Four Mid-Year Tax Planning Opportunities
It is hard to believe that the summer months have almost passed us by (it almost seems that we experience them faster every year), but in any case, halfway through the year is great time to review your current financial path.
Moreover, it can be a great time to consider making changes based on what has happened thus far, financial events you are anticipating in the second half, or even to begin thinking about open enrollment in October and November.
So, this week we will be diving into a few areas you can consider tweaking in your financial lives. Let’s dive in!
- Adjust contributions to your employer-sponsored retirement plan (401k, 403b, Simple IRA, etc.)
During my mid-year review meetings with clients, one of the first areas we look at is the contribution levels to their employer retirement plan. A lot can change from January to July – salary increase, bonus paid, stock options vest, etc. – so it is very important that we review our income and tax projections.
Furthermore, I have clients who receive salary increases that become effective on July 1st, which prompts us to determine if we need to increase contributions to their retirement plans based on contribution limits, or a chance in a percentage of their income. In addition, if we are contributing 100% ROTH, we will review it to understand if it makes sense to adjust this to allow for some pre-tax contributions based on the salary increase – which in turn affects the clients overall Adjusted Gross Income and taxable income figures.
In addition, if an individual turns age 50 during the calendar year, they will become eligible for the catch-up contribution with their employer-sponsored plans. The current contribution limits to 401ks are $23,000 (if under age 50), with an additional $7,500 catch-up contribution if the employee is over age 50. It is prudent to keep an eye on the timing of this to ensure you are taking full advantage of contribution limits.
The pattern continues, as the increase in income could affect the client’s ability to make individual ROTH IRA contributions – for 2024 you need to have Modified Adjusted Gross Income (MAGI) of $146,000 for single filers, and under $230,000 for joint files in order to make the full ROTH IRA contribution. Therefore, if we determine that the client could be over this MAGI limit and the client has already been contributing to their ROTH IRA, we will need to work with their CPA to take the necessary steps to retract this contribution and file the appropriate forms with their 2024 taxes.
Lots to consider!
- Adjusting Payroll Tax Withholding Levels
Another area we commonly check in on at this point in the year is a client’s level of payroll tax withholding – more specifically the level of Federal & State Tax withholdings, as Medicare and Social Security taxes are fixed percentages.
By using their 2023 tax return and current pay stubs, we can run a projection using the 2024 tax brackets to determine if they are currently on pace to potentially owe taxes, receive a refund, or be right on the bubble at tax time. It is especially important to review these elections if a client receives a raise or bonus mid-year, as the client could also push their income above the additional Medicare tax threshold of $200,000 for single filers and $250,000 for joint filers. Once clients go above this level, there is an additional .9% Medicare tax that is assessed – the tax has no cap. It should be noted, that as we go through this planning, we always make sure to connect with the client’s CPA to confirm we are on the right path prior to the client making any decisions.
In any event, we will never be 100% right in this area, however, we always want to be aware of potential tax surprises – both good and bad – and potential tax planning opportunities.
For reference, the IRS even has a simple calculator that can help you determine the level of Federal taxes you should be having withheld from your paycheck based on the income information you provide. See the link below!
https://www.irs.gov/individuals/tax-withholding-estimator
- Considering ROTH Conversions
This may come as a surprise, but mid-year is a great time to evaluate the potential of ROTH conversions. In my opinion, the key here is to maximize the tax efficiency by understanding what marginal tax bracket you are in today and using some assumptions to estimate your bracket down the line to determine the proper timing. In essence, you are designing a strategy to aim to reduce your lifetime taxes, rather than in one specific year.
With six months of the year in the books, we should have a pretty good idea of the income a client could expect to earn for the full year – which in turn provides us with their estimated marginal and effective tax brackets. So, with this information we can determine if a ROTH conversion is on the table for specific clients.
In most cases, the times we consider ROTH conversions are if the client is expecting a lower income year, if they are retiring (or retired in the first 6 months), or if our income projection is on pace to provide room in their current marginal tax bracket. When we take on this type of planning (while coordinating with the clients CPA), we can run the numbers to confirm whether this decision makes sense from a current and future tax standpoint.
Moreover, the state of the stock market does play a slight role. For example, as I right this the S&P 500 is still up 8% for the year but is down around 6% for the last month. The timing may allow for a more beneficial ROTH conversion, as the recovery from this recent draw down could be 100% tax-free on the amount converted. Small detail, but as we know, timing can sometimes play a major role in market returns – the best performing days in the stock market typically occur just after the worst days!
- Reviewing Benefit Elections
In most cases, open enrollment periods for employees falls in October or November – this is where you will elect your benefits for the upcoming fiscal year. Therefore, this is a great time to begin reviewing your current elections to identify any potential changes.
Below are the major benefits I have clients consider:
- Group Life Insurance Coverage
- Adding additional coverage if debt levels increased – i.e. a new or bigger house was bough - there was an increase income, new child is born, etc.
- Group Disability Insurance Coverage
- Income increases, debt increases, a spouse may stop working to take care of the kids or pursue a different career (starting a business)
- Type of Health Insurance Plan
- If not enrolled in a high deductible health plan (HSA eligible), we may want to weigh the costs and benefits of doing so
- Flexible Spending Accounts (FSA’s)
- Taking advantage of a Legal Insurance Benefit
The last bullet point is one that not many people do not know about, but it is becoming more common amongst employee benefit packages.
To summarize, employers will offer a legal insurance benefit (which you are charged for each pay period) that allows you to pick from a group of estate planning attorneys (your employer selects these) to have your estate planning documents drafted and executed – Wills, Medical Directives, Financial Powers of Attorney, Trusts, etc.
The best part is that this benefit will often cover some, if not ALL the cost. In most cases, the cost per pay period for this benefit is minimal when compared to how much the estate planning work would have cost if you paid for it out of pocket – in real numbers, an employee could be paying $20 / pay period ($520/year) for this benefit and have Wills, Medical Directives, Financial Powers of Attorney, and a Revocable Living Trust put in place for no additional cost. If they were to pay for these legal services out of pocket, the cost could range from $2,000-$6,000!!
Some folks do not even know that this benefit is an option within their employee benefit packages, or they skipped over it because the name was not very descriptive.
In any case, whether it is a new client or existing client, I always ask for their most recent benefit package to determine if there are adjustments we need to make for existing elections, or to see if there were new ones added that we can take advantage of.
In conclusion, as you embark on the final 5-6 months of the year, it may be worth it to check in on these four areas of your planning to identify areas of improvement, or even to confirm you are on the right path!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.