Elections come and go, as does our leadership in Washington D.C. But one thing that doesn’t change is the opportunities for savings that can be realized by making shrewd financial and tax moves at this time of year.
Here are 5 moves to consider as you plan year-end financial and tax strategies for this year.
1. Rethink income shifting strategies. The traditional advice is to defer income into the following year in order to reduce income taxes for this year. But if it’s likely that income tax rates will rise in the future, it may be beneficial to do the opposite: Accelerate income into the current tax year. Given the election results, this might be the preferred strategy for 2020, especially for taxpayers in the highest tax brackets.
You can do this by recognizing deferred compensation or capital gains, exercising stock options or converting a traditional IRA to a Roth IRA before December 31. Roth IRA conversions may enable retirees to realize income at lower tax brackets than if they wait until they’re claiming Social Security benefits and taking required minimum distributions (RMDs).
2. Finalize charitable giving strategies. Remember that the CARES Act raised the charitable deduction limit for cash contributions to public charities from 60% of AGI to 100% of AGI for tax year 2020. And if you’re 70½ years of age or over, you can still make a qualified charitable distribution (QCD) of up to $100,000 to one or more qualified charities. Making a QCD will allow you to realize the tax benefits of charitable donations without itemizing deductions on your tax return.
Also consider creating a donor-advised fund (DAF) and funding it with appreciated securities you’ve owned for more than one year instead of cash. The booming stock market could make this an especially appealing strategy this year. You can deduct the fair market value of the securities on your 2020 tax return and also avoid paying capital gains taxes on the appreciation. Alternatively, you could sell securities that have declined in value this year to create capital losses that can offset capital gains and donate these proceeds to charity.
3. Make additional retirement plan contributions. This is not only a great way to boost your retirement savings — it could also garner valuable tax deductions. 401(k) deferrals reduce current AGI, which lowers current income taxes, while you might be able to deduct IRA contributions if you meet certain conditions.
For tax year 2020, you can contribute up to $19,500 to your 401(k), or $26,000 if you’re 50 years of age or over. And you can contribute up to $6,000 to a traditional IRA this year, or $7,000 if you’re 50 years of age or over. 401(k) contributions must be made by December 31 of the current year; however, IRA contributions can be made as late as April 15th of the following year.
4. Max out your Health Savings Account (HSA) for the year. If you have additional funds after making retirement plan contributions, consider devoting them to your HSA. For tax year 2020, you can contribute up to $3,550 to your HSA, or $7,100 for your entire family. If you’re 55 years of age or over, this amount is increased by $1,000. Unlike 401(k) contributions, which must be made by December 31, HSA contributions can be made as late as April 15th of the following year (similar to IRA contributions).
5. Watch out for mutual fund distributions. Mutual funds typically distribute most of their net realized capital gains toward the end of the year. If you intend to purchase mutual funds in a taxable account before the end of the year, first find out if the fund is planning a large capital gains distribution before year-end and the date of the distribution. If so, the distribution may be subject to tax in 2020 if the fund is held in a taxable account, which could result in a big tax hit this year.
In this case, it might be wise to wait until after the date to qualify for the payout to invest in the fund. Or, purchase the fund in a tax-advantaged account like a 401(k) or IRA. You won’t pay taxes on dividends or capital gains distributions in the year they’re received as long as the funds remain in the tax-advantaged account.
Be sure to consult with your tax professional and financial advisor about these and other year-end financial and tax planning strategies.