By Karen Hube
Feb. 13, 2023
The 2023 tax year has only just begun, and the tax-filing deadline for 2023 taxes is more than a year away. But if you get a jump on planning, you can lock in big tax savings.
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With stock prices still way off their highs and the Internal Revenue Service’s recent inflation adjustments to 2023 tax thresholds, early-year tax moves could reduce your taxable income, enhance tax-deferred savings, and pass more to your beneficiaries free of taxes.
The latest tax law from Congress further enhances early-year tax moves. If you are thinking about funding a 529 plan this year, do it now to start the clock running on a new maneuver that could fund a tax-free account in the future for your children.
“Making a number of smart moves early can have a significant cumulative effect,” says Pam Lucina, chief fiduciary officer at Northern Trust Wealth Management. She ran an analysis of the benefits of early-year versus year-end gifting to family members to help motivate taxpayers prone to procrastination.
Consider the annual gift-tax exclusion, which allows each taxpayer to give $17,000 per recipient this year without triggering taxes. If the gifts are consistently made at the beginning of a year, they amount to significantly more over the long term thanks to longer compounding of returns, Lucina notes.
“Most people wait to make these gifts just before the end of the year, but our analysis shows that the beginning of the year is better because you get the appreciation out of your estate earlier, and the recipients get the benefit of the appreciation earlier,” Lucina says.
Assume a $34,000 gift by a couple each year to a child for 10 years, and a 5% pretax average annual return. By gifting at the beginning of the year, the child would have $448,031, or $21,000 more than gifting at year end for a decade, Lucina says.
The following other early-year moves can also lead to better tax outcomes:
Top Off Retirement Accounts
With stock values still more than 10% off their early 2022 highs, consider accelerating retirement plan contributions this year to snap up stocks at potentially bargain prices.
“Those who can afford to should consider front-loading annual contributions to take advantage of the suppressed prices,” says Brooke May, an advisor and co-founder of Evans May Wealth. “Most 401(k)s allow for you to change your withholding percentage at any time.”
Maximum contributions to defined-contribution plans like 401(k)s and 403(b)s were boosted by almost 10%, to $22,500 from $20,500, for 2023, the biggest inflation adjustment in 20 years. Folks aged 50 and older can contribute $30,000 this year, after the catch-up contribution was boosted to $7,500 from $6,500 last year.
This year’s individual retirement account contribution limit has been bumped to $6,500 from $6,000. Investors 50 and older can sock away an extra $1,000.
Finesse Your Tax Bracket
Estimate your taxable income for 2023 as early as possible to understand how close you are to tax bracket thresholds. With the luxury of almost a full year of planning, you may be able to shave back taxable income to land in a lower tax bracket, Lucina says.
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“You can try to avoid taking money out of your retirement account, or gift income-producing assets. If you’re taking required RMDs, think about making a qualified charitable distribution from your IRA to avoid the tax on the RMDs,” she says.
IRS rules allow for a $100,000 contribution made directly from an IRA to a charity to count toward satisfying a required minimum distribution without being subject to taxes.
High inflation could help reduce your income taxes. Thanks to a 7% inflation adjustment to this year’s income tax bracket thresholds, taxpayers can keep more income taxed at a lower tax bracket. For single filers, the 37% bracket begins on income of more than $578,125 this year, up from $539,900. For couples filing jointly, the top bracket begins with income of $693,750 this year, up from $647,850. The 35% threshold is up to $231,250 from $215,950 for singles and to $462,500 from $431,900 for couples.
Harvest Losses
Sell losing investments to offset gains throughout the year as opportunities arise. If you wait until year end, you will likely miss dips and the market may be setting new highs.
“2020 is a great example of why not to wait until the end of the year,” says Jeremy Milleson, director of investment strategy at Parametric Portfolio Associates, which systematically harvests losses for clients. “In March, the market was 34% off of its February peak. Anyone who waited missed out. By the end of the year the S&P 500 was up by 18%.”
The year-round systematic approach can add an average 1% to 2% percentage points to after-tax returns each year, Milleson says. Realized capital losses can be used to offset taxable gains, and up to $3,000 of losses can offset taxable income each year. Excess losses can be rolled forward to offset gains in future years.
Be Strategic About Your RMD
Folks who don’t rely on their IRA’s required minimum distributions to live on often leave the mandatory withdrawals to year end. That can work out well when markets are rising, because assets are allowed to grow tax deferred for longer.
But the size of RMDs each year is based on account values at the end of the prior year. So in a year when the market tanks, early-year RMDs mean you will need to sell fewer shares to satisfy them. After last year’s slide in stock and bond prices, year-end RMDs were inflated relative to battered portfolio values, and they took an extra bite out of retirement savings.
This year, be strategic about when you want to take your RMD, says Barbara Selig, a wealth management advisor at TIAA. If you believe the market will be up by year end, you may want to wait. If you are worried markets will slump further, take the RMD early. Or, to hedge your bets, you can take it in chunks through the year, Selig says.
Keep in mind the Secure Act 2.0, passed in December, raised the age when RMDs kick in to 73 from 72, effective this year. So if you don’t need the money, you have an extra year for it to grow tax-deferred.
Convert Your IRA Assets to a Roth
For folks whose incomes are too high to qualify to contribute to a Roth IRA—the cutoff is $153,000 for singles and $228,000 for couples—converting regular IRA assets to a Roth is a way to fund these tax-free accounts. You will owe income taxes on the converted amount, but with market values low and time to plan, this may be an ideal time for a 2023 conversion, says Steve Baxley, head of tax and financial planning at Bessemer Trust.
“When stock values are down as they are now, that makes a great opportunity to convert,” he says. “If you can reduce the tax cost of a rollover by combining it with a charitable gift so the deduction can offset the taxable income, that’s a slam dunk.”
Establish and Fund a 529 Plan
Parents of young children have more reason to set up a 529 plan as soon as possible under changed rules passed by the Secure Act 2.0 late last year.
These plans allow money to be withdrawn tax-free for education costs, but taxes and a penalty apply when money is used for other purposes.
The legislation creates another option for money leftover in 529 plans: Up to $35,000 can be rolled to a tax-free Roth IRA in a beneficiaries’ name. But to do so, the plan must have been established at least 15 years ago.
Start that 15-year clock as soon as possible, May says, “even if it’s with a modest contribution.”
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