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End of Year Tax Moves for a Down Market

taxes Nov 07, 2022

The next few months are going to be interesting. But, before we go ahead and celebrate or lament our political victory - let's take a few moments to protect our immediate financial future. Yes, I am talking about tax time.

It's that time of year again when we need to take a few moments and figure out ways to reduce our tax bill. But instead of just listing off some boring tips and tricks, let's make it a bit more fun.

Imagine this - you are sitting at your desk, looking over the piles of receipts and expenses from the past year. Suddenly, a fairy tax-reduction godmother appears before you. "Don't worry," she says with a wave of her wand. "I am here to grant you three tax-reduction wishes."

What do you wish for? Well, here are some ideas to get your creative juices flowing:

#1. Tax Loss Harvesting

The market is down? Great news - it's the perfect opportunity to sell off some underperforming investments at a loss, which can then be used to offset any capital gains. This is known as tax-loss harvesting.

Tax-loss harvesting is the process of selling securities at a loss in order to offset taxable capital gains. It is an important year-end tax-saving strategy that can be used to reduce your taxes and improve your portfolio’s performance.

There are several things to keep in mind when implementing a tax-loss harvesting strategy.

Beware of Wash Sales

First, you need to make sure that you don’t violate the “wash sale rule” by buying back the same or similar securities within 30 days before or after selling them. The easiest way to sell a stock in one company and buy an ETF of the industry, this gives you the double benefit of "harvesting" the loss, BUT - and this is critical - not locking in the loss to your portfolio. By buying the sector, you remove the individual risk of one company and swap it for participation in the overall market. A win/win.

Second, long-term and short-term gain/losses are calculated separately. So make sure you know which types of gains/losses you are harvesting.

Third, this isn't something that applies to your retirement accounts since you are not taxed while the money is in the account...except when it comes to wash sale rules - then it gets really messy. So try to keep it simple and easy.

Finally, only $3,000 of your losses can be used to offset current income. This strategy is primarily a strategy for people who have large taxable accounts, so before you spend all your time harvesting losses, take a few minutes to figure out if it will actually provide you any real-world benefits - or if it's just going to drive your accountant nuts come tax time.

#2. Roth Conversion

A close cousin to Tax Loss Harvesting is Roth Conversion. A Roth conversion is when you take money out of a pre-tax retirement account (like a traditional IRA) and move it into a post-tax retirement account (like a Roth IRA). When you do this, you will pay taxes on the amount converted in the year that it is done.

During years when your portfolio is down and/or when your taxable income is at its lowest are advantageous times for Roth conversions. This is because the taxes you pay on the conversion will be lower, and in the future when you withdraw from your Roth, that money will not be taxable.

Additionally, Roth accounts have no required minimum distributions (RMDs), meaning they can continue to grow tax-free indefinitely, and they are tax-free to your heirs.

The tricky thing about a Roth Conversion is making sure it's a net benefit.

Many times, I have people tell me horror stories of being pitched to convert all their money to Roth IRAs. In many cases, not only will this tip them into the highest tax bracket - but it will also destroy their long-term retirement plans. The reality is you can't just look at the current year's tax savings - you have to consider how this will affect your overall retirement plan.

Roth conversions can be a great tax-saving strategy, but they need to be done with caution and an eye toward the long term.

If you are interested in discussing a potential Roth conversion, schedule a call with us. We'll take a look for you and help you decide if and when a Roth conversion makes sense.You can also download our free guide here. We also have a free calculator you can use to help you figure out if it makes sense, check it out here.

Wondering if a Roth Conversion Is Right For You?

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Our only goal is to help you retire with financial security and peace of mind, and that means ensuring you don't outlive your assets and that you are making the best decision for yourself and your loved ones. To get a free Roth Conversion Analysis, click here.

#3. Max Out Your IRA/401k/HSA Contributions

For those who haven't maxed out their tax-advantaged retirement accounts, it's a good idea to contribute just before year-end. This way, the contribution is subtracted from your income for this year and will reduce your taxable income. Depending on your income level, you may also get an "earned income" tax credit.

In addition, if you're self-employed or own a business with employees, consider making contributions to their retirement accounts as an employer to take advantage of additional write-offs.

Consider a spousal IRA:
The tax code allows a working spouse to contribute to an IRA in the name of a non-working spouse. That way, the non-working spouse—who perhaps stays at home—can grow his or her retirement savings despite having little or no income. Like a regular IRA contribution, these are tax-deductible and can reduce your taxable income this year.

Don't Forget The Catch-up Contributions

If you are over 50, you can contribute extra to your retirement accounts. The numbers change on a regular basis, so if this applies to you, check out the IRS' website for more information. Here's a direct link: IRS Retirement Plans - Catch-Up Contributions

Plus, a down year is the best time to invest for your retirement!
It's when prices are low, and you get the benefit of getting more for your money.

Remember, because of inflation, the stock market will always go up over time...and if that ever changes, your retirement savings will be the least of your worries.

...So make sure to max out those retirement accounts! It gives you a reduction on your taxes this year and helps you accumulate long-term wealth, which brings us to...

#4. Donate appreciated securities

This year when you are giving to your favorite charities, consider giving stocks or mutual funds that have appreciated in value. Not only will you get the benefit of the donation on your taxes - but by donating the actual investment, you avoid paying the capital gains tax on those securities. It's a win-win for both you and the charity!

Just make sure to donate to a qualified charitable organization and be sure to get proper documentation for your records.

P.S. There are lots of ways to donate to charity, including some really nifty things like Donar Advised Funds (DAF) that allow you to invest, manage, and distribute the money as you see fit. Think of them as self-directed charity accounts that give you a tax deduction WHEN you transfer the money to the account.

#5. Defer income and accelerate deductions

Another way to reduce your taxes is to defer income and accelerate deductions. This can be done by delaying the receipt of income until next year or by prepaying expenses that can be deducted in the current year.

For example, you could delay receiving a bonus until next year or pay your January mortgage payment in December. These types of strategies can help reduce your tax bill for this year and save money on taxes.

If you have a business, you could "frontload" your expenses and pay bills you know you are going to pay next year - this year.

This can work particularly well if you have a slow fourth quarter and expect to be in a higher tax bracket next year.

As always, make sure to consult with your financial advisor or accountant before implementing any tax strategies to ensure they are the right fit for your unique situation.

Happy saving!

And remember, taxes are just one piece of the puzzle when it comes to retirement planning - make sure you have a comprehensive plan in place that includes not just reducing taxes but also creating income streams and building wealth for long-term security. We're here to help with that too! Give us a call today to schedule a meeting.

To your success!

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