There are many financial planning techniques that will be closed off to you if you wait until after New Years to manage your money. These include things like 401k contributions, Roth conversions, and managing capital gains. To manage your money effectively you need evaluate your financial situation at the end of the year and before the new year.
Here are 3 major financial planning techniques to consider before the new year.
- Contribute to your 401k
- Perform a Roth conversion
- Sell underperforming and overperforming stock
How To Know If These Planning Techniques Are Right For You?
You are going need to do an accounting of your finance at the end of the year. If you wait until the the new year and tax season it will be to late!
You will want to how much money you earned, and any deductions you are already know you are going to claim. FYI most people will use the standard deduction, but if you have already contributed to a retirement account or HSA you will want to know that.
You will also want to know how well your investments have done that you hold outside of tax shielded accounts, like a 401k or IRA.
Once you know that you can estimate you tax bracket and start planning. If you need help doing this I recommend contacting a tax professional to help you with your unique situation.
Why Contribute More To Your 401k?
Besides it being a good idea to save as much as possible, you may not be able to contribute to a traditional IRA because your income is to high.
That means unlike a traditional IRA where you can still contribute until April 15th, you will need to get you contributions in before December 31.
401k contributions reduce your taxable income, which makes them a powerful tool for managing taxes.
If you find yourself in a high tax bracket or a higher tax bracket then usual, you have the opportunity to avoid paying higher taxes. If you want to learn how you can get these deductions and pay little to no tax in the future, here is my strategy on how you can.
If you find yourself in a high tax bracket, like the 22% or higher, deferring your taxes becomes a very attractive option. A person in the 22% tax bracket can save up to $220 for every $1000 dollars they contribute into there 401k.
Why Perform A Roth Conversion?
What makes Roth accounts so great is you do not have to make taxes on the qualified distributions you make in retirement. This gives you a source of income in retirement that will not increase your taxable income and will keep you in a lower tax bracket in your golden years.
A Roth conversion is where you take money that is held in a traditional IRA and convert it over to a Roth Account. You will pay taxes on the money you convert when you do this. So, it is important to know what tax bracket you will be in before you convert.
This can be a great option for people that are in between jobs, or for whatever reason didn’t make as much money this year. Remember, you will have to pay the taxes on what you convert so you need to have enough in savings to cover the increase in your tax liability.
Example, Sarah was usually in the 22% tax bracket. This year she didn’t work a few months because she was in between jobs. Because of this she will now be in the 12% tax bracket. What Sarah can do is take this as an opportunity for a Roth Conversion why her bracket is low and convert the money she has in her Traditional IRA to a Roth IRA.
You need to be careful though and not convert to much. Lets say Sarah had $200,000 in a IRA and she converted the whole amount. She would catapult her way into the 32% tax bracket or higher. The tax bill would be enormous.
A good idea would be to only convert a small amount that will keep her in the 12% tax bracket, so only a few thousand dollars.
While using these techniques can seem complicated, they are very simple once you under stand the fundamentals. I recommend that you contact your financial and tax professional before you make any decisions and if you have any questions.
Why Sell Under Performing and Over Performing Stock?
To keep you investment portfolio balanced, you will eventually need to sell some stock. When you sell your stock you are going to have to realize a gain or loss on the stock and have to deal with the tax ramification of that.
Lets say you had a great year with one particular stock, and to rebalance your portfolio of investments you had to sell a lot of shares. This created a huge tax bill, that you would want to avoid paying if you can. What can you do? You can sell underperforming stock to manage the amount of capital gains you have.
For example, you have a $10,000 dollar capital gain from the selling of stock this year. You have a bunch of other stocks that over the years have preformed poorly, but you had held on to the for just this occasions. You sell those stocks and realize a $10,000 dollar loss.
These two realized amounts net out on your taxes, and you now have net $0 in capital gains.
Managing investments this way is definitely an advanced technique and requires a lot of planning and strategy.
This article is for informational purposes only and gives only general opinion based examples. Please contact your tax and financial professional about your unique situation.