As 2020 draws to a close, you might wonder how you can improve your tax situation – especially in terms of your investments. Here are a few year-end ideas to consider:
- Be a tax-loss harvester. In taxable investment accounts, you could sell investments that have lost value and use the losses to offset income from any capital gains you might have from selling investments that have appreciated. If you have an overall net capital loss for the year, you can deduct up to $3,000 of that loss against other kinds of income, including your salary and interest income. Unused net capital losses can carry over to future years. This strategy works best if you’re in a higher tax bracket now than you expect to be in the future. Take into account any costs associated with selling investments and be aware of the IRS’ “wash sale” rules, which prohibit you from claiming the losses if you purchase a “substantially identical” security 30 days before or after the sale of a position sold at a loss. You may want to work with a financial professional to find a replacement investment to keep you invested in the market. See your tax advisor before embarking on this type of tax-loss “harvesting.”
- Avoid mutual funds about to pay out taxable distributions. In December, many mutual funds pay out dividends and capital gains that have accrued over the year. If you’re planning to buy shares of a mutual fund in a taxable investment account, avoid purchasing funds on the verge of paying large taxable distributions. Instead, consider a more tax-efficient exchange-traded fund (ETF) or mutual funds that aren’t expecting large payouts. Conversely, if you were planning to sell a fund anyway, you could possibly reduce taxes by selling before the dividends are distributed.
- Boost your tax-favorable contributions. If you haven’t maxed out your contributions to your employer’s retirement plan, health savings account (HSA), and/or IRA, make additional contributions for 2020 if you can. If your employer suspended 401(k) matches this year and you can afford it, consider increasing your contribution to make up for the lost amounts. Traditional pre-tax contributions are deductible and reduce your taxable income in 2020, while Roth contributions will generally reduce your taxable income in future years, when you take withdrawals from Roth accounts.
- Consider strategies in a year without RMDs. If you’re older than 72 (or 70½ if you were born before July 1,1949), you typically need to take annual taxable withdrawals – technically called required minimum distributions, or RMDs – from your traditional IRA or 401(k). However, you got some relief this year, as RMDs are not required because of the COVID-19 pandemic. Nonetheless, you may want to consult with your financial advisor and tax professional to determine if a distribution from a traditional/pre-tax account still makes sense. If you’re in a lower tax bracket this year than you expect to be in future years, you may benefit from taking advantage of lower rates. Alternatively, if you don’t need the distribution to cover expenses, you might explore if a Roth conversion makes sense.
Your key motivator, in all investment-related decisions, should be whether your choices will help you achieve your long-term goals. Within this framework, taxes do matter – so, do what you can to control them.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor. Edward Jones.
Sean Payne, CFP® can be reached at (562) 596-3722.