Although 2020 has been a year of unexpected changes, one routine remains consistent: the fourth quarter means it’s time to review where you stand year to date and plan for the new year. With new tax and retirement considerations related to the CARES Act and the SECURE Act, and big changes in the White House just around the corner, it's not too early to start planning for 2021.
The following year-end financial planning checklist highlights important points to consider when reviewing at year-end with your advisor.
1. Max Out Retirement Contributions
Are you taking full advantage of your employer plan retirement accounts? If not, consider increasing contributions to max out your employer matches. Boosting contributions to an IRA could offer you tax advantages as well. Keep in mind that the SECURE Act repealed the maximum age for contributions to a traditional IRA, effective January 1, 2020. As long as you have earned income in 2020 as an individual, you can contribute to a traditional IRA after age 70½ — and, depending on modified adjusted gross income (MAGI), you may be able to deduct the contribution.
2. Refocus on Goals and Fund a 529 education plan
What are your savings goals for 2020? Are you increasing your life insurance plan? Do you have an education plan in place for your loved ones? Setting up a 529 College Savings Plan is always a welcome gift when you invest in your child, your grandchild, niece, or nephew. You can allow your funds to grow tax-deferred for several years and they can be withdrawn tax-free to pay for qualified education expenses. 529 plans with NextGen allow you to contribute and offer multiple grants for instances such as opening an account with automatic funds or matching grants when you contribute the max amount if you're already set up. Enroll before the end of the year to receive NextGen matching grants.
3. Use Flexible Spending Account (FSA) Dollars
Do you have an FSA? It's important to know that the Internal Revenue Service has relaxed certain “use-or-lose” rules this year because of the pandemic. Your employer can modify your retirement plan through the end of this year to allow you to “spend down” unused FSA funds on any health care expense incurred in 2020 — and let you carry as much as $550 over to the 2021 plan year. For those who don’t have FSAs, contact us to see what your qualifying health care costs are to see if it makes sense to establish one for 2021.
4. Take Advantage of Marginal Tax Rates
When on the threshold of a tax bracket, ask your advisor if you can be put in the lower bracket by deferring some income to 2021. If you itemize, discuss the possibility of accelerating deductions such as medical expenses or charitable donations into 2020 (rather than paying for deductible items in 2021), which may have the same effect.
Here are a few key 2020 tax thresholds to keep in mind:
- The 37 percent marginal tax rate affects those with taxable incomes over $518,400 (individual), $622,050 (married filing jointly), $518,400 (head of household), and $311,025 (married filing separately).
- The 20 percent capital gains tax rate applies to those with taxable incomes over $441,450 (individual), $496,600 (married filing jointly), $469,050 (head of household), and $248,300 (married filing separately).
- The 3.8 percent surtax on investment income applies to the lesser of net investment income or the excess of MAGI greater than $200,000 (individual), $250,000 (married filing jointly), $200,000 (head of household), and $125,000 (married filing separately).
5. Rebalance Your Portfolio
Ask your advisor to review capital gains and losses with you to reveal any tax planning opportunities; for example, you may be able to harvest losses to offset capital gains.
- Make sure your risk tolerance aligns with your financial goals.
- You can offset the taxes to capital gains by selling off poor-performing investments at a loss.
- Can deduct up to $3,000 in capital losses against ordinary income if those losses exceed gains.
- Be careful: There are distinctions between short and long-term capital gains/losses. Check with your advisor to see if this strategy applies to your account.
6. Explore Opportunities for Charitable Gifts
Donating to charity is another good strategy to reduce taxable income. Are you interested in looking into various gifting alternatives, including donor-advised funds? If you opt to make charitable contributions in 2020, you can deduct up to $300 for charitable contributions even if you don’t itemize deductions. This “above-the-line” deduction is new for 2020 under the CARES Act. If you itemize, the CARES Act also allows a deduction for all cash contributions to public charities up to 100 percent of your adjusted gross income. What if you're older than 70½? Don’t forget that neither the CARES Act nor the SECURE Act changed the qualified charitable distribution (QCD) rules. If you're older than 70½, you can still make a QCD of up to $100,000 per person directly to a charity — and married taxpayers filing jointly may exclude up to $100,000 donated from each spouse’s IRA.
7. Form A Strategy for Stock Options
It is good practice to develop an approach for managing current and future income when holding stock options. Ask your advisor to weigh the options when choosing how your money defers as taxable income. Does it make sense to avoid accelerating income into the current tax year or to defer income for future years? If you are considering exercising incentive stock options before year-end, ask your tax advisor to prepare alternative minimum tax projections to see whether there’s any tax benefit to waiting until January.
8. Plan for Estimated Taxes and Required Minimum Distributions (RMDs)
Both the SECURE and CARES acts affect 2020 tax planning and RMDs, so there are additional things to consider this year. Under the SECURE Act, individuals who reach age 70½ after January 1, 2020, can now wait until they turn 72 to start taking RMDs — and the CARES Act waived RMDs for 2020. Under the CARES Act, those who took coronavirus-related distributions (CRDs) from their retirement plans have four options:
- Repay the CRD.
- Pay all of the income tax related to the CRD in 2020.
- Pay the tax liability over a three-year period that includes 2020, 2021, and 2022.
- Roll the funds back in over a three-year period. (Repayments will be coded as rollover contributions but won’t count as your one allowable 60-day rollover per 12-month period.)
You will need to file IRS Form 8915-E to report the CRD repayment or its inclusion in taxable income. The IRS expects Form 8915-E to be available by the end of 2020. Remember that those who choose not to repay the CRD will need to elect on their 2020 income tax returns how they plan to pay taxes associated with the CRD. It’s important to point out, however, that once you select a strategy, you can’t change it. Likewise, individuals who took a 401(k) loan after March 27, 2020, will need to establish a repayment plan and confirm the amount of accrued interest.
9. Adjust Withholding
Are you looking at an estimated tax penalty? If you may be subject, consider asking your employer (via Form W-4) to increase withholding for the remainder of the year to cover any shortfalls. The biggest advantage of this is that withholding is considered to be paid evenly throughout the year instead of when the dollars are actually taken from your paycheck. This strategy can also be used to make up for low or missing quarterly estimated tax payments. If you collected unemployment in 2020, any benefits received are subject to federal income tax. Taxes at the state level vary, and not all states tax unemployment benefits. If you received unemployment benefits and did not have taxes withheld, you may need to plan for owing taxes when filing 2020 returns.
10. Review Estate Documents
Now is a good time to review your beneficiary designations and update estate plans to make sure they align with your goals and account for any life changes or other circumstances. Below are items that should be done on an on-going basis:
- Check trust funding
- Update beneficiary designations
- Take a fresh look at trustee and agent appointments
- Review provisions of powers of attorney and health care directives
- Review documents to ensure you have a full understanding
Keep in mind, this checklist is not necessarily all-encompassing, but it does serve to help you keep your financial plan in mind, even during the holiday season and global pandemic. As always, check with a tax professional regarding any decision which may impact your taxes. If any of these financial moves raise questions, please feel free to contact us and schedule a time to review or create a tax-smart investing plan that works for you and your family.
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