As 2020 comes to an end, here are 9 planning moves to consider. These won't apply to everyone but there may be a few that make sense for you.
Investment and Financial Planning
1. Review your income or portfolio strategy. Are you reaching a milestone in your life such as retirement or a major change in your personal circumstances such as the birth of a child or grandchild or a divorce or the loss of a spouse? 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 this volatility in stride, or feel any uneasiness? A pandemic, record high unemployment, 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. We do this by having a comprehensive financial and investment plan and utilizing a disciplined investment approach.
History and my own experience in this industry tells me that the shortest distance between an investor and reaching their 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. Unless #4 applies.
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.
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”) https://www.schwab.com/resource-center/insights/content/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.
This rule doesn't apply to retirement accounts such as IRA's.
6. Required minimum distributions (RMDs) are minimum amounts the owner of most retirement accounts must withdraw annually.
Please note that the CARES Act eliminated the RMD requirement in 2020. But let’s go through RMD requirements at a higher 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. Some plans may provide exceptions if you are still working where the plan is.
If you reached the age of 70½ in 2019 the prior rule applies where you must take your first RMD by April 1 of the year after you reach 70 1/2.
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. Note: Inherited Roth IRA's (and other inherited retirement plans) to a non-spouse are subject to the new rules where there is no RMD per se but rather the whole account needs to be empty by the 10th year after the date of death. There are some potential tax planning opportunities here so best to speak with a Certified Financial Planner™ practitioner if this applies to you.
In any event, don’t miss the deadline or you could be subject to a steep 50% 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. In fact, you can contribute on behalf of your spouse even if they aren't employed.
For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs. Working past 70? You can still contribute.
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). https://www.irs.gov/taxtopics/tc310
Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual’s 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 on the federal level.
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)”]. https://www.fidelity.com/learning-center/personal-finance/retirement/qcds-the-basics#:~:text=A%20QCD%20is%20a%20direct,excluded%20from%20your%20taxable%20income.
A QCD may be counted toward your RMD, up to $100,000. If you file jointly, you and your spouse can each 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.
Hopefully, you’ve found these planning tips to be helpful. Please feel free to reach out if you have any questions, or check in with your tax advisor.
This blog article is basic in nature and should not be misconstrued as tax or legal advice.
As always, please feel free to reach out to me anytime for a conversation. Click HERE to see my calendar or just shoot me an email or give me a call.
In good health.
All the best.
Rick Fingerman, CFP®
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.