Monday, September 26, 2016

8 Must-Do Financial Tasks Before the End of the Year


With only one quarter left in 2016, it's about time to begin thinking about year-end planning strategies. While you still have a few more months, keep in mind that nearly all of the strategies that can reduce taxable income must be complete by Dec. 31. These eight tips can help you avoid leaving money on the table.

Contribute to a health savings account. If you have a high deductible health plan, an HSA can help you pay for medical expenses and reduce your taxable income through pre-tax contributions. When the funds are used for qualifying medical expenses the earnings won't be taxed. Although you aren't required to use all of the funds annually, HSAs offer investment options, allowing your pre-tax contributions to grow tax-free.

Annual HSA contribution limits for 2016 (under age 55) are $3,350 for an individual and $6,750 for a family. Consult the IRS guidelines for details.

Use your flexible spending account. Flexible spending accounts are similar to HSAs but differ in a few key ways. Medical FSAs can help offset qualifying medical expenses with pre-tax contributions. Unlike HSAs, FSAs must generally be depleted during the calendar year or your contributions will be forfeited. FSAs do not have investment options but also do not require participants to have a high deductible health plan.

The dependent care FSA is a unique benefit not available in HSAs. Qualified dependents are typically your children younger than 13. The expenses must be incurred to enable you (and a spouse, if married) to work, look for work, or enroll in school full time. If so, babysitters, summer day camp, and after-school programs could be reimbursable. Annual contribution limits for 2016 are $2,550 for the health FSA and $5,000 for dependent care if married filing jointly. Consult the IRS guidelines for full details.

Maximize contributions to a tax-advantaged retirement plan. Reduce your taxable income while saving for retirement. For participants of employer-sponsored retirement plans like a 401(k) or a 403(b), you may contribute up to $18,000 in 2016. Individuals older than 50 may make an additional catch-up contribution of $6,000.

If you can't afford to contribute the full amount, try to contribute enough to get the full employer match. Also consider annual increases to contributions by 1 percent or more. While anyone may contribute to a traditional IRA, there are income limitations on who may deduct their contributions, which depend on marital status and if you (and your spouse if applicable) are covered by a retirement plan at work. You have until April 15, 2017, to make additions to an IRA for the 2016 tax year. To determine your eligibility, review the IRS guidelines.

Rebalance your portfolio. The underlying asset classes in a portfolio rarely perform in the same manner – some may experience strong growth while others could remain flat or negative. Portfolios are constructed with this in mind, to diversify the risk and create an asset allocation consistent with the investor's risk tolerance. As the various asset classes experience different growth levels, rebalancing may be required to revert to the original asset allocation. Rebalancing isn't always necessary and there may be costs to doing so. In a taxable account, selling securities you've held for less than a year will result in short-term capital gains taxes.

Consider working with your financial advisor beforehand to avoid unintended consequences. For example, mutual funds issue their capital gains distributions in fourth quarter based on the year's trading. You could find yourself owing capital gains taxes on those distributions despite just purchasing the position.

Use tax-loss harvesting. Tax-loss harvesting involves selling underperforming securities in a taxable account and buying similar replacement securities to take the loss in the current year. If, after netting short-term and long-term gains/losses against each other, a loss results, the loss can be used to offset taxable income in the current year or carried forward if over the $3,000 maximum. Whenever possible, tax-loss harvesting should be done in conjunction with portfolio rebalancing to minimize the potential for unintended tax consequences, wash sales, and additional trading fees.

Consider a Roth IRA conversion. There are income limitations on regular contributions to a Roth IRA. However, these restrictions do not apply to Roth IRA conversions which are available to all earners once a year. For many reasons, individuals choose to roll their old 401(k) out of a former employer's retirement plan. Among the options for the retirement funds is a conversion to a Roth IRA. With a Roth IRA you will pay income taxes now and won't owe any tax on qualified distributions later. However, a Roth conversion doesn't always make sense. You'll need sufficient non-retirement funds to pay the tax due on the converted dollars and believe you're in a lower tax bracket today than you will be in retirement.

Roth IRAs can be a powerful tax-diversification tool, but only if executed as part of a larger financial strategy. A one-time Roth IRA conversion may have little impact if it only represents a small portion of your retirement assets. Like the other strategies outlined in this article, consult a financial advisor and tax professional first.

Give back. If you itemize deductions on your tax return you may be eligible for a charitable deduction. Making a sizable contribution? Consider donating appreciated securities instead of cash. Appreciated securities in a brokerage account can be donated directly to a charity. You can receive a deduction for the full fair market value on the date of the gift while avoiding capital gains taxes. Talk to your financial advisor for details.

Watch the timing of 529 plan distributions. To avoid a portion of your 529 plan funds being accidentally classified as a non-qualified distribution and potentially subject to income tax and a penalty, make sure to carefully plan the timing of withdrawals. For example, if you withdraw money from a 529 plan in December, but don't pay the tuition bill until January, a portion of the funds may be considered a non-qualified distribution if the total 529 plan withdrawals for the year exceeded the qualified higher education expenses paid.

As you compare distributions to expenses, remember not to double count the American Opportunity Tax Credit/Lifetime Learning Credit and don't include any expenses covered by tax-free scholarships in your calculations.

Some of these strategies may take longer than others to research and execute. Getting a head start can help ensure you don't miss out on any planning opportunities or chances to put some more cash back in your pocket.