The tax season is in full swing, but there are still a few key moves that investors can make right now to lower their tax bills for last year and preserve their sanity. Here’s a look at four maneuvers that a financial advisor with a “holistic” approach to wealth management, which includes strategies to lower payments to the IRS, can shepherd clients through:
Go all out on contributions to retirement plans
Didn’t max out your contribution limits last year? The IRS allows contributions for 2021 to be made through April 15, 2022. That’s three days before this year’s April 18 filing deadline, which was extended due to the Emancipation Day holiday in Washington, D.C. Some contributions are deductible, so they’ll lower the total amount of income on which taxes fall, a savings to the taxpayer.
For 2021 returns being filed now, Americans could
Traditional IRAs are generally funded with money on which taxes haven’t yet been paid, while Roth plans are fueled by after-tax dollars. Pretax contributions grow tax-deferred, with the owner paying ordinary rates on future withdrawals. While investors can also contribute money on which they’ve already paid taxes, they pay ordinary tax on withdrawals, making after-tax contributions to a traditional IRA a double tax hit. In contrast, Roth plans grow tax-free, with no levies on withdrawals.
The Roth conundrum
It’s still not clear what might happen to so-called
Backdoor conversions involve an investor converting a traditional IRA into a Roth. They’re a way for wealthy people to sidestep the income limits for direct contributions to a Roth. An early version of the House bill banned conversions of after-tax dollars in IRAs and 401(k)s.
The House passed a somewhat softened version of that proposal last November. The legislation, which has to be passed by the Senate, would outlaw so-called
The backdoor strategy involves using hefty after-tax contributions to a 401(k) plan that permits them. Under IRS rules, a taxpayer could put as much as $58,000 last year into a workplace retirement plan ($64,500 for those 50 or older). One chunk of the money reflects the maximum pre-tax amount of $19,500 ($26,000 if 50 or older), while the remainder, up to $38,500, reflects after-tax dollars. The limits include any company matches. The taxpayer then converts her 401(k) to a tax-free Roth. The higher amounts can swell a retirement portfolio far beyond what direct contributions to an ordinary Roth can.
Christine Benz, Morningstar’s director of personal finance, wrote in a Jan. 21 research
“Given that these contributions and conversions are currently allowable,” she wrote, financial advisors have “been urging their clients to go ahead with them until the law officially changes." Benz quoted Aron Szapiro, the head of retirement studies and public policy for Morningstar, as saying that the likelihood of a retroactive ban on after-tax contributions is "close to zero.”
Of course, nothing’s final on Capitol Hill until it’s final. Nonetheless, Benz wrote, “given that backdoor Roths are one of the few mechanisms that higher-income heavy savers can use to achieve tax-free withdrawals and avoid RMDs in retirement, many such savers are apt to conclude that it’s a risk worth taking."
Get schooled
The college and private K-12 school savings plans known as
The plans don’t have annual contribution limits. But the IRS considers contributions to be gifts for federal tax purposes. That means a donor can exclude up to $15,000 for 2021. Amounts above that level count against the taxpayer’s lifetime estate and gift tax exemption amount ($11.7 million for 2021, double that for married couples).
The plans are run by more than 30 states and the District of Columbia. State rules vary on contribution deadlines. Most states set Dec. 31 as the deadline, but a few, including Georgia, Iowa, Mississippi, South Carolina, Oklahoma and Wisconsin, allow contributions until April 15 of the subsequent year,
Organize your pandemic chaos, and don’t mess up
When advisors and accountants refer to the 2022 filing season, which opened on Jan. 24, they mean federal and state returns that must be filed for income earned in 2021.
With the IRS still facing backlogs of unprocessed returns and staffing shortages as it copes with its third straight pandemic filing season, experts have
Amid the snafus, filing an accurate return electronically is the best possible way to avoid delays in refunds. Messing things up and later filing an amended return, which must be on paper, all but guarantees delays, given that they take longer to process. The IRS has an updated list of taxpayer frequently asked questions
By the time it’s filing season, there are substantially fewer things that a taxpayer can do to buffer tax bills from the prior year. All four moves above, said Todd Jones, the chief investment officer at Gratus Capital, a boutique wealth management firm in Atlanta, are in advisors’ tool kits.
