8 Year-End Tax-Saving Tips
December is here, which means that we are nearing the end of yet another tax year. This may be causing some of you to have visions of looming tax-bills instead of sugar plums dancing through your head. Fear not! Here are 8 tax-saving tips that you can do between now and the end of the year to possibly reduce your tax obligations for the year.
1.) Max Out 401k/403b Retirement Contributions
If you are wanting to reduce your tax obligations for the year, a good place to start is making sure that you’ve maxed out your 401(k) through work. Employee contributions to a 401(k) are pre-tax contributions. This means that for each dollar that you contribute to your 401(k), your taxable income for the year is reduced by a dollar. For 2018, each individual can contribute up to $18,500 in his/her 401(k). Note that the limit is per individual, not family, so if you and your spouse both have a 401(k) through work, then you could both contribute up to the $18,500 annual limit.
Plan participants that are age 50 or older are also allowed to make additional “catch-up” contributions each year. For 2018, individuals are permitted to contribute an additional $6,000 above the normal contribution limit of $18,500 for a grand total max of $24,500 in annual 401(k) contributions.
403(b)s work in a similar fashion to the 401(k), but are for tax-exempt and non-profit organizations (federal, state, and local governments; hospitals; religious organizations; schools; etc.). The annual 403(b) contribution limit in 2018 is also $18,500.
We are quickly approaching the end of the year, so if you are wishing to make a 401(k)/403(b) contribution before year’s end, I’d recommend contacting your HR department as soon as possible!
2.) Defer Compensation Through 457 Plans and Thrift Savings Plans
In addition to 401(k)/ 403(b) contributions, government employees have the ability to defer additional income until retirement (thus lowering taxes for the year) through a couple of employer-sponsored plans that are not available to the general public. For state and local government employees this additional contribution option is called a 457 plan, while, for federal government employees, it is called a Thrift Savings Plan (TSP). Both plans act similarly in that they allow plan participants to contribute up to $18,500 (for 2018) in addition to what they’ve already contributed to their 401(k)s or 403(b)s for the year. Similar to the 401(k) and 403(b), these plans also have a catch-up provision for anyone age 50+, which, for 2018, is $6,000. By maxing out contributions to both a 401(k)/403(b) and a 457 or TSP, you could defer up to $37,000 in income in a given year!
3.) Contribute to a Traditional IRA
For 2018, you may contribute up to $5,500 ($6,500 if age 50+) to a Traditional IRA. If you do not have access to an employer-sponsored retirement plan through work (401k, 403b, etc.) or are below the IRS income limits for the year, these contributions can be deducted from your taxes at the end of the year. Similar to the 401(k), the contribution limit for IRAs is per individual, not per family. Thus, if you are married, both you and your spouse are permitted to make contributions up to the annual limit. This allows a married couple to potentially deduct up to $11,000 from their Adjusted Gross Income (AGI) for the year.
4.) Harvest Losses in Your Portfolio
Do you have a stock or mutual fund in your portfolio that’s losing money for you and you keep holding onto it, waiting and hoping for it to turn around? Well, sometimes it’s best to sell and cut your losses…and use those losses to reduce your tax burdens for the year! By selling the losers in your portfolio and “harvesting” those losses, you are able to offset other capital gains that you might have realized from selling a position that has appreciated in your portfolio. If the loss that you harvest is larger than the sum of your capital gains for the year and you end up with a net capital loss for the year, then you can use that capital loss to deduct up to $3,000 (or $1,500 if married and filing separately) of income from other sources of ordinary income (salary, interest income, etc.). Additional losses in excess of the $3000 limit may be carried over and used in future years.
When dealing with tax-loss harvesting, you should be aware of two things. First, unless you need the cash for a current need and it fits into your plan to keep it in cash, I would suggest to not keep proceeds from a sold position in cash for an extended period of time. Secondly, in order to avoid wash-sale rules, you should not purchase the same or “substantially identical” security within 30 days before or after you realized the loss.
Example
Over the course of 2018, Joe has sold several stocks in his brokerage account that had appreciated in value since he first acquired them. This has resulted in Joe realizing $4,500 in long-term capital gains for the year. Several years ago, Joe purchased $20,000 worth of Lame Duck Inc’s stock. The stock has not fared well since Joe’s purchase and is now worth $11,000. Joe decides to sell all of his Lame Duck stock and reinvest the money into an S&P 500 index fund. By doing this, Joe has realized a $9,000 long-term capital loss on his Lame Duck stock. Assuming that Joe has no other capital gains in 2018, he may use $4,500 of the loss to offset his capital gains for the year, and then use $3,000 of the loss as a deduction on this year’s taxes. The remaining loss ($1,500) that Joe realized will be carried over to subsequent tax years.
*Note that this works only with your non-qualified accounts (brokerage account, etc.) and will not help you in your 401(k), IRA, or any other qualified account.
5.) Harvest Gains in Your Portfolio
While more people talk about harvesting losses in a portfolio than harvesting gains, if you are married filing jointly and are expecting to have a taxable income of less than $77,200 (or $38,600 if filing single) this year, then you should consider selling some holdings that have appreciated in value in your portfolio. The reason for this is that if you fall under these income thresholds, then your realized long-term capital gains (profits from selling assets that you’ve held for more than a year) will be taxed at a 0% tax rate! This is a great time to rebalance or diversify your portfolio by reducing/removing holdings that have appreciated in value and investing more money into asset classes that are currently out of favor with the market.
Even if you want to keep a particular security moving forward, since wash-sale rules do not apply to capital gains but only to capital losses, it might make sense to sell the security anyway and immediately repurchase it. Doing this will allow you to increase the holding’s cost basis without increasing your taxable obligations for the year.
6.) Contribute to a Health Savings Account
I’ve written before about how amazing I think Health Savings Accounts (HSAs) are. If you and your family are participants in a High Deductible Health Plan (HDHP), then you should be maxing out your family’s allowed contribution annually to this account, if possible. For 2018, each family* is permitted to contribute up to $6,900 ($3,450 if single) into an HSA. The reason why these accounts are so amazing is that you get the “tax trifecta”: tax deduction when making a contribution to the plan, tax-deferred growth while the money is in the plan, and tax-free withdrawal for a qualified medical expense!
*Note that, unlike the previously mentioned accounts in this post, the contribution limits for the HSA are a family contribution limit, not an individual limit.
7.) Fund a 529 Plan for Your Children’s Education
529 plans are tax-favored savings accounts that allow parents and family members to save money for college and K-12 tuition expenses for their children or relatives. All money that goes into these plans grow tax-deferred and can be withdrawn tax-free for qualified education expenses. While you do not receive a federal tax deduction for 529 plan contributions, most states (including South Carolina) allow for a deduction for state taxes, provided that you use the correct state-sponsored 529 plan(s). The sponsored administrator for the state of SC is the Future Scholar 529 plan administered by Columbia Management. You may make a contribution to a 529 plan of up to $14,000 ($28,000 for a married couple) per individual per year (i.e. so if you have two children, you may make two separate contributions of $14,000 to two different 529 plan accounts with each child as a beneficiary of one of the accounts).
8.) Donate to Charity
With the Tax Cuts and Jobs Act of 2017 practically doubling the standard deduction for 2018, it will most likely be in the majority of people’s best interest to claim the standard deduction on their taxes this year, instead of itemizing. However, for those that it does make sense to itemize deductions, giving to charity will not only make you feel good about making a difference, but it could also lighten the tax impact on your wallet. If you are planning on making charitable donations, it might make sense to “bunch” charitable donations into specific tax years or utilize a donor-advised fund to get the most tax-relief from your charitable contributions.
Conclusion
While we’re nearing years end, it’s not too late to take some steps that can reduce your tax obligation for the year. If you want to have a more detailed discussion on any of the above tax tips or want to know more about what strategies might be the right fit for your particular situation, feel free to email me at daniel@sweetgrassfp.com or schedule a free introductory consultation.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Daniel Patterson, and all rights are reserved. Read the full disclaimer here.
