Year-End Strategies to Lower Taxes & Optimize Investments

When a new year is approaching, that means the window for certain opportunities is closing. Taking advantage of a few simple year-end strategies can help save you taxes and increase your bottom line. 

The year is almost over, and it has certainly been a bumpy one for the financial markets and our economy. As financial professionals, we work with families to design investment strategies that help them pursue their goals for education, lifestyle, wealth transfer, and even social impact. An important part of our work is to help make clients aware of key year-end strategies. So, before you watch the ball drop on New Year’s Eve, make sure you’ve considered the items on our Year-End Financial Checklist.

Optimize Your Employer Retirement Plan

One of the most popular year-end strategies is to increase your retirement plan contributions. If your company offers a retirement plan, it is a good time to review your contribution strategy. In 2022, the 401(k) contribution limit is $20,500 before any company match or $27,000 if you are 50 or older. In 2023, the contribution limit is scheduled to increase to $22,500 or $30,000 if you are 50 or older.

If you have a Simple IRA, the 2022 employee deferral limit is $14,000, or $17,000 if you’re 50 or older.

Health Savings Account (HSA)

Not everyone has an HSA, but if you do, it is arguably one of the most tax-efficient vehicles in existence. Contributions to an HSA are made on a pre-tax basis, providing a tax benefit up front. HSAs can be invested for tax-deferred growth to increase the compounding effect. Lastly, qualified medical withdrawals can be taken out tax-free with no time restrictions, meaning any unused balances will simply carry over to next year.

Not always considered with other year-end strategies, as you have until April 15th each year (April 18th in 2023) to actually make an HSA contribution, but doing so through salary deferrals before December 31st will include the benefit of avoiding Medicare and Social Security tax as well.

Spend the Rest of Your Flexible Spending Account (FSA)

If you have a Flexible Spending Account (FSA), consider checking to see if you have a remaining balance before year-end. FSAs are typically “use it or lose it” accounts, only allowing $570 to be carried over from 2022 to 2023. If you are unsure how to submit medical expenses for reimbursement, consult your Human Resources department for instructions. For next year’s benefits enrollment, you may want to refine your FSA contribution to more closely align with your potential expenses.

Charitable Giving

Charitable giving in all forms is admirable. However, there are a few charitable giving strategies that could amplify the tax benefits that result from your giving. Instead of giving cash, consider donating appreciated securities (those with unrealized long-term capital gains). Doing so will help you avoid any capital gains tax and will still count toward your itemized deductions.

Bunching your donations into one year can also be an effective strategy. Due to higher standard deduction amounts that resulted from The Tax Cuts and Jobs Act of 2017, it has made it more difficult for those that are charitably inclined to use itemized deductions. But, bunching donations into a single year could result in the ability to itemize.

Using Donor Advised Funds (DAFs) is yet another creative charitable giving strategy, where donors can bunch several years of donations into a single year but can refrain from donating such a large amount all at once. Donors can even combine the benefits of these strategies by donating appreciated shares of stock to a Donor Advised Fund.

Tax-Loss Harvesting

Tax-loss harvesting is a strategy to potentially manage taxes by selling an investment at a loss and using that loss to offset capital gains (or up to $3,000 can be used to offset ordinary income). If there are no capital gains to offset in the year the loss was “harvested,” it can be carried over to offset future gains or future income—there currently is no expiration date but Congress can change tax laws at any point.

Tax-loss harvesting is relevant only for taxable investment accounts. Given this year’s financial market performance, it may make sense for some investors to consider this year-end strategy. As always, make sure to consult your tax professional before considering tax loss harvesting.

As a reminder, this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax professional before considering a strategy that would involve selling investments for tax purposes.

Harvesting Gains

Even though the market has been down in 2022 thus far, it’s possible that investors may still own securities with gains that have not yet been realized. Why does this matter? Well, it may be possible for investors with lower income to sell securities, triggering a capital gain, but not pay capital gains tax.

How does this work? Individual investors with taxable income under $41,675 (in 2022) pay 0% tax on any capital gains. Married couples with taxable income under $83,350 (in 2022) are also in the 0% capital gains tax bracket.

Therefore, if you haven’t reached those income limits, and you have room to purposely trigger more capital gains and stay below these taxable income limits, it could make sense to do so.

Roth Conversions

Roth conversions are a good strategy to review each and every year, but reviewing in 2022 may pay additional dividends (no pun intended). But, what exactly is a Roth conversion?

A Roth conversion is the repositioning of assets in a Traditional IRA or qualified employer sponsored retirement plan to a Roth IRA. In short, investors choose to pay taxes at the time of the conversion to move more assets in a Roth IRA, where it can grow tax free. Plus, doing so in a down market can amplify the benefits of a Roth conversion.

RMDs and Qualified Charitable Distributions (QCDs)

If you are 72 or older or have a beneficiary account, it’s time to consider this year’s RMD. Remember, if you are subject to RMDs and don’t take them, there may be a penalty. If you don’t need the distribution, one choice to consider is donating your distribution to charity through the use of a Qualified Charitable Distribution (QCD) (must be 70 1/2 to use a QCD strategy). 

A qualified charitable distribution might satisfy your annual RMD and can lower your taxable income even further beyond your itemized or standard deduction. Everyone’s situation is different, and before determining the best approach, it is best to consult with a tax professional who understands tax implications regarding QCDs.

Withholding Analysis

For retirees that are receiving income from new sources, estimating your tax withholding can be a challenge. Not only are you in a new tax situation, but many retirees don’t know exactly how much they’ll withdraw at the beginning of their first year in retirement. So, doing a withholding analysis at the end of the year can be helpful in that you still may have time to adjust pension withholding, IRA distribution withholding, and you may still have to time to make an estimated tax payment, if needed.

Large Cash Reserves

Given the decline in the value of the market, some people with cash reserves are wondering if it is a good time to invest. There is no one-size-fits-all approach, and it is important to take many factors into consideration.

Year-end is a time of reflection and giving thanks, but also a time to consider implementing some year-end strategies. Remember to consult with a qualified investment adviser, tax professional, or CERTIFIED FINANCIAL PLANNER™ professional before implementing any of the strategies previously mentioned.

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