Taxes should be on everyone’s mind at this point in the year. Retirement planning and end-of-year tax strategies should be interlinked to help you secure your retirement and pay as little as possible in the process.
We’re happy to have CPA Steven Jarvis of Retirement Tax Services (RTS) to explain to us that with one month left in 2022, there are a lot of tax strategies we can put in place that can make a big difference this coming year. In fact, he recommends that we think about tax planning every month of the year.
However, there’s a lot to do before the calendar year flips over.
What to Ensure Gets Done Before the End of 2022
A few things that Steven explains that we need to think about, and they may not apply to everyone, include:
- Required minimum distributions (RMDs): You need to begin taking care of your RMDs. RMDs are required when you hit 72, and if you don’t take them, you will face a major penalty from the IRS. The penalty is up to 50%.
- Qualified charitable distributions (QCDs): At 70-½, you can begin using QCDs if you’re charitably inclined. You can use QCDs during the filing year and it allows you to give to charity with some tax benefits attached.
- Retirees still working: Some retirees are still working and accumulating income, and they should check in with their CPAs to ensure that their taxes are in order. The filing deadline may be in April, but the IRS is anxious to get your money and will apply interest if the money isn’t received in January. You also go into 2023 knowing if you need to set up your tax withholdings.
There’s a lot to consider, and an accountant can help you navigate these complex tax considerations.
For example, let’s assume that someone at age 72 has an RMD of $30,000 and doesn’t need the money. In this case, you may want to consider a QCD if you’re charitably inclined. If you’re not charitably inclined, you’re better off just paying the taxes on the money and keeping it.
However, if being charitable is important to you, a QCD fits into your tax planning perfectly. The logistics here are very important:
- Don’t take the RMD. Put it into your bank account and then transfer it to the charity of your choosing.
- Do use a QCD, which allows a direct contribution to the charity without the money ever entering your possession and having to pay taxes on it.
Your IRA will allow you to write a check to the charity of your choosing. You can take the QCD and benefit from the tax deduction without needing to add it as a line item. Since most people take the standard deduction (more on that soon), this is a tax strategy that is perfect for you.
QCDs are very important tools that you can use before the end of the year to help reduce your tax burden while maximizing the amount of money the charity receives.
A standard deduction is available for:
- Married and filing jointly: $25,900
- Heads of household: $19,400
- Single filers: $12,950
The standard deduction allows you to remove the amounts above from your income. So, in this case, the $25,900 is not taxable for someone filing jointly.
For many people, a standard deduction is a win because it allows you to reduce taxable income drastically.
However, it doesn’t make sense for some people to use a standard deduction. If you do not have deductions that surpass the figures above, it’s better to use a standard deduction. Otherwise, you can reduce taxes more by using line items and taking these additional deductions.
Example of Not Taking a Standard Deduction
Let’s assume that for the next three years, you plan on giving a charity $15,000 annually for a total of $45,000. Donor-advised funds (DAF) will be used in this case, allowing you to put $45,000 in the fund now and take a deduction this year.
A DAF allows you full control of when and how the funds are distributed.
The $45,000 is above the standard deduction, so you can itemize your taxes this year and reduce taxes by $45,000. In net savings, you’ll save $4,000 – $5,000 by itemizing deductions. And next year, when you don’t have a DAF deduction, you can go right back to taking the standard deduction.
Why is this important?
You can save money while giving more money to the charities that you care about.
Deadlines for End of Year Tax Strategies
Roth conversions and contributions are going to be very important. The IRS doesn’t do us favors with their deadlines. You can carefully put money into an IRA for the previous year up until the tax deadline, but this must be done with precision.
If you have a traditional IRA, you must convert to a Roth IRA before the end of the calendar year.
There are two main things to consider if you’re unsure whether a Roth conversion is good for you:
- Bob and Sue will need a lot of money one day, maybe for an RV or roof repair. The IRS will take part of the money you take out for taxes, depending on the income buckets you have in place. A Roth account allows you to pay taxes now and not be concerned about paying taxes on the money in the future.
- You think tax rates may go up in the future. Roth buckets require you to pay taxes now and at today’s tax rates. The money that builds in the account is 100% tax-free.
You should proactively decide when you want to pay taxes using the information above.
In our business, a lot of clients ask if there’s a rate of tax on their Roth conversion. Understanding how the Roth conversion is taxed is important and is based on your marginal tax rate.
Roth conversions increase your taxable income, depending on your other income sources. You may have a 0% conversion or one that is 22% or higher. An accountant will need to look through your finances to really shed light on your situation and the taxes you’ll owe.
However, below is a good example to review.
Example of Roth Conversion Strategies
We have an individual who is under 72, so they do not have to take their RMDS. Additionally, this individual also has money in the bank that has already been taxed. When this person retires, they’ve set themselves up to have zero taxable income the first year in retirement because they’ll live on their cash.
The person has 0 income and still has a standard deduction of $25,900 they can take.
In this case, you can convert $25,900 and pay $0 in taxes on it because of the standard deduction that you have. You can also choose to convert $40,000, and in this case, the person would pay 10% in taxes on the $14,100 left.
You can also consider leveraging long-term capital gains to pay as little taxes as possible.
Everyone reading this will want to sit down with an advisor or CPA to find things that you can do to benefit your retirement.
Bonus: Inflation Reduction Act
While talking to Steven, we asked him about the Inflation Reduction Act and what it would mean for our average listeners. The media has made this Act seem very impactful, but Steven explains that the average person will not experience a direct impact.
Yes, 87,000 IRS agents were hired, but the agency has been grossly understaffed and has funding to improve customer service and other aspects of the IRS. The chances of being audited still remain low. Steven states that nothing will change for his clients: he’ll pay every dime in taxes that you owe, but never leave a tip.
Steven provided a lot of great information and ideas on what anyone heading into retirement should be doing before 2023 to help their tax situation.
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