Year-End Tax Strategies

A Glass Half Full

If this year’s bear market has got you down, there may be a silver lining to the market’s

drubbing, and we’re here to remind you of that. In this article, we discuss some of the year-

end investment and tax-planning opportunities available to help you keep more in your

pockets for years to come. We also address some important considerations for those

approaching or in retirement. The decision to undertake any of these strategies can involve

complexities not fully addressed in this article, so it’s best to consult your tax or financial

advisor to assess pros and cons of any strategy you may consider. (For those of you who missed it, a portion of this article is duplicated from that issued mid-year)

Inflation Adjustments

With inflation hitting levels not seen since the early 1980s, most of the news we read about

higher price levels is skewed to the negative. Fortunately, there are a few resulting

outcomes that will have more positive impacts on some of our wallets, including the recent

Social Security Cost of Living Adjustment (COLA), which will be 8.7% starting in 2023. This

will not only help defray some of the higher prices facing retirees in the short term, but

increase benefit payouts for future retirees for years to come. Civil and federal service

retirees will see a similar 8.7% COLA in their pension benefits. Additionally, tax calculations

and limitations are being impacted by the higher Consumer Price Index, with standard

deductions increasing by 7%, and retirement account contribution limits going up

substantially beginning in 2023 (see IRA/ROTH IRA articles below for details). Furthermore,

marginal tax brackets are also being adjusted higher, meaning more dollars will be taxed in

lower tax brackets. All of which is to say we’ll have a little more money in our pockets to

offset the impact of higher prices.

I-Bonds

While the recent spike in inflation has led to a significant correction in most investor’s

portfolios, another positive outcome has been the higher yields associated with bonds,

providing some prospective relief to retirees living on a fixed income. A type of bond we

especially like right now includes the Federal Series I Savings Bonds (“I-bonds”). With I-

bonds, the monthly interest rate earned is adjusted every six months and is added to the

value of the bonds, or “compounded” semi-annually. Those who purchased I-bonds

through the TreasuryDirect site before November 1 of this year were awarded a rich

composite rate (consisting of a fixed rate and an inflation rate) of 9.62% for 6 months,

followed by an inflation-only rate of 6.48%. While the newest rate beginning November 1

has since dropped to 6.89%, that’s still far higher than what one can typically earn in

savings or money market accounts or even certificates of deposit. Investors can purchase up to $10,000 worth of I-bonds every calendar year through www.TreasuryDirect.gov, with an additional $5,000 available via tax-refunds. Notably the limitation is per individual, not per household (meaning both spouses can purchase $10,000 for a combined $20,000). I-bonds can also be purchased for children and by trusts or estates, increasing the amount potentially available to households yearly. While I-bonds have a maturity of 30 years, investors can cash them in after one year. That said, if they cash them out before 5-years of time, they will forfeit the last three months of interest. Favorably, while I-bonds are taxable at the federal level, they are exempt from state and municipal taxes, and in some cases federally tax exempt if they are used to pay for qualified higher education expenses.

Note that I-bonds must be purchased directly from the Treasury at TreasuryDirect.gov (not available for purchase in brokerage or bank accounts).

“Harvesting” Capital Losses/Accelerating Gains

One particular “silver lining” associated with a market correction is the potential ability to

“harvest” some of your capital losses, whether alone or against realized capital gains. For

example, if you have a taxable asset with an “unrealized” loss, you may choose to sell the

asset and “realize” the loss to reduce your tax liability for 2022. Many choose to net those

realized losses against gains they realize with other assets, yet if you choose to only realize

capital losses, you can net up to $3,000 per year against your ordinary income, with any

remaining loss carried forward to future years. Of course, if your taxable income is below $41,675 (or $83,350 if filing jointly) and you are in the position to also realize long term capital gains, consider doing so while you can still avoid any tax at all (that’s right: 0%) on those long-term capital gains. Importantly, it’s essential to consider the impact of any strategy that impacts your income on other outcomes, such as higher Medicare or health care premiums or a higher level of taxation on Social Security benefits.

Accelerating IRA and ROTH IRA Contributions (and Maximizing 401K/403B Contributions)

If you typically make contributions to your IRA or ROTH IRA near the annual deadlines,

consider contributing to these accounts sooner rather than later to take advantage of

potentially lower market valuations. Since it is virtually impossible to predict a bear market

floor, another more conservative strategy would be to spread your contributions

throughout the year with a “dollar-cost-averaging” strategy, which simply means allocating

fixed dollar amounts toward the account at regular intervals rather than making a single

lump sum contribution.

To briefly review the difference between these retirement accounts, with a traditional IRA,

you typically contribute pre-tax dollars, allowing you to reduce your taxable income by the

amount you contribute to the IRA in the associated tax year. When you take distributions

from this IRA in the future, you will pay income taxes on the distribution at your marginal

tax rate at that time. With a ROTH IRA, you contribute “after-tax” dollars and do not receive

an income tax deduction, but your money will then grow tax-free, and subject to certain

holding period rules, you can generally make tax and penalty free withdrawals after age 59

½, and even earlier under some circumstances.

For 2022, the maximum amount you can contribute to your IRA or ROTH IRA is $6,000 per

year, plus an annual $1,000 “catch-up” contribution if you are 50 or older (these limits

increase by $500 in 2023). Importantly, there are income phase out limitations that you

should be aware of for IRA and ROTH IRA contributions. For 2022, if your income is below

$129,000 ($204,000 if you are married filing jointly), you are permitted to make a full

contribution to your ROTH IRA. If your income is between $129,000 and $144,000

($204,000-$214,000 if married filing jointly), you can make a partial, prorated ROTH IRA

contribution.

While there are no income limitations to make a non-deductible IRA contribution, those

with incomes over the following levels may not be able to take a tax deduction for their

contributions: Single: $68,000-$78,000; Married Filing Jointly: $109,000-$129,000; Married

Filing Separately: $0-$10,000. Exceptions to these limitations exist for spouses who have

little or no income or no workplace retirement plan, and we suggest you consult your

financial advisor for details if this applies to your situation.

Notably, many 401K plans now offer ROTH 401K accounts with far higher contribution

limits than for ROTH IRAs, which for 2022 permit contributions of up to $20,500 plus catch-

up contributions of $6,500 per year (these limits increase substantially in 2023 to $22,500/

$7,500.

“Back-Door ROTH IRA Contributions”

While contributions made to a traditional IRA are typically with pre-tax dollars, there are

some circumstances when it makes sense to make after-tax contributions, particularly for

those who exceed the income phase-out limitations for ROTH IRA contributions. In this

case, making these contributions and then converting these after-tax IRA funds to a ROTH

IRA could be an excellent strategy, as the value of the contributed dollars would not be

taxed if converted soon after. Importantly, this strategy would be less appealing if you had

other pre-tax IRA assets, as there is a “pro rata rule” that would apply to the conversion as a

proportion of that individual’s total IRA assets, meaning there would be a mix of pre-tax

and after-tax funds that would be converted, and partially taxable. As always, we

recommend you consult your tax or financial advisor to better understand the details if this

situation applies to you.

ROTH Conversions

Given that many stocks, bonds and funds have declined in price, this might be an ideal time

to consider converting a portion of your IRA or other retirement account to a ROTH IRA—

allowing for a future market recovery in the account that provides unlimited tax-free

growth. A “ROTH Conversion” simply involves moving assets from your traditional IRA (or

certain other retirement account types) to a ROTH IRA. Ideally, you would want to consider

ROTH conversions when you are in lower tax-rate years, such as upon retirement, during a

work-gap year, when you are young and early in your career, and/or when you expect your

future tax rate to be higher than it is today. A bonus to considering a ROTH conversion now

is that the lowered tax brackets from the Tax Cuts and Jobs Act of 2017 (TCJA) are set to

expire in 2025, with income tax rates set to revert to their higher pre-TCJA levels.

Importantly, the amount you convert from your IRA to your ROTH IRA will be considered

taxable income, so you should be careful not to convert so much as to move yourself into a

tax bracket that will be higher than you anticipate in the future. Additionally, using

retirement funds to pay this tax erodes the value of the ROTH conversion (and leads to a

“double taxation” scenario), so it’s best to pay the tax associated with the conversion from

your savings outside of your IRA.

These conversions become more powerful in a temporarily declining or “bear” market, as

you can convert a larger proportion of your “future growth” assets into your ROTH IRA

account without moving into a higher tax bracket. In other words, converting when

market values are lower allows you to move more assets that are “on sale” into your

ROTH IRA account where they can (hopefully) recover and grow tax free. The lower

security prices are, the lower your tax bill on the conversion of those securities. Currently,

while there are income limitations for IRA and ROTH IRA contributions, there are none for

ROTH conversions.

Importantly, if you are 72 or older and already taking your required minimum distributions

(“RMDs”) from your traditional IRA or other retirement account, you must take your RMD

before doing a ROTH Conversion. But once these assets are in your ROTH IRA, you will no

longer be subject to future RMDs in that account (with noted exceptions relating to

inherited ROTH IRAs).

RMDs: Have a Game Plan

In 2020, as part of the original Secure Act, rules pertaining to how you save in and withdraw

from retirement accounts changed dramatically. Key changes included moving the age

when minimum distributions from IRA accounts are required from 70 ½ to 72 and allowing

contributions beyond age 72 if still working and earning income. A negative change was to

reduce the ability of non-spouse beneficiaries of IRAs inherited after 2019 to “stretch” their

withdrawal timelines over their lifetimes. The Secure Act required these beneficiaries to

deplete the inherited retirement accounts via annual distributions within 10 years–with a

50% penalty on any missed distributions. Initially, the rule changes were interpreted to

mean there were no required distributions for years 1-9, but that the inherited account

must be fully distributed by the end of the 10th year following the original owner’s death.

Early in 2022, the IRS surprised planners by issuing guidance that distributions ARE required

in years 1-9 as well. Because many beneficiaries did not take a distribution in 2021, this

placed them at risk of owing a 50% penalty on the distribution not taken. Fortunately, the

IRS recently clarified the rules to stress the annual distribution requirements (which may still

be amended), yet also provided relief to those who failed to take RMDs from these

accounts up until now, stating that no penalties will apply for the failure to take RMDs

subject to the new rules in 2021 and 2022 (2020 RMDs were already waived due to the

CARES Act). Those who did pay a penalty for the missed 2021 distribution can also request

a refund of the penalty amount. Of course this remains a highly technical area as the above

only applies to accounts inherited after 2020 by non-spouse beneficiaries who were more

than 10 years younger than the decedent and are not minor children of the decedent. In

short, if this may apply to you, we suggest checking with your tax or financial advisor to

confirm the rules.

The views expressed represent the opinion of Opus Financial Solutions LLC. The views are

subject to change and are not intended as a forecast or guarantee of future results. This

material is for informational purposes only. It does not constitute investment advice and is

not intended as an endorsement of any specific investment. Stated information is derived

from proprietary and nonproprietary sources that have not been independently verified for

accuracy or completeness. While Opus Financial Solutions LLC believes the information to

be accurate and reliable, we do not claim or have responsibility for its completeness,

accuracy, or reliability.

Statements of future expectations, estimates, projections, and other forward-looking

statements are based on available information and the Opus Financial Solutions LLC’s view

as of the time of these statements. Accordingly, such statements are inherently speculative

as they are based on assumptions that may involve known and unknown risks and

uncertainties. Actual results, performance or events may differ materially from those

expressed or implied in such statements. Investing in equity securities involves risks,

including the potential loss of principal. While equities may offer the potential for greater

long-term growth than most debt securities, they generally have higher volatility.

International investments may involve risk of capital loss from unfavorable fluctuation in

currency values, from differences in generally accepted accounting principles, or from

economic or political instability in other nations. Past performance is not indicative of future

results.

Advisory services provided by Opus Financial Solutions LLC, a registered investment

advisor.

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