It's said the only constant is change, but there's also that saying about death and taxes.
At this point in my life, I’m no stranger to change—or taxes. (Thankfully, I’ve yet to cross paths with death and hope to avoid doing so for as long as possible!) Change can and does touch every part of your life, including your finances. And because finances and taxes are often inseparable, you can bet a change will come with a tax consequence or two as well.
Every change presents new opportunities. While it’s difficult to predict just what changes you’ll encounter in life, it doesn’t mean you can’t be aware of which opportunities they’ll present and how to take advantage of them when they do occur.
Let’s break life into three parts and look at some tax considerations you’ll find in each of them.
During these years, you're finding your footing. You're establishing your career. You're building your net worth. You’re starting and growing a family.
You should typically contribute to a Roth IRA or 401(k) rather than a Traditional IRA or 401(k) in years in which you expect your future marginal tax rates to be higher than your current rates. The dollars you contribute will be taxable now at the lower rates, and, in the future, eligible distributions will be tax-free when you’re presumably in a higher tax bracket. If your income is already quite high and you expect your future marginal tax rates to be lower than your current rates, it's usually better to contribute to a Traditional IRA or 401(k). The dollars you contribute will be deductible now at the higher rates, and, in the future, eligible distributions will be taxed when you are presumably in a lower tax bracket.
If you have a high-deductible health insurance plan (HDHP), chances are you can make contributions to a Health Savings Account (HSA). Your contributions are tax-deductible in the year in which you make them, and any growth is tax-free. Withdrawals are also tax-free if used for qualified medical expenses.
A 529, receiving its name from Section 529 of the federal tax code, is an account specifically for saving for and funding education expenses, normally higher education expenses. In certain states with income taxes, contributions are tax-deductible. Similar to HSAs, any growth is tax-free, and withdrawals are, too, if used for qualified education expenses.
If you've lived in your home for two of the last five years and are selling it, a portion of the capital gain resulting from the sale of your home is excluded from taxation. Your capital gain is determined by subtracting the tax basis of your home from its sale price. Sometimes, the tax basis is simply equal to your original purchase price. However, you can increase the tax basis by adding to it the cost of any work done that improved the value of your home, extended its useful life, or adapted it to new uses. By doing this, you reduce your capital gain. Just be sure to maintain detailed records of this work.
During these years, you're doing your best to juggle the responsibilities of your personal life with those of your professional life. Your children are older but so are your parents, and that has come with challenges. You've risen through the ranks in your professional life and your income has risen, too, increasing the amount of taxes you owe while limiting your options to reduce your tax obligation.
Benefits such as stock options can be difficult to understand, even at a fundamental level. Adding to their complexity, different types of stock options receive different tax treatments. In some cases, exercising stock options (i.e., purchasing the stock granted to you) can trigger the alternative minimum tax (AMT), an entirely different way of calculating your taxable income using rates less favorable than ordinary income tax rates. Familiarizing yourself with key information about your options, like the grant date, strike price, and vesting schedule, and creating a timeline for exercising and liquidating the options can save you thousands of dollars in taxes.
If your income precludes you from contributing directly to a Roth IRA, it could still be possible for you to contribute to one by making a "backdoor" contribution. This is done by making a non-deductible contribution to Traditional IRA, then converting, or transferring, the contribution into a Roth IRA. Although this might sound simple, there are some caveats, especially if you have an existing Traditional IRA that holds tax-deductible contributions made in previous years.
In a situation like this, taxes probably aren’t front of mind, which is understandable. However, it can make it possible for you to help them, and possibly your future self, mitigate taxes. For example, your parents can deduct qualified unreimbursed medical expenses, including transportation to healthcare appointments, modifications to a home or car for medical reasons, LTC insurance premiums (subject to limits based on age), privately hired in-home healthcare employees, and more, that exceed 7.5% of their adjusted gross income. Additionally, if your parents have a capital loss carryforward, they could sell an asset they no longer need or use at a gain and offset that gain using the carryforward loss (which will expire, if unused, after the death of the parent holding the loss).
Some forms of inheritance are taxable. When receiving an inheritance that’s taxable or will have future tax consequences, such as inherited traditional IRA RMDs, bonuses, severance pay, or certain types of settlements, it's prudent to reserve adequate cash to pay any resulting income tax obligations or make estimated payments as necessary if taxes aren't already being withheld. If the inheritance will also increase your taxable income, keep in mind the income thresholds associated with tax deductions and credits that normally apply to you.
During these years, you're reaping what you sowed. You're no longer working, and you’re spending time the way you want to spend it. You're supporting the people and causes you care about the most.
Depending on certain factors, like your retirement age and your sources of retirement income, there could be one or more years in which you expect to be subject to lower income tax rates compared to your other years. It's in those years that a Roth conversion, the act of transferring and paying the tax on assets from a qualified retirement account (e.g., Traditional IRAs, 401[k]s) to a Roth IRA, could be advantageous. Roth conversions can lower your future required minimum distributions (RMDs), thus reducing your future taxable income. Converted assets are able to grow tax-free as well.
This year, you're able to gift $17,000 to another individual without any tax consequences. If you want to gift someone more than that, the amount above $17,000 is applied to your lifetime gift and estate tax exemption, which, based on current tax laws, is $12,920,000. Note that there's no annual or lifetime limits on gifting between spouses though. If you want to learn more, we recently wrote a blog post about gifting rules and strategies.
With the passage of the SECURE 2.0 Act of 2022, the age at which individuals must begin taking required minimum distributions (RMDs) from their qualified retirement accounts (e.g., Traditional IRAs, 401[k]s) was changed from 72 to 73. If you have other substantial sources of retirement income, you might not actually need your RMD to fund your expenses each year, but, nevertheless, you have to take it, which results in "unnecessary" taxable distributions from your accounts. However, if you request that your RMD be made payable to a qualified charity, the amount of the distribution (up to $100,000 for those filing as single and $200,000 for those married filing jointly) is excluded in the calculation of your taxable income for that year. This is called a Qualified Charitable Distribution (QCD).
There are no monthly premiums for Medicare Part A, but there are monthly premiums for Medicare Parts B and D. Your monthly premium for the current year is determined by what your modified adjusted gross income (AGI) was two years ago, meaning your premiums in 2023 were determined using your MAGI in 2021. Currently, the base monthly premium for Medicare Part B is $230.80 and $12.20 (plus any premium for your prescription drug plan, if applicable) for Medicare Part D. Depending on your MAGI, they can be as high as $560.50 and $76.40 (plus any premium for a prescription drug plan, if applicable) though. These higher premiums are referred to as income-related monthly adjustment amounts (IRMAA). Knowing this, it's important to monitor your taxable income and plan accordingly if you regularly have significant retirement income or are anticipating a taxable windfall.
Changes, particularly those in your financial life, can be intimidating because they come with unknowns, but with enough knowledge and preparation you can put yourself in a position to navigate those unknowns with confidence. This confidence, and the informed decisions that stem from it, are just a few of the many benefits of working with an advisor to craft a comprehensive financial plan tailored to you, one that also includes detailed, proactive tax planning.
If you’re experiencing a change or just want to be ready when the next one comes your way, talk to your financial advisor to determine the best course of action, or learn how our financial planning process can help you.