It’s that time of year when you get to put a bow not just on gifts for loved ones but also your portfolio.
Here are some moves to consider making with your nest egg before the year ends.
Still working? Max out your 401(k)
If you’re still working, consider maximizing how much you’re contributing to your employer-sponsored retirement plan, said Patrick Kuster, a wealth adviser with Buckingham Strategic Wealth.
According to the IRS, employees can defer up to $19,500 in 2021 in their 401(k), 403(b), 457 and Thrift Savings plans, and those age 50 and older can contribute an additional $6,500 for a total of $26,000.
Check out a backdoor Roth conversion
For those with earned income above 2021 Roth contribution limits, Kuster said this may be the last year for “backdoor” Roth conversions due to proposals within the Build Back Better Act (BBB). “As such, the conversion of after-tax dollars may need to be completed by year-end,” he said. “For those evaluating this strategy, you may want to consider beginning the process sooner rather than later.”
A backdoor Roth IRA conversion is simply making a (typically nondeductible) IRA contribution, followed by a subsequent Roth conversion, according to Kitces.com.
IRA account owners — especially those in low-income tax years — might consider traditional partial or full Roth IRA conversions, Ashley Folkes, a senior financial adviser with Bridgeworth Wealth Management. Two reasons: As with backdoor Roth conversions, proposed tax law changes that could affect this opportunity in the future. Plus, you could leave a tax-free inheritance to your heirs, and it can create an account that can grow tax-free longer.
How’s your asset allocation?
December is also a good time to revisit your portfolio’s target asset allocation (now’s a good time to draft one if you don’t have an investment policy statement) and consider how best to bring that allocation back into balance.
There are several approaches. You could sell those assets that are say 5 percentage points above your target asset allocation and buy those assets that are 5 percentage points below your target asset allocation. You could change how your contribution is allocated.
Or, instead of reinvesting your internal inflows such as dividends and interest income into the same overweighted holdings, you can allocate those into areas that are underweighted, said Folkes.
Another more dynamic way of rebalancing your portfolio, said Folkes, is moving money from passive to more active management or vice versa if you believe the market conditions present themselves one way or another.
For nonretirement accounts, Kuster said Uncle Sam doesn’t know that your investments are up or down until you sell. While you think about rebalancing to bring your allocation back into balance, Kuster said a strategy to consider is to generate a tax loss for any investment values (or lots) that are down and seek to purchase back a similar (same asset class) but different (not substantially identical, per wash sale rules) investment. “The value in realizing the losses is their use to offset this year’s or future year gains,” he said.
As this strategy is, essentially, a tax deferral, Kuster said it is especially beneficial when losses are generated at higher tax rates and offset by future gains at lower tax rates. “If you think that you might have a heavy capital gains burden this year, expect to stay at a similar tax rate, or that your rate may even go down in the future, talk with your ﬁnancial and tax professionals,” he said. “They can help you identify whether loss harvesting may be a sound strategy for you.”
What’s more, Kuster said this may be the last year that wash sale rules don’t apply to cryptos, currencies and commodities. His suggestion: Consider selling any losses of these assets and repurchasing the investment a day or two later.
Not taking RMDs yet?
If you’re retired but not taking required minimum distributions, these may just be the lowest income-tax years of your life, and potentially the years where you withdraw the largest portions of your portfolio, said Kuster.
“Review your financial goals within the next few years and consider how downturns in markets may impact these goals or the long-term success of your portfolio,” he said. “As timing markets during this important segment of your life is unwise, it’s probably worth revisiting your asset allocation and evaluating the impact of placing the funds you need within the next six months to a few years on the sidelines.”
Kuster also recommends working with your financial adviser and tax professional to evaluate if converting funds from your pretax retirement accounts to a Roth IRA illustrates tax savings and would be in line with your financial goals. “As an example, if you don’t rely on your RMDs to pay the bills or don’t think you will in the future, converting and prepaying the tax now before balances grow may lead to lower taxes down the road.”
What if you’re taking RMDs?
If you’re retired and now in that stage of life when you’re taking RMDs (age 72 and older) and no longer contributing to a 401(k) or IRA, you’ve got it easy when it comes to rebalancing your portfolio back to its target asset allocation. You could sell those assets that are above your target asset allocation and buy those assets that are below your target asset allocation.
Consider too, said Kuster, making qualified charitable distributions or QCDs from an IRA directly to a qualifying charity. “While the donation won’t count toward a charitable deduction, this strategy can be especially efficient for those who don’t itemize deductions, essentially bringing back tax efficiency for those who take the standard deduction,” he said.
While you just need to be 70½ to execute QCDs, those 72 and over can leverage them to manage Medicare costs when your projected modified adjusted gross income is over $182,000. That’s because QCDs count toward RMDs. “Therefore, they can be used to reduce ‘counted’ retirement distribution amounts,” said Kuster.
Of note, the maximum annual exclusion for QCDs is $100,000, according to the IRS.