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What You Can Learn From Your Tax Return

Scrutinizing your tax documents can help you improve your financial and investment plan, says Maria Bruno, Vanguard’s head of U.S. wealth planning research.

What You Can Learn From Your Tax Return

Key Takeaways

  • Tax returns can offer insights into how investors are managing their investments, especially their nonretirement accounts and taxable accounts.
  • What are some specific things that people who are in retirement should be thinking about as they prepare their taxes?

Christine Benz: Hi, I’m Christine Benz from Morningstar. Tax season can be a grind, but our guest today thinks that you can gain valuable insights by paying attention to those tax forms. Maria Bruno is Vanguard’s head of U.S. wealth planning research, and she’s here to discuss that topic today.

Maria, great to see you.

Maria Bruno: Likewise, Christine. Thank you.

Benz: Thanks for being here. If people are working through their tax returns, you say that that 1040 form can actually be a source of information, a source of intelligence for improving your financial life. Can you talk about some of the high points that I want to be focusing on if I’ve done my own taxes or maybe I’ve outsourced them to a tax preparer?

Bruno: Good thing. The first thing is not to put it into a drawer and put it away. Take that tax return out and use it as a GPS for the current year. That’s what I’d like to say. The first thing would be, has anything changed, was anything different for last year or anything changed this year? Maybe if you’re going to have a baby this year, for instance, or maybe you had a bonus last year that you may not this year or your job might change. Look and see if there’s anything that might be changing. And then, also think about, well, what does that income picture look like and what do the deductions look like for this year. So, use that as a starting point to understand going into this current year what opportunities might present themselves. And I think we’ll talk a little bit more about some of those opportunities.

Lowering 2022 Taxes

Benz: I think people might be working through their taxes here in early 2023 and there might be a tendency to say, well, there’s really nothing I can do. My tax bill is what it is. It’s already cooked. What can people think about if they potentially want to try to lower the taxes that they owe for 2022?

Bruno: Well, at this point, the options are limited. But you don’t want to discount some of these contribution options that might still be open. If you have earned income, definitely look to consider making an IRA contribution for last year. April 18 is the tax filing deadline. So, you have until April 18 to make that contribution. So, I would encourage everyone to make that contribution. Also, if you have a health savings account, the deadline is the tax filing deadline as well. So, you still may be able to make a contribution to a health savings account. And lastly, if you want to make a contribution to a 529, by and large, most of the contribution deadlines for state tax deductibility is 2022, but there are a handful of states that extend that to April 18. You might just want to double check that if you’ve made or want to make a 529 contribution for the prior year.

Benz: Good advice. You think that working through our taxes can also be a lens to help us figure out where to make future contributions. So, if I’m making contributions to some type of account in 2023, my last year’s tax return can potentially help guide the way. Can you talk about that?

Bruno: Sure. Absolutely. Early in the year, you want to think about wherever possible, making those contributions early. So, if you’re going to make an IRA contribution, do it now if you can. If you’re getting a tax return, take that money and invest it into an IRA. Start that tax-free compounding growth early. Also look for other things. If you are making contributions to some of these tax-advantaged accounts, make them early to the extent that you can.

Gaining Insights Through Tax Returns

Benz: You also note that our tax returns can help us get some insights into how we are managing our investments, especially our nonretirement accounts, our taxable accounts. Can you talk about that?

Bruno: Absolutely. You want to take a look at what type of income has been generated by your taxable accounts. So, for instance, are you invested as tax efficiently as possible? For your stock holdings, for instance, might you be in actively managed funds that may be incurring high amount of turnover resulting in capital gains, for instance, these things that will cause taxation in the current year, whether it’s short-term capital gains or ordinary income taxation. You want to try and minimize those as much as possible. So, tax-efficient index funds or ETFs, for instance, might be a more prudent option. Also, if you’re in a high tax bracket and you’re holding bonds, think about whether or not municipal-bond funds or ETFs might be appropriate. These are funds that generate income, obviously, that are not taxable at the federal and potentially state level depending upon what you’re investing in. So, those are probably the two big things that I would suggest looking at for taxable holdings.

Benz: And certainly, yields are higher, so asset location matters more now than perhaps it did a couple of years ago. I wanted to ask about tax-loss selling. I think many of us consider this as a year-end type of activity, something we would have had to have done in late 2022. Can you talk about that, how potentially it’s not too late to consider doing some tax-loss selling to take advantage of the downturn that we’ve seen in equities?

Bruno: Yeah. Tax-loss harvesting is actually more of an evergreen planning topic. I mean, certainly, a couple of the obvious ones might be, hey, if there’s market volatility and you might have assets that may be depressed, and you might go in and take a look at your holdings and see what you might be holding at a loss and harvest some of those losses. That’s what we call the silver lining of market volatility. And the other one is at the end of the year when you have a pretty good tax picture. But think about activities that you may be doing in your portfolio, whether it’s rebalancing or if you have some realized gains set aside already accrued, look to see if you’re holding assets at a loss and harvest those losses. Certainly, be mindful when you’re transacting on the tax-loss harvesting to make sure that you’re not tripping the wash sale rules. But certainly, if you’re holding assets at a loss, it may be an opportunity to tax-loss harvest. Maybe use it as an activity much like rebalancing. We talked about going in and making sure that your asset allocation is prudent. Also take a look at your tax loss and see what you might be sitting on and if there’s an opportunity to build some tax efficiency.

What to Watch Out for When Reviewing Taxes

Benz: And I mentioned stocks were down last year, so were bonds. So, people may be able to do some tax-loss selling in bonds. I wanted to home in on the subset of people who are in retirement. What should they be looking for as they review their tax returns? Of course, a lot of the considerations we’ve already talked about would apply to them as well. But are there any specific things that people who are in retirement should be thinking about as they prepare their taxes?

Bruno: This is a good one and could provide some financial planning opportunities, particularly for those who have not started their required minimum distributions. Now they’re beginning at age 73. There’s a pretty good window there leading up to RMDs to plan for RMDs and managing that tax liability. Now, this may mean accelerating taxes, which may not be intuitive for many investors. But for many investors that have large tax-deferred balances, they’re sitting on these accounts that once RMDs start could trigger this tax torpedo, large taxation. So, the goal would be look for those years leading up to RMDs and see whether or not you can accelerate income taxed at a presumably lower relative rate.

There’s a couple of ways you could do this. One would be to spend from tax-deferred accounts, or it could be Roth conversions, doing a series of partial conversions to create that tax diversification. You do want to be mindful for a couple of things. One is, you want to take a look at Social Security. And if you are collecting Social Security, you want to be mindful of whether this additional income might cause Social Security to be taxable or taxed at a higher rate. And then, Medicare Part B premiums that are based upon income thresholds, you want to be mindful as well. But also take a look at where you are in your tax bracket and whether or not you might have low bracket dollars to use up, filling up that tax shelf space by accelerating income and smoothing out that tax liability. What that does is it lowers the traditional IRA balances and then the potential distributions that come with RMDs down the road.

Benz: Maria, great insights for tax time. It’s always great to see you. Thank you so much for being here.

Bruno: Thank you. Thanks, Christine.

Benz: Thanks so much for watching. I’m Christine Benz from Morningstar.

Watch “Should You Invest in Stocks, Bonds, or a 4% CD?” for more from Christine Benz.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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