Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)
Tax Day may still be months away, but there are plenty of actions you can take before then to help manage your tax bill. In fact, certain tasks should not—or in some cases cannot—wait until next year, lest you miss out on important tax opportunities.
Here are the top tasks to tackle before December 31—and those you have until Tax Day on April 18, 2023, to accomplish.
To consider by year-end
- Take required minimum distributions (RMDs): If you're over age 72, you must take minimum distributions from your tax-deferred retirement accounts by the end of the year. If you miss the deadline, you could be subject to a 50% penalty on the portion of your RMD you failed to withdraw. (If you turned 72 in 2022, you have until April 1, 2023, to take your first RMD.)
- Maximize your 401(k): Contributing the maximum amount to your tax-deferred employer-sponsored retirement plan can help reduce your taxable income for the current year. In 2022, the maximum contribution for 401(k)s and similar plans is $20,500 ($27,000 if age 50 or older).
- Contribute to a Roth 401(k): If your employer offers the option and you haven't maxed out your traditional 401(k), you can make after-tax contributions to a Roth 401(k) up to the $20,500 limit ($27,000 if age 50 or older)—minus whatever you might have contributed to your traditional 401(k)—before year-end. Once you reach age 72, Roth 401(k)s are subject to RMDs, but all contributions and earnings can be withdrawn tax-free.1
- Consider a Roth conversion: If your income exceeds Roth IRA contribution limits (see "To consider by Tax Day"), you can convert the pretax savings in a traditional IRA account to a Roth IRA in order to reap those tax-free withdrawals in retirement. You'll need to convert just enough to remain within your current tax bracket since you'll pay taxes on the converted funds, which will be treated as income. For example, if you're single and will earn $175,000 this year, you fall into the 32% tax bracket, which ranges from $170,051 to $215,950. That means you can convert up to $40,950 ($215,950 – $175,000) without being pushed into the next bracket.
- Consider a mega backdoor Roth: If permitted by your workplace retirement plan, a so-called mega backdoor Roth allows high-income earners to save in a Roth account while eschewing the income limits of a Roth IRA and the tax consequences of a regular Roth conversion. To take advantage of this strategy, you first max out your normal, pretax 401(k) contributions for the year—then contribute after-tax dollars up to the overall account limit of $61,000 in 2022 ($67,500 if 50 or older), after which you can convert those funds to a Roth IRA. You'll want to roll over those funds as quickly as possible to avoid being taxed on any additional investment returns.
- Optimize your giving: If charitable giving is part of your financial plan, act by year's end to ensure your largesse is as tax-efficient as possible:
- Charitable donations: In general, you can deduct cash donations to qualified charities worth up to 60% of your adjusted gross income (AGI), which is your total gross income minus certain deductions, such as contributions to retirement plans. Donating appreciated long-term investments via a donor-advised fund can be especially tax-efficient: You don't have to recognize the capital gains, and you can receive a tax deduction for the full fair market value of the donation (up to 30% of your AGI).
- Qualified charitable distribution (QCD): If you're 70½ or older, you can donate up to $100,000 to a charity directly from your IRA using a QCD. You won't receive a tax deduction for the donation, but the gifted amount can be used to satisfy all or part of your RMD without adding to your taxable income.
- Exercise nonqualified stock options (NSOs): If your company issues NSOs, which are taxed as ordinary income when exercised, waiting until the end of the year allows you to exercise just enough to stay within your tax bracket, thereby keeping your taxes lower than if you had exercised your options all at once.
- Harvest losses: The end of the year is a great time to make sure your portfolio is still aligned with your goals. If this year's market volatility has left you with losses, you can use them to offset any realized capital gains for 2022. To employ this strategy, tally up your gains, then cash out losing positions of equal value. If you have more losses than gains, you can offset up to $3,000 of ordinary income.
To consider by Tax Day
- Maximize all other tax-deferred savings accounts: Any money set aside in these tax-advantaged accounts can help reduce taxable income, but with these, you'll have until Tax Day to make contributions for the prior tax year. In 2022, the maximum contributions are:
- Health savings accounts: $3,650 for individuals ($4,650 if 55 or older) and $7,300 for families ($8,300 if 55 or older).
- Individual retirement accounts (IRAs): Up to $6,000 ($7,000 if you're 50 or older). However, if you or your spouse is covered by an employer retirement plan, contributions may not be fully tax-deductible.2
- Contribute to a Roth IRA: Roth IRA contributions are made with after-tax dollars, so they won't help reduce your taxable income. However, once you reach retirement, all contributions and earnings can be withdrawn tax-free3—and Roth IRAs aren't subject to RMDs. Unfortunately, you can't contribute to a Roth IRA if your income exceeds $144,000 ($214,000 for married couples), and the contribution limit is gradually phased out for those with income between $129,000 and $144,000 ($204,000 and $214,000 for couples). However, if you expect to be in a higher tax bracket in retirement, a Roth conversion could help you save on taxes in the long run.
A final tip
In 2022, you can give away up to $16,000 ($32,000 if married) per person to an unlimited number of people without eating into your lifetime estate- and gift-tax exemption. This won't reduce your taxable income for the year, but it will allow you to strategically transfer wealth to your heirs tax-free.
1So long as the account holder is 59 1/2 or older and has held the account for at least five years.
2If you or your spouse is covered by a workplace retirement plan, the deduction may be phased out.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax-free, and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59½ are subject to an early-withdrawal penalty.
Past performance is no guarantee of future results.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.1122-256K