Year End Tax Planning Tips
December 3, 2024
By Barbara O'Neill, CFP®, AFC®
As the year winds down, so does your opportunity to take proactive steps to reduce your income tax bill to the Internal Revenue Service (IRS) and keep more of your hard-earned money. Now is the time to consider last- minute moves to lower your 2024 taxes and start proactive tax planning for 2025. With a few notable exceptions (e.g., contributions to individual retirement accounts (IRAs) and plans for those with self-employment income), tax-saving moves must be completed by December 31.
Tax-saving strategies often have related moving parts. In other words, some action must be taken before tax savings can occur. For example, a large contribution to charity, combined with other deductible expenses, might enable a taxpayer to itemize deductions to save money. A spousal traditional IRA contribution for a non-employed spouse can reduce adjusted gross income (AGI). Certain energy-efficient home improvements (e.g., insulation, windows, heat pumps) can qualify for the Energy Efficient Home Improvement Credit.
This post describes over a dozen year-end tax planning strategies, including those that are unique to 403(b) plan participants. The strategies are organized into four categories: tax planning, investing, retirement planning, and philanthropy. It concludes with a summary of two tax-related research studies, three “need to know” facts, and six take-away action steps.
Tax Planning Strategies
2024 Pro Forma Tax Return
The first step in year-end tax planning is a pro forma (projected) tax return with “best estimates” of taxable income and tax write-offs. By December estimates should be pretty accurate (e.g., 403(b) contributions and tax withholding). If certain data are unknown (e.g., mutual fund distributions), use 2023 tax numbers. I personally use the Tax Forecasting Worksheet in the Guide to Personal Tax Planning issue of the AAII Journal, published each December. You can also simply line up a piece of paper with your 2023 tax return.
Once your 2024 pro forma return is prepared, compare it to 2023 to identify changes in income and/or expenses that will affect takes owed. For example, high annual percentage yields (APYs) on savings accounts and/or money market funds, stock market gains, or a raise or side hustle, may have increased taxable income. The goal is to avoid paying taxes at a higher marginal tax rate. For example, if you are near the top of the income range for the 12% tax bracket, you want to try to avoid slipping into the 22% tax bracket.
0% Long-Term Capital Gains (LTCG) Tax Rate
The 0% LTCG tax rate requires holding taxable (brokerage) account securities for more than a year and taxable income below $47,025 for single taxpayers and $94,050 for married couples filing jointly in 2024 ($48,350 and $96,700, respectively, in 2025). Taxable income is significantly lower than gross income because it is calculated by subtracting the greater of the standard deduction or itemized deductions from AGI.
Seeing where your income stands, using a pro forma tax return, can inform tax-planning strategies to qualify for the 0% LTCG rate. For example, contributing more to a 403(b) and taking long-term capital gains in tax years when taxable income is reduced (e.g., unemployment, retirement, or unpaid leave).
Bunching Deductions
Bunching means occasionally grouping sufficient itemized deductions into a single tax year so they exceed the standard deduction of $14,600 (single), $21,900 (head of household), and $29,200 (married filing jointly) in 2024 ($15,000, $22,500, and $30,000, respectively, in 2025), plus additional amounts for blind taxpayers and those age 65 and older. In other words, alternating between itemizing and taking the standard deduction.
Deductible expenses for bunching include unreimbursed qualified medical/dental expenses that exceed 7.5% of AGI, state/local taxes, qualified mortgage interest, charitable contributions, and qualified disaster losses. Bunching often requires significant charitable gifts, especially for married couples, and time-shifting the payment date for property taxes and elective medical procedures.
Safe Harbor Rules
Safe harbor rules exist to protect taxpayers from underwithholding penalties. As part of year-end tax planning, do the math and make sure that your tax withholding is sufficient. The IRS will not charge a penalty if you:
- Pay at least 90% of tax owed for the current tax year
- Pay at least 100% of tax owed for the previous tax year (110% with an AGI over $150,000)
- Owe tax of less than $1,000 after subtracting withholdings and credits
Estimated Tax Payments
For income not subject to withholding (e.g., self-employment and saving/investment earnings), estimated tax payments are due to the IRS in four installments on April 15, June 15, September 15, and January 15 of the following year. The January 15 payment is especially important because it will be informed by your pro forma tax return and is your last opportunity to apply tax payments toward your prior year’s liability.
FSAs and HSAs
Flexible spending accounts (FSAs) are funded with pre-tax dollar payroll deductions to pay for health care or dependent care expenses. Contributed funds are exempt from both income and Social Security/Medicare (FICA) tax. FSAs are “use it or lose it,” meaning contributions must be spent down by year-end or the excess is forfeited. Limited employer-specific grace periods may apply. Two key year-end tax planning strategies are spending down funds in a current year’s FSA and deciding how much to save the following year.
Health savings accounts (HSAs) are triple tax-advantaged accounts available to employees with high-deductible health plans. Contributions are tax-deductible, earnings grow tax-deferred, and distributions for qualified medical expenses are tax-free. HSAs funded via payroll deduction are also exempt from FICA tax. The maximum contribution in 2024 is $4,150 for self-only coverage and $8,300 for family coverage. In 2025, these limits rise to $4,300 and $8,550. Unlike FSAs, there is no requirement to spend down annual deposits.
Investment Strategies
Tax-Free Investments
Year-end tax planning should include an evaluation of whether tax-free investments make sense. Roth IRAs and 403(b)s, for example, are especially valuable for young workers with low incomes and those who expect to be in a higher tax bracket when they retire. Other tax-free investments are municipal bonds, bond funds, and ETFs, which are especially valuable to those in higher marginal tax brackets. To determine the taxable account equivalent of a tax-free investment, divide the tax-free yield by 100 – your marginal tax rate. Example: In the 24% tax bracket, with a 3% tax-free yield, 3 ÷ 76 (100 - 24) = a taxable account yield of 3.95%.
Tax Loss Harvesting
This is the process of selling investments that have decreased in value to offset gains from profitable securities. Investment losses can also offset up to $3,000 of other income annually, with remaining losses carried over to future years. To get started, calculate the value of investments as part of preparing a net worth statement. Be aware than you cannot deduct losses if you buy a similar security within 30 days of the sale.
Tax Diversification Review
Tax diversification means holding a mix of investments that are taxed in different ways; i.e., taxable (brokerage), tax-free, and tax-deferred accounts. At year-end, determine what percentage of your total portfolio is in each type of account and make adjustments to future investments accordingly.
Mutual Fund Distributions
Mutual fund investors cannot control the amount or timing of dividend or capital gains distributions which, by law, must be passed on to investors in proportion to the number of shares they own. Often these distributions are made once at year-end, although they can also occur monthly or quarterly. To avoid “surprises,” it is wise to visit your mutual funds’ website(s) in early December to stay updated on fund distributions and factor them into your pro forma tax return. If distributions are large, extra tax withholding may be needed.
Retirement Planning Strategies
Qualified Employer Plans
The maximum annual contribution to either a traditional tax-deferred (pre-tax dollar) and/or Roth (after-tax dollar) qualified employer plan, such as a 403(b), is $23,000 in 2024 ($30,500 if age 50+) and $23,500 in 2025 ($31,000 if age 50+). The extra $500 amounts to less than $20 per biweekly paycheck next year and the “paperwork” to authorize a higher payroll deduction should be done now. Traditional account contributions are tax-deductible in the year that they are made. Roth accounts have back-end benefits: tax-free earnings withdrawals after age 59½ if an account is open for at least five years.
Super Catch-Up Contributions
Catch-up contributions help older workers accelerate their retirement savings as they get closer to the time that they plan to exit the labor force (often sometime during their 60s). The standard catch-up amount for workers age 50+ is $7,500 in both 2024 and 2025, as indicated above. Starting in 2025, as a result of the SECURE 2.0 Act, there is a higher maximum catch-up contribution amount available for workers ages 60 to 63.
Dubbed a “super catch-up,” this is a maximum contribution of $11,250. The super catch-up contribution is calculated as the greater of $10,000 or 150% of the standard catch-up contribution that is periodically indexed for inflation. In 2025, $7,500 x 1.5 (150%) = $11,250. It should be noted, however, that the super catch-up is workplace specific and voluntary for employers to offer to their workers. The extra $3,750 catch-up contribution is about $432 more per biweekly paycheck and should be authorized now, if available.
Individual Retirement Accounts
In addition to a 403(b), plan participants can fund a Roth or traditional IRA. The maximum contribution is $7,000 ($8,000 if age 50+) in 2024 and 2025. Annual inflation-adjusted income limits apply for tax-deductible traditional IRAs and for the ability to fund Roth IRA accounts. Married couples with one (or a substantially higher) earner can also fund a separate IRA for the no/low income spouse to lower their household’s AGI.
Roth Conversions
When a traditional IRA is converted to a Roth IRA, taxpayers pay ordinary income taxes on the converted amount to have tax-free growth and tax-free withdrawals because Roth accounts are not subject to required minimum distribution (RMD) rules. Part of year-end tax planning is deciding if and when a Roth conversion makes sense (e.g., in a year with reduced income or when you expect a higher tax bracket in later life).
RMD Withdrawals
403(b) participants age 73 and older (75 starting in 2033) are subject to mandatory withdrawals from tax-deferred accounts. Failing to take an RMD (or a correct RMD) can result in a 25% penalty on the amount that should have been withdrawn but wasn’t (10% if corrected within two years).
Year-end tax planning for RMDs involves three critical components: 1. withdrawing at least the required amount by December 31 of each year, 2. incorporating the RMD amount into a pro forma tax return for tax planning, and 3. deciding what to do with the money. As shown on this RMD planning worksheet, money that is withdrawn can be spent, gifted, or resaved (e.g., in taxable accounts).
Philanthropy Strategies
Annual Gift Tax Exclusion
The amount that can be given to any one person in 2024 without having to file a gift tax return is $18,000 ($19,000 in 2025). Making gifts to others reduces your taxable estate (estate taxes), removes assets from your portfolio that will generate future taxable income (income taxes), and provides support for loved ones.
Charitable Contributions
Taxpayers often make substantial donations as part of a planned bunching strategy to exceed the standard deduction for a specific tax (calendar) year. By making a donation to charity, they get a tax deduction and remove assets that generate future taxable income. The annual cash contribution limit is 60% of AGI and the limit for non-cash appreciated assets held longer than one year (e.g., stock) is 30% of AGI.
Donor Advised Funds (DAFs)
DAFs are accounts set up at investment companies (think Schwab, Fidelity, and Vanguard) where donors make a charitable contribution to the DAF, receive a tax deduction for the amount of the contribution, and recommend gifts (called grants) to charities over time. Like direct charitable contributions, DAFs are often established as part of a proactive bunching of itemized deductions. They can be funded with cash or appreciated securities.
Qualified Charitable Distributions (QCDs)
For charitably inclined individuals, QCDs are a tax-saving strategy that taxpayers age 70½ + might consider. A donation of up to $105,000 in 2024 ($108,000 in 2025) can be made to a qualified charity directly from a traditional IRA custodian. A QCD donation can count toward a donor’s RMD if age 73 + or it can remove funds from traditional IRAs between ages 70½ and 73 (or 75) to avoid future RMDs. Unfortunately, QCDs are not available for 403(b)s and other qualified employer plans.
Research Results
A 2020 study of 1,131 American adults identified substantial gaps in knowledge with respect to tax liability, tax brackets, deductions vs. credits, income and exclusions, and more. Rates of misunderstanding of key concepts ranged from 30% to 79% and tax literacy was higher among males and older, more educated, and higher-income respondents. A 2024 study examined the impact of the Tax Cuts and Jobs Act (TCJA) on charitable giving and found that tax reform decreased charitable giving by about $20 billion annually.
Three (More) Things
- 403(b) plan participants with self-employment or freelance income can fund a Simplified Employee pension (SEP) for additional tax-deferred savings up to 20% of net income or $69,000 in 2024.
- An important component of year-end tax planning is incorporating life events that affect income taxes. Examples: marriage, divorce, birth of a child, unemployment, a new job, a side hustle, and retirement.
- If the TCJA is not extended beyond December 31, 2025, tax brackets will revert to higher 2017 levels. For example, the 12% and 24% brackets will rise to 15% and 28%, respectively. Taxes are “on sale” until then.
Six Smart Strategies
No. 1: Review Your Tax Withholding — After completing a pro-forma tax return, compare what you expect to owe with what you have had withheld this year to date. Use the IRS Tax Withholding Estimator calculator for additional withholding feedback.
No. 2: Consider a “Backdoor Roth IRA” — If your income is too high to fund a Roth IRA (over $161,000 for singles and $240,000 for couples in 2024), contribute to a non-deductible traditional IRA and quickly move the money to a Roth account.
No. 3: Take Advantage of “Gap Years” — Consider whether it makes sense to take withdrawals from tax-deferred accounts in the years between age 59½ and RMD age. Sometimes it makes sense to pay taxes early to save on taxes later at a higher tax rate.
No. 4: Take “Above the Line” Deductions — Learn the items that directly reduce AGI and use them. Examples of adjustments to income include half of self-employment tax (side hustles), alimony payments, traditional IRA contributions, and student loan interest.
No. 5: Keep Good Records — Keep records for annual tax returns at least six years and for capital assets (e.g., stock) as long as you own them plus six years. In addition, save receipts for home improvements to use for capital gain calculations.
No. 6: Get Help When Needed — Contact a tax advisor or financial planner for assistance with multi-year tax planning and implementing the strategies discussed in this article.
In Summary
The end of the year is a great time to take action to reduce income taxes this year and next. If you want a tax-saving strategy to take effect in January, now is the time to do some math and complete paperwork.
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Dr. O'Neill is the owner/CEO of Money Talk: Financial Planning Seminars and Publications where she writes, speaks, and reviews content about personal finance. She is a Distinguished Professor Emeritus at Rutgers University and a long-time 403(b) plan participant.