Closing Out One Year and Starting Another

The stretch from Thanksgiving to New Years is one of my favorite times of the year. There always seems to be a lighter mood: family, friends, food, decorations and stories all bringing people together and creating memories. I love to cook so I enjoy getting to spend time in the kitchen both constructing and indulging guilt free on my favorite foods. It’s also a good time to look back and reflect on the year and be grateful for all that we have, and contribute our time and resources to help out where we are able. In this blog we’ll explore some various strategies to strengthen both our personal financial foundation and those in our communities. 

Not only is this the time for end of the year planning to maximize retirement contributions and tax strategies, it’s also a good time to look at some of the more subtle fundamentals of personal finance that often get neglected. For the most part these aren’t complex intricate financial planning concepts that require a wealth of knowledge to implement; they’re (usually) quick and easy items to have on anyone’s annual end of the year financial review to prevent small mistakes from having a long-term drag on your financial plan, or even worse, irreversible permanent damage to your financial plan. 

I call this the end of the year “housekeeping” checklist. There are certain items that are imperative to complete before January 1st. There are also a few things that are good to get into the habit of reviewing at least annually. Whether that happens to be at the end of the year or not, to each their own; I just think these annual fundamentals fit in well with the “housekeeping” theme. Then we’ll look at a couple ways to be charitable; who is able to receive tax benefits for charitable contributions, and how we can go about contributing to our favorite charities and helping to strengthen our communities.

Workplace benefits

Workplace benefits usually run on calendar year cycles with December 31st bringing to a close one year and January 1st bringing a fresh start. Here are a couple of areas to pay attention to in order to get the most bang for your buck.

Qualified Retirement Plans

401(k) and other workplace salary deferral plans require contributions to come out of your paycheck. Unlink IRA (Individual Retirement Accounts) contributions that can be made up until tax-filing deadlines, with extensions, qualified retirement plans contributions must be made by December 31st. If you would like to max out your contributions for 2023 ($22,500 and an additional $7,500 for people over 50) you must make the necessary changes to your payroll withholding so additional money is withheld from your paycheck. The IRS does not allow employees to receive money from their employer and then deposit it into qualified retirement accounts.

Depending on your unique compensation structure (salary, bonus, commission, overtime, etc.), it can be difficult at the beginning of the year to calculate the exact amount to be taken out of each paycheck. Typically, people do not want to over contribute because they would have to withdraw the excess and it can complicate and prolong filing taxes, so they underestimate how much to contribute at the start of the year. You’ll want to stay on top of your contributions throughout the second half of the year. Not every qualified retirement plan allows contributions to be changed every pay period because of the administrative burden. Make sure you’re evaluating your contributions periodically to give yourself adequate time before the end of the year to make the necessary changes because for some high income earners, maxing out your retirement accounts can be the difference between qualifying for or missing out on certain income-based tax credits and other tax incentives.

Health Savings Accounts

Health Savings Account contributions, like IRA contributions, can be made up until tax-filing deadlines; this comes with a caveat, however. HSA contributions that are processed through payroll deductions are exempt from FICA taxes and PA State Income Tax. While you will still get the PA State Income deduction if you make an out-of-pocket contribution directly to your HSA, you will not receive a FICA deduction. The employees share of FICA taxes equates to 7.65%. If you would like to shelter your HSA contributions from payroll tax, make sure you are meeting the annual HSA limit for 2023 ($3,850 for an individual and $7,750 for a Family) through payroll deduction contributions. Most HSA plans allow for contributions to be changed every pay period so if you need to you are able to elect to have a larger chunk withheld from your paycheck for the last period, or two.

Tax Planning

Roth Conversions

A lot of planning and future tax assumptions go into whether it is appropriate or not to do a Roth conversion. The one thing that is certain is when the earned income from doing a conversion is reported. The income from a conversion is reported for the tax year in which the conversion was completed. If you would like to do a Roth conversion and have the income included for 2023, the conversion must be done by December 31st. Don’t get Roth conversions confused with IRA/Roth IRA contributions, which you can make for the previous year up until tax-filing deadline. And just remember: once money is converted from Traditional to Roth, it cannot be converted back.

Tax Gain & Loss Harvesting

Stocks for the most part have had a great year so far in 2023, especially U.S. Large Cap Growth. As of writing this blog, The NASDAQ is up just over 35% year-to-date and the S&P 500 is up almost 19%. But that doesn’t mean every stock in your investment portfolio is up since the date it was purchased. Some investments may have been purchased at 2021 market highs. Other investments may have been purchased in a sector that hasn’t fully recovered like U.S. Large Cap stocks. Many bond funds are still down almost 20% or more from their 2021 highs.

The run that some investments have been on over the last decade plus bull market may mean they have become an outsized portion of your portfolio. Often the prudent thing to do is trim the position and reallocate the proceeds; the problem is you don’t want to foot the tax bill. The solution is tax-loss harvesting. You can sell investments that have losses to offset the gains on other investments. To avoid “wash-sale” rules, you cannot buy the same investment for 30 days before or after the date you sold it and realized the loss. What you can do is reinvest the sale proceeds into a different investment that is not “substantially identical.” And even if you don’t have investments with gains you want to sell, up to $3,000 of losses can be used to offset earned income and the rest over that threshold can be carried forward to future years. Tax-loss harvesting can be a great way to reduce your current tax liability and defer payment of taxes to the future.

Tax-Gain harvesting is the flip side of tax-loss harvesting. It is selling assets to realize a gain. Why would you want to do this? The current 0% federal capital gains bracket applies to single filers with taxable income less than $44,625 ($89,250 Married Filing Jointly). For individuals/families with taxable income below these thresholds they can sell assets, realize the gain, step-up the basis, and not pay federal income tax if executed properly. The best part is, you can even buy the asset right back after selling it; wash sale rules do not apply to realizing capital gains, they only apply to losses. This is a great strategy to utilize each year for people with taxable income below these thresholds to plan for reducing future taxes.

The rules can get a bit complicated when it comes to adhering to wash-sale rules and realizing capital gains. It is wise to consult with a financial advisor or tax professional when it comes to utilizing tax-gain/loss harvesting strategies.

Estate Clean up

This can often be the easy stuff, but then life gets in the way and we forget, and then something unexpected happens and we’ve made something more complex than it needed to be, all the while dealing with a personal loss in many cases. For most people that are diversified investors, one bad investment doesn’t ruin their financial plan. On the other hand, one estate planning misstep can be costly, time-consuming, or both. At least annually, all beneficiary designations on investment accounts and insurance policies should be reviewed to make sure they are current. The same goes for a will; at least annually it should be reviewed to make sure it is up-to-date.

These are a few common estate planning missteps that should be avoided.

  1. Missing Retirement Account Beneficiary: Retirement accounts typically pass directly to the beneficiary, avoiding probate. If there is no beneficiary on file then the account can be subject to the probate process. Not only does that delay distribution of assets, it also changes the tax consequences for the person inheriting the money, and not for the better. The IRS imposes less favorable distribution rules for IRA money that passes through the decedent’s estate rather than directly to a listed beneficiary. The “stretch” IRA is reduced from 10 years down to 5 years, likely increasing the tax burden on the inheritor.
  2. No Contingent Beneficiary: Every account application I have seen has a place to list at least one contingent beneficiary, and usually multiple. This is who will receive the assets if the beneficiary predeceases the account owner. There is no harm in listing contingent beneficiaries, as long as you are content with them being second in line to inherit the asset.
  3. Minor Listed as Beneficiary: Oftentimes parents will have children listed as their contingent beneficiary after their spouse. While there is nothing wrong with this is most cases, children are considered minors till the age of majority, and can’t legally receive the assets. It is advisable to consult with an estate attorney to set up conservatorship & guardianship for your children in the event of a tragedy.
  4. Family Dynamics Change: You’ve likely heard the statistic that half of marriages end in divorce. But it is not just divorce. Death, birth, marriage and other circumstances can all change. When family dynamics change, wills and beneficiary designations should all be reviewed and updated accordingly to be consistent with current wishes.

Scrubbing those subscriptions

With so many products and services being offered via subscription it can be hard to keep track of what we are actually using versus what we’re just paying for. One of my favorite ways to stay up on my subscriptions is by using a budget tool with a data aggregator to feed in bank accounts and credit cards from multiple vendors. This is an easy and effective way to track spending across segregated platforms. Transactions can be coded into their respective categories and then tracked. While I really like this for tracking subscriptions and memberships, it’s an effective way to easily track any spending habits across various financial institutions.

Once transactions are categorized during the initial program set up, most of the work is done by the software, except for purchases from any new vendors you may transact at. By running an annual – or quarterly – report, you can track spending on streaming services, food delivery, fitness memberships, clothes, clubs, and more. Canceling those unused subscriptions might only seem like a few dollars, but they can really add up in the long term.

Charitable giving

I’ve always understood the act of giving to not be contingent on receiving anything in return. Giving should be done because we can and want to help others. The tax code apparently has other thoughts on giving and has decided to give back to those that give, with a few caveats.

In order to receive a deduction for charitable contributions you must itemize your deductions. For 2020 and 2021 those who used the standard deduction could receive a limited charitable deduction depending on their filing status – that has since expired and is no longer available. For those that itemize, here are a few interesting concepts for being charitable and utilizing the tax code to your advantage.

You don’t have to contribute cash to charities. While you certainly can contribute cash, there are other assets that can receive charitable deductions. Stocks, mutual funds, and property can all be contributed to charities. If a stock has been held for a long period it can have a rather large unrealized capital gain. By donating the stock to the charity the donor receives a tax deduction, and since qualifying charities are tax-exempt, the charity can sell the stock and not pay income tax. The IRS does impose certain limits on charitable contributions for different asset classes, so it is always wise to consult with a tax professional before making a charitable contribution.

Donor-Advised Funds

A Donor-Advised Fund (DAF) is a great way to maximize charitable contributions for charities and donors alike. DAFs are type of investment account where the contributions are tax-deductible (within IRS limits) up front, but the donor maintains investment control over the assets. The funds can no longer be withdrawn for personal use, but the donor retains a few benefits over standard charitable contributions.

  • There is the benefit of an immediate tax deduction, but that doesn’t mean contributions to charities need to be made immediately. The donor can elect to make charitable contributions to any IRS qualifying charity, in any amount, on any annual schedule. It may not be practical for some people to make large charitable contributions every year. This is a way to make a large contribution in one single year and receive the tax deduction, and continue to give over many years.
  • The money can continue to grow tax-free inside the DAF. Not only do they grow tax-free for the charities, but the growth is no longer taxable to the donor. This means more money for charities and less taxes paid by the donor.

Most Donor Advised Funds are not limited to cash contributions and can receive securities as well. This means a potential triple ancillary benefit for being charitable: Up front charitable deduction, no paying capital gains tax on the disposition of securities, and tax-free future growth. DAFs are definitely something to consider to get the most bang for your buck for those who would like to make substantial charitable contributions.

happy holidays

Whether it is tidying up your own personal finances or making the extra effort to serve others, the end of the year is a great opportunity to reflect on the past year and to start being proactive about planning for next year. 

Amidst all the holiday chaos, remember to take some time to slow down!