Year-end is a time when many people review their financial situation. As you look at your finances this year-end, here are five financial planning issues to consider.
Portfolio review and rebalancing
It’s a good idea to review your investment portfolio at the end of every year, but especially this year thanks to the volatility in the stock market. Is the asset allocation of your portfolio still in line with your risk tolerance and your financial goals?
Rebalancing and making adjustments to your portfolio as we move forward into 2023 and beyond can help ensure that your portfolio is aligned with your overall financial plan. Generally year-end adjustments won’t entail a major overhaul of your portfolio, but rather some minor adjustments as warranted. Rebalancing your asset allocation back to its target percentages by asset class is perhaps the most important part of this review process for investors.
This is not always an option for investors, but with the declines we’ve seen in the stock market in 2022 tax-loss harvesting might be a viable strategy as part of your year-end planning. Tax-loss harvesting involves selling stocks, bonds, mutual funds, ETFs or other securities at loss. That realized loss can be used to offset gains that may have been realized from the sale of other investments. Tax-loss harvesting should be incorporated into your portfolio rebalancing activities if possible.
There is an ordering or matching process to match long and short-term capital gains. Any excess losses can be used to offset up to $3,000 of other income. Any unused losses beyond that level can be carried forward to a subsequent tax year.
Besides capital gains realized from the sale of securities, mutual funds and ETFs can distribute capital gains to investors based on activity in the fund.
When using tax-loss harvesting it is important that investors don’t violate the wash sale rule. This rule says that the same or a similar investment cannot be purchased over a 61-day period surrounding the sale. If this rule is violated you will not be allowed to use the loss to offset capital gains or other income.
An example of similar security would be selling the Vanguard 500 Index fund for a loss and then buying Fidelity’s S&P 500 index fund. The wash sale rule extends to all accounts including retirement accounts like an IRA or 401(k).
Reviewing your 2022 tax status before year-end is critical. What does your 2022 tax liability look like at this point? If it looks like you will owe more in taxes than you’d like, this is the time to make some moves to reduce your tax liability for the year.
Contribute to a retirement plan. This could mean adding to your contributions to your 401(k) or other retirement plan, contributing to an IRA on a pretax basis if eligible, or funding a self-employed retirement plan if you work for yourself or have a side gig.
Make charitable contributions. If you can itemize deductions, these contributions could serve to reduce your income for the year. Making the contributions with appreciated securities can also serve to eliminate capital-gains taxes that would be due if those securities were sold.
Are there deductible expenses that can be accelerated into 2022? An example might be medical expenses that would put you over the threshold for deductibility in 2022. This threshold is that the medical expenses must exceed 7.5% of your adjusted gross income (AGI).
Along these lines you might consider bunching several years’ worth of charitable contributions into 2022 in order to be able to itemize them. This can be especially beneficial if your income is going to be higher than normal in 2022.
Required minimum distributions (RMDs)
For those who must take RMDs from their retirement accounts such as an IRA or 401(k), these distributions must be taken by Dec. 31. The exception is a first-year RMD which can be deferred until April 1, 2023. This will mean that you will need to take two RMDs in 2023.
Failure to take all or part of the RMD by the deadline will result in a penalty of 50% of the amount not taken so it is important to be sure that you take your full RMD by the end of the year. If you need to raise cash in your retirement account to make the distribution be sure to make plans as to how you will do this to allow yourself enough time to complete your RMD.
Check beneficiary designations
It’s important to be sure that your beneficiary designations reflect your desires and your current family situation. These should be checked periodically to ensure that they are correct and year-end is an excellent time to do this.
Retirement accounts such as IRAs, 401(k)s, 403(b)s and other pass to beneficiaries based on the beneficiary designation. The same is true with annuities and with the death benefit on a life insurance policy. It doesn’t matter what your will might say, for these types of assets the beneficiary designation governs the distribution of the death benefit or account balance upon your death.
Life changes can necessitate a change in your primary and/or secondary beneficiary designations. These can include getting married, getting divorced or the death of a spouse. Other situations that could call for a change might include the birth or adoption of a child. Even if nothing has changed, it is a good idea to check these beneficiary designations annually to ensure they are in line with your desires and your estate plan.
These are certainly not the only components of financial planning that you might need to consider at year-end. Others might include updating your financial plan, a full review of your investment strategy, deciding whether a Roth conversion makes sense for you and updating your estate plan.
Whatever financial planning issues are important for you, year-end is a good time to ensure that your financial house is in order.