6 tax planning ideas for the end of the year
Take advantage of these suggestions by December 31 to see if you can reduce your tax liability. With the possibility of future tax law changes, a year-end assessment is more crucial than ever.
1. Review your withholdings on your paycheck.
If you declare too few allowances on your W-4, you may receive a refund when it comes time to file your taxes. You may owe taxes if you claim too many allowances. Use the IRS tax withholding estimator to see if you’ve been withholding the correct amount to avoid surprises in your filing.
- If you need to make changes, submit a new W-4 to your employer.
- Choose “0” allowances to pay a bigger portion of your taxes over the year.
- File a new W-4 and adjust the number of allowances if the calculator suggests you’ve been withholding too much.
2. Contribute the maximum amount to your retirement account.
Traditional IRAs and 401(k) plans are tax-advantaged retirement funds that compound over time and are funded with pre-tax dollars. As a result, they’re an excellent long-term investment. They’re particularly advantageous at tax time, as payments to these programs reduce your taxable income.
The following are the maximum 401(k) contributions for the current tax year:
$19,500 up to age 49
$26,000 (with a $6,500 catch-up payment) for people over 50.
The following are the maximum IRA contributions for the current tax year:
$6,000 up to age 49
$7,000 (with a $1,000 catch-up payment) for people over 50.
Consider maxing out your HSA (health savings account) contributions (currently $3,650 for individuals, $7,300 for families, and an additional $1,000 for adults 55 and older).
Do something: Can’t contribute the maximum amount to your 401(k)? At the very least, try to contribute the amount that your company will match. By December 31, all 401(k) contributions must be made. You can contribute to IRAs and HSAs until the year’s tax deadline.
3. If you’re 72 or older, take any RMDs from traditional retirement funds.
Regular minimum distributions (RMDs) are required by all employer-sponsored retirement plans, traditional IRAs, SEP, and SIMPLE IRAs by April 1 of the year after your 72nd birthday. To avoid the penalty, annual withdrawals must be made by December 31.
RMDs are treated as taxable income. If you lose in taking the RMD, you will be subject to a 50% excise tax on the amount you should have withdrawn based on your age, life expectancy, and account balance at the start of the year.
Take action by December 31st to receive your RMD. To avoid penalties, you must take your first withdrawal after turning 72 on or before April 1 of the following year.
If you don’t need the money and don’t want to increase your taxable income, a Qualified Charitable Distribution (QCD) from your qualified account to a public charity may be a good option. However, you will not be fit for the itemized deduction for charitable contributions. A QCD contribution can be made as early as age 70 1/2 and is restricted to $100,000 each year.
4. Use your investment losses to offset your gains by “harvesting” them.
Tax-loss harvesting is a strategy for reducing your tax liability by selling taxable* financial assets such as stocks, bonds, and mutual funds at a loss. This loss can be offset against investment gains elsewhere in your portfolio, lowering your capital gains tax liability.
If your capital losses outweigh your gains in a given year, the IRS will let you apply up to $3,000 in losses against other income and carry the rest over to future years to offset income.
The purpose of tax-loss harvesting is to postpone paying income taxes for several years, ideally until you retire, when you’ll be in a lower tax rate. This method allows your portfolio to grow and compound faster than if you had to pull money out of it to pay taxes on its gains.
Do something: Tax-loss harvesting necessitates accurate tax loss tracking across a portfolio and market changes because tax-loss harvesting might occur at any time. A financial advisor can help you determine any losses that can be used to offset any benefits.
Tax-loss harvesting does not apply to tax-advantaged accounts, including regular, Roth, and SEP IRAs and 401(k) s and 529 plans.
5. Consider grouping your itemized deductions.
Certain expenses, such as the ones listed below, are considered “itemized” deductions:
Expenses for medical and dental care
A mortgage interest that qualifies, including points for buyers
Net investment income plus investment interest
Contributions to charity
Losses due to casualties, disasters, and theft
To itemize, your costs must exceed a particular percentage of your adjusted gross income in each category (AGI). Consider the following scenario: you want to itemize your medical bills. The threshold for itemizing medical expenses in 2021 is 7.5 percent of your adjusted gross income. It is unnecessary to enumerate if your medical expenses exceed 5% of your AGI.
Bunching is a technique for achieving the minimum threshold. You might defer 2.5 percent of your costs to the following year in this case. Then you’d be more likely to hit the 7.5 percent AGI threshold the next tax season, allowing you to itemize.
Take action: If you’ve been putting off certain medical and dental bills or charitable contributions, you should bundle them to maximize your itemized deductions.
6. Put any money you have leftover in your flexible spending account (FSA)
FSAs are essentially savings accounts for out-of-pocket medical expenses. Your pre-tax resources are earmarked for medical bills, lowering your taxable income.
When you inform your employer how much of each paycheck to put into your FSA, keep in mind that any cash left in the account on December 31* will be subject to taxes. Plus, you’ll lose access to the funds unless your employer authorizes a set amount of rollovers for the following calendar year.
Do something: By December 31, make any last-minute appointments or eye tests. Prescriptions for you and your family will be filled. Is your balance still intact? Purchase things eligible for FSA reimbursement (e.g., contact lenses, eyeglasses, bandages).