10 Year-End Tax Planning Tips for High Earners and Retirees

As your income rises, the more important it becomes to look for opportunities to reduce your overall tax bill. However, tax planning doesn’t end once you’re in retirement. Depending on your sources of income and lifestyle, finding ways to lower your taxes may be an even higher priority after you stop working. If you’re looking for ways to reduce your tax liability for 2021, consider these 10 year-end tax planning tips for high earners and retirees.

Tip #1: Consider a Roth Conversion

A Roth conversion occurs when you transfer money from a traditional 401(K) or IRA to a Roth account. While you’ll pay taxes on the amount you transfer, your money can continue to grow in the Roth account tax-free. In addition, you won’t pay taxes on future withdrawals while in retirement.

A Roth conversion typically makes sense if you expect your tax bracket to be higher in the future. However, there are many factors to consider before taking advantage of this strategy. Be sure to consult a trusted financial planner or tax expert to determine if a Roth conversion is right for you.

Tip #2: Minimize Capital Gains with Tax Loss Harvesting

Unmanaged capital gains can eat away at your investment returns over time—specifically in non-qualified investment accounts. Fortunately, the IRS allows investors to offset realized capital gains with realized losses from other investments.

That means you can realize profits on your top-performing investments while selling poor performers to reduce this year’s tax bill. If you have substantial losses, you may be able to completely offset your gains and potentially reduce your taxable income. Note: most fiduciary financial planners proactively take advantage of tax-loss harvesting to help their clients with year-end tax planning.

Tip #3: Reduce Future Capital Gains Taxes

Are you in a very low tax bracket this year (10 or 12%)? If so, you can avoid capital gains taxes on the sale of appreciated investments. This can be a good way to defray your overall tax bill in the future, especially if you think your tax bracket will increase.

Tip #4: Don’t Forget to Take RMDs

A required minimum distribution (RMD) is the amount of money you must withdraw from an employer-sponsored retirement plan, traditional IRA, SEP, or SIMPLE IRA. Prior to 2020, account owners had to begin taking RMDs at age 70 ½. However, in 2020 the age changed to 72 as part of the SECURE Act. In addition, the SECURE Act of 2019 changed the rules for inherited IRAs. Now, certain heirs may have less time (10 years maximum) to draw down an IRA.

In most cases, RMDs are treated as ordinary income for tax purposes. However, you don’t have to pay taxes on your basis (any amount you already paid taxes on). In addition, failing to take an RMD can result in a harsh penalty from the IRS.

Required distributions can significantly impact your tax situation if you don’t have a strategy for taking them. Whether you’re in retirement or you’ve recently inherited an IRA, year-end tax planning is key for avoiding unnecessary tax consequences.

Tip #5: Consider Donating Your RMD to Charity for Year-End Tax Planning

Depending on the size of your RMD and your other sources of taxable income, RMDs can potentially push you into a higher tax bracket. Alternatively, they can increase your tax bill in a year when your taxable income is already higher-than-normal.

If you don’t need the income, one option is to donate your RMD to charity. A qualified charitable distribution (QCD) allows IRA owners to transfer up to $100,000 directly to charity each year. A QCD can satisfy all or part of your RMD, depending on your income needs.

The IRS considers the first dollars out of an IRA to be your RMD until you meet the full requirement. Therefore, if a QCD is part of your year-end tax planning, be sure to make the QCD before making any other withdrawals from your account.

#6: Be Aware of Additional Medicare Tax and Net Investment Income Tax

Individuals with taxable income above $200,000 and couples with taxable income above $250,000 are subject to an additional Medicare tax of 0.9% for all income above the threshold amount. In addition, any gains from sales of investments are subject to an additional Net Investment Income Tax (NIIT) of 3.8% if your taxable income exceeds those same thresholds. Keep in mind you can be exempt from Medicare taxes and still be subject to NIIT.

If you expect your taxable income to be subject to these additional taxes, year-end tax planning can be beneficial. You may want to look for deductions and credits to offset your overall tax bill before the new year. Or better yet, work with a financial advisor or CPA who can find these opportunities for you.

#7: Understand How Your Social Security Benefits Are Taxed

To understand whether your Social Security benefits are taxable, divide the amount received for the year by half and add the amount to your other sources of taxable income. If the amount exceeds $25,000 for a single person or $32,000 for a married individual, then part of your Social Security benefits may be taxable.

The amount of Social Security benefits that are taxable can vary from 50 to 85%. They may also be taxable in your specific state of residence. For year-end tax planning purposes, understanding how your benefits are taxed can help you reduce this year’s tax bill. It can also help you manage your taxable income in 2022.

#8: Maximize Your Qualified Retirement Plan Contributions If You’re Still Working

Be sure to check the contribution limits on your employer-sponsored or self-employed retirement plans for 2021. You can also contribute up to $6,000 to an individual retirement account in 2021 ($7,000 if you’re age 50 or over).  If you haven’t already maxed out your qualified retirement plan contributions, consider doing so as part of your year-end tax planning efforts.

#9: Consider Philanthropy for Year-End Tax Planning

If you’re feeling charitable this holiday season, consider donating to your favorite non-profit. If you itemize, you may be able to deduct up to 100 percent of qualified contributions from your adjusted gross income. Otherwise, those who take the standard deduction can claim an above-the-fold deduction of up to $300 for cash contributions to qualifying charities in 2021.

Alternatively, if you own a financial asset that has appreciated significantly in value, you may want to consider donating it. Not all charities accept non-cash donations. However, many donor-advised funds and community foundations will take securities and other assets in kind.

#10: Delegate Year-End Tax Planning to a Trusted Financial Advisor

Tax laws are continually in flux, and many of these strategies are complex. It’s also important to emphasize that effective tax planning is a year-round process. One of the best ways to tackle ongoing and year-end tax planning is to work with a trusted advisor who will proactively look for opportunities to minimize your tax bill.

As tax planning advisors, Milestone Asset Management Group works directly with our clients to help them minimize their tax burden. In addition, we have a full suite of CPAs and tax attorneys to help us stay up to date on current tax laws. If you’d like to speak with a fiduciary financial advisor about investment and tax planning opportunities, please schedule a call.