The 2023 tax year has only just begun, and the tax-filing deadline for 2023 taxes is more than a year away. That said, by getting a jump on planning, you may be able to lock in significant tax savings.
With stock prices still off their highs and the Internal Revenue Service’s recent inflation adjustments to 2023 tax thresholds, early-year tax moves could reduce your taxable income, enhance tax-deferred savings, and pass more to your beneficiaries free of taxes.
Max out Funding of Retirement Accounts
Maximum contributions to plans like 401(k)s and 403(b)s were increased to $22,500 from $20,500, for 2023, the biggest inflation adjustment in 20 years. Those aged 50 and older can contribute $30,000 this year, after the catch-up contribution was increased to $7,500 from $6,500 last year.
This year’s individual retirement account contribution limit has been bumped to $6,500 from $6,000. Investors 50 and older can save an additional $1,000, $7,500 in total.
Finesse Your Tax Bracket
Estimate your taxable income for 2023 as early as possible to understand how close you are to tax bracket thresholds. With the luxury of almost a full year of planning, you may be able to reduce taxable income to land in a lower tax bracket. You could elect to take money from a brokerage account instead of an IRA, gift income producing assets, or make a Qualified Charitable Distribution from your IRA to avoid the tax on RMDs. IRS rules allow for up to a $100,000 contribution made directly from an IRA to a charity to count toward satisfying a required minimum distribution without being subject to taxes.
Be Strategic About Your RMD
One of the most critical changes to come from the Secure Act 2.0 was increasing the age at which owners of retirement accounts must begin taking required minimum distributions (RMDs) to 73. And starting in 2033, RMDs may begin at age 75. If you have already turned 72, you must continue taking distributions. However, if you are turning 72 this year and have already scheduled your withdrawal, you may want to revisit your approach to allow an extra year of tax-deferred growth.
For those who don’t rely on their IRA distributions for living expenses, it may make sense to leave mandatory withdrawals to year end. That will have a positive impact when markets are rising because assets remain untaxed and can grow tax deferred. This is particularly relevant in years following market declines, which was the case in 2022. Delaying your 2023 RMD allows your portfolio additional time to grow and potentially recoup losses.
Convert Your IRA Assets to a Roth
When values are down, it represents an opportunity to convert traditional IRA assets to Roth as the corresponding tax on the conversion has dropped, as well. Ultimately, you can convert more shares at a lower cost. Subsequent growth in the Roth IRA is tax deferred and can be withdrawn tax free. Moreover, Roth assets are not subject to RMDs and Roth assets transfer to heirs tax efficiently at death. In addition, if you are charitably inclined, you can combine a Roth conversion with a charitable gift to offset the taxes for an additional tax benefit.
Establish and Fund a 529 Plan
Parents of young children have more reason to set up a 529 plan under changed rules passed by the Secure Act 2.0. These plans allow money to be withdrawn tax-free for education costs, but taxes and a penalty apply when money is used for other purposes.
Starting in 2024, pending certain conditions, individuals can roll a 529 education savings plan into a Roth IRA. If the beneficiary of the accounts gets a scholarship, goes to a less expensive school, or doesn't go to school, the money can get repositioned into a retirement account. However, rollovers are subject to the annual Roth IRA contribution limit. Roth IRA distributions must meet a five-year holding requirement and occur after age 59½ to qualify for the tax-free and penalty-free withdrawal of earnings. Tax-free and penalty-free withdrawals are allowed under certain other circumstances, such as the owner's death. The original Roth IRA owner is not required to take minimum annual withdrawals*.
Keep in mind that this update is for informational purposes only, so consult with your tax professional before making any changes in anticipation of the 2023 tax year. You can also contact your trusted financial professional, and they can provide you with information on ways to get a jump on planning.
*CNBC.com, December 23, 2022
This is not a recommendation and is not intended to be taken as a recommendation. This material was prepared for general distribution and is not directed to a specific individual.
LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.