Tax Planning: Moving the NeedleSubmitted by Fountain Financial Associates | Financial Advisors on June 5th, 2019
Post by Buck Beam in the FFA Summer 2019 Newsletter
The tax landscape has changed dramatically in recent years. New lower tax rates and higher standard deductions have helped some taxpayers, but other changes have limited the use of deductions for others—particularly higher earners.
Still, there are several powerful planning strategies that may be able to help you save on taxes, whether you are using the new standard deduction or still itemizing.
Here are a few ideas that can “move the needle” for your overall tax bill:
1. Bunching deductions
Starting in tax year 2018, the standard deduction increased and many itemized deductions were eliminated or capped. Taxpayers with total itemized deductions below the new standard deduction—$12,000 for singles and $24,000 for married couples filing jointly—will most likely use the new standard deduction.
That means a simpler tax filing, and possibly a lower tax bill for some. But it means others may lose some of their deductions for charitable gifts, home mortgages, and state and local taxes.
To make the most of the potential tax deductions that still exist, consider “bunching.” That means concentrating deductions in a single year so they can exceed the standard deduction, then skipping itemization for 1 or more years. This strategy can work well when total itemized deductions fall below the new standard deduction in most years.
Here’s an example of how it could work: Instead of making annual charitable gifts, concentrate 2, 3, or even 5 years’ worth of donations in a single year, then take a few years off. Focusing all donations in a single year can increase the value of deductions beyond the standard deduction for a single year. Then you could take the standard deduction in the “skip” years.
A donor advised fund can be an interesting tool to consider when using this strategy. Donor advised funds can let you make tax-deductible contributions of cash or appreciated assets in a given year, but then recommend grants to charities over several years.
2. Consider a Roth IRA Conversion
The new tax law lowered income tax rates and changed the income thresholds for different tax brackets, but those changes are set to expire in 2025. If you have saved money in a traditional IRA, you may be able to effectively lock in today’s rates by converting portions of your savings to Roth accounts.
Because you pay taxes on your conversion amount up front, rather than when you withdraw the funds, you’ll owe no taxes on future earnings as long as your withdrawals are qualified. If taxes go up, or your income is higher in the future, a Roth conversion could save you money. Another potential advantage: Roth accounts don’t have required minimum distributions.
3. Be tax-smart about retirement savings
Fortunately for retirement savers, the new tax law did not change incentives for retirement savings. Pretax contributions to a 401(k) or similar workplace retirement plan can still generally reduce taxes. The 2019 contribution limit is $19,000, or $25,000 if you’re age 50 or older.
A traditional IRA offers potential tax breaks similar to those of a 401(k). For 2019, you can contribute up to $6,000 to an IRA, and if you are age 50 or over an extra $1,000.
High earners, particularly business owners and the self-employed, may be able to save even more than the 401(k) limit using a specialized defined benefit plan. Contributions for those plans can be as high as $200,000 per year, subject to multiple variables. We have experience with these plans and can help evaluate if it could make sense for you.
Another option for reducing taxable income is a health savings account (HSA). HSAs have triple tax benefits: Contributions are deductible, earnings are tax free, and qualified withdrawals are not taxable. People enrolled in high-deductible health plans are eligible to open an HSA. Those people can consider contributing up to $3,500 for an individual and $7,000 for a family, plus an extra $1,000 if you are age 55 or older for 2019.
4. Consider contributing RMDs to charity
If you are age 70 1/2 or older and your itemized deductions add up to less than the standard deduction, you may effectively lose the deduction for charitable contributions. But there is another way to support your favorite charities and still get a tax break.
We wrote in more detail about this strategy in our last issue- Qualified Charitable Distributions (QCD). This is a direct transfer of funds from your IRA to a qualified charity, which counts toward your required minimum distribution (RMD) for the year, up to $100,000.
Making a QCD comes with tax advantages. QCDs are not included in gross income and do not require itemization to be effective. The rules can be a little complicated, but many clients are benefiting from this strategy.
With all tax-related planning, we recommend working closely with us and your tax advisor to understand if these ideas will move the needle for you. Let us know if you would like to chat- we are here to help!
*For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.