Year-Round Tax Planning Tips

Tax Planning
Tax season is upon us, and for many people, that means taxes are top of mind. This makes sense for many reasons: you’ve been getting tax documents in the mail, coordinating with your accountant or inputting data into your tax software, and so on. That’s all important, but the reality is tax planning occurs throughout the year, not just when you file your tax return! Here are some things to consider from a financial planning perspective that may save you some stress (and money) this year.

If you have a tax-advantaged account, consider making contributions:

The first thing that comes to mind here might be your employer-sponsored retirement plan (i.e. a 401k). Your contributions are “pre-tax” which means they go into the 401k before taxes are taken out, which can reduce your taxable income. But this idea applies to many other types of accounts. If you do not have a retirement plan at work, or you are under the income limits for deducting contributions, you may find it useful to make pre-tax contributions to a traditional IRA.
Health Savings Accounts (HSAs) are perhaps the most tax-friendly accounts of all. You can contribute pre-tax dollars, and if you use them for qualified healthcare expenses, the growth of the HSA assets is tax-free upon withdrawal. This means that you can reduce your taxable income today without picking up any more down the road. HSAs are valuable enough to warrant their own blog post, so if you’re looking for more details, stay tuned.
Finally, if you have children or family members who are attending or may attend college, consider contributing to a 529 college savings plan. These contributions aren’t pre-tax, but many states offer versions of the 529 plan that provide tax breaks to residents. Here in Indiana, residents get a 20% tax credit for any 529 plan contributions up to $5,000. This means you can get up to $1,000 in tax credits just for helping fund a loved one’s education.

Consider charitable giving:

If you are charitably inclined, or looking for a way to lower your tax bill, this can be a great answer. If you itemize your taxes, you can deduct donations to qualified charitable organizations. Make sure to gather and keep your receipts to make things easy to manage on your next tax return.
When choosing what assets to give, it often makes sense to gift highly appreciated assets. Normally, when you sell these assets, you will have to realize a sizable capital gain, which means you’ll owe more taxes. Gifting them away allows you to avoid this.
Gifting doesn’t always have to come from your taxable accounts. Making Qualified Charitable Distributions from an IRA is also a good strategy if you are over age 70½. You can gift funds from the IRA account directly to a qualified charity to satisfy some or all of your Required Minimum Distribution (RMD). If you don’t need the entire RMD amount for living expenses, this means you don’t have to pick it up as taxable income.

Pay attention to your asset location:

Chances are, over the course of your life, you will have multiple investment accounts. And chances are, those accounts have different tax characteristics. For example, your 401k is not taxed the same as a joint account with your spouse, and neither of those is the same as a Roth IRA. Because of these differences, it can be beneficial to keep certain types of investments in different types of accounts.
For example, in taxable investment accounts, you can look for investments that minimize taxable events. There are mutual funds that are managed specifically with this in mind. They do their best to limit things like capital gains, so if you can find a fund like this that fits your investment plan, you can increase your tax efficiency. If you are going to hold bonds or bond funds in this type of account, take a look at municipal bonds. While they might not always be right for you, they provide Federal tax-free income, whereas the income from non-municipal bonds will be subject to federal tax.
In short, you want the most tax-efficient investments in your taxable accounts, and the least tax-efficient investments in your tax-advantaged accounts. However, it is important to note that asset location should be considered only after you have developed an overall investment plan that suits your needs. Once you have that, investing with asset location in mind can be very helpful.

If you have some poor performers, utilize tax loss harvesting:

Unfortunately, there are times when certain investments just don’t perform as we had hoped. But that doesn’t always have to be a bad thing. If you have investments with unrealized losses, consider selling them. Realizing these losses can give you an opportunity to offset some gains and reduce your tax bill. This is called tax loss harvesting.
Before doing any tax loss harvesting, be wary of the wash sale rule. This rule says that in order for those losses to be used, you can’t buy that same investment again for 30 days after selling it. You certainly have the option to keep the money in cash, but in today’s investment landscape, it is often possible to find a good alternative that still fits your overall investment plan, allowing you to sell an investment and buy a replacement without disrupting your plan. After 30 days, you can buy the original investment back with no penalty, but you are not required to.

When selling part of an investment, sell the most tax-efficient lots:

When selling some (but not all) of an investment holding in a WealthPoint client’s taxable account, we sell the lots that lots that have the most tax efficiency. “Lots” are the different segments in which you bought into the investment. For example, if you purchased a specific stock ten years ago, haven’t purchased any of that stock since, and chose not to reinvest dividends, you would just have one lot of the stock. However, if you bought another chunk of that same stock five years later, you’d have two lots. If you chose to have dividends of that stock reinvested, each dividend would create new lots.
This is important because you pay different prices for each lot. Chances are, there will be a scenario where some lots have decreased in value since you bought them, and you will be able to sell them at a loss. Even if the stock has done well for you since the original purchase, you may have smaller lots with losses that you can sell for tax reasons, without touching the other lots.
In general, it makes sense to sell lots in the following order: short-term losses, long-term losses, long-term gains, and short-term gains. Keep this in mind when partially selling an investment from a taxable account.

Tax season can be very stressful, and even more so when you get a big tax bill. Hopefully, you will be able to apply these tips and tricks throughout the year to not only reduce stress during tax season, but also save yourself some money in the process. While these techniques can be confusing and difficult to implement, they can save you money by reducing your tax burden. It is recommended to discuss these items with a financial planner, who will take a comprehensive look at your situation and give you advice that best fits your specific needs.

As always, thanks for reading!

About the Author: Josh Bentz

Josh Bentz, CFP®, Wealth Advisor, helps clients organize and simplify their financial lives by providing comprehensive, personal financial planning. As a Wealth Advisor, Josh provides comprehensive financial planning for clients. He enjoys getting to know individuals and families so he can give specific, meaningful advice. He believes in being a fiduciary and doing what is in the best interest of clients.