In this article, we’re sharing four key tax savings strategies you may not know about if you manage your own money.
If you’re planning for or in retirement, there can be many advantages to hiring a financial advisor to oversee your personal finances. Yet despite the peace of mind that often comes with hiring a financial professional, many people prefer to take a do-it-yourself approach.
Whether you have a passion for the markets or simply know enough about investing to go it alone, you may decide that DIY investing makes more sense than working with an advisor. In fact, if you choose to manage your own investments, many financial advisors won’t even consider taking you on as a client.
Thus, DIY investors often miss out on valuable tax planning opportunities. Indeed, proactively taking steps to minimize your tax burden is typically one of the benefits of working with a fiduciary financial advisor.
Here are four tax savings strategies you may not know about if you’re a DIY investor:
#1: Tax Loss Harvesting
Harvesting losses can be an effective (and important) tax savings strategy if you’re trading securities within a taxable brokerage account. That’s because capital gains taxes can meaningfully reduce your investment returns over time.
In most cases, investors must pay the capital gains tax when selling an investment for a profit. For most taxpayers, the long-term capital gains tax rate is 15%, which applies if you hold an investment for at least 12 months. Meanwhile, the highest earners are subject to a 20% capital gains tax in 2022.
Fortunately, the IRS allows investors to offset realized capital gains with realized losses from other investments to reduce taxes. Thus, most fiduciary financial advisors proactively take advantage of tax-loss harvesting to help clients reduce taxes at year-end.
But if you’re a DIY investor, you may be missing out on a valuable tax planning opportunity. Moreover, you may not be aware of the various ways to harvest losses—or the rules that accompany these tax savings strategies. For example, the IRS imposes a wash-sale rule, which prevents investors from selling and buying back the same security within a 30-day period.
A financial advisor like Milestone Asset Management Group can help DIY investors maximize their potential tax savings and avoid costly missteps.
#2: Roth Conversion
The IRS allows individuals to convert a traditional IRA to a Roth IRA via a Roth conversion.
A Roth IRA conversion shifts your tax liability to the present. As a result, you avoid paying taxes on withdrawals in the future. In addition, Roth IRAs don’t require minimum distributions. Due to these benefits, a Roth conversion can be one of the most powerful tax savings strategies available to investors.
When you convert your traditional IRA to a Roth, you pay taxes on the amount you convert at your current ordinary income tax rate. As such, this strategy tends to be most effective in years when your income is below average, or the market is down.
After you convert your traditional IRA to a Roth, any withdrawals you make in retirement will be tax-free if you’re over age 59 ½ and satisfy the five-year rule. And since Roth IRAs don’t have RMDs, you can leave your funds to grow tax-free until you need them.
While Roth conversions can be beneficial for many, they’re also complex and don’t make sense for everyone. Fortunately, the right financial advisor can help you determine if this strategy is right for you—and help you execute it efficiently.
#3: Qualified Charitable Distributions (QCDs)
If you’re age 72 or above, the IRS requires you to take annual distributions from your traditional retirement accounts.
These distributions—called required minimum distributions or RMDs for short—can increase your taxable income for the year and thus, your overall tax bill. Meanwhile, the IRS imposes a penalty of up to 50% if you fail to take your full RMD before the deadline.
The good news is there are tax savings strategies available to help you manage your RMDs and avoid unnecessary penalties. For example, DIY investors may not know that you can donate your RMD to charity—a strategy called a qualified charitable distribution (QCD). A QCD allows IRA owners to transfer up to $100,000 directly to charity each year.
QCDs can satisfy all or part of your RMD each year, depending on your income needs. You can also donate more than your RMD amount up to the $100,000 limit. And since QCDs are non-taxable, they don’t increase your taxable income like RMDs do.
It’s important to note that like most tax savings strategies, the IRS has rules and guidelines for making QCDs. Be sure to read up on these guidelines or work with a financial advisor who has experiencing helping clients manage their RMDs as mistakes can be costly.
#4: Strategic Charitable Giving
Lastly, DIY investors who are charitably inclined may be missing out on valuable tax savings strategies. This is especially true if you need to write checks to your favorite charities throughout the year without considering the impact on your tax bill.
Currently, taxpayers who itemize deductions can give up to 60% of their Adjusted Gross Income (AGI) to public charities and deduct the full amount on your tax return. You can also deduct up to 30% of your AGI for donations of non-cash assets. Furthermore, you can carry over charitable contributions that exceed these limits in up to five subsequent tax years.
Consider a Donor-Advised Fund (DAF)
Many DIY investors may not know that donating to a donor-advised fund (DAF) can meaningfully reduce your tax liability relative to other giving strategies. For example, if you typically donate $10,000 each year to your favorite charitable organization, you may find it’s more beneficial to take the standard deduction when you file your taxes.
On the other hand, you can front-load a donation of $50,000 to a donor-advised fund and request that the DAF distribute funds to your chosen charity each year for five years. In year one, you can receive a more favorable tax break by itemizing on your tax return. Meanwhile, you’ll still be meeting your charitable goals each year via the DAF. This strategy can be particularly beneficial in above-average income years.
Better yet, you can donate non-cash assets like highly appreciated stock to a DAF and avoid paying the capital gains tax. This strategy can also help you diversify your investment portfolio without triggering an unpleasant tax bill. Plus, you can take an immediate deduction for the full value of the donation (subject to IRS limits).
Of course, this is just one charitable giving strategy that can help you minimize your tax burden. A financial advisor who specializes in tax and retirement planning can help you maximize your charitable impact while lowering your overall tax bill.
DIY Investors Don’t Have to Go It Alone
This is by no means a comprehensive list of tax savings strategies. However, it may help illuminate the potential value of working with a financial advisor—even if you’re a DIY investor. Unfortunately, many asset managers and financial advisors won’t take on clients who manage their own investments.
The good news is you can still benefit from professional oversight if you prefer to invest on your own. Milestone Asset Management Group offers ongoing tax and retirement planning for an annual flat fee. We help DIY investors reduce taxes and optimize retirement income, so you can maximize your financial wellbeing and retire on your terms.
If you’re interested in learning more about our flat-fee tax and retirement planning services, the first step is to request your free Financial Milestone Roadmap™. We look forward to hearing from you!