We all have that friend or family member who is late for everything. Frequently, these same friends also tend to put things off until the last minute.
This can be frustrating for Type A personalities, but there are times when this approach actually works well. A specific occasion when this makes sense is with year-end tax planning.
Waiting until later in the year to employ tax strategies can be beneficial because your income tax situation is clearer by then. At the beginning of the year, there are frequent unknowns that may influence the best strategies to employ.
5 Tax Planning Strategies To Consider
Deduction Bunching: This strategy refers to bunching itemized deductions into one year to reduce your overall tax deduction. On some occasions, people who don’t bunch their deductions into one year do not receive any additional tax benefit. This strategy just got a boost because the state and local tax deduction cap has been increased from $10,000 to $40,000 until 2030. Examples of itemized deductions include state and local taxes, home mortgage interest, medical and dental expenses that exceed 7.5% of your adjusted gross income, and charitable contributions. Some of these deductions can be accelerated into one year. It is important to note that some of these deductions are phased out for high income earners.
Roth Conversions: A Roth conversion entails converting money from an IRA to a Roth IRA. When this occurs, tax must be paid on the converted amount. This frequently makes sense if the tax on the converted amount is lower than what it would be in the future when you take withdrawals. Many of our clients with larger IRAs may see their tax rate increase in the future when they are forced to withdraw large amounts from their IRA when required minimum distributions start at either age 73 or 75, depending on their date of birth. By waiting until the last quarter of the year to employ, this strategy can be favorable because we can see a more accurate depiction of what the total income will be for the entire year. Once we estimate this amount, we can forecast your current tax rate vs. your estimated future tax rate to determine if this is a valuable strategy to employ. This strategy can also be a favorable estate planning tool for individuals with large estates, as it can reduce the overall size of the estate subject to estate taxes while providing an income tax-free inheritance for beneficiaries. This strategy just got a boost with recent tax law changes for some investors who are 65 years old and older because the new standard deduction has increased by $6,000 per person, thereby providing more room for these individuals to use up lower tax brackets. The increased standard deduction benefit phases out for upper income earners.
Distribution Planning: One of the questions we often ask our clients is whether they expect any major expenses in the next few years. The reason we ask this is because we are trying to anticipate large distributions from investment accounts. In many circumstances, these larger distributions will require tax to be paid. This can be valuable information to know because spreading larger distributions into multiple years can keep people into lower tax brackets. For example, if someone needs $100,000 in 2026 for a house project, we might suggest taking out $50,000 in 2025 and the remaining $50,000 in 2026 if it helps keep them in the 12% tax bracket for both years. This can be beneficial if it prevents them from taking all $100,000 in 2026, which could push them into 22% tax bracket.
Income Planning: Similar to distribution planning, income planning in advance can reap rewards. This plays a role when an individual can push off income taxes into the next year. For example, if someone is selling a highly appreciated stock or asset that will generate capital gains tax, it may make sense to delay the sale until after the first of the year. This approach usually makes sense for someone expecting a higher tax rate in 2025 and a lower one in 2026.
Contribution Planning: For individuals still working, make sure you are utilizing all the tax-advantaged savings plans you can. This may include work retirement plans, IRAs, Roth IRAs, 529 plans, and HSA accounts. If you are a person who has money outside of these accounts that is not needed in the future, always consider utilizing these accounts to fully fund the tax-advantaged savings accounts mentioned above.
The reason our advisors ask you a variety of different questions each year is that it helps determine the strategies discussed here, as well as hundreds of other strategies not mentioned in this article. This is why it is so important for us to have accurate data.
It is important to note that some of these strategies must be employed by November to ensure they are fulfilled by the end of the year. Please reach out to us sooner rather than later to explore the tax planning strategies mentioned in this newsletter, if you haven’t already discussed these with your advisor.
Fortunately, we maintain a personalized list of potential strategies for every client, so you can feel confident knowing these opportunities are being considered on your behalf.
I hope you have had an excellent start to your fall!
