Taxes might seem like the last thing you think of when the holidays are just around the corner. A little preparation can make all the difference in April.
These are five things you should be paying attention to as the year winds down.
1. If you are able, increase your 401(k), contributions
Contributing to a company-sponsored retirement plan like a 401(k) allows you to save for retirement and receive a tax break. Contributions are usually made before tax, which can help reduce your taxable income for that year.
The amount you can afford to contribute and your retirement age will likely impact how much. Taxpayers can contribute as much as $20,500 to a 401(k) in 2022. Those 50 and older receive a catch-up which allows them to contribute up $27,000.
Employers often match a portion your contributions. A Vanguard 2022 study found that the average promise of employee match was 4.4% of the salary in 2021.
Clay Ernst, a Colorado Springs-based certified Financial Planner and executive director of Financial Planning for Edelman Financial Engines, said that if you contribute only enough to win the match, it could mean you are leaving money on the table. Why? You can reduce your taxable income by contributing more before Dec. 31.
2. Consider a solo 401k if you are a newly independent worker.
Solo 401(k) is not something you should have considered if you are a freelancer, self-employed, or a business owner without employees. There are many benefits to setting up a plan. Contributions you make can help lower your taxable income.
A nice bonus? Ernst says that although you have only 31 days to open an account, you still have until April 18th, 2023, the deadline for tax filings, to make contributions that qualify for a 2022 deduction.
3. Take stock of all your losses in investment
Are you an investor who has been watching the stock markets take a tumble in 2022? This may be the year to take advantage tax loss harvesting , which can help you squeeze some lemonade from the lemons in the portfolio.
It works like this: Investors who have sold investments at a loss are able to subtract that loss from any investment gains. If their losses are greater than gains, investors can offset them with up to $3,000 in ordinary income. They can also carry any losses forward to be deducted in the future.
Note: Tax-loss harvesting cannot be done on assets that are sold in taxable accounts such as brokerages. This strategy cannot be used to invest in tax-advantaged accounts such as 401(k), IRAs, or IRAs. A tax or financial advisor is a good idea as they can help you determine the best strategy for you and guide you through the complicated IRS rules.
4. Consider deferring income
It is possible to have enough tax withheld over the year to avoid unexpected bills. You could be earning more if you do freelance work or get a bonus.
Self-employed workers who bill their clients per project might want to delay invoicing.
Ernst says, “If you bill your services later in the year in the third or fourth weeks of December, it is highly likely that you won’t get the income until next tax year.” This can help you plan for 2023 and reduce your taxable income.
You can ask your employer to delay paying your bonus until January if you are expecting one and have a lower income next year. This tactic is not right for everyone. You’re not trying to avoid taxes forever, but you are merely delaying them until 2023.
5. Look into a Roth IRA conversion
Roth IRA conversions let you convert assets from your traditional IRA to a Roth IRA. This allows your investments’ growth and qualified withdrawals to be tax-free in the future. However, you will likely have to pay taxes on the converted amount.
The down market can be a good thing. If your account’s value has fallen, you are converting less money which could translate into lower taxes.
There are some drawbacks to be aware of. The conversion taxes and the possibility of being placed in a higher tax bracket can be a downside. An inflated income can also have an impact on other factors, such as your tax liability and general tax liability. It can affect your Social Security taxable amount and the cost of certain Medicare premiums if you are retired or near retirement.