Review and update your “personal balance sheet”.
Reviewing your total net worth is helpful to understand progress throughout the year. How did balances change in investment accounts, retirement accounts, and liabilities? Did you see progress that supports your long-term goals?
Evaluate your cash flow (income vs. expenses).
Assess your total income vs. expenses for 2022 and ask yourself the following questions: (1) Were you net positive (i.e., you brought in more income than went out in expenses), (2) How much did you save throughout the year? (3) What percentage of your total income did you save last year? (4) How do you expect your net cash flow to change in 2023? This exercise can help you find new opportunities to potentially save more, reduce expenses, and/or pay down debt.
Supercharge your savings.
Once you understand your cash flow, look for ways to boost your savings to support your long-term goals. A good, general rule of thumb to follow is saving at least 15-20% of your pre-tax income. One great “out of sight, out of mind” strategy is to set your savings on autopilot by directing a certain amount each month to an investment account, savings account, and/or an IRA or Roth IRA. Also, if you expect to receive a bonus at some point this year, create a plan of how to allocate and save those funds either towards retirement or other, shorter-term goals, such as purchasing a new car or new home.
Pay down “bad” debt.
Debt that has high interest rates and/or has no tax benefits, such as car loans, credit card debt, or student loans, generally falls in the “bad” category. As interest rates have climbed over the last 12 months, more loans are charging higher rates north of 6%, which can really add up if you hold the debt for a long time period. If you have excess cash flow, or extra cash on hand, you may consider paying off some of this debt and save yourself that higher interest cost.
Boost retirement plan contributions.
You can still contribute to IRAs or Roth IRAs for the prior year up until the tax filing deadline ($6,500 maximum or $7,500 if age 50+). For the new year, review your current contribution rate into your employer-sponsored retirement plan, such as a 401(k) or 403(b). If you expect to have higher income, you may consider increasing contributions. At a minimum, if your employer offers a matching contribution, try to defer enough from your paycheck to take advantage of that match….think of it like a “free bonus!” For those looking to maximize 401(k)/403(b) savings, you can defer a maximum of $22,500 from your paycheck this year ($30,000 if age 50+). This is a 10% increase from last year thanks to a larger-than-average inflation adjustment!
Review your asset allocation and current investments.
Is your mix of stocks and bonds still in alignment with your goals? Rebalancing back to your targets to start the year could be beneficial. Also, you may look to identify other investment options that are lower cost, lower risk, and/or more tax advantageous to consider.
Review tax withholding.
This is one of the most underappreciated tax planning tips. Understanding the current withholding from your paycheck can be the difference between a large refund or a large tax bill. This is especially important if you expect a substantial change in your income this year.
Tax Bracket Management.
Tax brackets are changing this year, for the better, thanks to a higher-than-normal inflation-adjustment. As a result, this creates a planning opportunity to manage your taxable income within brackets. For example, if you are considering a Roth conversion, selling an appreciated asset, or simply expect to have higher taxable income this year overall, you may be able to take strategic actions (i.e., increasing retirement plan contributions, gifting to charity, etc.) to avoid bumping yourself up into the next highest tax bracket.
Plan out your charitable giving for the year.
It’s never too early to start, and this can help set a baseline of those organizations you want to support during the year. This also helps plan ahead to understand how large of a charitable deduction you may want to target, particularly if you expect higher taxable income. Donor advised funds could also be considered if you expect a higher taxable income this year, as can Qualified Charitable Distributions for those taking Required Minimum Distributions from their IRA. Speaking of QCDs, with the new changes in the SECURE 2.0 legislation, you can now (1) make a one-time $50,000 charitable distribution from your IRA to fund a charitable gift annuity or charitable remainder trust and (2) distribute more on an annual basis given that the $100,00 maximum is now indexed to inflation.
Review current life insurance coverage.
Do you have the proper amount of death benefit coverage to protect your family against a sudden loss? Or do you have too much or too little? If the former, there may be ways to keep the level that you need but reduce premium costs. If you don’t have enough, the start of the year is a good time consider new options.
Get your estate plan in order (including reviewing beneficiaries!).
This one is easy to put off “until next year” as it is a gloomy topic, yet it is critical to have your essential estate documents drafted (or updated): Last Will & Testament, Powers of Attorney, Living Will. The start of the year is also a good time to ensure your beneficiaries and account titling are up to date. Make sure primary and contingent beneficiaries on your retirement accounts and life insurance policies are up-to-date and consistent with your wishes. Also, if you have trusts, ensure that the assets you want in the name of those trusts are properly titled.
Consider a Roth IRA conversion.
With financial markets still down significantly AND due to higher inflation-adjusted tax bracket levels, a Roth IRA conversion could be beneficial. While you have the short-term pain of paying income tax on the conversion amount, the long-term potential benefit is tax-free growth and future tax-free distributions.
Use an alternate “Back-Door” strategy for Roth IRA contributions.
If your income is above $153,000 (for single filers) or $228,000 (for married filing jointly), then you are unable to make a regular contribution to a Roth IRA. However, an alternate (and acceptable) strategy is to utilize the “back-door” method, where you (1) make a non-deductible contribution to a Traditional IRA, (2) leave the funds in cash or in a money market fund in the IRA for a reasonable period, and then (3) convert the balance to your Roth. If there are no earnings while the contribution was held in the IRA, then the conversion will be a non-taxable event.
Save for college via tax-advantaged 529 accounts.
Whether for your kids, grandkids, or even yourself, a 529 account is a great savings tool to utilize. Contributions grow tax-deferred, and distributions are tax-free as long as they are used for qualified expenses. If you don’t end up using all of it, you can transfer the balance to siblings or other eligible family members who may need to use it. Also, in Illinois, you can get a state tax deduction of up to $10,000 in contributions each year.
Consider Roth contributions in your employer retirement plan.
More and more employer retirement plans are offering a Roth option to their plans, which offers a tax-free alternative to a traditional tax-deferred plan. If your income is too high for making regular contributions to a Roth IRA, this is a great way to still save into a tax-free bucket. You can also save more into a Roth in these plans compared to a Traditional IRA (i.e., $22,500 max in a Roth 401k vs. $6,500 max in a Roth IRA). Also, as a result of the new SECURE 2.0 legislation, (1) it is now permitted to allocate matching contributions into a Roth 401k/403b/457b and (2) a Roth option is now available for SIMPLE IRA and SEP IRA accounts.
Look at a Health Savings Account (HSA) as another tax-advantaged savings bucket.
An HSA is primarily designed to set aside funds on a pre-tax basis to pay medical expenses. It is also a “triple tax-advantaged” vehicle because you can (1) contribute pre-tax dollars, pay no tax on earnings, and (3) withdraw funds tax-free if used for qualified medical costs. Additionally, let’s say you reach age 65 and no longer need to use the funds for medical purposes. At that point, you can distribute the funds for any reason without being assessed the 10% penalty, which at that point makes the HSA very similar to an IRA.
Reconsider investment-grade bonds as a reliable income stream.
For the last 10+ years, the main benefits of high-quality bond investment have been safety and diversification. Interest rates were low and did not provide a significant income stream for investors. All of that changed last year with rising rates, and now many bonds are paying 4-5% or higher. As a result, bonds are now an attractive income-producer again! This is especially true for retirees and those seeking a consistent, reliable income source.
Utilize high-yield savings accounts for your Emergency Savings/Reserve.
One benefit of higher interest rates is that you can now actually make money on your cash savings! There are several, reputable online banks that are paying over 3% on FDIC-insured savings or money market accounts. This is an easy way for your emergency fund and other savings accounts to actually work for you in a safe and conservative way.
Consider Series I-Savings Bonds.
These government savings bonds, offered through TreasuryDirect.gov, may not be paying over 9% anymore, but they still offer a rate of 6.89% (through 4/30/22) and are state-tax free. They are also a good inflation hedge as a portion of the rate is inflation-adjusted. As a reminder, investors can purchase up to $10,000 annually, and then you need to hold it for at least a year. You can withdraw the funds after 12 months, but you would be assessed a 3-month interest penalty if redeemed from years 1-5.
Align your investments with your values.
There are several more opportunities to invest in companies or funds these days that may support your personal values, beliefs, and passions. As a result, you can customize your investment portfolio towards areas such as environmental protection and social impact, or more specifically clean energy, animal welfare, diversity, etc. You can even align what you are investing in with charitable causes you support via Donor Advised Funds. Take the opportunity to review your portfolio to see if this is an area that you want incorporated into your investment strategy.
Identify opportunities to increase your household bottom line.
While the market is unpredictable, we believe that you have control over costs, risk exposure, and tax impacts. Proper income tax planning, tax-efficient investing, risk assessments, and cost analysis can help potentially find opportunities to add further value, or what we call “Household Alpha,” to your family’s bottom line.
Create (or update) your comprehensive financial plan.
A financial plan encompasses all of the above and more. It is an all-encompassing roadmap for your entire financial life, helping you assess your current financial condition across all facets, then identifying ways to enhance it and improve the probability of achieving your goals.
Invest in yourself and wellness.
While not directly related to your finances, this is probably the most important aspect of all of your planning. To enjoy your financial successes, you will want to be around and healthy to do so! Figure out goals to improve your physical and/or mental wellness, such as running, biking, yoga, etc. Make them challenging yet attainable, and don’t be afraid to start small either…..doing something is better than nothing!