The stock market began its current slide on Jan. 3, 2022, and was confirmed a bear market – generally defined as a drop of 20% – on June 13. The big question on many investors’ minds is what to do now.
The average bear market lasts 11 months, but this cycle has no obvious expiration date. We’re nine months in, so history indicates we’re closer to the end than the beginning.
The average bear market lasts 11 months… we’re closer to the end than the beginning
The ability to maintain “staying power” in markets can be worth its weight in gold over time. A famous example is Rick Guerin. Most people are familiar with Berkshire Hathaway and the partnership between Warren Buffett and Charlie Munger, but the duo used to be a trio. In the 1970s, Buffett and Munger had another partner named Rick Guerin.
Buffett told the story: Rick invested on margin because he was so bullish on Berkshire Hathaway stock. During the bear market of the 1970s, Rick got flushed out. He couldn’t pay his margin debt and was forced to sell his Berkshire shares back to Buffett at $40 a share. As of Sept. 29, 2022, Berkshire A shares fetched $406,700 a share.
Every investor must be able to survive bear markets. Also, with just a few months left in 2022, most taxpayers have a good idea where their income will end up for the year, so it is time to review your tax situation and act before the year-end deadline. Here are some tips intended to ease the pain.
The Tax Cuts and Jobs Act of 2017 reduced income tax rates for individuals through 2025. With these historically low rates in effect, consider accelerating income in years when you may be in a low bracket. This may mean exercising stock options or converting funds from an IRA to a Roth IRA to take advantage of current low tax brackets. If income is higher than normal this year, consider deferring income (such as bonuses) into the next tax year.
Medicare has a two-year look back to determine premiums
If you are enrolled in Medicare or are within two years of receiving benefits, review your modified adjusted gross income to see how it will impact future Medicare premiums. Medicare has a two-year lookback to determine premiums, so your 2022 income will impact your 2024 premiums. Consider accelerating or deferring income to stay within certain Medicare premium tiers.
Now that you have a good handle on your income, review whether your federal and state income tax withholding is appropriate. To avoid federal underpayment penalties, you need to pay in 100% of last year’s tax (110% if adjusted gross income is higher than $150,000 if married, $75,000 if single) or 90% of the current year’s tax, whichever is lower.
are your federal and state income tax withholdings appropriate?
Consider increasing withholding to cover any shortfall or adjust your fourth quarter estimated payment. Don’t forget to doublecheck your state withholding, as state underpayment penalties are generally higher than their federal counterpart. Use this IRS withholding calculator to see if your withholding will cover your federal tax obligation: www.irs.gov/individuals/tax-withholding-estimator.
If you know you will be in a high tax bracket, or if you have a withholding shortfall, consider increasing your tax deductions.
Consider maximizing the contributions to your 401(k) plan by year’s end. In 2022, the 401(k) contribution limit is $20,500 plus an additional $6,500 if over age 50. If your income is within the IRS limits, you and your spouse may be able to contribute $6,000 each to a tax-deductible IRA ($7,000 each if over age 50). IRA contributions can be made until the April 15 tax filing deadline.
Are you enrolled in a high deductible health plan? If so, make sure to maximize your contributions to a health savings account (HSA). You can make additional contributions directly to your HSA until April 15. The maximum contribution is $3,650 for single filers, $7,300 for families, with a $1,000 catch-up contribution if you are over age 55.
Charitable donations can be another great way to reduce tax liability. Review your itemized deductions for the year to see how close you are to the standard deduction threshold ($25,900 if married, $12,950 if single). Consider contributing to a donor-advised fund if you want to bunch several years of charitable donations into one tax year. This way, you get an upfront tax deduction and can dole out the donations in future years. Charitable donations need to be received by the charity before Dec. 31 to be deductible in the current tax year.
Are you saving for your child’s or grandchild’s college education? You could contribute to a 529 plan to get a possible state tax deduction. To qualify, you must contribute to the plan sponsored by the state where you live. For example, married Illinois residents can contribute up to $20,000 to the Bright Start 529 plan and save almost $1,000 in state tax.
Look into harvesting losses in your portfolio. You can sell and buy something different but similar and lock in that loss for tax purposes and never leave the market. Make sure you are rebalancing your portfolio after these market swings to prevent an unintended allocation outside your risk tolerance.
Required Minimum Distributions
Are you age 72 in 2022? If so, you may need to take your required minimum distribution (RMD) from your IRA or 401(k) plan by Dec. 31. If this is your first year taking your RMD, you have the option to delay until April 15 of 2023. Keep in mind, though, that you will be doubling up on RMDs in 2023. Also, if you are charitably inclined, you can donate up to $100,000 from your RMD directly to charity as a qualified charitable distribution, which counts toward your RMD amount and is excluded from income. You will need to keep a record of these donations to give your tax preparer since the donations are not subtracted from income on the tax forms provided by your custodian.
‘The Stock market is a device which transfers money from the impatient to the patient’
With inflation and the markets making a dent in many people’s budgets this year, year-end tax planning can be a great way to make your money work harder for you. As Warren Buffett said, “The stock market is a device which transfers money from the impatient to the patient.”