Don't Get Taxed by Surprise: Year-Round Tax Planning Tips
It may be tax season, but you should be thinking about taxes year-round. When it comes to your overall financial plan, tax planning is often one of the most valuable and overlooked pieces.
It often takes a triggering event to prompt someone to reach out to a financial planner. A newborn child or an inheritance are common triggering events. Sometimes those are surprises, but much of the time they are anticipated. What we hear a lot and what tends to be unforeseen is: “I just had a huge tax bill.” The common culprit is vested RSUs (Restricted Stock Units). RSUs, often offered as part of an employee compensation package, are taxed as they vest. Employers will generally withhold taxes, but usually not enough, leading to an unexpected bill come April.
Can you avoid this? Perhaps. There are companies that allow you to elect to exchange a portion of your RSUs for SARs (Stock Appreciation Rights). There are pros and cons to doing this, but strictly from a tax standpoint, SARs allow you to control when to exercise and incur the tax. Employee Stock Options allow for some tax leeway as well, but there are different strategies depending on whether you have ISOs (Incentive Stock Options) usually reserved for key employees or NQOs (Non-Qualified Stock Options) which are more frequent offerings.
A few additional common tax planning opportunities, include the following:
Tax-Loss Harvesting
Tax-loss harvesting involves selling investment positions at a loss and using the losses to offset any gains you may have elsewhere. Many people wait until the end of the year to implement this. The truth is that you can do this anytime and even multiple times per year. In March of 2020, the onset of COVID-19 caused the stock market to plummet. You could have harvested your losses then and used them against the gains you would have had by the end of the year if you had reinvested the proceeds elsewhere and remained in the market.
As long as you’re mindful of wash sale rules, this could help you save on taxes. There are times when the opposite strategy is beneficial, too. We’ve had CPAs call us and say: “Our client has a large number of losses to use up. Please trigger some gains.”
Roth Conversion
Are you experiencing a lower than usual income year or an early retirement? You might consider a Roth conversion. This involves converting pre-tax money to an after-tax account and investing the money to grow tax-free. You would owe taxes on the converted amount, which could be appropriate if you’re temporarily in a low tax bracket. Early retirees often benefit from this strategy, as they’ve stopped earning income and have yet to begin taxable distributions from retirement accounts.
Back-Door Roth Conversion
If you’re a high earner, you may benefit from a back-door Roth conversion. In this case, you make a non-deductible contribution to an IRA and then convert the money to a Roth IRA. As long as you don’t have other IRA money, the conversion doesn’t incur tax and your conversion will grow tax-free.
What if you do have additional IRA accounts? You may be able to roll your IRA funds into your current employer’s 401(k) plan, if allowed. The IRS considers all of your IRA accounts as one and will prorate taxes based on the percentage of deductible versus non-deductible money, but doesn’t include 401(k)s.
Create Your Own Retirement Plan
If you have a side-hustle, you may be able to create your own retirement plan for your 1099 income. SEP-IRAs, solo 401(k)s, and cash balance plans are all viable options. The correct one for you depends on how much 1099 income you’re earning.
If you’re a business owner, simply creating a retirement plan or offering health insurance, especially a plan with a high-deductible and HSA (Health Savings Account) option, will not only help you reduce business taxes, but also allow you to contribute more towards your retirement.
Pushing or Pulling Income
Pushing or pulling income between years is also a simple yet effective way to transfer taxes to a different year. Expecting a lower income next year, perhaps you can push your bonus payment until then or you could group charitable contributions together into a higher income year.
These opportunities and others can potentially save you large amounts in taxes over the course of the year and your lifetime, as long as you know that the opportunities exist, and you plan for them. You should discuss any and all possibilities with your tax preparer and financial professional prior to execution because missing a seemingly small requirement has the potential to negate your efforts.
People often become fixated on what financial professionals charge, based solely on investment returns; however, if tax planning is done in concert and aligned, you may actually be getting quite a value.
This article was written by Brad Wright from The Street Retirement and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.
