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Make Your Year-End List & Check it Twice: 9 Smart Planning Moves to Consider

Make Your Year-End List & Check it Twice: 9 Smart Planning Moves to Consider

| December 11, 2020
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1. Review your income or portfolio strategy

Are you reaching a milestone in your life such as retirement or a change in your personal circumstances? Has your tolerance for taking risk changed? We experienced historic volatility this year. The broad-based S&P 500 Index lost over 30% in one month. The sell-off was steep and violent but short-lived.

As November came to close, the major market indexes had recaptured prior highs. It’s a testament to adhering to the long-term financial plan.

Did you take volatility in stride, or feel any uneasiness? A pandemic, a shuttering of the economy, and a swiftly falling stock market are bound to create some anxieties. But if you experienced sleepless nights or sought the safety of cash, now may be the time to re-evaluate risk and your approach. 

One of my goals has always been to remove the emotional component from the investment plan. You know, the one that encourages investors to load up on stocks when the market is soaring or one that prods us to sell when volatility surfaces.

The hard data and my own personal experience tells me that the shortest distance between an investor and his/her financial goals is adherence to a well-diversified holistic financial plan.

2. Rebalancing your portfolio

Despite the rollercoaster ride, overall market performance has been good this year. U.S. equities have provided a nice lift to your portfolio, but you may have too much exposure to stocks as we approach 2021.

If that’s the case, we may need to trim back on equity exposure. However, we may want to wait until January in non-retirement accounts so that any gains are booked in tax year 2021.

3. Take stock of changes in your life and review insurance and beneficiaries.

Let’s be sure you are adequately covered. At the same time, it’s a good idea to update beneficiaries if the need has arisen.

Download our end-of-year checklist to assess different parts of your financial life and note any major changes.

4. Tax loss deadline

You have until December 31 to harvest any tax losses and/or offset any capital gains. It may be advantageous to time sales in order to maximize tax benefits this year or next. We may also want to book gains and offset with any losses.

But be aware that short- and long-term capital gains are taxed at different rates, and don’t run up against the wash-sale rule (IRS Publication 550) that could disallow a capital loss.

A wash sale occurs when you sell a security at a loss and then purchase that same security or “substantially identical” securities within 30 days, either before or after the sale date. (See Schwab: “A Primer on Wash Sales”)

5. Mutual funds and taxable distributions

This is best described using an example.

If you buy a mutual fund on December 15 and it pays its annual dividend and capital gain on December 18, you will be responsible for paying taxes on the entire yearly distribution, even though you held the fund for just three days.

It’s a tax sting that’s best avoided because the net asset value hasn’t changed. It’s usually a good idea to wait until after the annual distribution to make the purchase.

6. Required minimum distributions

RMDs are minimum amounts the owner of most retirement account must withdraw annually.

Please note that the CARES Act eliminated the RMD requirement in 2020. But let’s go through RMD requirements at a high level.

The SECURE Act made major changes to RMD rules. If you reach age 70½ in 2020 or later you must take your first RMD by April 1 of the year after you reach 72 (IRS: Retirement Plan and IRA Required Minimum Distributions FAQs). Some plans may provide exceptions if you are still working (IRA FAQs: Required Minimum Distributions).

If you reached the age of 70½ in 2019 the prior rule applies.

For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31.

While delaying the RMD until April 1 can cut your tax bite in the current year, please be aware that you’ll have two RMDs in the following year, which could bump you into a higher tax bracket.

The RMD rules apply to all employer-sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs and SIMPLE IRAs.

They do not apply to ROTH IRAs.

Don’t miss the deadline or you could be subject to a steep penalty.

7. Contribute to a Roth IRA or traditional IRA

A Roth gives you the potential to earn tax-free growth (not just deferred tax-free growth) and allows for federal tax-free withdrawals if certain requirements are met.

You may also be eligible to contribute to a traditional IRA. Contributions may be fully or partially deductible, depending on your income and circumstances. Total contributions for both accounts cannot exceed the prescribed limit.

There are income limits, but if you qualify, the annual contribution limit for 2019, 2020 and 2021 is $6,000, or $7,000 if you’re age 50 or older.

You can contribute if you (or your spouse if filing jointly) have taxable compensation.

For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.

For 2019, if you’re 70½ or older, you can't make a regular contribution to a traditional IRA. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age (IRS: Retirement Topics-IRA Contribution Limits).

You can make 2020 IRA contributions until April 15, 2021 (Note: statewide holidays can impact final date).

8. College savings

A limited option called the Coverdell Education Savings Account (ESA) allows for a maximum contribution of $2,000. It must be made before the beneficiary turns 18. Contributions are not tax deductible.

Distributions are tax free if used for qualified education expenses. But beware of income limits (IRS: Coverdell Education Savings Accounts).

Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individuals modified adjusted gross income for the year is less than $110,000. For individuals filing joint returns, that amount is $220,000.

A 529 plan allows for much higher contribution limits, and earnings are not subject to federal tax when used for the qualified education expenses of the designated beneficiary.

As with the Coverdell ESA, contributions are not tax deductible.

9. Charitable giving

Whether it is cash, stocks or bonds, you can donate to your favorite charity by December 31, potentially offsetting any income. 

Did you know that you may qualify for what’s called a “qualified charitable distribution (QCD)” if you are over 70½ years old?

A QCD is an otherwise taxable distribution from an IRA or Inherited IRA that is paid directly from the IRA to a qualified charity [Fidelity:“Donating to a charity using a qualified charitable distribution (QCD) ”].

A QCD may be counted toward your RMD, up to $100,000. If you file jointly, you and your spouse can make a $100,000 QCD from your own IRAs.  This becomes even more valuable in light of tax reform as the higher standard deduction may preclude you from itemizing.

You might also consider a donor-advised fund. Once the donation is made, you can generally realize immediate tax benefits, but it is up to the donor when the distribution to a qualified charity may be made.

Rebalancing may be a taxable event. Before you take any specific action be sure to consult with your tax professional.

Converting from a traditional IRA to a Roth IRA is a taxable event. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

Investors should also consider whether the investor's or beneficiary's home state offers any state tax or other benefits available only from that state's 529 Plan.  Any state-based benefit should be one of many appropriately weighted factors in making an investment decision.  The investor should consult their financial or tax advisor before investing in any state's 529 Plan.

Generally, a donor advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor's representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. Donors take a tax deduction for all contributions at the time they are made, even though the money may not be dispersed to a charity until much later.

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