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Year-End Financial Planning Tips With an Eye on Taxes

Vanguard's Maria Bruno offers some fourth-quarter portfolio strategies prepare retirees for next year's tax season.

Christine Benz: Hi, I'm Christine Benz from Morningstar. We're in the fourth quarter and that means it's time for all investors, but especially retirees, to strategize about year-end tax and portfolio planning. Joining me to share some tips for the fourth quarter is Maria Bruno. She's head of U.S. Wealth Planning Research at Vanguard. Maria, thank you so much for being here.

Maria Bruno: Thanks. Always good to be here, Christine.

Benz: Let's talk about kind of a to-do list for retirees when they think about their taxes and their portfolio-management jobs before year-end. So, at the top of the list, if you are over 70 1/2, you've got to put those required minimum distributions, right?

Bruno: Yes, I would agree that's probably the big one. So, most retirees have accumulated wealth in tax-deferred retirement accounts. And beginning at age 70 1/2, you have to start taking distributions from those accounts. So, the important thing is you need to take those in a calendar year. So, the RMD must be satisfied. If not, the penalty is pretty stiff--it's 50% of the amount you should have taken and then that's all subject to income taxes as well. In the year you turn 70 1/2, you can certainly defer that until the following year, April first of the following year, but you want to be mindful by doing that deferral, because then the following year you'd be subjected to two distributions.

Benz: OK, you've got to take another one by year-end if you do that.

Bruno: Correct.

Benz: Ok.

Bruno: And that might have not-so-good consequences for the next year's tax return.

Benz: That could be a really high tax year if you had two in one year.

Bruno: Yes, it could. Depending upon how large the balances are, absolutely. So, the key there is to make sure that you take the RMD before the end of the year once you begin taking those distributions at 70 1/2.

Benz: OK, so one thing that I think is kind of a neat strategy--and I'd be curious to get your take on it--is this qualified charitable distribution that can be tied in with a required minimum distribution. So not just anyone can take it, but let's talk about how the QCD works and what the benefit is, especially if you were inclined to make charitable contributions of some kind.

Bruno: Yeah, no, I'm a big fan of that strategy. So if you are charitably inclined, one thing you can do is a charitable qualified distribution from the IRA, for instance. And what that means is you are actually designating the beneficiary to get the proceeds of the RMD. So, you don't as account holder, take the RMD, but it's actually payable to the charity. So, it bypasses you altogether. What's nice is it fulfils the charitable intent. The amount is $100,000--up to $100,000, once you reach age 70 1/2, and that's per account owner. So, if you have a married couple, and they both have IRAs, it could be up to $100,000 for each account owner.

Benz: But it can be lower if you're a smaller giver.

Bruno: It can be lower, yes.

Benz: OK.

Bruno: I guess my point there is that the limits are pretty generous, if you are charitably inclined. And the nice part about that then is it does not even factor into your adjusted gross income. So, you take it off the top. So, your income is lower, just by that very step; you satisfy the RMD; the charity gets the full amount of the money; and it doesn't factor into your tax picture at all. So, things that are triggered from income, whether they be the taxation of Social Security, whether it may be Medicare Part B premiums that are based upon income thresholds or even your marginal rate in general. Those things that are triggered off of income are lower just by that very strategy itself.

Benz: OK. So, a really neat strategy to consider if you're subject to RMDs. Charitable contributions, it's all changed, given the new tax laws and the fact that we have this higher standard deduction. But there are ways that retirees can think about tying in their taxable holdings to make a charitable contribution and potentially get a tax break. What are some of those strategies?

Bruno: Yeah, certainly. I mean, and the one thing I will add to the QCD as well, if you do that approach, then you can't take a charitable deduction. So essentially…

Benz: On that same amount.

Bruno: On that amount, right. So, you can't double dip. It's either one or the other. But there's benefits to doing that, if you're charitably inclined, and you have the proceeds to do that. Otherwise, if you have taxable moneys and you want to do gifting, whether it's a charity or even if it's giving to family members. If it's a charity, the standard deduction has gone up, so many individuals who used to itemize, they may be taking advantage of the standard deduction. So, the benefit of you know, itemizing through charitable deductions may not necessarily be there. That doesn't necessarily mean that you shouldn't still do that, if you're charitably inclined--there may be tax benefits. So, for instance, if you have highly appreciated assets. So, many retirees have built wealth in taxable assets, and they're sitting on hefty capital gains. If they were to liquidate those assets and donate cash, they'd be subjected to cap gains taxes on those proceeds. What they could do is donate the highly appreciated assets and the basis transfers to the transfers out of the individual holder. So, the charity gets the full amount, and then you never really have to pay gains on that amount. So, it's one way to satisfy charitable intent, but doing in a very tax-efficient way, as opposed to giving cash.

Benz: Another strategy that you mentioned, Maria, is that even though you wouldn't get a charitable deduction for doing so, if you wanted to give some funds or some assets to your loved ones, you can also tie in those highly appreciated taxable assets there too, right?

Bruno: Absolutely. So, if you find that you're in a high tax bracket, and maybe your kids are in a lower tax bracket, by transferring those assets or gifting those assets over the basis carries over. And the children can either keep those assets or liquidate, liquidate them at maybe a lower tax rate as well. So, some tax maneuvers there that are worth exploring if that's an option.

Benz: Right. Let's talk about tax loss selling. Doesn't seem like 2019 where we're sitting here in kind of mid-October. It's not shaping up as a great year for tax loss selling, but that might be a strategy. Tax gain harvesting is something you're hearing a lot about. Tell us about that.

Bruno: Yeah. So, it's interesting as you think about it, the tax process has changed, right the tax--the federal taxes changed last year. So how we think about taxes on an annual basis may be different because of the higher standard deduction, particularly for married individuals. So, whether or not you're itemizing or using a standard deduction, there's strategies you can still use within that. So, certainly if you have losses within your account that you may want to look at, particularly if you need to rebalance the portfolio, if you're overweighted in certain areas, well, maybe you could take advantage of some losses. That's not necessarily going to help rebalance your portfolio, but it may help mitigate some of the tax consequences of rebalancing with any gains that would offset that. So, for instance, if you have losses, you can offset the gains. You can offset income up to $3,000. You can also carry those forward. Capital gains harvesting is exactly that you're selling assets that are at gains. But if you find that you're in a lower tax bracket this year for whatever reason, maybe you are itemizing and you might be able to take advantage of some "extra income." Cap gains harvesting can be a way to help maybe rebalance the portfolio, better your financial situation in terms of portfolio construction, and maybe using that extra income, those cap gains, maybe if they're offset by something else. So that's the strategy there. And those are really pairing strategies, in my opinion.

Benz: OK. So, an example would be, say, I've got some security in my portfolio that is maybe larger--a larger portion of my portfolio than I really want it to be. Maybe it's company stock or something like that.

Bruno: Yes.

Benz: I am in a temporarily lower tax bracket. The idea is “get that out the door” at the time you're in a lower tax bracket, so the tax burden associated with the selling isn't as great as it would be.

Bruno: Right. So you might find, for instance, that hey, well maybe you might take a qualified charitable distribution, maybe your income's a little lower this year, okay, maybe I'll accelerate a little bit of cap gains or some income here to help offset that. And presumably be in a better tax situation when I do liquidate those assets. So that's the tactic there.

Benz: OK. So throughout, it seems like a recurrent theme is “I'm thinking about not just what's good for me from a tax standpoint, but what's good for me from a portfolio standpoint and with some of these tax moves, I'm trying to correct some of these issues.” Is that a good way to think about it?

Bruno: I would actually think about the portfolio first, right? So how am I from a portfolio standpoint, and then how do I either maintain that or correct that in a tax-efficient way? You never really want the tax to drive the investment decisions. But if you're making investment decisions or putting money into the portfolio or taking them out, think about how you do those moves to better the investment consequences of that.

Benz: OK. So, final point is, you think it's a good time of year to kind of look at maintenance of various items. You mentioned beneficiary designations before we got rolling. I think that's a good one for people to check up on. What else?

Bruno: Yeah, we kind of get lazy, right? So, we set these things up and we may not necessarily check them over the years, but I would say first, take a look at the asset allocation, make sure your goals haven't changed, and that your risk tolerance, your time horizon, all those remain intact. If so, then your asset allocation should be okay. Key there is, we know, is that it will help you if things get a little rocky in either the economy or the markets or things like that. And then from there, look at things like insurance. Are you adequately covered? Do you have the right beneficiaries? Do you have… look at the portfolio. Do you have a lot of overlap, for instance, or money at different institutions? You may benefit by consolidating to make the [indiscernible] trivia a little bit easier. So, those are types of things that aren't necessarily fun, but they're necessary. And then sometimes when you go through them, you feel better because, we're good. Or you might find you want to make a few changes here or there.

Benz: And you're probably, if you're looking at some of these other tax issues, you're touching some of that data already. So you might…

Bruno: You are, yes.

Benz: …do it while you are in there.

Bruno: And you know, some of these can get a little tricky. So, maybe you want to talk to an accountant or an advisor who can help number crunch some of these things with you. The key is to do that, you know now not necessarily on 12/31, because your options may be a little bit more limited, but certainly use the fall season to take a look at these options and then make the right decisions and then implement them before the end of the year.

Benz: Maria, always love to get your perspective. Thank you so much for being here.

Bruno: Thank you.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.

Note: A previous version of this transcript noted an incorrect amount of income that can be offset. The amount is $3,000.