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Tax Time in December? 5 Ways to Plan Now

Tax time comes every April, but thinking about taxes before December 31 could help reduce your tax bill. Our financial consultants offer five tax planning tips for now.

10/23/2023

Key Takeaways

Waiting until your tax filing deadline to think about saving on taxes may be a little late, especially when you can address some things now.

Not all the actions have a December 31 deadline, but you may need time to figure out how to implement a plan now.

Our financial consultants offer five tips to consider before the end of the year to help you save on taxes or avoid a rush.

Tax Plan Now With These 5 Tips

While your taxes typically don’t need to be filed until April, planning for it—and for possible ways to reduce what you owe—could happen right now or at least before the end of the year. We asked financial consultants Ryan Adams, Jimmy Merdian, Sarah Pedersen and Addison Tantillo for their top tips for investors to plan for tax time now. Here’s what they said.

1. Consider a Roth Conversion to Save on Taxes Later

Converting a traditional IRA to a Roth IRA can help you have future withdrawals that won’t be taxed. This could help you stay in a lower tax bracket in retirement.

“You will need to do Roth conversions by December 31,” says Ryan. “And you’ll want to leave yourself enough time to make sure you’re doing it in a way that makes sense for you, and that doesn’t create unintended negative tax consequences.”

You also may want to consider what’s happening in the markets. “While we never encourage market timing, many people like to convert when markets are lower,” says Addison. “Then, when the market rebounds, their money is in a Roth tax-free account.”

Our consultants can help by using planning tools to help you see what timing makes sense and how a potential conversion will play into your retirement plan down the road.

What to Know Before You Convert

“There is a five-year rule on Roth conversions, meaning you cannot withdraw the money tax-free for five years,” says Jimmy. “However, if you convert at the end of this year, you get credit for the entire year because it is retroactive to January 1. Converting at year-end gives you one year down.”

Also, note income taxes could be a pitfall. “Some people don’t understand you have to pay taxes on some or all of the amount you convert to a Roth IRA,” says Addison. “And you want to be careful about converting so much you fall into a higher tax bracket after the conversion.”

Some investors like to have taxes withheld and sent to the IRS as an early credit for the conversion, however our consultants believe it may be better to set aside separate money to pay those taxes (if you can).

If you’re not 59½, any amount withheld is not only considered taxable income, you also may incur an early withdrawal penalty.

Roth Conversions and Taxes—Know the Rules
  • Some or all the amount you convert to a Roth IRA may be taxable, depending on the types of contributions you previously made to your traditional IRA.

  • Taxes are due when you file your return for the year you convert.

  • The converted taxable amount is added to your other taxable income for that year, so be mindful of your tax bracket.

  • If you choose to have money withheld from your conversion, not only is the withholding considered taxable income, but you may also incur penalties for premature withdrawals if you are under age 59½.

  • Tax-free withdrawals from a Roth conversion account are not allowed until the fifth calendar year after the conversion.

Since Roth conversions mean you will owe additional taxes for the year you convert; you may also want to consider if a tax-loss harvesting strategy is right for you—also before year-end—especially if you are looking for a way to offset taxable capital gains.

2. Contribute to a 529 for Tax-Free Withdrawals

Adding money to a 529 education savings account helps a student and comes with tax benefits. The primary advantage is that neither you nor the student beneficiary pay taxes on qualified education withdrawals.

Contributions may also be tax deductible in some states and must be made by December 31 to get credit for that year. You may also qualify for educational credits at tax time, depending on your income. Anyone can contribute to a student’s 529, including parents, grandparents, aunts and uncles, and family friends.

New Flexibility Makes 529s More Appealing

Money from a 529 can now be rolled over to a Roth IRA to help kickstart retirement savings for the student named on the 529 account. That addresses the worry some may have about the “what ifs” about scholarships or if the child doesn’t attend college.

“With this provision, you do have to have the money in the 529 for 15 years to transfer it, so the sooner you start, the more flexibility you may have,” says Ryan.

“Although we need more guidance from the IRS on some of the new rules, and there are further restrictions not covered here, we think clients will be pleased with this new option,” says Sarah.

Those with student loans may also be happy to hear that students can use up to $10,000 from a 529 account to pay off that debt. “This makes adding to a 529 another good idea, and parents should know they aren’t past the point of contributing when their student is in college,” says Addison.

3. Put Strategy Behind Your Required Minimum Distribution

Required minimum distributions (RMDs) from retirement accounts are due by December 31. Not taking one (or not taking enough) can result in hefty tax penalties. But beyond meeting the deadline, you may want to think about when to take money from a traditional IRA or other qualified retirement account and the associated tax implications.

“Many investors don’t want to touch their IRAs, so they don’t like taking money out of them, especially before they reach RMD age,” says Jimmy. “But you might not want to wait too long and end up with a huge forced RMD withdrawal in later years—and the additional taxes that come with it.”

Using the money to supplement your income earlier in and throughout retirement can help you reduce that risk.

“We can help clients develop an RMD strategy,” says Addison. “A strategy is essential when you start drawing Social Security and Medicare. You don’t want too much taxable income because of your RMD.”

Too much income can raise the premiums on Part B Medicare and make your Social Security benefits subject to income taxes. Consider talking to a consultant and tax advisor sooner rather than later about your RMDs.

4. Give Wisely—Don’t Sweat Gift Taxes

Many people think about charitable giving or giving to a loved one around the end of the year. Some of that may be due to being faced with a large tax bill and not utilizing tax strategies earlier. But there are also some benefits for the giver.

Qualified charitable donations (“QCDs”) can lower your adjusted gross income (which is more beneficial than making a tax-deductible charitable donation). “QCDs can help offset taxes while satisfying your RMD from an IRA,” says Sarah. “If you don’t need the RMD for living expenses, the donation can make your financial picture more tax efficient and help you save taxes at the end of the year.”

Sarah cautions to work closely with your investment company to follow the right process for charitable donations because the check needs to go directly to the charity. A cash donation you make directly to a charity, even if using the proceeds from your RMD, equates to a plain tax-deductible charitable donation, which is not treated as favorably tax-wise as a properly executed QCD.

Gifts and Gift Taxes

When giving to individuals, investors may be concerned about gift taxes. “I’ve had several clients concerned about giving too much and what the tax consequences may be, but most don’t have to worry,” says Ryan. That’s because most people will not come near the threshold allowed by the IRS.

Know Tax Rules Before You Give
  • For 2023, the IRS allows individuals to give up to $17,000 annually and married couples can give up to $34,000 to a donee (recipient of the gift) with no gift tax or estate tax implications.

  • You can give those amounts to an unlimited number of recipients in the same year.

  • Amounts over the limits are subject to potential gift taxes, and the giver (not the recipient) pays them.

  • Charitable donations to nonprofits may be tax deductible, but gifts to family or friends are not.

Also note that any amount you give will be added to your lifetime gift tax exclusion, so you’ll want to keep track of what you’ve given over the years. There are other considerations regarding gifting property to others, so please consult with your tax advisor for more guidance and information.

5. Stay on Top of Distributions

Most investors don’t think about capital gain distributions from their investments and what they may mean for them until tax time. Our consultants say to pay attention to estimated distributions, which we typically publish for our mutual funds by the end of October.

“A lot of larger funds tend to pay distributions, and being unprepared can cause headaches,” says Addison. You should also know that distributions can be paid on a fund, even if your mutual fund account has experienced a decrease in value during a calendar year.

“It can be confusing to understand distributions,” says Jimmy. “I remind clients that distributions aren’t necessarily based on fund performance; rather, it’s about gains from companies the fund invests in and movements within the fund’s portfolio.”

Our consultants can also help you find ways to relieve some of the tax burdens that distributions can bring.

Talking Over Your Tax Plan Can Help

Taxes in general and on your investments can be complicated, so we encourage you to talk to a tax advisor before making any moves. Our consultants can also work with your tax professional to help develop strategies to make tax time less taxing for your investments.

“We’ll help with those investing strategies, including discussing some tax-efficient portfolios and investments that may help those particularly concerned about taxes,” says Ryan.

Contributors

Financial Consultant Ryan Adams
Ryan Adams

Financial Consultant

Financial Consultant Jimmy Merdian, CFP®
Jimmy Merdian, CFP®

Financial Consultant

Financial Consultant Sarah Pedersen
Sarah Pedersen

Financial Consultant

Financial Consultant Addison Tantillo, CFP®
Addison Tantillo, CFP®

Financial Consultant

Plan Now for Tax Time

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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.

Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.

For 529s:

The earnings portion of non-qualified withdrawals is subject to federal and state income taxes and a 10% federal penalty.

The availability of tax or other state benefits (such as financial aid, scholarship funds and protection from creditors) may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.