Answers to some pressing end-of-year tax questions

If you’re self-employed or have other income without any tax withholding and you make quarterly estimated tax payments, then you already know that Jan. 16 marks the deadline for your final 2023 payment. But according to a survey from online tax preparation company TaxSlayer, 57% of Americans are not confident about their understanding of the tax code and ways their investment portfolio affects their tax burden. We at Metric Financial in Simsbury, Connecticut, are trying to reduce that number to 0% during this tax season by educating consumers about tax laws and legislation that influence investments so that everyone can mitigate tax liability while increasing wealth. 

A big mistake that people make during tax season is not consulting a financial adviser about their monetary position and overall investment strategy before they meet with their accountant. Nine times out of 10, there are financial ways to offset your income and select investments that offer the maximum tax savings before an accountant files your tax return with the Internal Revenue Service (IRS). 

Ideally, your financial adviser and accountant should be working closely all year round but especially during tax time for the mutual client’s ultimate fiscal benefit. However, that client must also do due diligence and that means some taxation literacy. Here are some common questions and their perhaps uncommon answers: 

What tax bracket am I in?    

“There are seven distinct tax brackets that an individual may fall under based on income. However, a big misconception is thinking you are taxed only in one percentage bracket. In reality, the IRS tax code is tiered, so a person might be taxed at 12% for a portion of the income up to a certain dollar amount, as well as simultaneously taxed at 22 % on a greater amount of income.  A financial adviser and accountant can help determine a person’s marginal tax rate, which offers a more accurate depiction of overall tax liability. 

Why am I paying capital gains taxes on mutual funds if I didn’t sell anything?  

“Every year, investors with mutual funds in non-retirement accounts receive a 1099 with capital gains that they have to pay taxes on even if they didn’t sell anything. Exchange Traded Funds (ETFs), which also have lower costs and are just as diversified, tend not to distribute the same capital gains, offering people savings. It is always a good time to look at your exposure to capital gains. Likewise, there are ways to offset capital gains in a down market. Your adviser should always take advantage of those environments.  Even if you don’t have gains to offset, you can reduce your income tax burden by taking up to $3,000 in losses against income. That carries forward, so if a person has $6,000 in losses in 2023, he or she can take $3,000 against income this year and $3,000 again in 2024.” 

Do I need to take a mandatory IRA distribution this year? 

“The recent Secure Act 2.0 changed the Required Minimum Distribution (RMD) age to 73 and in 2033, the age will increase to 75. This does not change your RMD for an inherited IRA, which does not need an annual distribution, but the account needs to be empty by year 10 after inheriting. We generally recommend an annual distribution to spread out the taxes.” 

Should I open a 529 plan for my child’s future college education?  

“Many parents worry about saving in a 529 plan because of the penalties if the money is not withdrawn for educational expenses specifically. The Secure Act 2.0 changed that, too. Starting in 2024, there are provisions for moving unused 529 balances to a Roth IRA. There are nuances to this, so consult a financial adviser or accountant.” 

Should I max out my pretax retirement plan contributions? 

“It depends. Remember to think about what it will look like when you take withdrawals in retirement. Anything coming out of retirement accounts will be taxable as income. On the other hand, anything you take out of a traditional brokerage account will only incur capital gains. Long-term capital gains generally are taxed at a lower rate than income, so it’s a good idea to spread your investments around.” 

 I own my own business, so I don’t have a 401(k). How do I save for retirement?  

“Many business owners use a Simplified Employee Pension, or SEP, IRA. This allows you to invest funds for retirement, and contributions are tax-deductible. There is a specific formula for what the IRS will allow you to contribute, so be sure to consult with a tax accountant. If you have employees, a SIMPLE IRA or SIMPLE 401(k) might be better. A financial adviser can help you determine what fits best.” 

Can I make a contribution to a Roth IRA? 

 “If you are married and filing jointly, the rule in 2023 is that your eligibility begins to phase out when you and your spouse make more than $218,000. If you are single, it begins to phase out at $153,000. Be careful if you are married and filing separately, because you cannot contribute to a Roth IRA if you make more than $10,000.” 

My company offers both a Roth and a traditional version of a retirement plan. Which should I contribute to?  

“Again, it’s important to think about what things will look like in retirement when you withdraw money. A Roth is after-tax now and tax-free at withdrawal. A traditional retirement plan is pretax now and taxable at withdrawal.  People need to ask when they will be in a higher tax bracket – now or in retirement.” 

I need money to repair my home. Can I borrow against the value of my IRA?  

“No, a person can only borrow against an employer retirement plan. Once a year, an employee can withdraw money from his or her IRA. However, that needs to be replaced in the IRA within 60 days. If it is not returned in 60 days, it will become taxable income and, if you are under 59 ½, you will pay a 10% penalty on top of the taxes.” 

Americans work hard for their money and the job of any good financial adviser and accountant is to help preserve and grow it. Our main mission at Metric Financial is to educate people on the tax ramifications and, more important, the costs of each investment option, so that they can keep more of their returns, reduce payouts and improve their financial picture over time. 

 Chartered Financial Analyst Timothy Baker is the principal owner of Metric Financial, a Connecticut-based investment management and financial planning firm that offers educational sessions and public seminars on creating and preserving wealth for retirement. For more, visit metricfin.com.