Advisor Insight

4 money 'musts' for your to-do list before year-end

With the year drawing to a close, it's time to get busy making holiday plans and winding up projects at work. It's also time to get serious about year-end financial planning.

During the hectic holiday season, it can be tempting to put off financial decisions until the new year, but taking certain steps now may well be worth the effort. Timing is especially important when it comes to making tax-related moves that may reduce what you owe when filing season rolls around.

"The year end is a busy time for all of us," said Aaron Graham, a certified financial planner with fee-only advisory firm Abacus Planning Group. "There are some things that can always wait, but there are a couple of tax-related planning opportunities that truly have a deadline of Dec. 31."

Here are some issues that advisors say investors ought to have on their radar during the final months of 2016.

Aslan Alphan | Getty Images

1. Tax planning. The fourth quarter is an optimal time for tax planning because, by now, many of us have a good sense of how our personal and financial lives have changed over the past year.

Tax-loss harvesting is one way to reduce taxes on realized capital gains from winning investments. Start by evaluating what you own in your portfolio and why you own it, and then consider selling some holdings that have lost value by the end of the year.

These so-called realized losses can be used to offset realized capital gains. If losses exceed gains, taxpayers are allowed to deduct up to $3,000 from their ordinary income. Any excess loss can be carried forward to future tax years.

If you're a retiree who relies heavily on investments in taxable accounts for income, this strategy is worth considering, said Aaron Grey, a certified financial planner and wealth advisor at fee-only Buckingham Asset Management.

"Tax-loss harvesting is generally for people who have taxable income and are looking to create a write-off via taxable loss," he explained.

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Proceed with caution, though. Selling portfolio holdings simply for the tax benefit can undermine your investment strategy. Tax-loss harvesting, experts say, should accomplish two things: It should enhance both your portfolio and your tax situation.

For retirees with low levels of recurring income and large portfolios in taxable accounts, it may make more sense to sell some holdings that have appreciated over time, said Grey. That's because in 2016, taxpayers in the 10 percent and 15 percent income brackets can realize long-term capital gains (or receive qualified dividends) without being taxed.

"If you are in the 15 percent [or lower] bracket for ordinary income, your long-term capital gains bracket is zero," added Grey.

2. Charitable giving. It feels good to support your favorite charity during the holidays. Of course, doing so can have some nice tax benefits, too.

Many people simply donate cash to charities, which, while well intentioned, may not be the most effective way to maximize the tax breaks tied to charitable giving. One frequently overlooked strategy is to donate stocks, bonds or mutual fund holdings that you've owned for at least a year and that have risen in value.

By doing so, you get an income-tax deduction and — because the securities are donated, not sold — you won't owe capital gains taxes, according to Graham of the Abacus Planning Group. Tax-exempt charitable organizations can sell donations of appreciated assets without having to pay capital-gains taxes on the profits.

"What's better than giving and receiving at the same time?" asked Graham.

You may also want to consider supersizing your tax deductions through a strategy called bunching.

Most taxpayers take the standard deduction or itemize, depending on which provides a greater benefit. Rather than waiting until filing season to make that choice, consider timing the payments of tax-deductible items, such as property taxes and charitable contributions, to maximize your itemized deductions for this year.

If you tithe at your church, for instance, you can make your normal contributions for the year and then prepay next year's tithing in a lump sum. Homeowners can take a similar approach, paying next year's property taxes before the end of this year.

Low-income years can be a great opportunity to convert IRA balances to a Roth. You can potentially pay a lower tax rate on the conversion.
Ben Gurwitz
senior financial planner with Financial Life Advisors

"If you bunch your deductions by pushing multiple years into one, you can get a supersized deduction and itemize for that tax year," said Ben Gurwitz, a senior financial planner with Financial Life Advisors, a fee-only firm. "Then you take the standard deduction the following year."

3. Workplace benefits. If you have a 401(k) or similar retirement plan through work, it's a good time to take a look at how much you've contributed this year. You may still have time to bump up your salary deferral to ensure that you put away the maximum allowable amount for 2016, which is $18,000. The catch-up contribution limit for employees over age 50 is $6,000.

Some investors may want to convert a traditional individual retirement account or 401(k) plan into a Roth IRA. There is no upfront tax deduction for Roth IRA contributions, but qualified distributions are tax-free. Roth IRAs generally make sense for investors who expect to be in a higher tax bracket after they begin taking distributions.

"Low-income years can be a great opportunity to convert IRA balances to a Roth," said Gurwitz, a certified financial planner.

"You can potentially pay a lower tax rate on the conversion" than you would during a high-income year, and "the account grows tax free and doesn't have future required minimum distributions," he added.

During the fourth quarter, many Americans re-enroll in health plans at work and make decisions about other employee benefits. Grey, of Buckingham Asset Management, said workers often overlook two perks with significant tax benefits — namely, dependent-care flexible spending accounts and health savings accounts.

A dependent-care FSA allows you to set aside money on a pretax basis to be used for eligible child-care expenses. Contributions to this type of plan are deducted from your income on a pretax basis, lowering your overall taxable income.

Health saving accounts are available only to people enrolled in high-deductible health insurance plans meeting strict criteria, including certain minimum deductibles and out-of-pocket maximums. As with 401(k) plans, HSAs typically offer a menu of investment options.

Some advisors call HSAs the Holy Grail of savings vehicles because of their rare triple-tax benefit. Contributions to HSAs are made with pretax dollars (in most states), assets grow tax-free, and distributions are tax-free if used to pay for qualified medical expenses or as reimbursement for such expenses.

Advisors say an HSA may make sense if you have minimal medical expenses and thus are able to let your balance compound over time.

"Depending on your health or family situation, it may make sense to convert to an HSA," said Grey of Buckingham Asset Management. "You can pay a lower health-insurance premium [on a high-deductible health plan] and get the HSA tax benefits."

Get the balance right

4. Rebalance your portfolio. Many investors rebalance their portfolios during the fourth quarter to maintain their target asset allocation. Left untouched, portfolios can easily drift from their original strategy. If that strategy no longer matches your needs or risk tolerance, it might be time to rethink your allocation to stocks, bonds and cash.

"The end of the year is a time when people often ask, 'What did I do during the past year? How much did I make? And am I still on track to get where I want to be in a few years?'" said Mark Germain, a certified financial planner and CEO of fee-only firm Beacon Wealth Management.

As they reflect on these questions, many of his clients, he said, have been tempted to ratchet up their exposure to the U.S. stock market in hopes of getting higher returns. Germain has discouraged most from doing so, on the basis that the potential incremental gains aren't likely to be worth the added risk.

"There is tremendous unrest globally," he said, pointing to economic uncertainty in Europe and slowing growth in China. Both issues, he added, will likely to continue to weigh on the U.S. stock market next year.

There have been times, he said, when it has made sense to take on more risk, such as in 2012, 2013 or 2014. Next year isn't likely to be one of those years, said Germain.

"History doesn't tell you anything. You have to look at the risks going forward," he said. "The fundamentals are for slow growth in a somewhat volatile marketplace."