The Year-End Planning Tip That Has Finance Profs Talking

Another easy last-minute strategy for clients pushed into a higher tax bracket is to save more in their 401(k). RICP co-director Prunier points out that having an employer take out a large plan contribution by the end of the year is an "especially valuable tax planning strategy if your client's long-range retirement plan indicates that their marginal tax rate in retirement will likely be the same (or lower) as the lower income tax bracket that they could possibly drop into this year."

The essence of asset location in qualified accounts is relative marginal taxation today and when the money is withdrawn from the account in the future. Higher marginal tax rates favor traditional qualified accounts such as 401(k)s and traditional IRAs.

Roth Recharacterization

Higher future tax rates favor Roth. Workers can still recharacterize their Roth contributions in their workplace Roth as pretax contributions, Prunier says. "Don't be confused on this point: although Roth conversions can no longer be recharacterized, there is no such restriction on recharacterizing Roth contributions," he notes.

Recharacterization is particularly attractive now because stocks and bond values are lower than they were at the beginning of the year. This means that "you are buying out your silent partner (Uncle Sam) at a depressed price."

Planning Ahead

Small-business owners can have greater flexibility when it comes to adjusting taxable income in 2022. Associate professor of taxation Sophia Duffy notes that business owners can "lower taxable income for the year by prepaying certain business expenses for the next calendar year and taking advantage of special tax benefits such as accelerated depreciation and business expenses that qualify for deduction under section 179."

With a client age 63 or older by the year-end, consider projecting the brackets of the Medicare income-related monthly adjusted amount, or surcharge added to Part B and Part D premiums, two years into the future.

If you lower the client's IRMAA bracket by decreasing adjusted gross income this year, start thinking about ways to lower the adjusted gross income today. For example, Prunier suggests maximizing health savings account, or HSA, contributions this year or increasing pretax workplace or IRA contributions (or recharacterizing workplace Roths as a traditional contribution).

Prunier also advises financial professionals to estimate federal and state tax returns for the new year at the beginning of 2023 in order to to explore strategies that can be implemented at the beginning of the year. For example, clients who will be subject to RMDs, especially if this is the year that the client turns 72, should consider taking them in January.

Why? "This action could prevent potentially adverse interactions between RMDs and partial Roth conversions that might occur later in the year," he explained.

The first funds distributed from an IRA when RMDs are required are legally considered RMD funds. That means they aren't rollover eligible — "if a client subject to RMDs makes a Roth conversion as their very first financial action of the year (accomplished in January), they have inadvertently converted their RMD dollars into a Roth account. That's not good!" says Prunier.

Don't Let a New Year Go to Waste

The new year can also be a great opportunity to revisit your retirement savings rate. Of course, all clients should be taking advantage of employer match opportunities that are essentially free money.

Our research shows that today's lower expected real return environment will increase optimal savings rates significantly for higher-income workers — up to 20% of income if they don't start saving until age 35. For higher-income workers, it makes sense to maximize 401(k) savings and look for ways to efficiently increase non-qualified investments.

Finally, behavioral research suggests that milestones such as the end of a calendar year can be a good time to address important goals that would otherwise go by the wayside.

Assistant professor and Chartered Life Underwriter director David Pierce refers to "December planning" as the "turn of the calendar" month, meaning "we should always go into the new year having reviewed/updated beneficiary designations on retirement accounts and insurance contracts as well as updating trust beneficiaries and all related estate planning."

Of course, this goes for both clients and financial advisors. Use the new year as an opportunity to take care of important loose ends and to establish new habits that will help you accomplish professional goals in 2023.