Checking your income tax planning now is a good idea – tax planning can be done year-round. As with any planning, acting while you can have an impact is best. Tax laws may change before the end of 2022, e.g. Secure Act 2.0 may be adopted, but it’s still wise to know where you stand now.
The IRS seems to have a similar thought about tax planning as they created a website with tools and resources at Steps to Take Now to Get a Jump on Your Taxes – if you check it out, let us know what you think.
First question: did you get a tax refund, or did you owe?
Some people enjoy seeing a big refund, but as you may have heard, you are giving the government an interest-free loan with your money. If you want to save, there are better ways, like an auto-debit to an IRA or to a savings account.
Not sure what happened to your refund? There is a updated IRS tool for “where’s my refund” that now goes back three years at “Where’s My Refund?”
The tool confirms receipt of your tax return, shows if the refund has been approved and indicates when it will be or has been sent. If three weeks pass without receiving the refund, then you may want to contact the IRS.
If you owed a significant amount for 2021, the IRS has another tool that helps make sure you have enough withheld for 2022 at Tax Withholding Estimator. This way you can avoid penalties and interest for under withholding.
If you do not get clear answers using the estimator tool, try comparing your 2022 paystub to your 2021 tax return, review the IRS guidance at Publication 505, or contact us for help.
Second question: what happens if you act now?
Marginal vs. average tax rate
Knowing the rate at which additional net income will be taxed helps you make decisions such as the one in the next section, whether to convert an IRA to a Roth IRA or not.
The marginal rate is your tax bracket, the rate at which the last portion of your income is taxed. Any additional income would be taxed at this rate. Your average tax rate is the percentage of income taxes to total taxable income. You can have a low average rate but hit a high marginal rate, which may mean that taking more income into the current year would be costly.
Time to convert to a Roth IRA?
The decision to convert a traditional IRA to a Roth IRA depends on several factors. One is the rate of tax you pay now compared to the rate you expect to pay in retirement. If your rate will be the same at retirement as now, then there are many reasons to convert, such as no required minimum distributions at retirement for a Roth IRA. If your tax rate at retirement will be significantly less than currently, then converting now would be less tax efficient.
If you want more on this decision, see “To Roth or not to Roth?” or check out Pros and Cons here.
Also, we discussed the back-door Roth IRA in our year-end post on 2021 tax planning.
Last question: how with this affect the rest of your finance?
Coordinate with investing and estate planning
Make sure any changes take for tax reasons do not foul your investment or estate planning. For more on estate planning, see estate planning checkup post.
As you review your 2022 tax planning, check your 2021 returns for ideas on what to adjust, consider the impact of future tax rate increases and act when the impact on other planning also makes sense.
Let us know if you have any questions.