This year has been quite challenging for investors. We have experienced a volatile stock market, staggeringly negative fixed-income returns, high inflation, aggressive policy tightening by the Federal Reserve and the global effects of the Russian war on Ukraine.
Due to these circumstances, many people have experienced a decline in their personal net worth and may be avoiding reviewing anything that relates to their finances.
Even though, financially, this year is one we may want to forget, as with any year, general financial housekeeping is necessary to wrap up the year-end. With that in mind, here are a few year-end topics that would be prudent to review:
Tax-loss harvesting is a tax-efficient investing approach used for taxable accounts.
Retirement accounts do not qualify. To take advantage of tax-loss harvesting, you may consider selling select investments from your portfolio at a loss to help offset the tax implications from other holdings that have generated taxable capital gains.
Eligible investments aren’t limited to stocks or stock funds, which means losses from bonds and other asset classes can be used to offset gains as well.
Additionally, if your losses are larger than your gains, you can use the remaining losses to offset up to $3,000 of your ordinary taxable income (for married couples filing separately, the limit is $1,500). Any amount over $3,000 can be carried forward to future tax years.
The tax impact of tax-loss harvesting can be significant for taxable account holders with high incomes. However, an investor selling securities as part of a tax-loss harvesting strategy should trade cautiously due to the Internal Revenue Service restriction known as the wash-sale rule.
The wash-sale rule states that if you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale, the loss is typically disallowed for current income tax purposes.
Required minimum distribution
Unless your retirement funds are in a Roth IRA, you will need to take the annual required minimum distribution from your Individual Retirement Account once you reach age 72.
If your 70th birthday was before July 1, 2019, you began taking your RMD at age 70 ½. However, due to changes in federal law as part of the Setting Every Community Up for Retirement Enhancement Act of 2019, if your 70th birthday took place after July 1, 2019, your distributions were not mandated until age 72.
The distribution amount varies annually and is determined by an IRS table, the year-end balance of your account and your age. If you miss the window to take your annual RMD, you will be subject to an IRS penalty of 50% of the RMD amount.
ROTH IRA conversion
Portfolio values are down this year, so the time may be right to convert some of your assets from an IRA to a Roth IRA.
Assets converted from an IRA to a Roth IRA are taxable as income in the year of the conversion. But following the conversion, Roth IRAs are not subject to RMDs. Additionally, when the funds are distributed from a Roth IRA during retirement, the income is not taxable.
For individuals who itemize their deductions in 2022 through 2025, you may deduct up to 60% of your adjusted gross income for cash donations to public charities.
One caveat is that the 60% deduction only applies to qualified public charities.
Last year, taxpayers who did not itemize were able to claim a deduction from their gross income for up to $300 in cash donations to public charities. This deduction has been eliminated for 2022.
Donating long-term, highly appreciated taxable securities — that is, stocks, mutual funds and exchange-traded funds that have realized significant appreciation over time — to nonprofits is one of the most tax-efficient ways to give. You receive a tax deduction for the full value of the gift without having to pay the capital gains you would have paid if you sold the securities.
Also, you can significantly increase the amount of funds available for charitable giving because you are not paying capital gains taxes on the gift. In other words, you are gifting the full value of the security, not the after-tax net value.
Assets held for one year before they are gifted reap the following benefits:
—Capital gains taxes are avoided on the future sale of the securities;
—A tax deduction is received for the full fair market value of the securities, up to 30% of your AGI.
Most banks and brokerage firms can assist you with this transaction but will require you to sign a letter of instruction to transfer the shares to a charity. Do not wait until the last week of December to begin this task, or it may not happen in 2022.
Qualified Charitable Deductions
At the end of 2015, lawmakers approved a permanent measure allowing individuals who are 70 ½ years old or older to make qualified charitable distributions directly from their IRAs to their favorite qualified charities.
In addition to the well-known benefits of giving to charity, a QCD offers this additional benefit: the donated amount is excluded from taxable income, unlike regular withdrawals from an IRA, which are taxed as ordinary income.
A lower income may also help reduce your Medicare premiums, which are income based.
A few facts about QCDs:
—The QCD can be made only on or after IRA owner is 70 ½ years old
—The distribution must be paid from the IRA directly to the qualified charity
—QCDs are limited to $100,000 per person annually and must be distributed by Dec. 31 of the calendar year
—The charitable distribution can satisfy the IRA’s annual RMD, but not exceed it
—QCDs are not subject to tax withholdings
Donating assets to a charitable trust provides a tax deduction and removes the assets from the donor’s estate. Depending on the type of trust established, these assets could provide a future benefit for the donor or heirs.
You can also avoid capital gains tax on the sale of real estate, private company stock, and other nonpublic assets by gifting them to charity. When you do, you’ll receive a charitable deduction for the value of the asset. However, most charities may not be set up to accept alternative donations directly, so you may want to consider utilizing a donor-advised fund.
A donor-advised fund is a charitable savings account that allows you to set aside funds and capture a charitable deduction for those funds without immediately selecting a specific charity. Donations to a DAF can be made at any time, but when they are made, they are irrevocable.
The funds grow tax-free for the sole purpose of funding IRS-qualified public charities. Over time, the donor recommends grants that will be distributed to their favorite charities. Additionally, assets in a DAF are not included in the donor’s estate at death. A DAF can be established at your local community foundation or through many financial services companies.
As the year-end approaches, remember: Markets will always be unpredictable, and the volatility experienced in 2022 will be no exception. Take the time to review your financial situation with your advisor and implement the strategies you can control before the year is over. Plan for your financial future today — then enjoy the feeling of personal empowerment that comes from actively managing your finances.
Teri Parker is a vice president for CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Reach her via email at [email protected]