To paraphrase Benjamin Franklin, the two most certain things in life are death and taxes. While you likely don’t think about the end of your life every day, you should be thinking about your taxes. We all owe our fair share, but there is never a need to tip Uncle Sam. You should consider every available strategy to help reduce the impact of taxes.
Tax planning is a year-round responsibility. Experienced investors have a strong understanding of their financial picture and make proactive use of the many provisions offered by the IRS.
The difference between good and great management of your wealth is the implementation of a layered tax plan. This goes well beyond simply focusing on taxes once a year when taxes come due.
Understand that the goal of successful tax planning is not to reduce your taxes every year. Sometimes it makes sense to accelerate your taxes for a few years to reduce your projected overall lifetime tax liability.
We address this advanced concept throughout the article, as well as the various strategies used to accomplish this goal and help strengthen your financial position.
Retirement Contributions in 2023
Traditional IRA
Contributions to your Traditional IRA can be made until April 18 of next year to count for 2022. The limit is $6,500 (plus $1,000 catch-up for those over 50). Be aware of the deductibility of Traditional IRA contributions, especially if you’re filing your own taxes. Earning over a certain amount and having access to a retirement account like the TSP may phase you out of the deductibility of Traditional IRA contributions.
Roth IRA
Remember that your contribution to your Roth IRA counts toward the overall $6,500 total for IRA accounts but can still be made up until April 18, 2023. There are income limitations for Roth IRA contributions, but not for the Roth TSP.
If you earn too much to be eligible for a Roth IRA contribution, consider making a non-deductible Traditional IRA contribution, then “backdoor” the contribution into a Roth. Be aware of the Roth Pro-Rata rule or risk complications with the IRS.
Roth Conversions
You may want to consider Roth conversions if you believe you’ll be in a higher bracket in the future. RMDs often force federal retirees into tax brackets beyond their income prior to turning RMD-age, especially if most of your savings was built within the Traditional TSP or other Traditional retirement accounts.
Perhaps you are recently retired or only working part time; years with low income may be good years to convert Traditional retirement money into Roth by paying taxes in lower brackets, and turning it into money that grows tax-free. You cannot convert your Traditional TSP, but Traditional IRA monies are eligible.
Thrift Savings Plan
Your 2023 contribution limit is $22,500 for TSP salary deferrals ($7,500 catch-up for those over 50), so plan your TSP withholdings accordingly this year. Make a habit to increase your TSP contributions by 1% each year if you’re able to work towards the maximum contribution amount.
Income and Capital Gains Tax
Tax-Loss Harvesting
Tax-loss harvesting is a strategy in which investors sell low-performing, taxable investments and use the losses to offset current or future gains, thereby lowering their taxable earnings.
If done correctly, investors can regain their account values as markets increase while simultaneously having the tax-savings of the volatility on their “books”, and possibly make money without paying taxes. We illustrate exactly how this works here.
If you’re facing a year with high income or you had significant losses, you may want to consider this strategy. Many harvest portfolio losses towards the end of the year, but savvy investors perform these tasks throughout the volatility during the whole year for their taxable accounts. Even in bull (increasing) markets, this strategy can still add tax-savings annually.
Tax-Free Eligible Medical Care
If you have a high deductible health plan, you have access to a Health Savings Account (HSA) is a tax-advantaged account used to pay for qualified health care needs. Contributions go in pre-tax, and qualified medical expenses allows you to make withdrawals tax-free.
They can be grown over time by investing, and HSAs can be used as long-term investment vehicles so you can save for retirement health care costs in a tax-advantaged manner. You need to be enrolled in a high deductible health care plan to be eligible to contribute.
Health Care FSAs are slightly different, and eligibility is depending on FEHB eligibility. It works similarly to an HSA and can help you save roughly 25-30% on medical expenses. Learn more here.
Tax-Efficient Investing
Individual, joint, and trust accounts do not share the tax-deferred characteristic as retirement accounts. You need to be aware of the investments you are using within such accounts. Vehicles like Mutual Funds will create all sorts of tax problems for you each year.
Be aware of your investment holding periods and basis. Perhaps realizing gains in early retirement will keep your AGI (adjusted gross income) below levels that allow you to pay lower taxes. Doing too much may increase your capital gains bracket or Medicare premiums. Plan carefully.
Utilize vehicles like ETFs or municipal holdings to offer greater tax shelters against careless tax liabilities and reduce your capital gains taxes. Trade tactfully to harvest tax savings while not cannibalizing your portfolio.
529 Plans
A 529 is a tax-advantaged savings plan that can be used for qualified educational expenses. Money that goes into a 529 is deductible in most states, and you can fully fund 529 plans for yourself, kids and grandkids, and other family. Check with your state to see what the rules are for tax benefits in your state. Be careful though, distributions from 529s must be qualified or face a penalty.
Charitable Giving
Qualified Charitable Distributions (QCD)
At age 70.5, you can send distributions from an IRA directly to a qualified charity. By doing this QCD, the distribution may qualify and count towards your RMDs but will not be treated as taxable income. If you’re charitably inclined and of proper age, consider utilizing this strategy to meet both goals simultaneously. Individuals may distribute up to $100,000 in a year using this strategy.
Qualified Charitable Cash Donations
Qualified charitable cash donations up to $300 can be deducted as an above the line deduction per the CARES Act for 2020. This was extended for the last tax year but that temporary deduction does not apply for the 2022 tax year.
Non-Profit Donations
Maintain records of donations made to non-profits. Keep good records, they may help offset your taxes.
Charitable Remainder Trusts
Charitable remainder trusts are a tax-exempt way to leave assets to beneficiaries for a certain period of time before giving the rest to charity. Work with the proper professionals to help make sure you’re taking full advantage of the tax opportunities. Donor Advised Funds (DAFs) are another vehicle to be considered.
Estate Planning and Transfers of Wealth
$17,000 annual gift tax exclusion
This is the amount a person can give away in 2023 to as many people as they wish without it counting against their lifetime estate exemption. If you are projected to leave significant assets to your heirs, annual gifting can help reduce your overall taxable dollars on death.
Currently the lifetime estate exemption is very high ($12M+), but it has not always been this high, nor is it likely to remain this high forever. Smart investors do not wait for tax laws to change only to be forced to hurry and make changes last minute.
Wills and Trusts
The beginning of the year is a great time to double check the details of your Wills, Trusts, beneficiaries, etc., especially with the SECURE Act and its complexities surrounding retirement accounts and the new RMD timelines. Read up on the SECURE Act and its possible subsequent amendments to ensure you’re keeping up with how it will impact your family’s wealth.
Tax Concerns for 2023
Inherited Accounts
The IRS exempted 2022 as well from annual RMD on new-rule Inherited IRAs. We do not expect that there will continue to be no annual requirement during the 10-year liquidation period. Understand what a change to the rule will do to your tax picture, and whether you want to accelerate distributions accordingly.
The SECURE Act requires many inherited retirement accounts to be fully depleted in 10 years. 2020 was the first year these new rules started to apply, so 2021 is the first year in which the 10-year SECURE Act clock starts to run. Make sure this is accounted for in your financial plan.
Required Minimum Distributions
If you are of RMD age (72) or were previously at the lower age of 70.5, these distribution requirements will be in place as they were this year. Understanding what your RMDs will look like not just for 1-2 years, but for the duration of your expected lifetime is critical in knowing how to minimize the taxes.
Perhaps taking higher distributions beyond your minimum amount makes sense. Perhaps delaying your pension for the first year makes sense. Make sure to make these decisions while considering all other financial elements. Learn more here.
SECURE Act “2.0”
This year brought us the SECURE Act “2.0” in early 2022. It passed the House with flying colors but has not yet passed the Senate. It was widely expected that 2023 would contain the changes implemented. If it becomes real next year as-is, there are several changes federal employees should consider. There were similar bills introduced by the Senate Finance Committee, the EARN, and the RISE & SHINE Acts.
Bigger catch-up contributions would allow people who are 62 to 64 contribute an additional $10,000 to ERISA retirement plans (TSP, 401k, 403b, etc.) These catch-up contributions would be subject to income tax prior to being invested.
Delayed RMDs are also on the table. This act would implement a gradual increase to the RMD age: 73 immediately, to 74 by 2029, to 75 by 2032.
The act would also make it easier for plans to offer annuities by easing certain RMD requirements and implementing QLACs (qualified longevity annuity contracts). Given the TSP-annuity, it is unclear how this would impact the TSP. Annuities can be helpful because they provide income for life (FERS, Social Security, etc.) However, annuities struggle to keep up with inflation over time, generally have high fees, and retain lesser purchasing power as time goes on. Personally, we’re not fans of additional annuities for federal employees beyond Social Security and your FERS pension, both of which you’ve paid for during your lives. This is why we general recommend against the TSP annuity. Liquidity and longer-term growth potential is more important for feds.
Consider taking time to reassess your plan to ensure you’re making the most out of the available provisions within the law. There are many credible organizations, such as Vanguard and Morningstar, that have produced extensive research on the added value of continually and correctly executing on many of these strategies. Take greater control over your finances in 2023; after all it’s not just your money, it’s your future.
