Senate Cents: A Financial Wellness Blog

As the calendar and individual tax years come to a close, it’s sound practice to review several year-end strategies which may improve your tax planning or general financial planning. 

If you don’t review your annual tax planning until you begin receiving tax documentation for the prior year, and schedule to meet with your tax advisor or preparer, you may miss out on opportunities that may help to reduce your current liability.

Maximize qualified retirement plan salary deferral contributions.  While you can elect to contribute to an Individual Retirement Account or Health Savings Account up until the tax filing deadline, your contributions to your employer-sponsored retirement plan (e.g. 401(k), 403(b), Thrift Savings Plan, etc.) must be deducted from your compensation in the calendar year for which they are to apply.

• While direct contributions to an HSA can be made until April salary reduction contributions must be made by 12/31. While both forms of contributions are deductible for income tax purposes, salary reduction contributions also avoid Social Security and Medicare taxes.
• You can review your contributions to-date for the current tax year by reviewing your most recent pay stub or contacting the plan administrator or your HR department. If you can afford to save more and are not on pace to reach the annual maximum contribution limit, requesting that your salary deferral rate be increased may be a sound decision.

If you expect to help fund education expenses in the future, consider using 529 Plan accounts as a savings vehicle. Federally, 529 Plans don’t receive a current deduction, but growth is tax-deferred, and distributions for qualified expenses are tax free.  A plan offered by your state of residence may offer state income tax deductions for contributions made by year-end. Maryland, Virginia, and the District of Columbia all offer state deductions to residents.  Recent legislation has expanded “qualified expenses” to include up to $10,000 annually for private K-12 tuition expenses.

If you have business or self-employment income, you may be able to accelerate or defer expenses or income across tax years. You will first want to determine whether you expect your marginal income tax rate will be higher or lower from year to year.  If 2019 has been an exceptional year, and you have business expenses which you can pay prior to year-end, that may result in a lower average effective tax rate.  It is important that you understand whether your business is subject to cash or accrual accounting, and in either case, that simply not cashing a check received does not delay the constructive receipt of that income for tax purposes.  

Take Required Minimum Distributions from Qualified Retirement Accounts.  If you turned 70 ½ in 2019, you’re required to begin taking distributions from Traditional IRAs and certain other retirement accounts by the filing deadline of next year.  Going forward, your RMD must be made by December 31^st.  Therefore, while you can defer the income tax inclusion of your first RMD, that would also require that your first and second RMD are received and included in your taxable income in the same year, which may result in an increase in your effective tax rate, and could potentially increase the Income Related Monthly Adjustment Amount (IRMAA) that may be added to Medicare premiums in the future (although there is an appeal process for income which is not expected to continue).

While income tax rates are marginal, and having one dollar of income in the next higher tax rate threshold only subjects that one dollar to a higher rate, the IRMAA thresholds for Medicare additional premiums are fixed. If you are close to the next IRMAA threshold, it will be important to get a solid understanding of your expected taxable income, and methods you may have to reduce your Medicare costs by maximizing deductions. The income used for calculating IRMAA is two years’ prior (e.g. 2020 costs are based on 2018 income); however, if you’ve had a significant reduction in income, you may appeal your IRMAA calculation to use more recent income.

Medical expense planning: Gather substantiation for expense reimbursement from Flexible Spending Accounts or potential tax deduction, and you may choose to schedule appointments for needed care before the end of the year, especially if you have reached your deductible or out-of-pocket maximum for the year.

Medicare Open Enrollment runs from October 15^th to December 7^th, and is the time of year when you will want to review available options and determine if making a change to your current plan is prudent.  If you obtained individual medical insurance through an Affordable Care Act exchange, Open Enrollment is from November 1^st through December 15^th.  Many private employers use a calendar year for their plan years, so you may have open enrollment approaching as well.  An understanding of your out-of-pocket costs incurred for the current year as well as the benefits you received, will help you to determine the most appropriate plan moving forward.    

Determine whether you expect to itemize or use the Standard Deduction.  If you expect that you’ll be electing the Standard Deduction in lieu of itemizing, several strategies that require itemizing (like personal charitable contributions and medical expense deductions) will not provide any tax savings.  Qualified Charitable Distributions from IRAs (covered below), can be processed in conjunction with the Standard Deduction.

If you expect that you will benefit from itemizing, donations to qualified charitable entities may provide additional deductions for income tax purposes. If you expect to take the Standard Deduction and are age 70 ½ or older, you may still benefit by donating via a Qualified Charitable Distribution (QCD) for an IRA.  A QCD must be made directly to the qualified charity by your IRA custodian, and can satisfy part or all of your RMD, up to a maximum of $100,000 annually per individual.  You cannot take a deduction for a QCD, but the distribution is not included in income, which is generally more favorable.    

Consider tax-loss (or gain) harvesting in non-qualified investment accounts.

• Review any losses carried forward from your 2018 return.
• Selling investments prior to year-end will include the realized gain or loss on your 2019 return.  While any net gain would be taxable, a net loss can be used to offset up to $3,000 of ordinary income, with any excess loss carried forward indefinitely.
• If you have carried forward losses from prior years, it may be an opportunity to sell appreciated assets without generating a net gain for the year.
• Given the exceptional performance in equity markets over the past decade, many assets have appreciated considerably.  When a mutual fund realizes a net gain by selling from its’ holdings, the gain is distributed out to all of the shareholders of the fund as of the record date of the distribution, regardless of how long they have held their shares.  If you own mutual funds in taxable accounts, you’ll want to be aware of any capital gain distributions, and to determine whether you may want to sell your shares prior.

Evaluate potential Roth IRA Conversions. Converting Traditional IRA balances to Roth accounts can be beneficial for a number of reasons, but requires that any pre-tax balances in your Traditional IRAs are included pro rata as taxable income upon conversion.  As such, this strategy tends to be more attractive when income is relatively low. Growth in Roth IRAs can generally be distributed income tax free, to you or your heirs, and Required Minimum Distributions from Roth IRAs are not required.  Distributions prior to age 59 ½ in Roth IRAs can also be accessed with greater flexibility, but it’s generally required that you’ve been a participant in a Roth IRA for at least five tax years, and that it’s been five years since a conversion has been processed.

Review beneficiary designations. While this will not have an impact on tax planning, it is prudent to periodically review all aspects of your financial planning, and generally your estate planning every three to five years.  Beneficiary designations are far easier to review and update if necessary, so we recommend reviewing annually.  You’ll want to review primary and contingent beneficiary designations for all life insurance policies, employer-sponsored plans, IRAs, as well as Payable on Death or Transfer on Death agreements for non-qualified banking or investment accounts.  It is often prudent to consider the financial implications of inheritance as some assets may be more efficient than others depending on the beneficiary.  E.g., if a beneficiary is in a higher income tax bracket, leaving them a pre-tax retirement account will create an ongoing income tax liability if they’re required to take distributions.

Finally, while it’s nice to receive a tax refund, all that means is that you’ve overpaid your tax liability, and are simply getting your own money returned to you (with no interest).  If you expect a significant refund, or worse, expect to owe, you’ll want to consider completing a new W-4 to minimize overpayments and ensure you avoid underpayment penalties.