Financial Advisor Insights

4 Year-End Financial Moves You Haven't Thought Of

by Kristin McFarland, CFP® on December 04, 2018 in Financial Planning

The end of the year is always a busy time, but it's often the last chance to ensure money-moves will count towards the current tax year. If you've been slow to tackle your financial to-do list this year, now may be the perfect time to redeem yourself. 

4 Year-End Money Moves That May Surprise You

1. Stop hoarding extra cash

If you're a high-earner, you may have noticed your regular paycheck increased at some point during the year. Maybe you got a raise, but it's also likely you've exceeded the Social Security taxable wage base. In 2018, the taxable wage base is $128,700, so once your pay exceeds this limit, you're no longer subject to the 6.2% employee-share of the Social Security tax. Further, depending on how you've allocated your retirement plan contributions throughout the year, you may have already contributed the 2018 maximum, so nothing further is being taken out of your paycheck.

These factors (and others) can lead investors to inadvertently hold more cash than they need or is advisable. As a general rule of thumb, one-income households should keep 6-9 months of non-discretionary expenses (e.g. mortgage and groceries) in cash, whereas two-income households should generally keep between 3-6 months of emergency cash reserves. Assuming there are no major expenses on the horizon, you may be doing yourself a disservice by keeping too much cash on the sidelines. 

Often, investors realize they're holding too much cash, but they're just not sure where to invest it or how to best allocate the funds between their goals, as is the case with many of our new clients. Especially if you expect to receive a year-end bonus or other distribution, managing your cash flows will be a key component of maximizing your wealth.

If this sounds like you, consider the following options for your extra cash before year end:

  • Diversify your investments from a tax perspective with a brokerage account 
  • Make a contribution to a Roth IRA or Traditional IRA (subject to eligibility) or a non-deductible contribution to an IRA (which virtually anyone with earned income can do if under age 70 1/2) 
  • Escalate your contributions to your 401(k) or 403(b) if you haven't already reached the 2018 limit ($18,500 or $24,500 if age 50+), provided your retirement plan can accommodate your wishes
  • Consider paying down high-interest debt such as student loans, credit card debt, or variable lines of credit - but don't go overboard. Consider the interest rate on the debt as your 'hurdle rate' if you were to invest the cash instead. Also weigh the benefits of long-term compounded growth versus the cost of carrying the debt for longer. Wiping away debt can feel great - but in many cases the best strategy is a blend between high-cost debt and long-term investments

2. Consider increasing your tax withholding

Particularly if you're self-employed or an owner in a business and receive income that is not covered by withholding taxes, you may want to consider increasing your withholding during the final regular paycheck(s) of the year to help reduce or avoid any estimated tax penalty that may be due. Unfortunately, even the most careful quarterly estimated tax payments may not be enough for some individuals to avoid an underpayment penalty altogether, especially if future income projections are fuzzy. Even if a taxpayer increases their quarterly estimated tax payments during the year, the penalty could still apply, if any previous payments are deemed to have been 'underpaid' based on the total income that was actually received at the end of the year. To avoid underpayment penalties, taxpayers can make quarterly payments of at least 110% of last year's tax liability (if their adjusted gross income is over $150,000). 

However, when taxes are withheld by an employer via a payroll deduction, those tax payments are always deemed to be timely paid. This allows individuals to potentially catch up on any previous under withholding, once they have more concrete income estimates near year end. 

Aside from business owners or partners, individuals who sold stock options throughout the year may also want to adjust their withholding. Employers are not required to withhold taxes on incentive stock options (ISOs) and standard withholding on non-qualified stock options (NSOs) may be insufficient. 

Although it can be much more difficult to estimate, if you've realized a significant amount of investment income during 2018 from short-term capital gains or dividends, it may also be advisable to consider increasing your withholding. Contact your CPA or accountant to discuss the best approach for your situation. 

3. Diversify out of a concentrated stock position or reallocate your investments in a tax-efficient way

The end of the year presents an opportunity for investors to reallocate their portfolio in a tax-sensitive way by tax-loss harvesting. The incredible run in the stock market over the past 10 years has left investors looking to rebalance taxable accounts with few options but to realize gains. Recent volatility may present the perfect opportunity to rebalance your portfolio or shift away from an active management strategy.

For investors looking to diversify out of a concentrated stock position, most typically employer stock, the end of the year presents an opportunity to spread taxable gains over 2 calendar years, within a matter of days. If you've been paying attention to the high-flying 'FAANG' stocks this year, (Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOG)), it's clear that even the biggest companies are not insulated from sharp volatility and deep declines. Particularly when a company is also your employer, wild swings in the stock price can mean anything from bonuses to payoffs. If a large part of your net worth is tied up in company stock, it may mean taking a double-hit, so carefully consider your exposure and whether it's time to diversify out of vested restricted stock units or other forms of equity compensation. 

If you own actively managed mutual funds in your taxable accounts, and are thinking of selling them, be aware that mutual funds issue capital gains distributions at year-end, which will be taxable to you.  Check to see whether your fund has already issued the distributions, but if not, try to sell before the ex date (if you own the fund on the ex date capital gains will be reportable to you for tax purposes even if you sell the day after the ex date).

4. Considerable charitable giving 

If you are charitably inclined, you may want to consider giving back this holiday season. As you might recall, the sweeping changes to the tax code passed at the end of 2017 included provisions which impact nearly every aspect of the tax law, including the deductibility of charitable contributions. 

Under the new tax code, the standard deduction has nearly doubled:

  • Single filers: $12,000 (from $6,350 in 2017)
  • Married filing jointly: $24,000 (from $12,700 in 2017)

Using a married couple as an example, this means that unless the pair has itemized deductions in excess of $24,000, they would be better off claiming the standard deduction. 

The most common itemized deductions include:

  • Mortgage interest (the limits also changed in 2018, but generally for mortgages before 2018, interest may be deducted on loans up to $1,000,000)
  • State and local taxes (SALT) (again, the rules changed in 2018, but generally state income tax, property tax, sales tax, and so on is now capped at $10,000)
  • Qualified medical expenses (as a result of tax reform, medical expenses in excess of 7.5% of adjusted gross income (AGI) can qualify as an itemized deduction in 2018. This limit returns to 10% of AGI in 2019)
  • Charitable giving (2018 changes discussed below)

Although the hurdle is a bit higher for taxpayers to itemize their deductions, those who can will likely enjoy an expanded charitable deduction. Prior to 2018, the limit on cash donations to qualified public charities was 50% of adjusted gross income (AGI). Starting in 2018, the limit will increase to 60% AGI. The limits on donations of appreciated long-term securities remain the same: donors may be able to deduct the fair market value of donated appreciated securities to a public charity, up to 30% of AGI. Any unused deduction can still be carried forward for 5 years.

Individuals can't control when most itemized deductions are realized, such as mortgage interest and SALT taxes. However, after tax reform, a new strategy called 'bunching' has developed, which can help some investors maximize their tax benefits.

Here's a very simplified example of how this would work:

A couple with no mortgage lives in a state without income taxes. Their property taxes are $12,000 per year. (For simplicity, we'll assume there is no sales tax or other local taxes.) They also donate $10,000 annually to their favorite public charity. In 2017, the couple's itemized deductions would be $22,000, compared to the standard deduction for a married couple filing jointly (MFJ) of $12,700. 

Assuming the same set of facts, here's how the couple's tax situation would have changed in 2018. After their state and local taxes (SALT) are capped at $10,000, they have $20,000 in itemizable deductions, which is less than the $24,000 standard deduction. If the couple 'bunched' their charitable deduction instead, making their 2018 and 2019 donation in 2018, they could take $30,000 of itemized deductions in the current tax year. In 2019, they would then opt for the standard deduction, which would be greater than the $10,000 in property taxes that could be itemized. 

Donating appreciated securities can be a very efficient way to maximize the support for your chosen charity and your financial benefit from the donation, assuming you can itemize your deductions. Since the securities are donated directly to the public charity, the taxpayer does not incur long-term capital gains taxes as they would if the security was sold to raise cash for the donation. Work with your financial advisor and CPA to identify whether any securities in your portfolio may be candidates for this strategy and to understand the potential tax impacts. 

As the days of 2018 grow fewer, it is important to prioritize your financial to-do list, particularly as it may involve coordination with your financial and tax advisor.  

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