Believe it or not, 2021 is almost over. 2022 is less than 12 weeks away. Time is running out, but luckily there’s still enough to get your financial house in order. One of the main ways you can do this is through proper year-end tax planning. Here are two simple steps that will help you uncover opportunities to minimize your taxes. Then, you can put the money you save toward your financial goals.
Review Your 401(k) Contributions
The 2021 annual individual maximum contribution limit is $19,500, which includes your out-of-pocket contributions, NOT the amount your employer contributes. Depending on your situation you should consider the following when reviewing your contributions.
If you always max it out and have only worked at one company...
Confirm that you are on track to do so before the end of the year. Even if you’re sure that you signed up for the maximum, it’s always good to double-check just in case the timing of your paychecks or any other variables have thrown off your calculations.
If you always max it out and have worked at more than one company…
Confirm that you are on track to save the maximum without exceeding the $19,500. The annual maximum is the total amount you can contribute for the calendar year regardless of how many plans are offered to you. If you exceed this number, the IRS wants you to initiate an excess removal by the tax deadline or they will charge you penalties.
If you aren’t maxing out yet…
Review your contributions and determine how much more you can contribute before the end of the year. If these new contributions are deposited into the pretax portion of your plan, you will receive a decent tax break for every dollar you contribute.
Example: An individual making $150K falls into the 24% tax bracket. They review their cash flow and decide that they can afford to save an additional $2,500/month between now and December 31. This additional contribution of $7,500 will save them $1,800 ($7,500 * 24%). An individual earning $175K will save $2,400. With numbers this high, it’s worth a second look.
Implement a Tax-Loss Harvesting Strategy
Tax-loss harvesting is the act of selling off investments with the primary objective to sell at a loss. Why would someone want to sell at a loss? It’s simple. We do this to offset the taxes owed on short-term or long-term capital gains in their taxable account. When you sell off investment at a gain, you will be subject to short-term or long-term capital gains.
Short-term capital gains
Short-term capital gains are charged on investments sold within one year of purchase. These are taxed at the individual’s ordinary income rate, which can be up to 39.6% if you’re in the highest bracket.
Long-term capital gains
Long-term capital gains are charged on investments sold after a year of purchase. The rates on these sales are much lower ranging between 0%-20%.
Selling at a loss
When you sell at a loss you can deduct the amount of the loss from any gains that you have. The gains above and beyond your losses will be taxed at the appropriate rate. The losses above and beyond your gains will carry forward into future years.
Example: An investor sells off their shares of XYZ company resulting in a taxable gain of $10K in their brokerage account.
With a loss of less than $10K: $10K in gains minus $5K in losses equals a taxable gain of $5K taxed at short term or long term capital gains depending on the timeframe they held the shares.
With a loss of $10K: $10K in gains minus $10K in losses equals no taxable gain this year.
With a loss of greater than $10K: $10K in gains minus $13K in losses equals no taxable gain this year and a loss carried forward of $3K. This carry-forward will result in a loss of $3K to be deducted from next year’s gains.
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By taking these two steps, you could potentially save thousands of dollars in taxes while adding a significant amount of money to your savings. The Fall is a sweet spot to take advantage of year-end planning. Need a little help with your financial plan? CLICK HERE to see if Merino Wealth can help you implement these strategies and more!