As the year concludes, high-income and high-net-worth households need to consider strategies that can help them minimize their tax liability and maximize their savings. Many of these end-of-year tax strategies revolve around assessing a taxpayer’s marginal tax bracket now versus where it will likely be. At Janiczek Wealth Management, we utilize tax projection software to help our clients make these end-of-year tax planning decisions with clarity and confidence, to minimize their lifetime tax liability while utilizing their wealth to accomplish what is most important to them. Four end-of-year tax optimization strategies are most common for our affluent client group: charitable giving, maximizing retirement plan contributions, utilizing backdoor Roth IRA contributions, and implementing Roth IRA conversions.
1. Charitable Giving Strategies:
Charitable giving not only supports important causes but also provides valuable tax benefits. Our clients frequently utilize two strategies: Donor Advised Funds (DAFs) and Qualified Charitable Distributions (QCDs).
- Donor Advised Funds (DAFs): Donor advised funds allow you to contribute to an account and receive an immediate tax deduction, even if you decide on the end charitable recipients later. This flexibility will enable you to contribute to the DAF during a high-income year, potentially bundling multiple years’ worth of your charitable giving into one year, taking advantage of this tax deduction when it is most beneficial to you, and then distributing funds to your chosen charities over time at your discretion. This strategy is supercharged if you contribute highly appreciated portfolio assets to your DAF. You get the deduction for your DAF contribution in a year when it makes the most sense for you, and you also get the capital gain tax liability out of your portfolio. These highly appreciated assets can then be sold within your DAF without tax liability and diversified for portfolio optimization purposes. Utilizing DAF contributions usually makes the most sense if you are younger than age 70½ and in a higher-than-normal taxable income year.
- Qualified Charitable Distributions (QCDs): If you are 70½ or older with a significant IRA balance, you can make tax-free direct transfers up to $100,000 per year (indexed for inflation) from your Individual Retirement Account (IRA) to qualified charities. These transfers, known as Qualified Charitable Distributions (QCDs), count toward your required minimum distribution (RMD) if you are age 73 or older and are excluded from your taxable income. QCDs are typically the most tax-efficient way to fulfill your charitable goals while minimizing your taxable income at age 73 or older.
2. Maximizing Retirement Plan Contributions:
Suppose you are employed and can participate in a 401(k) or 403(b) plan via your employer. In that case, we recommend that you max out contributions to your plan as an end-of-year checklist item. You can contribute $22,500 in 2023 to such plans and an additional $7,500 if you are 50 or older. If you are in a 22% or lower tax bracket this year and think you will be in a higher tax bracket in the future (likely due to sizable RMDs or future changes/increases in the tax code), consider making these contributions with after-tax dollars (Roth contributions) if available within your specific plan. If you are a self-employed individual, you can utilize a Solo 401(k) to contribute $22,500 (and an additional $7,500 if you are 50 or older) in 2023, plus an additional amount up to 25% of your earned income capped at $66,000 of aggregate contributions ($73,500 of aggregate contributions if you are 50 or older). Self-employed individuals can also contribute to a Simplified Employee Pension (SEP) IRA as an alternative to a Solo 401(k), contributing up to 25% of net earnings up to a cap of $66,000 in 2023. SEP IRAs do not have a catch-up contribution provision for those 50 and older.
3. Back Door Roth IRA Contributions:
If your income exceeds the limits for direct Roth IRA contributions ($153,000 for single filers and $228,000 for joint filers in 2023), the back door Roth IRA strategy offers a great solution. You do this by making a nondeductible contribution to a traditional IRA with a zero balance in the amount of $6,500 ($7,500 if you are age 50 or older) and then converting those funds into a Roth IRA with no consequences. There are no tax consequences when you convert the nondeductible contribution to the Roth IRA because you are only converting after tax contribution dollars, since you contributed to a zero-balance traditional IRA. No other funds are being converted to the Roth IRA. Once the contribution is in the Roth IRA it grows tax free for your and your spouse’s lifetime, and then for 10 years after your and your spouse’s death when it eventually needs to be distributed out of the Roth account without any tax consequence to your non-spouse heirs. This technique of systematically funding back door Roth IRA contributions year after year is a great way for our high earning clients to harness the power of tax-free compounding returns for a portion of their net worth.
4. Roth Conversions:
If you have retired and are still not Required Minimum Distribution (RMD) age, which is now age 73 as of this year, consider converting all or a portion of your traditional IRA at a lower marginal tax rate than you anticipate being at in the future when you begin taking RMDs. By converting funds when your current tax rate is lower than your expected future rate can lead to substantial long-term tax savings. Converting in-kind shares at artificially depressed prices can make this strategy even more attractive, minimizing the amount of tax paid on the conversion while maximizing the long-term value of your Roth IRA when these share prices spring back.
End-of-year tax planning is an important step in managing your financial health, especially for high net worth and high-income taxpayers. By leveraging charitable giving tools like DAFs and QCDs, maximizing retirement plan contributions, and implementing Roth IRA strategies where sensible, can minimize your short-term tax burden and maximize your long term savings.
At Janiczek we recognize that managing your wealth is a profoundly personal journey. We partner with you in creating and nurturing a comprehensive plan that maximizes your wealth’s potential while minimizing your lifetime taxes. To learn more about Janiczek Wealth Management and our holistic approach to wealth management contact Cathy Wegner, Director of New Client Engagements, at 303-339-4480 or firstname.lastname@example.org.