Year-end tax planning is a proactive step that can make a real difference in your finances. As the end of the tax year approaches, taking advantage of tax-saving strategies can help reduce your tax burden and position you for financial success. Here are some practical year-end tips that I recommend as a financial professional for anyone looking to keep their taxes as low as possible.
Max Out Retirement Contributions
One of the most straightforward ways to reduce your taxable income is by maximizing contributions to retirement accounts. For 2024, individuals can contribute up to $23,000 to a 401(k) plan, with an additional $7,500 allowed for those aged 50 and older. This is a particularly effective way to lower taxable income, especially for high earners looking to reduce their current tax bill while investing in their future.
In addition to 401(k) plans, traditional IRAs also provide an opportunity for tax-deferred growth. For 2024, IRA contributions are capped at $7,000, with a $1,000 catch-up contribution for those over 50. Contributing to both types of accounts can offer flexibility and maximize tax benefits. It’s worth noting that these contributions need to be made by the end of the year for employer-sponsored plans, though IRA contributions can usually be made up until the tax filing deadline.
Take Advantage of Health Savings Accounts (HSAs)
Health Savings Accounts (HSAs) are one of the most tax-advantaged accounts available, offering a unique “triple-tax benefit.” Contributions to HSAs are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are also tax-free. For those enrolled in high-deductible health plans, the HSA contribution limit for 2024 is $3,850 for individuals and $7,750 for families, with an additional $1,000 catch-up contribution available for those 55 and older.
What makes HSAs unique is their flexibility. While many people use them to pay for current medical expenses, funds can be left to grow, creating a tax-free investment vehicle for future healthcare costs. I often recommend HSAs to clients as an additional retirement savings tool, as funds can be used tax-free for qualified medical expenses in retirement.
Use Tax-Loss Harvesting to Offset Gains
Tax-loss harvesting is a strategy where you sell investments that have lost value to offset capital gains on other investments. This can be particularly useful for anyone who’s sold appreciated assets during the year and wants to reduce their capital gains tax. The IRS allows you to use losses to offset gains on a dollar-for-dollar basis, and if your losses exceed your gains, you can use up to $3,000 to offset other income, with the ability to carry forward any unused loss to future years.
Throughout the year, I regularly review portfolios to identify opportunities for tax-loss harvesting, especially when markets are volatile. It’s important to be aware of the IRS’s “wash-sale rule,” which prevents you from repurchasing the same or substantially identical security within 30 days before or after the sale. Staying mindful of these rules helps maximize the benefits of tax-loss harvesting.
Consider a Roth IRA Conversion
A Roth IRA conversion involves moving funds from a traditional IRA to a Roth IRA, paying taxes on the amount converted in the current year. This strategy is beneficial if you anticipate being in a higher tax bracket in the future, as Roth IRAs allow for tax-free withdrawals in retirement. While this conversion incurs taxes today, it can save money in the long run by allowing for tax-free growth.
Roth conversions are especially appealing during years of lower income or when the value of the investments is temporarily down, as these factors reduce the tax cost of the conversion. For those nearing retirement or expecting a higher income down the line, a Roth conversion is a worthwhile consideration, especially in low-income years. Careful planning with a tax professional can ensure this strategy aligns with long-term tax goals.
Make Charitable Contributions Before Year-End
Charitable giving is another effective way to reduce taxable income while supporting causes you care about. Donations to qualified charities are tax-deductible if made by December 31. For taxpayers who itemize deductions, charitable contributions can provide substantial tax savings. Donating appreciated assets, such as stocks, instead of cash is an additional strategy to avoid paying capital gains tax on the appreciation, resulting in a double benefit.
I recommend keeping records of all charitable contributions and understanding IRS rules for documenting these donations, especially for non-cash contributions. Charitable donations don’t just reduce taxable income; they can also contribute to the overall financial and estate planning strategy for those with a focus on philanthropic goals. For larger gifts, donor-advised funds provide flexibility, allowing for an immediate deduction while letting you decide on specific charities over time.
Take Required Minimum Distributions (RMDs)
For those who are 73 or older, Required Minimum Distributions (RMDs) from retirement accounts such as 401(k)s and traditional IRAs must be taken by December 31 each year. Failing to take the full RMD can result in a significant tax penalty—up to 25% of the amount not withdrawn. Reviewing your RMDs each year and withdrawing the necessary amount can prevent unnecessary penalties.
I find that many retirees benefit from having a set schedule for RMDs, sometimes aligning withdrawals with other income needs. By planning in advance, it’s possible to minimize tax impact while ensuring retirement income is managed effectively. Qualified charitable distributions (QCDs) can also count toward your RMD and offer tax benefits if donated directly to a qualified charity, making them a strategic option for those inclined toward philanthropy.
Adjust Tax Withholding and Estimated Payments
If you’ve had a significant change in income this year, adjusting your tax withholding or making estimated tax payments can help avoid underpayment penalties. Unexpected gains, bonuses, or other income spikes can increase your tax liability, and reviewing your withholdings toward year-end can ensure that you’re adequately covered.
A quick check-in on withholding is especially valuable for those with multiple income sources or self-employed individuals who pay estimated taxes quarterly. If you’re expecting a large end-of-year bonus or additional income, adjusting your withholding can keep you from owing a large tax bill in April. I often advise clients to review their withholdings during the last quarter to ensure they avoid penalties and achieve a balanced approach to their year-end tax planning.
Utilize Flexible Spending Accounts (FSAs)
Flexible Spending Accounts (FSAs) allow you to set aside pre-tax dollars for medical and dependent care expenses. However, FSAs come with a “use-it-or-lose-it” rule, meaning that any unspent funds are typically forfeited at the end of the year. Reviewing your FSA balance and planning to use remaining funds for qualified expenses can prevent you from losing these pre-tax dollars.
For those with medical FSAs, scheduling year-end appointments or purchasing eligible medical supplies can be a simple way to maximize FSA benefits. Some employers offer a grace period or allow limited rollovers, so checking with your employer regarding specific rules is always advisable. Planning FSA spending toward the end of the year ensures that these funds are used effectively and meet your healthcare and childcare needs.
Key Tips for Year-End Tax Planning
- Max Out Retirement Accounts: Contribute to 401(k) or IRA accounts to reduce taxable income.
- Harvest Tax Losses: Offset gains with losses for tax savings.
- Convert to a Roth IRA: Pay taxes now for future tax-free withdrawals.
- Donate to Charity: Take advantage of deductions and avoid capital gains.
- Take Required Distributions: Avoid penalties by meeting RMD requirements.
In Conclusion
Year-end tax planning is a valuable opportunity to review and optimize your financial strategy before the tax year closes. From maximizing retirement contributions and charitable donations to utilizing tax-loss harvesting and Roth conversions, each of these strategies can help reduce your tax liability and prepare you for the upcoming tax season. Taking the time to assess your finances with a professional advisor can ensure you’re well-prepared and taking full advantage of every available tax benefit.