Last month, we discussed the benefit of Roth conversions in our blog titled Roth Conversions 101. However, Roth conversions are just one of several year-end tax moves investors can utilize.
As we approach December 31st, two additional tax strategies are worth considering and include taking distributions from qualified accounts and capturing after-tax returns.
Like Roth conversions, both strategies rely on realizing income from your investment accounts up to the tax bracket or amount you want to pay.
With distributions from qualified accounts, you would withdraw funds from a pre-tax retirement account, such as an IRA or 401(k), to increase your income. Since these monies have never been taxed, each dollar drawn is added to your ordinary income bucket when filing taxes. Therefore if you make $70,000 a year after deductions and are single, you could remove an additional $19,000 from your IRA before bumping up to the next tax bracket.
While the bump in brackets from 22% to 24% is minimal, the steps from 12% to 22% and 24% to 32% are drastic.
So why consider drawing funds from your qualified accounts up until the next tax bracket? One, you can hedge against future tax rate increases. Two, your income may vary yearly, meaning this strategy can save you money during lower-income years.
Still, this strategy only makes sense for those who are 59.5 or above. Otherwise, the early withdrawal penalty of 10% applies unless a qualifying exemption exists.
The second strategy of locking in returns applies to anyone with an ordinary after-tax brokerage account. Using it, the individual would capture gains or losses on their investments.
When locking in gains on investments held for one year or longer, most individuals will fall into the 0% and 15% federal tax brackets for these investments. When locking in losses on investments, investors can use them to offset other investment gains or to lower their taxable income for the year.
To decide if a Roth conversion, qualified distribution, or capturing returns in your after-tax investment accounts fits into your financial plan, always talk with an accountant to ensure you fully understand any potential benefits, drawbacks, and pitfalls.
At Lundeen Abrams Advisors, we regularly help clients with all three of these year-end tax moves and would be happy to show you how there could fit into your financial plan. So, please reach out to us today to discuss these strategies before the year ends. We will look forward to talking with you soon!