Year-end financial planning
Although the ups and downs of the financial markets get considerable attention, personal financial planning involves much more than just managing investments. While we always preach the value of maintaining a well-grounded long term perspective, it is also worthwhile to consider short term tactics that can boost one’s bottom line. Our year-end financial planning not only aims to identify actions that should be taken prior to December 31st, but also those that should be postponed until next year.
While we always preach the value of maintaining a well-grounded long term perspective, it is also worthwhile to consider short term tactics that can boost one’s bottom line.
The cornerstone of this type of financial planning is a comparison of what the result would be if an action was taken in 2013 against the probable outcome from waiting until 2014 to take that same action. In many cases, the tax consequences drive the decision. It is our aim to save a client taxes by evaluating what income streams and deductions they can control and choosing the best year in which to incur the income or make the deductible payments. What follows is a brief summary of some of these opportunities.
Controllable income:
Withdrawals from retirement accounts: At age 70 ½, Required Minimum Distributions must be taken from retirement accounts. In some cases, it is wise to take additional funds beyond the minimum if it is needed or will soon be needed. This allows the extra withdrawal to be taxed at a lower rate than it would be if taken later.
Those age 59 ½ are no longer subject to a 10% early withdrawal penalty and are free to take as little or as much as they wish from their retirement accounts. If at any time during the next 11 years (until age 70 ½) there is room to incur more taxable income within a lower tax bracket, withdrawing funds even if they are not needed for spending can be beneficial.
If funds withdrawn from retirement accounts are not needed for spending, converting the amounts withdrawn in excess of any RMD to a Roth IRA might be a good idea. Roth’s grow tax free, withdrawals are tax free, and Roth accounts are not subject to RMDs while the owner is alive.
Capital Gains: When you sell capital assets like stocks or mutual funds that have been held for 12 months or more for a profit, they are taxed as a long term capital gains. For all taxpayers, the rate applied to long term capital gains is lower than the rate applied to ordinary income. In fact, clients in the 15% or lower tax brackets pay zero taxes on long term capital gains.
Stock options: Clients with stock options are often well served by considering what year to exercise these options to get the best after tax result.
Controllable expenses:
Charitable contributions: Charitable gifts can be tax deductible. If one gives shares of investments that have appreciated, the potential capital gains are erased. Clients over 70 ½ can give to charity directly from their IRA’s positions. Called Qualified Charitable Distributions (QCD), these actually count toward a RMD and are particularly beneficial to non-itemizers. Though popular, this provision is set to expire at the end of 2013.
Capital Losses: Selling investments that have declined in value from the time of purchase can lower taxes by offsetting gains. If the loss exceeds the gain, up to $3,000 can be deducted from income and any excess beyond that is carried forward to offset future gains or income.
Itemized Deductions: As December 31st approaches, a number of tax deductible expenses can be accelerated so they all apply to 2013 or postponed to apply in 2014. This can reduce taxes in a higher tax year or allow a family to itemize when they wouldn’t have been able to do so had they not “bunched” their deductions.
For instance, a family that would normally use the standard deduction in 2013 could postpone their year-end charitable donations, property tax payment, and perhaps some medical expenses until after December 31st. They would make their usual year-end donations and property tax payment for 2014 at the usual time late in 2014. Now they have double the charitable donations, twice the real estate taxes and the medical expenses all hitting in 2014. They get the same standard deduction for 2013 they would have had they not postponed, but they will itemize in 2014 and therefore deduct more than the standard deduction.
More Considerations:
Employees that have not maximized their contributions to a retirement savings plan like a 401(k) or 403(b) can increase their payroll deduction between now and year-end to increase their tax deductions for 2013.
Families that are interested in gifting to other family members can gift up to $14,000 per person, per calendar year free of gift taxes. These gifts are not income tax deductible but once December 31st passes, the option is gone for 2013.
Of course, the tax code has gotten more complex over the years so financial planning has become more difficult. 2013 saw many changes particularly for higher income taxpayers. Households with income nearing $200,000 face the phase out of exemptions and itemized deductions, a higher capital gain rate, and taxes on certain investment income for 2013 and beyond. If one’s tax withholdings or estimated payments are not sufficient, penalties and interest may be assessed.
Late in the year we have much less uncertainty about what our income and expenses will be because those items are “in the books.” Where needed, we will prepare a tax projection for 2013 to help us be more precise about what maneuvers may benefit each of our client families. We typically start this formal tax projection process in November.
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If you have any questions or would like to discuss this further, please give us a call or send us a note.
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