The Year-End Planning Tip That Has Finance Profs Talking

What’s special about year-end planning in 2022?

Harvesting equity losses isn’t novel, but this year advisors get to pick from a range of assets that fell at the same time as stocks — most notably long-term bonds. Clients who dabbled in digital assets finally get to experience the joy of harvesting losses (or paying taxes on gains if they got out early).

Structural changes include changes in required minimum distribution tables and increases in qualified plan contributions, as well as the imminent passage of the Secure 2.0 Act.

Gain From Losses

To help put together a comprehensive list, I asked the faculty at The American College of Financial Services for their own ideas. On everyone’s list was tax loss harvesting, particularly for bonds that experienced historic losses in 2022.

For example, Vanguard’s long-term corporate bond ETF is currently sitting 22% below its price of Jan. 1, 2022. Harvesting is a no-brainer to lock in losses since there are plenty of other similar bond ETFs that can be substituted without worrying about wash sale rules.

While you’re at it, if your Dogecoin is down 80% and you’re considering HODLing, remember that you can use crypto losses to either offset gains or you can reduce your taxable income by up to $3,000 per year by selling.

Research shows that individuals often hold on to their losing investments too long hoping they’ll eventually recover, and advisors should help clients view loss-harvesting as an opportunity to reduce taxes rather than an acceptance of failure. Taking losses is even more valuable for investors who would otherwise pay short-term capital gains captured earlier in 2022.

Bunch Charitable Donations

Charitably inclined clients who earned enough to get bumped into a higher tax bracket, and in particular the big jump from the 24% to the 32% marginal rate, can take advantage of bunching donations by the end of 2022 in donor-advised funds.

Retirement Income Certified Professional (RICP) co-director Steve Parrish notes that by combining anticipated future donations in 2022, a client can exceed the significantly higher standard deduction in place since 2017.

The roughly 7.1% increase in tax brackets in 2023 means that 2022 is the year to take advantage of bunching opportunities since clients are more likely to benefit from deductions — especially for those who expect their incomes in 2023 to be about the same or lower.

If you’re going to itemize, RICP adjunct professor Art Prunier reminds advisors to recommend that clients pay estimated state taxes and property taxes by the end of the year to maximize potential 2022 deductions. If possible, also consider bunching health care expenses by the end of the year to optimize itemization.

More Tax-Friendly Ways to Give

While you’re making contributions to a donor-advised fund, consider the opportunity to add adult children as advisors for the donations. “Since DAFs allow for joint or supervised charitable giving, you can pass along your values and share with your children the principles of charitable giving,” notes Parrish. “As successor advisors they can even continue making charitable gifts in your name after your death.”

Clients over 72 who will take the standard deduction can still get a tax break through a qualified charitable distribution from their IRA. Instead of taking a required minimum distribution and making a charitable donation that offers no tax benefit without itemization, Parrish calls the QCD a no-brainer.

A QCD provides “a way to avoid the taxation of an IRA, and a way to escape other retiree taxes such as Medicare’s IRMAA premium,” he says. “Rather than being forced to take an IRA payment into your adjusted gross income, you can have the IRA custodian send funds directly to your charity. The transferred donation counts as part of your RMD payment and never becomes part of your 1040 income.”

401(k)s and RMDs

While clients have until their tax filing deadline to contribute to an IRA, this isn’t the case with contributions to an employer-qualified savings plan. Assistant Professor Kevin Lynch notes that “While IRAs can be funded as late as the tax filing deadline, qualified plans have a Dec. 31, 2022, deadline.” Don’t forget the $6,000 in available catch-up contributions for clients who turned 50 in 2022.

Of course, clients who turned 72 in 2022 should consider taking RMDs by the end of 2022 even if they can wait until April to avoid taking two distributions in 2023. And don’t forget to use the updated RMD tables!

Another easy last-minute strategy for clients pushed into a higher tax bracket is to save more in their 401(k). RICP co-director Prunier points out that having an employer take out a large plan contribution by the end of the year is an “especially valuable tax planning strategy if your client’s long-range retirement plan indicates that their marginal tax rate in retirement will likely be the same (or lower) as the lower income tax bracket that they could possibly drop into this year.”

The essence of asset location in qualified accounts is relative marginal taxation today and when the money is withdrawn from the account in the future. Higher marginal tax rates favor traditional qualified accounts such as 401(k)s and traditional IRAs.

Roth Recharacterization

Higher future tax rates favor Roth. Workers can still recharacterize their Roth contributions in their workplace Roth as pretax contributions, Prunier says. “Don’t be confused on this point: although Roth conversions can no longer be recharacterized, there is no such restriction on recharacterizing Roth contributions,” he notes.

Recharacterization is particularly attractive now because stocks and bond values are lower than they were at the beginning of the year. This means that “you are buying out your silent partner (Uncle Sam) at a depressed price.”

Planning Ahead

Small-business owners can have greater flexibility when it comes to adjusting taxable income in 2022. Associate professor of taxation Sophia Duffy notes that business owners can “lower taxable income for the year by prepaying certain business expenses for the next calendar year and taking advantage of special tax benefits such as accelerated depreciation and business expenses that qualify for deduction under section 179.”

With a client age 63 or older by the year-end, consider projecting the brackets of the Medicare income-related monthly adjusted amount, or surcharge added to Part B and Part D premiums, two years into the future.

If you lower the client’s IRMAA bracket by decreasing adjusted gross income this year, start thinking about ways to lower the adjusted gross income today. For example, Prunier suggests maximizing health savings account, or HSA, contributions this year or increasing pretax workplace or IRA contributions (or recharacterizing workplace Roths as a traditional contribution).

Prunier also advises financial professionals to estimate federal and state tax returns for the new year at the beginning of 2023 in order to to explore strategies that can be implemented at the beginning of the year. For example, clients who will be subject to RMDs, especially if this is the year that the client turns 72, should consider taking them in January.

Why? “This action could prevent potentially adverse interactions between RMDs and partial Roth conversions that might occur later in the year,” he explained.

The first funds distributed from an IRA when RMDs are required are legally considered RMD funds. That means they aren’t rollover eligible — “if a client subject to RMDs makes a Roth conversion as their very first financial action of the year (accomplished in January), they have inadvertently converted their RMD dollars into a Roth account. That’s not good!” says Prunier.

Don’t Let a New Year Go to Waste

The new year can also be a great opportunity to revisit your retirement savings rate. Of course, all clients should be taking advantage of employer match opportunities that are essentially free money.

Our research shows that today’s lower expected real return environment will increase optimal savings rates significantly for higher-income workers — up to 20% of income if they don’t start saving until age 35. For higher-income workers, it makes sense to maximize 401(k) savings and look for ways to efficiently increase non-qualified investments.

Finally, behavioral research suggests that milestones such as the end of a calendar year can be a good time to address important goals that would otherwise go by the wayside.

Assistant professor and Chartered Life Underwriter director David Pierce refers to “December planning” as the “turn of the calendar” month, meaning “we should always go into the new year having reviewed/updated beneficiary designations on retirement accounts and insurance contracts as well as updating trust beneficiaries and all related estate planning.”

Of course, this goes for both clients and financial advisors. Use the new year as an opportunity to take care of important loose ends and to establish new habits that will help you accomplish professional goals in 2023.