15 Quick Ideas: Tax Planning
Photo by Markus Winkler on Unsplash
(Article updated in April 2024)
Wondering what you might be able to do to improve your tax picture?
Tax planning can be extremely beneficial, potentially leading to thousands upon thousands of dollars saved if done well.
So let’s go through 15 common strategies I use with my clients. My hope is that perhaps something in here will be helpful to you, hopefully reducing that pesky tax bill a bit.
1: Tax planning is NOT tax preparation
First, let’s tee this up a bit.
Tax planning is not the same thing as tax preparation.
Everyone does tax preparation. Tax prep is inherently REACTIVE; it’s looking backwards at what happened during the previous year and filling out the forms to report the events to the IRS (and potentially your state).
Tax planning is much more rare. Tax planning is inherently PROACTIVE; it’s thinking about what the future may hold and making moves now to reduce your lifetime taxes.
2: Dial in that tax withholding
Have you received huge tax refunds in the past? If so, you should consider lowering your “tax withholding” from your paycheck or retirement distributions.
In getting a refund, you’re essentially giving the IRS a 0%-interest-rate loan. You give them the money throughout the year, then you get it back the following year when you file your tax return.
Instead, consider lowering your withholding so that you can enjoy that money during the year. You can put it into a bank‘s high-yield online savings account that pays you 4%+ interest if you’d like to save it for later.
On the other hand, if you’re able to project your tax withholding and tax bill before the end of the year (not easily done), will enough tax be withheld from your paychecks? If not, you may owe a big pile of money when you file your tax return, plus be subject to a tax penalty for “underwithholding”.
In that case, you might consider dramatically raising your tax withholding for the final few paychecks of the year (enough to avoid the tax penalty). Then, you’d need to remember to adjust it again at the beginning of the year.
Or, if you’re retired, you could take a distribution from your IRA or 401(k) and have 100% sent to the IRS/state.
3: Take your RMDs
Are you age 73 or older and own a Traditional or Rollover IRA?
Do you own an Inherited IRA?
If you answered yes to either of those, you’ll most likely have to take a Required Minimum Distribution (RMD) from the account.
The custodian (where your IRA is held) can tell you the amount you’ll need to withdraw.
Make sure to take the full RMD before the end of the year, as there can be steep penalties for not doing so (usually a penalty of 25% of the amount not taken on time … ouch).
By the way, if you’re 70.5 or older and don’t need the money, you can have your RMD donated directly to a charity (called a Qualified Charitable Distribution, or QCD). Just make sure your accountant knows about it at tax time, otherwise you might be taxed on it.
4: Harvest capital losses
Do you own any stocks, bonds, ETFs, or mutual funds (in taxable brokerage accounts) that have gone down in value since you purchased them?
If so, you might be eligible for a tax break.
Sell those securities, and you can offset other capital gains you may have from selling securities at a gain earlier in the year and/or from year-end mutual fund distributions. That means you don’t have to pay taxes on those gains.
Even better, if your capital losses are more than your capital gains, you may be able to offset up to $3,000 of ordinary income. If you’re in the 24% federal tax bracket, that equates to up to $720 of tax savings, plus any saved state tax (for example, another $279 saved in California).
Any net capital losses over $3,000 can be carried over into next tax year to give you a tax break then.
Just be careful not to purchase the same security 30 days before or after the sale, including via reinvested dividends, in the same or any other account. If you do, the “wash sale rule” will disallow the tax loss.
Instead you could buy something that’s somewhat similar to the security you sold, giving you similar investment exposure. After the 30 days, you can consider purchasing the original security again.
5: Harvest capital gains
Is this a relatively low income year for you? Perhaps you retired. Or lost a job. Or commissions were really low.
If so, there are some tax moves you should consider.
One is to “harvest capital gains”.
What that means is to sell stocks, bonds, ETFs, and mutual funds that have risen in value since you purchased them, and which you’ve held for more than one year, purposely creating capital gains.
It might make sense to do this if you’ll be in the 0% capital gains tax bracket for the current year. You’d essentially pay no taxes on the profits. Nice.
In 2024, you’ll be in the 0% capital gains tax bracket if your taxable income will be less than:
Married filing jointly: $94,050
Head of household: $63,000
Single or Married filing separately: $47,025
If your taxable income is projected to be below the applicable threshold, you might consider generating enough capital gains to bring your taxable income closer to the limit (the profits you generate will stack on top of your other income).
(You can also consider this if you’ll be in the 15% capital gains bracket this year, but expect to be in higher brackets in the future.)
If you do this, feel free to immediately buy back the securities you sold, as there’s no “wash sale rule” to worry about like there is for generating capital losses.
6: Watch out for capital gains distributions
Do you own mutual funds in taxable (non-retirement) accounts?
If so, you will likely be affected by year-end capital gains distributions.
These are distributions that often act as “phantom income” to you … that is, you don’t receive any cash, but you pay taxes on the amount nonetheless (the money is usually reinvested to purchase more shares of the mutual fund).
Make sure you account for these if you’re doing any sort of tax projections for the year. If your account is of a decent size, these CG distributions can add quite a bit of capital gains income to your tax return.
Mutual fund companies will often post estimates of these distributions on their websites.
Going forward, it may be a better idea to purchase ETFs rather than mutual funds in taxable accounts. ETFs tend to be much more tax efficient because they don’t make (or make smaller) capital gains distributions.
You could also consider selling your mutual funds toward the end of the year before these distributions are paid, usually in the final two weeks of December. And then you can reinvest the proceeds in ETFs instead. Just be aware of any capital gains you might be generating by selling them.
7: Roth conversions
Will this be a low-income year for you?
If so, you may want to consider a Roth conversion.
With a Roth conversion, you deliberately generate “income” by moving tax-deferred IRA or 401(k) money into a Roth IRA.
The amount you convert is reported as income on your tax return, even though you don’t actually receive it in your hands.
The great thing about Roth money is that you never have to pay tax on it again; it’s tax-free money, even when withdrawn in the future.
The reason to do it during an otherwise low-income year is that you may end up paying a lower tax rate on your conversion now, compared to what you’d pay later. That is, if the tax rate you’ll pay now is lower than the tax rate you may pay in the future when withdrawing money, then a Roth conversion is likely a good idea.
There are other factors to consider, so make sure to do your research, or, even better, work with a financial planner and/or tax advisor.
8: IRMAA
If you’re receiving Medicare or are within two years of receiving Medicare, watch out for IRMAA surcharges.
IRMAA (Income-Related Monthly Adjustment Amount) surcharges are assessed via paying a higher amount for your monthly Medicare Part B and Part D premiums.
They are assessed if your income (MAGI, or modified adjusted gross income) is high enough during a given tax year. There are several thresholds, with IRMAA surcharges getting higher and higher as your income increases.
These surcharges are applied with a two-year lag, so if your MAGI is high one year, you’ll pay the IRMAA surcharge for one year, two years later. For example, if your MAGI in 2024 passes an IRMAA threshold, it will affect your 2026 Medicare premiums.
And it’s important to know that the income thresholds are “cliffs”. That is, if your MAGI goes one dollar over a threshold, you’ll pay the higher premiums two years later.
If you have some control over your income (increasing or decreasing it), look out for these thresholds and see if you can stay below the next one.
9: Giving strategies
‘Tis the season for giving!
Charitable giving can provide not only enormous emotional benefits, but can also help you pay less tax.
There’s a lot that goes into this topic, but at a high level, you may want to consider:
…if you’re over age 70.5, giving directly from your IRA via what’s called a Qualified Charitable Distribution (QCD). You don’t pay any taxes on the distribution, and it can count toward your RMD. Just make sure you tell your tax preparer about it, otherwise you may pay taxes on it.
…giving stocks, bonds, mutual funds, or ETFs that you’ve owned for longer than a year and that have gone up in value since you bought them (“appreciated assets”). Doing so makes it so that you don’t have to pay capital gains taxes on the profits.
…“bunching” a few years’ worth of donations into one year. This can be helpful if it allows you to itemize your deductions.
…giving to a Donor-Advised Fund. These are great vehicles that can allow you to combine the bunching and appreciated assets strategies above.
10: FSA - use it or lose it
With year-end approaching, the deadline to use up your FSA funds is almost here.
FSAs (Flexible Spending Accounts, aka Health Care Flexible Spending Accounts) have a provision that says that if you don’t spend all the money in the account by a certain date, the money will be lost.
In other words, “use it or lose it”.
The deadline depends on your employer’s plan, but it’s usually either year-end or March 15 of the following year. Some plans let you carry over a limited amount of money to the following year (up to $640 for 2024 into 2025).
One idea of how to spend this money would be to proactively purchase OTC medication.
Be careful though, as “stockpiling” isn’t allowed. That term isn’t defined, but some people think it could mean buying more than 3 of the same item.
Make sure you understand the rules of your plan and use up those funds ASAP!
By the way, this doesn’t apply to HSAs (Health Savings Accounts). There is no “use it or lose it” requirement for HSAs; you can let money pile up there (in fact, it’s better to do that, invest it, then use it for medical expenses during retirement!).
11: HSAs
You might want to investigate whether you’re eligible for a high-deductible health insurance plan (HDHP) with a Health Savings Account (HSA).
HSAs are a fantastic way to save money for medical expenses during retirement. They are the only type of account that has a “triple tax break”:
(1) a tax deduction for the contribution,
(2) tax-free growth, and
(3) tax-free withdrawals as long as you use the money for medical expenses.
In order to take advantage of (2) above, you’ll need to get the money that’s in there invested. HSAs offer an investment option once your cash balance exceeds a certain amount (often $1,000-2,000).
That also implies that you don’t want to use the HSA funds for current-year medical expenses. Instead, pay those with cash from your bank account if you can and let the HSA funds grow.
There are all sorts of other tips and tricks when it comes to these accounts, so make sure you understand them.
By the way, don’t sign up JUST for the HSA. The underlying health insurance plan needs to make sense for your situation, and may very well be unsuitable for you if you have high medical expenses.
12: Retirement contributions
Have you fully funded your employer retirement plan (401(k), 403(b), etc.)?
How about your IRA?
With employer retirement plans, you can contribute up to $22,500 for 2023, or up to $30,000 if you’re age 50+ at the end of the calendar year. (Note that there may be exceptions to these limits if your employer makes a large contribution on your behalf.)
In 2024, the limits go up to $23,000, or $30,500 for those age 50+.
With Traditional and Roth IRAs, the limits are $6,500 for 2023, or $7,500 for those age 50+ at the end of the calendar year. In 2024, the limits go up to $7,000 or $8,000.
Be careful with IRA contributions though, as there are income limitations to being able to contribute to Roth IRAs and other limits that dictate whether you can deduct a Traditional IRA contribution. So tread carefully.
13: Asset location
Be mindful about which assets you hold in which accounts.
Come again?
That is, whether you hold stocks, bonds, or cash in your taxable accounts, tax-deferred accounts, and tax-free accounts.
This is called “asset location”.
Generally speaking, you want your highest-appreciating holdings (e.g., stocks) in your tax-free accounts, since you’ll never have to pay taxes on them again.
And you’d like your lowest-appreciating assets (e.g., bonds) in your tax-deferred accounts, as you’ll have to pay taxes on the growth eventually.
Taxable accounts are somewhere in the middle, and are unique because you pay tax each year (so it may be best to not hold securities that distribute a lot of cash each year).
It’s a lot more complicated than that, but that’s the basic idea.
Taxable = regular brokerage accounts
Tax-deferred = Traditional, pre-tax IRAs and employer retirement plans like 401(k)s
Tax-free = Roth IRAs and employer retirement plans like Roth 401(k)s; HSAs
14: IRS Identity Protection PIN
Consider signing up for an IRS Identity Protection PIN.
Why? One way identity thieves are making money is by filing tax returns on behalf of others. They falsely file a tax return on your behalf, claim a large refund, and have it directed to their own bank account. And you’re left having to pick up the pieces.
Applying for an IRS Identity Protection PIN will help protect you from this. When you apply, the IRS will issue you a PIN for that tax year and you’ll need to input it on your tax return when you file. A tax return that’s filed without that PIN will be rejected, thus protecting you from fraud.
You can request a PIN each year starting sometime in January. There’s more info on the IRS website: https://www.irs.gov/identity-theft-fraud-scams/get-an-identity-protection-pin
15: Is it worth it?
Three things to ask yourself before implementing a tax strategy:
Is the additional time & work worth the savings?
Do you have a plan to reinvest the savings?
Does the strategy create more confusion and headache than you want?
Let your answers to these questions guide you on whether you’d like to pursue a particular strategy.
16 (Bonus Edition): My general approach
Spencer Financial Planning’s general approach to tax planning:
We should pay our fair share of taxes, but no more.
Taxes should be managed over one’s lifetime, not just on a year-by-year basis.
Get creative and have fun!
If you feel like you need help in this area, I highly encourage you to work with a financial planner who specializes in tax planning.
If you don’t have one, make plans now to start interviewing a few!
Feel free to start with Spencer Financial Planning :-): Start Here