Planning for One Thing That’s Certain: Taxes

October 17, 2022

As we enter the final months of this year, which has been full of uncertainties, we wanted to share some of the timeless strategies that we focus on in our discussions with clients around one thing that is certain this year – taxes:

  • Maximize the use of tax-deductible retirement plan contributions each year to lower your tax liability as much as possible. The SECURE Act now permits savers to continue contributions to IRAs even after age 70½.
  • Make annual or one-time gifts to family members to transfer taxable income and future gains from your portfolio to others, potentially reduce family-wide tax liability, and reduce your taxable estate during your lifetime.
  • Gift appreciated securities held for more than one year directly to charities or to a charitable donor-advised fund (DAF). The tax deduction is based on the value of the gift, and tax liability for you on any built-in capital gains are eliminated.
  • Concentrate multiple years of charitable deductions into one year to maximize the tax benefits of giving, using the technique of “charitable bunching.”
  • Consider qualified charitable distributions (QCDs) from IRAs for those over age 70½, especially if you would not otherwise receive as advantageous a tax deduction for gifting taxable assets. If you’re over 72, QCDs also count towards your required minimum distributions.
  • Consider a Roth IRA or Roth 401(k) conversion or even discretionary distributions of IRA assets, especially if this will be a low-income-tax-rate year for you and/or when asset values are down. If you have not begun taking required minimum distributions from IRAs, one strategy we often recommend is to reduce or eliminate your pre-tax traditional IRA assets before they kick in.

Throughout the year, we regularly look for opportunities to maximize after-tax portfolio returns beyond investment selection, allocation, and periodic rebalancing. As part of our tax sensitivity in managing investment strategies we utilize some of the following techniques in our client portfolios:

  • We aim to hold investments in taxable accounts for more than one year before selling them so that long-term capital gains tax rates will apply. The tax difference can be significant. (However, we always assess the potential risk and return tradeoffs that result from any decision to extend an investment holding period.)
  • When raising cash in your portfolio, we do so by selecting securities or individual lots of a security that have the lowest taxable gain consequences.
  • We consider carefully before selling investments with large built-in gains, unless the sale is justified by a higher expected return from another investment or is necessary to maintain portfolio asset allocation objectives.
  • We seek to place the interest-earning portion of portfolios in tax-deferred accounts given interest income is taxed at the top marginal rate, unlike long-term capital gains.
  • For portfolios without significant tax-deferred assets, we will generally recommend holding tax-exempt bonds in lieu of taxable bonds, depending on the client’s marginal tax rate.
  • We look for opportunities to “harvest” capital losses if there is market volatility throughout the year, as well as during our year-end review. These realized losses can then be used to offset realized gains elsewhere within or outside the portfolio, either in the same tax year or rolled forward to future tax returns. Proceeds can then be placed in comparable investments so the portfolio allocation remains intact.
  • We consider any anticipated taxable year-end distributions from investments within a portfolio when rebalancing, raising cash or harvesting taxable losses.

As always, we welcome the opportunity to discuss these planning topics with our clients and to coordinate with their tax advisors to determine the best techniques for each client’s individual tax situation. Please contact your Litman Gregory Wealth Management advisor for more information and to review your situation.

Note: As with all tax planning, every person’s situation is different. We suggest consulting with your tax advisor before implementing any of these tax planning techniques.

Key Tax Changes in 2022

In 2022, several changes went into effect that may impact your tax situation. Here are a few key highlights:

  • 401(k), and other employer-sponsored plan contribution limits: The annual contribution limit for 401(k)s and similar plans increased to $20,500 (up from $19,500 in 2021). Those age 50 or older can make an extra “catch-up” contribution of $6,500, for a total of $27,000.
  • IRA contribution limits: Traditional or Roth IRA contribution limits (combined) remain at $6,000, or $7,000 if you are age 50 or older. However, the modified adjusted gross income limitation to make Roth IRA contributions increased to $144,000 for those filing single, and $214,000 for those filing joint tax returns.
  • Annual gift tax exclusion limits: The annual amount that any individual can give to another individual without having to report the gift to the IRS (or use some of their lifetime estate tax exemption) is now $16,000, up from $15,000 where it has been since 2018.
  • Estate & gift tax exemption limits: The federal estate and gift tax exemption amount is now $12.06 million, up from $11.7 million in 2021. (It is important to note that as the law currently stands, this amount will sunset after 2025 and revert to the 2016 limit of $5 million indexed for inflation.)

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