The markets have experienced a turbulent year, as elevated geopolitical tensions, high inflation and an about-face by central banks have depressed stock valuations and increased government bond yields. In particular, the Federal Reserve’s campaign to raise rates and taper its balance sheet, and possible slowing impacts on the economy, could continue to pressure markets through the second half of 2022 and into 2023. That said, aside from a 15% corporate minimum tax rate for large companies, many recent proposals to reform the tax code have failed to gain traction in a closely divided Congress, maintaining access to various attractive planning strategies in the near term. In this environment, we feel it is especially important to assess personal wealth plans and to consider potential action steps before year-end. We share some ideas along these lines below.

Manage Your Risk

In our view, the market volatility experienced this year should prompt revisiting your asset allocation profile to make sure your investments remain in line with long-term goals and objectives, and to help avoid taking unnecessary risks. In part, this exercise may involve tilting portfolio weightings toward more defensive positioning (income-producing stocks, value over growth, etc.), but it may also mean assessing exposure to interest rate risk in bond holdings, and seeking to broaden diversification.

One side effect of the long-term equity bull market through 2021, and the dizzying declines over much of this year, is the danger that some portfolio positions may be overly concentrated and pose a risk to return profiles moving forward. We find reducing exposure to any given concentrated holding to under 10% is a prudent rule of thumb; for those with charitable intent, such securities may be strong candidates to help fund a giving plan, as you avoid realizing capital gains while reducing portfolio risk.

Harvest Losses

Market weakness for much of the year has likely given many investors the ability to harvest losses to offset other investment gains. Consult with your wealth manager and/or portfolio manager to clarify your potential gain/loss picture for the calendar year. You can potentially offset any realized capital gains and up to $3,000 of ordinary income with losses, whether realized in 2022 or carried over from previous years. Be sure to abide by “wash sale rules,” which apply if you purchase the same or substantially identical securities (or acquire a contract or option to do so) within 30 days before or after the sale resulting in a loss.

Manage Your Cash

It may be tempting to hold onto cash given market turbulence, but unless you need it for liquidity/emergencies or are treating it as dry powder for investment opportunities, we feel it’s better to put this cash to work. Despite limitations, one appealing use for cash is to purchase government-backed Series I-Bonds to help mitigate against loss of purchasing power. Series I-Bonds are currently yielding 9.62%,¹ and this rate adjusts twice per year (May and November) based on the level of the Consumer Price Index (CPI). There is an annual cap on I-Bond purchases of $10,000 per individual or $20,000 for a married couple; but for those who receive federal income tax refunds, up to an additional $5,000 can be applied to further I-bond purchases.

Maximize Retirement Contributions

Use of retirement savings vehicles can provide significant opportunities for investment growth potential over time. The limit on annual employee 401(k) plan contributions is $20,500 for 2022 (plus an additional $6,500 for those over 50); and you can contribute up to $6,000 to a traditional individual retirement account (IRA) in 2022 ($7,000 if you are 50 years of age or older), though the tax deductibility of your IRA contribution may be reduced or disallowed if you also participate in a retirement plan at work and your earnings exceed certain thresholds.

Don’t forget that your nonworking spouse can use your earnings to contribute to an IRA, in which case income-based phaseouts take place at higher levels than those for the working spouse. Moreover, you and/or your spouse can still contribute to a nondeductible IRA or convert a traditional IRA to a Roth IRA.

Make Annual Gifts

Under current law, you can give up to $16,000 ($32,000 as a married couple) gift-tax-free to as many individuals as you like in 2022, without using your lifetime federal gift tax exemption.

All of your gifts, including those made directly to children via taxable investment accounts and/or UTMAs, 529 college savings accounts and, indirectly, to life insurance trusts to cover annual premiums, must be coordinated to ensure you don’t inadvertently exceed the annual gifting limits for any one person. Also, you can pay your children’s (or anyone else’s) tuition directly to an educational institution, or medical expenses/health insurance premiums directly to the service providers, in unlimited amounts without dipping into the annual exclusion or lifetime gift exemption.

Contribute to a 529 Plan

A potentially effective way to use the annual gift exclusion is to contribute to a 529 account on behalf of a family member or other individual. It’s possible to front-load up to five years of exclusions in one 529 contribution. Although the contribution isn’t tax deductible at the federal level, account assets grow tax-free, and withdrawals are also not taxable if they are used for qualified education expenses, including both college and private K – 12. Many states provide a limited income tax deduction for residents who contribute to a 529. However, keep in mind that the range of investments available in the different plans can be quite limited, and program specifics—and quality—vary.

Convert Your Traditional IRA to a Roth

For higher income earners, it may be advantageous to consider a Roth conversion given the reduced asset levels in many portfolios. Conversions are taxed in the year they take place and are typically considered most attractive if asset values are depressed, and you believe your current tax rate will be lower than your rate when you retire (or start taking taxable distributions from a traditional IRA). Post-conversion, there’s no requirement that you or your spouse take any withdrawals from a Roth IRA, thereby permitting the funds to continue to grow tax-free for both lifetimes.

It may also make sense to pair the conversion with contributions of cash or appreciated assets to a donor-advised fund (DAF). The income tax deduction on the DAF contributions can offset the increased tax liability from the Roth conversion, while donations of low-basis stock, for example, can avoid capital gains on its appreciation. (See “Three Areas for Optimizing Your Year-End Philanthropy.”)

Manage Your Marginal Tax Rate

Those who have not begun taking distributions from traditional retirement plans may face meaningful required minimum distributions (RMDs) in the future. In such cases, it may make sense to take some distributions to tactically “fill up” your existing tax bracket before RMD status begins, rather than expose that income to potentially higher tax rates in the future.

Assess Your Charitable Giving

Year-end is typically an active time for charitable donations, and individuals can make deductible charitable gifts in cash of up to 60% of their adjusted gross income for 2022. Giving away appreciated securities can be an effective way to benefit from capital gains, with the donation of long-term public holdings providing a deduction of market value (compared to cost for short-term gains), up to 30% of adjusted gross income. Some individuals may choose to bunch donations in a particular year to overcome the high standard deduction and allow for itemization of gifts.

Standard Deduction Amounts

Source: IRS.

If you are age 70½ or older, you can donate up to $100,000 of your retirement distribution directly to charity this year and avoid paying taxes on those dollars. Rather than counting as a deduction, the amount gifted directly from your IRA to charity is excluded from income (although you must note the contribution on your income tax return). This approach can be particularly beneficial for those who take the standard deduction instead of itemizing.

Make Sure You and Your Family Are Protected

Consider reviewing your risk management program (i.e., your insurance policies) to ensure you have no gaps in coverage should you or your family members be party to a lawsuit or legal judgment. One specific type of coverage that is often overlooked and is critically important in providing overall protection is excess personal liability (umbrella) insurance. This kind of policy provides a backstop in the event you are sued for amounts in excess of the regular liability coverage offered by homeowner and automobile policies. As a general rule of thumb, you should consider coverage of up to your net worth to properly protect your family’s assets.

Also, assess whether you might benefit from coverage for future long-term care, which can be a particularly costly outlay late in life. Individuals typically begin to consider whether or not to have this type of coverage between the ages of 50 and 70. Eligibility and premiums are a function of the applicant’s health and age at the time of application, as well as the type of policy and features selected.

Finally, consider reviewing your life insurance coverage. Low interest rates in recent years and related dividend crediting rates are contributing to underperformance in some policies, creating potential for lapse if not addressed. In our view, it would be prudent to request in-force illustrations from the insurance carrier every couple of years to make sure there are no surprises down the road.

Use the Lifetime Exemption

The current lifetime federal exemption of $12.06 million per person (or $24.12 million per married couple) from estate and gift tax is set to revert to past levels after 2025. Where feasible, we believe gifting above the historical exemption amount of $5 million (indexed from 2010) per person could be an effective way to move assets out of your estate on a gift-tax-free basis.² If you are uncomfortable with (or it’s not feasible to make) such a transfer, gifting borrowed assets, lending assets to heirs, or employing certain trust vehicles (see below) may be worth considering. As part of this assessment, you may need to consider the level of your state tax exemption, if any.

Capitalize on Still-Low Rates, Lower Valuations

Given persistent high inflation, the Federal Reserve is expected to continue raising interest rates into next year. Certain strategies seek to surpass an IRS-set interest rate, above which potential returns are transferred to beneficiaries free of estate or gift tax. As those hurdle rates increase with Treasury yields, the value of using such strategies now rather than later increases. Meanwhile, the prices on many assets have come down, providing an opportunity to transfer them at depressed levels, through vehicles like grantor retained annuity trusts and sales to intentionally defective grantor trusts.

Cover Your Bases

As part of your late-year review, we believe you should make sure you have addressed issues across your financial situation, which may include some of the following:

• Are the beneficiary designations correct on insurance and retirement accounts, particularly where you might have designated a trust for planning reasons?
• Do your payroll withholdings need to be adjusted?
• Are your Flexible Spending Account withholdings realistic, and are you on track to eliminate balances by the deadlines?
• If you are enrolled in a high deductible health plan, have you fully funded a health savings account?
• Have you reviewed your cash management strategy? Consider maximizing your earned interest rates while ensuring that you adhere to FDIC limits where applicable. Many short-term Treasury vehicles are yielding more than the dividend yield of the overall stock market.
• Have you taken the opportunity to restructure your debt balances? As a result of rate increases, many adjustable-rate mortgages will likely need to reset higher, which could increase monthly carrying costs. Clients may need to evaluate whether converting to a fixed-rate product makes more financial sense in a rising interest rate environment.
• Have your circumstances changed in any way that might require a reassessment of your asset allocation, or a fresh look at your estate planning?
• Are the individuals named in your estate planning documents, such as trustees, executors or attorneys-in-fact, still appropriate?
• Is your home adequately insured, given that valuations and rebuilding costs have increased substantially in many markets around the country?
• Have you taken steps to protect your personal and financial data? This may include a review of your credit report to address inaccuracies or identify unusual activity.

Consult With Advisors Now

The economic and market picture continues to shift, making it important to work with your advisors to make sure that your accounts and planning are in line with your individual needs and can fully capitalize on currently available wealth strategies. Please contact your NB Private Wealth team with any questions about your portfolio or any topics covered in this article.