Year End Tax Planning Strategies

October 20, 2023

Where did the year go! Here we are in the final quarter of 2023, but there’s still plenty of time to consider some planning that may help with your taxes, and more importantly, your longer-term goals.

Let’s discuss three strategies to consider:

1. Spousal IRA contribution

This strategy is useful when either you or your spouse do not have access to a retirement plan through an employer. It’s rare, but sometimes employers don’t offer a 401(k) or other types of retirement plans. This strategy is also useful when one spouse is not working, which can limit them from saving towards retirement.

A spousal IRA is a great way to still be able to save. Usually, the rule for contributing to an IRA is that you must have some type of earned income. The spousal IRA strategy allows you to use your or your spouse’s income to bypass that rule on behalf of the other person. You spouse can contribute $6,500 to the spousal IRA or $7,500 if you’re over the age of 50.

You can contribute to the nonworking spouse’s IRA and receive a taxable deduction subject to a combined income cap. If your adjusted gross income is above $228,000 filing jointly, both you and your spouse may still contribute to IRA’s, but you lose the ability to take a tax deduction. While you lose the tax deduction, it can still be beneficial to set funds away to grow tax-deferred in an IRA.

Action: Use extra savings to contribute to an IRA for you and/or your spouse.

2. Back-door Roth Contribution

Depending on your adjusted gross income, you may not be able to contribute directly to a Roth IRA. Roth IRA phaseouts occur between $138k and $153k for single filers and $218k to $228k for joint filers.

With a back-door Roth, regardless of your income level, you make an after-tax contribution into an IRA. Once you have contributed, a best practice is to leave the cash in the IRA for 30 days. Next, you convert the cash contribution in the IRA into a Roth IRA. There are no tax consequences because you contributed after-tax cash and you did not invest the funds.

Note that this strategy works best for those that do not have any existing IRAs. If you already have an IRA with a balance, the conversion could trigger a taxable event by prorating your conversion across existing balances. Consult with your accountant if you have existing IRAs.

The great thing about this strategy is it gives you the opportunity to build up the tax-free part of your portfolio for your retirement. You have until April 2024 to contribute to the IRA for the 2023 tax year.

Action: If you don’t have a traditional IRA and you exceed the AGI limit for a Roth IRA, work with your advisor to execute a back-door Roth IRA.

3. 401k Contributions

More and more, we are seeing employers offer Roth 401k’s alongside traditional 401k’s. You can contribute up to $22,500 plus an additional $7,500 for those over the age of 50. There are no income limitations when contributing to a Roth 401k like there are with Roth IRA’s.

For high earners, contributing to a Roth 401k could be an effective long-term strategy. Continually contributing to a traditional 401k can result in an oversized taxable 401k in which each dollar you withdraw in retirement will be taxed as ordinary income. The withdrawals become mandatory when you are required to take distributions from your IRA in your 70s. With Roth 401k’s that are eventually rolled in Roth IRA’s, there are no mandatory distributions.

In some cases, there’s an added bonus! Some employers offer the option to make additional deferrals beyond the yearly limits. You may have an opportunity to contribute an additional $40k per year.

If you are able to make these additional contributions, you will be required to pay taxes on these funds today, which would qualify them as after-tax contributions. Because you are paying taxes today, you avoid paying taxes on these funds when you are required to take distributions. These contributions would eventually roll into a Roth IRA, which would add to your tax-free portion of your portfolio.

Action: Check with your 401k plan administrator to see if they allow for additional after-tax contributions and what is required to set this up.

Lastly, don’t forget to review your FSAs (flexible spending accounts) and use funds before the end of the year. FSAs are pre-tax dollars earmarked for out-of-pocket health care or child care costs. Some plans allow a portion to be rolled into the following year, confirm this with your plan administrator or manager. You do not want lose those pre-tax dollars.

Before the year wraps up, coordinate with your advisor to discuss how these strategies may benefit you. While the goal should be to max out as much as possible, contributing a portion will always help towards achieving those longer-term goals.

Susie McLane
Managing Director, Senior Wealth Advisor

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