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In this particular distribution, I’m going to focus primarily on financial planning updates/reminders as you file your 2023 returns and get your 2024 planning fully in order, but I’ll be putting out another one focused around economic & market outlook for 2024 (and review of Q4 2023) in two weeks on 2/16.
Over the past couple of years, I have started noticing a disappointing decline in the proactivity and attentiveness to detail of many of the tax preparers with whom our clients work. Especially clients who primarily earn income on W2’s, but have high incomes and still a fair amount ‘going on’ when it comes to their situations and tax filing requirements. In summary, there is a growing CPA labor shortage which I think can at least be partially explained by this article ‘Tax prep fees are rising because accounting is not a ‘cool’ career’ With fewer CPAs, fees are increasing and they’re still spread thin, with many turning to outsourcing more of the basic tasks related to their work (i.e. data entry), and often focusing more of their attention on more complex clients (i.e. business owners) who pay higher fees. So, I’ve just become mildly concerned that, especially for our high-earning, primarily W-2 clients, there isn’t enough proper communication and probing to determine that the tax filing is truly complete and optimizing deductions. That said, we just plan on being a little more proactive with tax-related reminders going forward, to help you avoid issues.
To start us off, I’m going to re-share some useful guides:
What Documents Do I Need To Collect For Filing My 2023 Tax Return?**
2024- What Issues Should I Consider At The Start of the Year?
Important Numbers 2024 (Updated figures on qualified retirement account limits, tax brackets, RMDs, etc.
Important Dates 2024
AGI/MAGI Summary Guide (Table to help you determine your AGI/MAGI for the year)
What Issues Should I Consider As A Business Owner or 1099 Worker?
What Issues Should I Consider Regarding My Restricted Stock Units?
What Issues Should I Consider Regarding My Incentive Stock Options?
What Issues Should I Consider Regarding My Non-Qualified Stock Options?
**Fidelity 2023 tax forms if not already available, should be available by 2/15/24 latest. To obtain online:
- Go to Fidelity dashboard/homepage
- Under ‘All Accounts’ heading @ top/center of page, select ‘Documents’
- On top left side of next page, under ‘Statements’ select ‘Tax Forms’
- Primary form you’ll be looking for is ‘Consolidated Form 1099’
Important Tax Filing Headlines
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If you made a Qualified Charitable Distribution (QCD) from your IRA in 2023, be mindful that these donations should not be reported on Form(s) 1099-R, as they came directly from the IRA and are excluded from taxable income.
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If you have a Solo 401k and the balance was more than $250,000 as of 12/31/2023, you are required to file Form 5500-EZ by 7/31/2024. If we manage this Solo 401k for you, we will be in touch well in advance of that deadline to ensure this filing happens.
- If you made a gift in excess of the annual gift exclusion amount ($17,000 in 2023), this needs to be recorded on your 2023 tax return.
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More on this below, but if you utilized the back door Roth IRA strategy in 2023, you should make this very clear to your tax preparer, and carefully complete IRS Form 8606
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If you made a gift to a Donor Advised Fund (DAF), the charitable contribution/deduction is reported in the tax return (1040) on Schedule A
- If you paid interest to borrow against the value of your non-qualified/brokerage/trust account (typically referred to as a ‘margin loan’), you can deduct the interest from your taxes by itemizing your deductions and subtracting margin interest costs from your net investment income. Tax law limits how you can apply margin interest deductions. Specifically, you can never deduct more than your investments earn in any given tax year. However, any margin interest you don’t deduct from taxes can apply to future years. Be sure to make it clear to your tax preparer that you paid margin interest in 2023.
- Investopedia: The Most Overlooked Tax Deductions
And one more thing to add under this heading—if you’ve experienced significant tax liabilities in the past, and feel that you’re already maximizing your tax withholdings (e.g. high earning spouses should typically elect Single-0 on the W4), you may want to consider making estimated tax payments to avoid penalties & interest. This guide might help: Do I Need To Start Making Estimated Federal Income Tax Payments?
Retirement Account Contributions
As a reminder, if you’re still working and funding 401k’s &/or 403b’s, the limit for 2024 has increased from $22,500 (2023) to $23,000 (2024). If you’re age 50+ (or turn 50 in 2024), you are eligible to do an additional ‘catch up’ contribution of $7,500. So, your new limit is $30,500 for 2024.
If you haven’t already, please check and adjust your payroll deductions for retirement contributions while it’s still early enough in the year.
Also, if you do any type of IRA (Traditional IRA, Roth IRA, Spousal IRA, SEP IRA) or Solo 401k funding, we until the moment until you file your 2023 taxes to finish making those contributions for 2023 (as long as the Solo 401k account was established by 12/31/2023).
If you have any non-W2 income from consulting, moonlighting, etc., you are likely eligible to make additional tax-deferred retirement contributions with some or all of the funds, so if you haven’t already discussed this with us and you’re interested in making a contribution to reduce your taxable income in 2023, please bring this income to our attention immediately!
Backdoor Roth
The backdoor Roth strategy can be valuable for those whose high income levels preclude them from making regular contributions to a Roth IRA. While income phaseouts apply to contributions made to a Roth IRA, there are no such limitations on contributions made to a traditional IRA, nor on conversions from a traditional IRA to a Roth IRA. Thus, the strategy itself consists of a 2-step process involving 1) a non-deductible, or after-tax contribution made to a traditional IRA, followed by 2) conversion into a Roth IRA.
While this process might seem relatively straightforward, there are many reporting requirements for non-deductible IRAs (through IRS form 8606) and numerous IRS rules around timing and accounting that can quickly turn this seemingly simple strategy into a literal lifetime of extra paperwork filing required of the taxpayer if completed incorrectly. For instance, if you have existing IRA dollars, backdoor Roth conversions can be complicated significantly. This is mainly because of the IRA Aggregation Rule, stipulating that when determining the tax consequences of an IRA distribution (which includes a conversion), the value of all IRA accounts will be aggregated together for the purpose of any tax calculations (turning a ‘clean’ backdoor Roth into a messy partial Roth conversion!)
To avoid this situation, we as your advisory team need to make sure we know about every IRA dollar (everywhere in all accounts), and we simply do not recommend this strategy if you have a Rollover IRA, a Traditional IRA, a SEP IRA, Spousal IRA, or SIMPLE IRA. So, if you haven’t heard us talking about a backdoor Roth for your situation, it’s likely because you have one of the aforementioned IRA accounts.
If you’ve implemented this strategy, you should be sure to communicate this to your tax preparer, as there are many reporting requirements for non-deductible IRAs (through IRS Form 8606). Each spouse should complete their own Form 8606 to be filed with their 1040 tax return. Parts 1 and 2 of the form need to be completed; the amount of the contribution will appear on multiple lines throughout the form but, will ultimately end with the full contribution and conversion being reported as non-taxable in Part 1 on line 13, and with line 18 in Part 2, which asks for the taxable amount, being blank.
When a backdoor Roth IRA is executed and reported correctly, there is no impact on taxable income. However, the conversion amounts will be reported as a ‘distribution’ on line 4a of Form 1040 (while being left out of line 4b because it’s a non-taxable conversion of after-tax dollars).
A step beyond the backdoor Roth IRA is the ‘Mega’ backdoor Roth, which is sometimes an option within your 401k or 403b. Employees who participate in 401k plans can put up to $23,000 in pretax or post-tax Roth contributions in 2024. But there’s another limit, $69,000, including employee and employer contributions, that may let you set aside even more. If the 401k or 403b plan allows for it, workers may add after-tax contributions beyond the $23,000 limit for 2024 up to $69,000. There will be other plan features we want to check thereafter before implementing the strategy, but the first thing you’ll look for in determining if this is available to you, is whether there are THREE (3) boxes for different contribution types, wherever you go to elect/adjust plan contributions (either 401k provider site, or HR portal). There would be THREE (3) boxes---one for ‘Pre-tax’ or ‘Traditional’ contributions, one for ‘Roth’ contributions, and a 3rd for ‘After-tax’ or ‘Post-tax’. If you’re interested in this, log in and check the contributions page and let us know if you see that 3rd option. If not, this strategy probably isn’t currently available within your 401k/403b plan.
Can I Make A Backdoor Roth IRA Contribution?
Can I Make A Mega Backdoor Roth Contribution?
This lesser-known 401k feature is a ‘no-brainer’ for big savers
Roth Conversions for Retirees
Roth conversions are, in essence, a way to pay income taxes on pre-tax retirement funds in exchange for future tax-free growth and withdrawals. The decision of whether or not to convert pre-tax assets to Roth is, on its surface, a simple one: If the assets in question would be taxed at a lower rate by converting them to Roth and paying tax on them today, versus waiting to pay the tax in the future when they are eventually withdrawn, then the Roth conversion makes sense. Conversely, if the opposite is true and the converted funds would be taxed at a lower rate upon withdrawal in the future, then it makes more sense not to convert.
Typically, this means that an individual will wait for lower-earning years to engage in (partial) Roth conversions. While these years could occur during one’s career (e.g. if they took a sabbatical or experienced a period of unemployment), they can also happen after they retire. For instance, an individual who retires at age 62 (and has sufficient cash/assets or income streams to support their spending) might have several years of very low taxable income (perhaps until they claim Social Security or have to take Required Minimum Distributions from their pre-tax retirement accounts). This could present a prime opportunity for (partial) Roth conversions that not only could provide them with more secure retirement (as converted funds can grow and be withdrawn tax-free), but also benefit their heirs as well (particularly if the tax rate paid on the conversion is less than the rate a beneficiary would pay on an inherited traditional IRA)! More on this here (note: written for financial advisor audience): Don’t Overlook Post-Retirement Roth Conversion Benefits
HSAs (& How to Use Them in Retirement)
HSAs offer a ‘Triple Tax Benefit’ that includes tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses. This can allow individuals to save a significant amount that can be withdrawn tax-free for medical expenses later in retirement.
Given these benefits, many individuals pay out-of-pocket medical expenses during their working years from their ongoing cash flow, allowing the full amount of their HSA to be invested and grow into the future. Which can lead to a larger HSA balance when the individual reaches retirement and their medical expenses are likely to increase.
Notably, qualified medical expenses for HSA distributions not only include ‘regular’ medical expenses (e.g. doctor’s visits or rx’s), but also for Medicare premiums, Part B and Part D deductibles, copays, and coinsurance, as well as a certain amount of long-term care insurance (once an individual reaches age 65 they can withdraw HSA funds for any purpose penalty-free, though they will owe ordinary income tax on the distribution).
Retirees have a few options to leverage the dollars in their HSA. The simplest strategy might be to pay for qualified medical expenses directly from the HSA (account holders typically receive a debit card that they can use to pay medical bills). However, an alternate approach is to pay for medical expenses from other income sources and then save the receipts from the medical expense, as individuals with HSAs can make tax-free distributions for qualified expenses at any time (i.e. not necessarily in the year the expense occurred) as long as the expense was incurred after the HSA was established.
Importantly, retirees will generally want to empty their HSA before death, as, like IRAs, they are a relatively tax-inefficient way to bequeath wealth (though surviving spouses can maintain the HSA status).
Ultimately, the key point is that HSAs represent one of the most tax-efficient savings vehicle available to investors and can be used for a variety of health-related expenses in retirement. And given the range of potential draw-down strategies, we can help you choose the optimal approach based on your unique situation!
How to use your HSA in retirement
529/College Planning Updates
A recent development with 529 plans is what is being referred to as the 'grandparent loophole'. Starting with the 2024-2025 college year, a grandparent's contribution is not reported as an asset on the FAFSA. So, if you’re intending to help fund grandkids’ education, and your children’s income might otherwise qualify for financial aid, you should consider gifting to a 529 for which you are the custodian, not your children.
Another recent development with 529s is you can convert a portion of any excess funding (if not used for college) to a Roth IRA for the grandchild. The rollover amount from a 529 plan into a Roth IRA account will still be subject to the Roth IRA annual contribution limits set by the IRS, which is $7,000 for 2024. Currently, there’s a $35,000 lifetime limit per beneficiary for 529 plan rollover contributions to Roth IRAs. This is so new that it’s still very unclear whether this limit will be increased over time (as are qualified retirement contribution limits).
Rollovers From a 529 Plan to a Roth IRA: What to Know
So, long story short, 529s have recently become a bit more attractive, particularly for grandparent gifts.
Well, that’s enough for now. Stay tuned for market outlook distribution.
Have a great weekend.
Charlie
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