Top 5 year end investment tips to lower your taxes

6 min read

Our top 5 year end investment tips to lower your taxes

Let’s face it, 2020 has been taxing enough already. With the year closing fast, there is no better time than now to take prudent measures to make sure you optimize your investments and minimize your tax liability.

While the IRS allows you to take advantage of several tax reducing incentives up until you file your taxes next year (like IRA contributions for example), there are a few things that must be completed by December 31st of this year.

Tax-loss harvesting

Tax-loss harvesting is a way to reduce your tax liability by selling investments that declined in value and generated a loss, and using those losses to offset other investments that you sell that have capital gains. Here’s an example of how it works:

This tax reduction technique is particularly useful in a year in which the market has had a significant downturn like, say, the pandemic sell-off earlier this spring! 

There are many other considerations, including the IRS’s wash-sale rules, which specify how much time you must wait to buy a stock back after it was sold for a loss. And there are more sophisticated strategies including intentional wash sales to step up your cost basis in an asset while minimizing capital gains. 

Since taxation on capital gains have separate rates and tax loss harvesting requires careful navigation of IRS policies, it is best to refer to IRS Publication 550. Or if an 80 page notice on tax treatment doesn’t get you up in the morning, reach out to your tax preparer or talk with an advisor on the specifics of how this strategy can apply to you.

Maximize your 401(k)

While this is rather straightforward advice, reports indicate that fewer than 13% of workers maximize their eligible 401(k) plan contributions. While contributions to your individual retirement (IRA) accounts can be made up until next year's tax-filing deadline (April 15th), it is important to remember that your 401(k) plan contributions, made through your employer’s plan, must be made by the end of the year. 

Many employees are often too busy to check in on their year-to-date status. It’s usually not top of mind when you’re trying to get everything else done by the end of the year. 

And it’s easy to underestimate the time it takes for changes to take place. After updating contribution requests on your plan custodian’s website, it can take two payroll cycles to see those changes go into effect. That means any changes or last minute contributions you want to make this year need to be in by late November or early December. 

As a reminder, for 2020, your 401(k) contribution maximums are $19,500 for individuals under 50 year of age and $26,000 for individuals 50 years or older 

Offset surprise capital gains from your mutual funds

Unlike ETFs which are not actively managed, the managers of mutual funds often make last minute end-of-year changes to put their fund in the most attractive position possible. The problem with that for you is that any capital gains that these managers incur are passed on to you (proportionally to your individual holdings) regardless if you wanted them or not. 

These unrequested and unwanted gains in turn drive up your taxable income. Therefore, investors should contact the funds directly or work with their advisors who typically have access to online tools, to get insights on future distribution, usually listed as a percentage under potential capital gains exposure.  Once determined, investors can offset gains by taking losses (see our tax loss harvesting principles above). 

Maximize Your Charitable Donations 

Within the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act there are several new first and one-time-only tax benefits for charitable donations. These include options for taxpayers that elect the standard deduction on their return and alternatives for those that itemize. Check out this post where we’ve included more details on how you can take advantage of this.

For convenience, IRS policies for 2020 are summarized in the table below:

There are several nuances to the tax law for charitable contributions, and again, we recommend you speak with your accountant or schedule time with an advisor to talk through them. 

And always remember receipts!

Rebalance your portfolio  

If you haven’t rebalanced your portfolio yet, it may be good timing to do so now. Rebalancing is the process of buying or selling investments in order to preserve your original asset allocation. This allows you to re-establish the risk/reward profile that you’re targeting as the underlying investments drift away from it over time. 

Rebalancing also serves as an ideal time to step back and re-assess your risk/reward profile. You can then make any changes that might be appropriate for you as your situation changes.

It is generally a best practice to rebalance your portfolio at preset intervals or when the asset allocation of your portfolio drifts away from your target by more than 5%. Or even better yet, have your portfolio automatically rebalance itself by using a modern investment platform. 

If you haven’t yet, there is no better time to rebalance than before the end of the year. If you rebalance before years’ end you can take advantage of the tax loss harvesting opportunities discussed above and organize your portfolio for the start of the new year. 

Time is running out!

Completing these tax reducing tactics by year end can lower your taxable income so that less of your hard-earned money is taxed at higher rates. That can mean the difference in qualifying for (e.g., not getting phased-out) attractive tax credits including:

  • Earned Income Tax Credit
  • American Opportunity Tax Credit
  • Lifetime Learning Credit
  • Child and Dependent Care Credit
  • Savers Tax Credit

And it's not too late to check off any other financial goals you might have. Check out our 2020 financial checklist to see if there's anything else you can do to put yourself or your family in a great position before year-end.

2020 is rapidly coming to a close. Whew! Why not work with your accountant or find time with a financial advisor to leverage these proven strategies to position yourself for a great start in 2021?

Roy Satterthwaite

SVP Client Management & Investment Committee Chair

Roy is a registered FINRA advisor who holds an MBA from the Columbia University Graduate School of Business and a Certificate of Finance Planning from the University of California Berkeley. With over 35 years of investing experience, Roy is at Farther to provide game-changing financial planning and investment advice to our clients.

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