Following a year like 2022 when most investment strategies performed poorly, one way to add value in 2023 is to lower your taxes. Here are six tax savings ideas to consider:
Donor Advised Funds
Clients who are charitable during their working years would often like to continue making gifts during retirement. Why not create a donor advised fund now, generating an upfront tax deduction for the entire amount contributed during your high-earning years? You can then distribute gifts throughout your retirement. The tax break you get from contributing in higher-earning years is more valuable than philanthropic deductions during presumed lower-income retirement years. Donating from your fund during your lower-income years has the same benefit to the charity. Donor advised funds are an excellent way to create a maximized tax deduction today for anticipated future philanthropic donations.
Health Savings Accounts
Health savings accounts (HSAs) are unique, and one of our tax code’s more interesting deduction opportunities. No other vehicles in the tax code give a federal tax deduction for contributions that grow tax-free and have tax-free distributions for qualified medical expenses. A 529 Plan comes closest in tax benefits, but deductions on contributions are often more limited. HSA owners can use their balances during their working years for medical expenses, but we recommend they be considered retirement vehicles. Think of an HSA as your “retiree medical IRA.” The planning recommendation would be to max out your HSA and get a deduction this year, then invest those dollars and pay medical expenses out of pocket until retirement. Those saved HSA dollars can grow tax-free until use in retirement when medical costs are assumed to increase. In addition to traditional healthcare expenses, HSA funds can pay for qualified medical expenses, including Medicare parts B & D and long-term care insurance premiums. The catch is that you can’t contribute to an HSA once you’re 65 and on Medicare, so start early when your medical expenses are presumably lower.
Securities Based Line of Credit
Selling appreciated securities generates capital gains tax, which we want to avoid. When cash needs arise that exceed available cash balances, whether for a special situation or a short-term need, preventing the sale of investments that create a capital gain may be preferable. Consider opening a Securities Based Line of Credit (SBLC) using your brokerage account as collateral. There are no fees to establish an SBLC, and you’re only charged interest if you take a distribution. Lending rates and loan percentages are more attractive than using margin and can be established without underwriting or mountains of paper. You can pay down or pay off the note on flexible terms, and your appreciated assets remain invested, with no capital gains tax due.
Qualified Charitable Distributions
If you are over age 70.5 and make charitable contributions but don’t have enough deductions to itemize, the Qualified Charitable Distribution may be for you. QCDs are a way to contribute to charity directly from your IRA, reducing your taxable income without the need to itemize deductions, making this strategy one of the more efficient methods for funding your charitable interests. Minimizing your taxable income through a QCD may also prove beneficial by placing you in a lower income bracket for Medicare premiums.
Converting your traditional IRA to a Roth IRA will not be a tax-saving strategy in the year of conversion, but it could save you from paying taxes in later years. ROTH IRAs are also a much more attractive inheritance vehicle for your beneficiaries. Because Roth IRAs do not require minimum distributions, they are a much more tax-efficient account to own when you reach age 73. Beneficiaries of a Roth IRA also get to take tax-free distributions, so clients with substantial wealth who don’t mind paying taxes for their heirs may want to convert to a ROTH now, leaving a tax-free distribution vehicle for heirs. If you intend to make a Roth conversion, the sooner you start, the better. Completing multiple smaller ROTH conversions over several years is much more tax efficient than waiting until approaching RMD years.
Municipal bonds pay tax-free interest and can be considered for your taxable brokerage account. There are also taxable municipal bonds available for retirement accounts. Tax-free municipal bonds are exempt from both federal and state taxes and have historically had a very low default rate. While their thinner trading volumes can result in more significant price swings during interest rate volatility – especially for lower credit quality bonds – the long-term results for municipals have been strong. Municipal bonds should have a place in the fixed-income allocation of clients in higher tax brackets.
These tax savings strategies will not be appropriate for all situations or clients. Please visit your financial planner if one or more of these strategies is appealing and speak with your CPA to determine what is best for your tax situation.
Jonathan is a straightforward, consultative planner with an ability to bring balance between the analytical and emotional aspects of his clients’ finances. He is a trusted advisor to executives, professionals, and entrepreneurs. Jonathan joined Carter Financial Management in 2006 and serves on the Management Team.