Some of you may be reflecting and resetting this New Year's Eve. As 2020 winds to a close, also consider year-end tax saving moves when preparing for the future. So, no time to waste as we dig into some ideas for your consideration as we say a less-than-fond farewell to the year that was supposed to bring us 20/20 clarity.
- Maximize and match. Max out your retirement plan contributions for your qualified plans such as 401(k)s and 403(b)s. And if you are 50 years old by year end, you are entitled to make an additional $6,500 contribution to your plan this year. You make these contributions through payroll deductions, so hop on it! Can't do the max? Just be sure to at least contribute as much as any available employer match, which is free!
- Consider Roth IRA conversion. Low taxable income year for you? Think about a possible Roth IRA conversion. This conversion involves moving assets from your qualified tax deferred retirement account into a Roth IRA. Although you are taxed on the move of funds, after they land in the Roth the growth is tax-free for your life, and you are not required to tap into these annually during your life for Required Minimum Distributions (RMDs). Be sure you have cash to pay the tax on this strategy in excess of the amount you are converting. Note that under current law once the year ends, you can't go back and undo what you've converted. Engage your CERTIFIED FINANCIAL PLANNER™ professional to help you navigate your own unique options.
- Withdraw eligible assets. Low taxable income year or not paying any taxes this year? And not interested in a Roth conversion? Think about simply withdrawing some of your IRA or eligible qualified retirement account assets before year end anyway. If you could withdraw funds from one of your retirement accounts and pay little or no taxes, why not do so now? Next year we have every belief that RMDs will be back on track. Skipping a distribution for 2020 if you are in this situation, you might miss an opportunity to pay the least amount of tax possible on these otherwise tax deferred assets. Reach out to your tax professional and financial advisor to determine how to approach this calculation.
- Make charitable contributions. If you'll be 70-1/2 by year end, even though tax legislation removed the need for an RMD this year, you could still contribute to your favorite charity using the Qualified Charitable Distributions (QCD) option up to the amount your RMD would have been if not made optional for the year by law. It is a nice way to shelter and lower future distributions from your retirement account(s) while supporting the causes that matter to you now.
- Track deductions. For all of us this year, we are entitled to an 'above the line deduction' for qualified charitable contributions up to $300, even if we can't benefit from itemizing our deductions. Whether it's cleaning out your closets to find warm clothes for organizations who collect them, or donating canned goods to food banks, or simply giving cash, keep track of what you donate so you can help lower your taxes.
- Review and rebalance. Working with your trusted advisors, year-end is a great time to review your investments and analyze what you own. Determine if your assets are indeed supporting your goals and objectives. Rebalancing in your retirement accounts is a nontaxable event, so pay close attention to moves you can make there. Also, think about any repositioning you'd like to make in taxable accounts. For some it's been a very low taxable income year, so maybe locking in gains in taxable accounts will not inflict a big tax burden. For others, you may have some unrealized losses you'd like to book, either against gains taken this year, or to carry forward to future years. You can use up to $3,000 in net losses on your 2020 return, carrying forward any unused losses to next year.
- Estimate and adjust. It's also time to review your tax situation for the year and ballpark if you think you'll owe more taxes for 2020. If you calculate that you will, consider making an adjustment to your last paycheck to withhold the needed shortfall, or consider an estimated tax payment in January. Either of these might help you mitigate tax penalties on being under-withheld. Even if you are able to escape penalties because of safe harbor provisions, it's a good idea to have an estimate of what you expect to owe when you file your return so that you have the funds set aside and aren't caught off guard and unprepared. Getting into debt to pay taxes is not a great way to start the new year. Work closely with your tax professional on these calculations and decisions.
- Prepay unemployment income. Many Americans received unemployment this year as a result of the global pandemic. This income is taxable to you even though no tax withholding was taken out. Be aware and if it looks like you'll owe as a result of these support checks, you can either prepay now through withholding, pay what you owe via estimated taxes, or set aside as much as you can in anticipation of a tax bill when you file next year.
- Use it or lose it. If you have access to Flexible Spending Accounts through your employer, and can afford to do so, fully fund them via payroll deductions by year end to lower your taxable income. That said, know that you must 'use it or lose it' typically by year end. Many plans give you an extension until March 15th of 2021 to use these monies, and some allow you to carry forward small amounts to future years. Know your plan and if you need guidance, reach out to your HR department to understand the details.
- Explore 'bunching.' Some of us can itemize deductions on our tax returns, but many no longer can due to recent changes in tax laws limiting the deduction of state, local and property taxes, and limiting the deductible amounts on new mortgages. You might want to explore 'bunching,' which involves proactively maximizing some flexible deductions such as medical costs and charitable deductions this year, or perhaps not spending that money until next year if you feel you'll have a better chance to itemize then. Also, think about your state income tax law. Some states have their own independent tax laws that don't always conform to federal rules.
- Gift to family and friends. Family gifting won't give you a tax deduction, but it could help lower the taxable assets in your name and might also lower estate taxes due in the future. Each of us can gift up to $15,000 to another person annually without filing a gift tax return. And it doesn't have to be cash — you could also gift assets from your portfolio that might have a low basis and be taxed at a higher rate if sold by you than by another person in a lower bracket. However, this is another instance where not using it means losing it. You can't carry forward to future years this gifting exemption. This is a wonderful time of year to help family and friends who matter most to you, so it's worth your consideration.
- Plan for the new year. Are you ready for 2021? Don't start the year on the wrong tax foot by ignoring your withholding. If your tax withholding isn't on track from the outset, you'll have to catch up later in the year, which can derail your plans for financial safety. Similarly, determine how much you can afford to fund into your retirement and other pre-tax plans at work, and get that in place correctly with your very first check. Mark on your calendar to check in late in March to be sure you are on track and give yourself plenty of time to make appropriate adjustments.
I hope you can benefit from these planning ideas. Although I know it seems like a lot, and while you may be tempted to just grab some eggnog and forget about it, you don't need to tackle all this alone — you have help waiting for you! I encourage you to reach out to your trusted CERTIFIED FINANCIAL PLANNER™ professional. They will help you make those tax planning moves that are most helpful to you and your unique life and times. Wishing you a very happy holiday season and a very healthy, bright, new year!