And though the U.S. Treasury recently announced a change in the “use-it-or-lose-it” rule that allows account holders to carry over up to $500 in excess money into the next benefit year, your company has to take steps to adopt it.

Be sure to check with your employer, and if you must use your FSA money by December 31st, make sure you do.

4. Harvest tax losses

One of the basic analyses we perform for our clients prior to year-end is to review their tax situation along with loss carryforwards and gains/losses in their current portfolio.

If you have assets in your portfolio that have lost value, they could be a valuable tax tool.  Capital losses can be used to offset any capital gains.  If you have more losses than gains, you can use up to $3,000 annually to reduce your ordinary income amount.  More than $3,000 can be carried forward to future tax years.

Capital losses could be especially helpful to higher income taxpayers facing the 3.8% Net Investment Income Tax.  This surtax, which is part of the Affordable Care Act, applies to the unearned income of taxpayers with modified adjusted gross incomes of more than $200,000 if they are single or head of the household; $250,000 if married and filing jointly; and $125,000 if married and filing separately.  High earners with investment income can reduce this new tax burden by using capital losses to reduce their taxable amount.

If you do face the 3.8% surtax, consult your financial advisor and tax professional.  In addition to figuring your modified adjusted gross income, you must take into account the different types of investment earnings that are subject to the tax and how to appropriately calculate losses within each category.

Tax losses techniques can also be used in Charitable strategies; see #8 below.

5. Make the most of your home

Home ownership provides a variety of tax breaks, some of which you can use by year-end to reduce your current year’s tax bill.  Make your January mortgage payment by December 31st and deduct the mortgage interest on your year-end tax return.  The same is true for early property tax payments.
 
Caution:  due to the phase out of exemptions and impact of Alternative Minimum Tax (AMT), these tactics may not be as helpful as those not impacted by the phase out and AMT.

6. Bunch your deductible expenses

Taxpayers who itemize deductions know there are many ways on Schedule A to reduce adjusted gross income, or AGI, to a lower taxable income level.  But in several instances, deductions must be more than a certain threshold amount.

Medical and dental expenses, for example, cannot be deducted unless they exceed 10% of AGI.  The 7.5% AGI threshold still applies to taxpayers age 65 or older through 2016.  Miscellaneous expenses, which include business expense claims, must be more than 2% of AGI for all filers, regardless of age.

To get over these deduction hurdles, start consolidating eligible expenses now.  This strategy, known as bunching deductions, will push them into one tax year, where you can make maximum tax use of them.  The sooner you start this process, the better.  It’s much easier to plan your costs now than scramble to come up with eligible expenditures as December days fade.

Caution:  due to the phase out of exemptions and impact of Alternative Minimum Tax (AMT), these tactics may not be as helpful as those not impacted by the phase out and AMT.

7. Add to or open an IRA

Remember that additional money you put in your 401(k) to lower your taxable income?  Bulk up your retirement planning even more by contributing to an individual retirement account (IRA).

If you have an IRA account or open a traditional IRA, you might be able to deduct at least some of your contributions on your tax return.  If you don’t make a lot of money, your contribution also could be used to claim the retirement savings contributions credit.

Even if you won’t get a deduction, you’ll be adding to your nest egg so that you can retire on your terms.  And while it’s true that you can wait until the April 15th filing deadline to contribute for the previous tax year, the sooner you put money into an IRA, traditional or Roth, the sooner it can start earning more for your golden years.

Self-employed workers also get an added retirement saving benefit.  There are a variety of plans—SEP IRAs, Keoghs, solo 401(k) plans—into which you can put some of your self-employment earnings.  If you’re a sole proprietor, your contribution to a self-employed retirement plan is also deductible on your tax return.

8. Be generous to charities

As you’re putting together your year-end/holiday shopping list, be sure to include charitable gifts that could help reduce your taxes.  In addition to the usual dollar donations or household goods and clothing, consider some less traditional ways to give to charities.

If you have a practice of making Charitable gifts, you may consider donating stock or mutual funds that you’ve held for more than a year but that no longer fit your investment goals in a diversified portfolio.  We find that many clients have held favorite stocks, some for many years, which may or may not fit in a current diversified portfolio.  But due to the low-cost basis, it may not make sense to sell and recognize a large capital gain, along with other tax implications noted earlier.  A gift of appreciated property may be just the answer.

The charity receives the asset to hold or sell, and your portfolio rebalancing nets you a deduction for the asset’s fair market value at the time of gifting.  You also avoid the capital gains impact on the asset’s appreciation, while the charity receives the full financial impact of the contribution.  This strategy can be expanded by timing some contributions in one year to a Donor Advised Charitable Gift Fund that allows contributions to be recognized in one year (see #6 above) and then directing the contributions to qualified charities in subsequent years.  This strategy has been used successfully by many of our clients to manage their contributions and, in many cases, taxable income in certain years.

As noted in #4 above relating to harvesting tax losses, if you are considering contributions and have an investment with a loss that you do not want to maintain in your portfolio, it would be best to sell that security to recognize the tax loss and then donate the cash proceeds to charity.  Simply donating the loss in value investment to charity would eliminate the possibility of reducing your income with the loss.

This can be a complicated area in many family situations, so make sure that you coordinate with your Financial Strategist and tax preparer.
 
9.  Review Estimated Taxes and Withholding

Ideally, the amount of money withheld from your paycheck, or sent to the IRS in quarterly payments, should come as close as possible to your actual tax liability.  Withhold too little and you could have a big tax payment, possibly including a penalty, when you file your return.  Withhold too much and you’re giving the IRS what amounts to a tax-free loan of money that you could be using to pay down debt or save for retirement (and, potentially, reduce your taxes).

There’s still time to adjust your withholding for 2016 by making changes to the W-4 you have on file with your employer.  Or, if you make quarterly payments, you can increase or decrease your payments between now and when the last 2016 payment is due in January 2017.  Keep in mind that the longer you wait, the fewer pay periods you’ll have to reach your target tax withholdings.

If you’re in danger of an underpayment penalty, try to make up the shortfall by increasing withholding on your salary or bonuses.  A bigger estimated tax payment at year-end can leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year.

10. Gift Tax Exemptions
 
You can gift up to $14,000 a year to as many people as you like, tax free.  Taking full advantage of the gift tax exclusion can be a tax-efficient way to begin the distribution of cash and investments that are part of your estate and that would potentially be subject to estate or inheritance taxes.
 
 
There is certainty in that one must and will be paying taxes; however, there are plenty of tactics to use in reducing the immediate impact of paying taxes.  All of these tactics are worth exploring and, where appropriate, implementing.  Don’t hesitate to contact us, or your financial advisor, if we can help.
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