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Getting ready to file? Here are some considerations for tax efficiency

We’re in the middle of tax season, which means that Americans across the country are getting ready for the April 18th filing deadline. Whether or not you have an accountant prepare your return, you may be questioning how to reduce your tax burden for 2023 and beyond.

Here are some ways to be tax aware, no matter where you are on life’s journey.

You are busy accumulating wealth

During your peak earning years, when you are saving for retirement and other financial goals, reducing your taxable income may help you benefit from the power of compounding and increase your savings potential. Some strategies include:

 – Deferring: Leverage IRS-qualified tax-deferred savings vehicles, such 401(k)s, traditional IRAs, and Health Savings Accounts. (Keep in mind that there are penalties for withdrawing the funds too soon or using them for non-qualified expenses, and that these assets should be invested according to your timeline and goals.)

 – Deducting: Choose whichever is greater, the standard deduction (which is $27,700 for a married couple filing jointly and $13,850 for single filers for tax year 2023) or your qualified deductible expenses (such as charitable contributions, qualified medical expenses, mortgage and home loan interest, state, and local taxes). If it’s more favorable for you to itemize your deductible expenses, remember to save your receipts!

 – Investing: Interest earned from tax-advantaged bonds, such as municipal bonds (which are effectively loans you make to a state and/or local government) are exempt from federal and potentially state and local taxes. Your financial advisor can help determine if this asset class is appropriate for your portfolio.

 – Harvesting. Your advisor can also help you potentially reduce investment gains through tax loss harvesting, offsetting investment gains with assets that have fallen in value. If your capital losses exceed your gains, you can reduce your income to the lesser of $3,000 or your net loss. If your losses exceed $3,000, you may be able to carry over the excess against future gains.

 – Timing. Profit-yielding investments owned for one year or less are short-term capital gains, which are taxed at your income tax rate; those owned for more than a year are taxed as long-term capital gains. For high earners, the long-term capital gains rate is around 15% or 20%, whereas your income tax could be as high as 37%.

You are drawing down funds in retirement

When you no longer earn a paycheck, you need to draw income from the funds you have saved. A tax-efficient withdrawal strategy can help you make the most of your accumulated assets, because the order of withdrawals can make a difference. In general, the following sequence is most effective in optimizing the growth of your assets while minimizing taxes.

 –  Taxable brokerage accounts. It is generally advisable to draw from the least tax-efficient accounts first. Doing this allows tax-advantaged accounts, such as IRAs and Roth IRAs, more time to grow and compound.

 –  Traditional IRAs and 401(k)s. From a tax perspective, it doesn’t matter which of these you draw from first, and both require account holders to take minimum distributions. Although you were previously required to begin taking RMDs beginning at age 70 ½, as a result of the Secure Act 2.0 those born between 1951 – 1959 need to begin taking them at age 73 and if you were born after 1960, you need to begin taking RMDs at age 75. If most of your assets are in tax-deferred accounts, you may also want to convert your IRA to a Roth IRA. By converting, you’ll have assets that will not be taxed when withdrawn allowing you to better manage your tax brackets during retirement. However, please keep in mind that conversion amounts are taxable. If you convert too much in one year, it could bump you into a higher tax bracket, so you need to have a conversion strategy in place.

 –  Roth IRAs. The Roth IRA should remain untouched for as long as possible, and you are never required to take minimum distributions.

Of course, your withdrawal strategy will depend on your unique circumstances, and your financial planner or tax accountant can help you determine the withdrawal sequence that is best for you.

You are planning to leave a legacy

If you’d like to leave your money to loved ones and/or charitable causes important to you, there are several tax considerations to keep in mind, including:

 –  Give a gift. You’re allowed to give your children, grandchildren, or other individuals a gift each year, up to the annual gift exclusion maximum, without having to pay the federal gift tax which is $17,000 (or $34,000 for a married couple) for 2023. The lifetime gift tax exclusion is $12.92 million in 2023, but is set to revert back to its pre-2018 amount of $5 million, adjusted for inflation.

 –   Make a donation. There are a variety of ways to give to charities tax efficiently, including donating appreciated stock or other assets, making a Qualified Charitable Distribution (QCD), creating a Donor Advised Fund (DAF), Charitable Remainder Annuity Trust (CRAT) or its inverse, a Charitable Lead Annuity Trust (CLAT). These are more complex estate planning tools that a financial planner can help you evaluate and determine the solutions that are best for you.

Everyone’s tax situation and financial goals are different. Your Mason Financial Planner takes the time to get to know you to create a tailored strategy that may assist you in making the most of your assets.

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