The end of the year is a good time to think about long-term financial goals and get your taxes in order
Consider increasing 401(k) contributions and other simple year-end tax strategies
If you make a charitable donation before December 31, you may be able to write it off on your 2023 taxes
Yearend tax planning is something you don’t want to get lost in the holiday rush. “It’s always a good idea to start getting your taxes in order at this time of year,” said Lisa Greene-Lewis, a CPA and tax expert for TurboTax.
Here are a few tax-planning and tax-saving strategies to consider before December 31 to potentially help reduce your tax burden (or maybe even get you a larger refund in 2024):
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1. Increase your 401(k) contributions
Several top tax-planning strategies endure from year to year. These include increasing contributions you make to employer-sponsored retirement plans and other tax-deferred retirement accounts that are taken out of your paycheck before taxes, helping to potentially lower your taxable income today. While Roth 401(k) contributions don’t decrease your taxable income today, once you reach retirement, the earnings can be withdrawn tax-free for qualified withdrawals. In addition, if your employer matches your contributions, increasing your 401(k) contributions to their match limit can help you avoid leaving “free money” on the table.
For 2023, the maximum 401(k) salary contribution for an employee is $22,500 for those under 50 and $30,000 for those 50 and older. If you’re an employee who receives a W-2 form, you should generally make any 2023 contributions by December 31 (other types of compensation may have different deadlines).
2. Roth IRA conversion considerations
With traditional individual retirement accounts (IRAs), contributions are typically made with tax-deductible dollars and can grow tax deferred. However, withdrawals are usually fully taxable. With a Roth IRA, money is contributed with after-tax dollars, so you can take “qualified distributions” that are tax free.
In general, a qualified distribution is one made after you turn 59 1/2 or under certain exemptions (such as to buy a first home, or if you became disabled). Also, Roth contributions are subject to a five-year holding period before the earnings on your contributions are considered “qualified” for tax-free distribution.
The tax savings from an immediate reduction in taxable income should be compared to the alternative. Take a moment to calculate how much tax you’d pay on those funds versus the tax you may face on the gains when you withdraw the money in the future.
You have until April 15, 2024, to make IRA contributions for 2023, but the sooner you get your money into the account, the sooner it can be invested. For the 2023 tax year, you can contribute a maximum of $6,500 to an IRA, plus an extra $1,000 if you’re 50 or older.
3. Consider Flexible Spending Account (FSA) funds
Make sure you’re timely about submitting FSA expenses by the end of the year, unless your FSA allows you to roll funds to the next year (check with your employer to verify). An FSA allows you to set aside pre-tax money to pay for qualified out-of-pocket health care costs. Typically, the funds are a “use it or lose it” proposition with a deadline of December 31.
Spending these funds doesn’t directly lower your taxes, but remember, the purpose of the FSA is to provide tax savings when you contribute. If you don’t spend the funds, you lose not only the tax benefit, but the funds set aside as well. FSAs can apply to a broad array of expenses, though the IRS can change what expenses qualify.
4. Consider tax-loss harvesting and charitable contributions
Losses from selling stocks, bonds, or mutual funds can potentially be used to offset taxable capital gains, a practice known as tax-loss harvesting. The size of the potential benefit from tax-loss harvesting depends on your income level and the amount of your short- and long-term capital gains (minus any current losses you may have already realized or any losses carried forward from other years).
Also, if you make a charitable donation before December 31, you may be able to write it off on your 2023 taxes. That means you can support causes you’re passionate about and potentially trim your tax liability or realize a deduction.
Charitable giving is one possible offset to the tax implications of a Roth conversion. Although a Roth conversion may increase your taxable income, charitable contributions can have the opposite effect if you can take the deduction. It may be possible to combine tax-loss harvesting and charitable contributions.
5. Bunch your deductions
If your total itemized deductions don’t exceed the standard deduction, consider “bunching” deductions, particularly in categories where you have to cross a minimum threshold.
For example, you might decide to bunch your deductions on alternating years, meaning you’d take the standard deduction one year. Then, the next year, if you managed the timing of your purchases carefully, you’d likely surpass the standard deduction. You could also bunch charitable contributions by increasing donations in the years you plan to itemize and decreasing them in the years you plan to take the standard deduction.
Yearend tax-planning strategies for 2023: See the big picture
The end of the calendar year is an opportune time to pause and reflect, a mindset that applies to your taxes, household budget, retirement plans, and other financial items and goals. Is your house in order, and are you on track to meet your targets?
It’s natural to have questions about taxes, and it’s OK to not have all the answers. If you have any tax questions, you can visit the TD Ameritrade Tax Resources center.
Please note that the information being provided here is for informational and educational purposes only. TD Ameritrade does not provide tax advice. We strongly recommend you consult with a qualified legal or tax-planning professional with regard to your personal circumstances.