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Investing Specialists

Retirees' Year-End Tax-Planning Guide

Our to-do list can help you reduce the tax pain in April.


With Thanksgiving falling so late this year, the holiday season will be truncated and the year will be over in the blink of an eye. Because the holiday season coincides with a lot of year-end tax-related deadlines, it's wise to knock them off before the craziness begins in earnest.

As the year winds down, here are some of the key tax-related jobs to put on your schedule if you're retired. 

Take Required Minimum Distributions
If you're older than 70 1/2 and own tax-deferred accounts such as traditional IRAs and 401(k)s, be sure to put required minimum distributions at the top of your to-do queue. The RMD deadline is Dec. 31, and if you miss it, you'll owe taxes not just on your distribution, but a 50% penalty on the amount that you should have taken but didn't. I love the idea of tying in RMD-taking with year-end portfolio maintenance, pruning those distributions from parts of your portfolio that you wanted to scale back on anyway and/or refilling your portfolios cash bucket. And if your RMDs go above and beyond what you need for near-term living expenses, remember that you don't need to spend them; you can always reinvest any extra money back into your portfolio. While you can't get the cash back into an IRA, you can reinvest in a taxable account or, if you or your spouse has earned income, in a Roth IRA. This article discusses how to use RMDs to improve your portfolio.

Scout Around for Tax-Loss Sales (or Tax Gains)
Tax-loss selling can be a worthwhile strategy at year-end: By pruning losing holdings from your portfolio, you can use those losses to offset an equivalent amount of capital gains or, if your losses exceed your gains, up to $3,000 in ordinary income. But as 2019 winds down, most major investment categories are well in the black; bonds and U.S. and foreign stocks have enjoyed terrific gains. That and the long-running strength of the market mean that investors in mainstream mutual funds and ETFs will be hard-pressed to find good tax-loss sale candidates, but individual stock investors may be able to identify losing positions.  

Tax-gain harvesting is also worthy of consideration by investors who expect to be in the 0% tax bracket for long-term capital gains, meaning that their total income comes in under $39,375 (single filers) or $78,750 (married couples filing jointly). Tax-gain harvesting can reduce the tax bills that could eventually be due if an individual is no longer in the 0% capital gains bracket, and it can also allow an investor to rebalance and/or remove problematic positions from a portfolio without triggering taxes on the repositioning. This article covers the ins and outs of tax gain harvesting and its utility.

Watch Out for Mutual Fund Capital Gains Distributions
As the year winds down, mutual funds begin making capital gains distributions to their shareholders, with distribution season in full swing in December. Thanks to the combination of a generally rising equity market and redemptions from actively managed funds, 2019 is shaping up to be another doozy of a year from the standpoint of these distributions. Fund companies are just beginning to release their distribution estimates. If your fund is planning to make a sizable distribution, it might seem tempting to pre-emptively sell it in advance of the distribution, but remember that won't necessarily help you dodge taxes altogether. That's because as a fund shareholder, you face two potential set of tax bills--one triggered by the distribution the fund makes to you, and the other by your own selling, assuming you have a gain over your holding period. That said, you'll get credit for the taxes you pay on a fund's capital gains distribution, in the form of an increase in your cost basis (the amount that you paid for your shares). The net effect of this accounting is that if your fund has made a lot of these distributions over the years and you want out, you may have already prepaid a lot of your tax bill. This article discusses that concept in greater detail.

Revisit Charitable Giving Strategy
Owing to changes in the tax laws that went into effect starting last year, many fewer taxpayers are likely to benefit from itemized deductions than in the past; they'll get a bigger bang from the standard deduction. That calls for rethinking your charitable giving strategy. If you're older than age 70 1/2 and taking required minimum distributions from IRA, you can employ what's called a qualified charitable distribution. With the QCD, you steer all or a portion of your RMD, up to $100,000, to the charit(ies) of your choice; the amount of your contribution reduces your adjusted gross income. If you're not yet subject to RMDs and/or you'd like to make additional charitable contributions, you can consider "bunching" your charitable contributions into a single year in which you itemize, as discussed here. A donor-advised fund enables you to make a large charitable contribution in a given year (and potentially take a deduction on it) but take your time in getting the money deployed to charities.

Revisit Strategy for Healthcare Deductions
Just as charitable contributions may not be deductible unless your itemized deductions exceed the standard deduction, so it is with healthcare expenses. Thus, as with charitable contributions, retirees may be able to "bunch" together their healthcare expenditures (especially big-ticket elective ones) into a single year, so as to obtain critical mass for deductibility. It's worth noting that the threshold for deductibility has increased as of 2019: While qualified healthcare expenses in excess of 7.5% of adjusted gross income were previously deductible, that percentage increases is now 10%.

Develop Next Year's Cash Flow Strategy
Finally, year end is a good time to develop your cash-flow strategy for next year. How much will you withdraw from your portfolio, and where will you go for the withdrawals? This article discusses the conventional thinking around withdrawal sequencing. But the best way to limit your taxes in a given year might be to withdraw from more than one account type (taxable, traditional tax-deferred, Roth) with an eye toward keeping yourself in the lowest possible tax bracket. A tax-savvy financial advisor or an investment-savvy tax advisor can help you strategize about the best accounts to tap for your income needs. 

Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.