By Greg Hart, CFP®
As we quickly approach the end of 2020, it’s time to wrap up some loose ends and set yourself up for the new year. One of those loose ends is your taxes. Even though taxes are far from festive, proactively planning can save you money, and that’s cause for celebration! Here are some year-end tax strategies that you may benefit from.
Harvest Your Tax Losses
The IRS allows investors to offset their capital gains with similar capital losses. If you happen to be holding a losing investment, now might be a good time to sell it so that you can use the loss to offset your capital gains for this year and, therefore, lower this year’s tax bill. Also, be mindful of short term versus long term gains and losses. To figure your capital gains for the year, match short-tern gains against short-term losses and then match up long-term gains against long-term losses. Then net the short-term and long-term gains/losses to see where you stand so far for 2020. Remember, you can use $3,000 of net capital losses to offset ordinary taxable income, so that’s a number to focus on. If you have larger than $3,000 in losses, the remainder can be “rolled over” and used against gains and income in future tax years. Also remember, investors in the lowest tow tax brackets pay no capital gains on long term gains, so there may be planning opportunities therein.
Contribute To Charity
Contributing to charity can lower your tax bill if you itemize your deductions. And it doesn’t have to be just money that you donate. Clean out your closet and kitchen cabinets and take a box over to your local 501(c)(3) thrift store. As long as they give you a receipt for the donation, you will be able to itemize and deduct whatever the fair market value is for the items.
If you have appreciated stock, you can get an even greater benefit by donating it to charity. You get to deduct the fair market value of the stock as a charitable contribution and the charity is not liable for the capital gains.
Open A Donor-Advised Fund
With the new, higher standard deduction created by the Tax Cuts and Jobs Act, many of those who are charitably inclined are considering donor-advised funds. Donor-advised funds work as charitable giving savings accounts where you get a deduction when you put the money into the fund, not when you distribute it to a charity.
If your itemized deductions are close to the standard deduction, you’ll need to hurry, but you can open a donor-advised fund before year-end and put a large sum of money into it in 2020. You get to take the tax deduction for this year but hand the money to charities next year, at your leisure. Then, in 2021, you may not have deductions for your charitable giving, but you can still take the standard deduction.
Convert Funds from Your Traditional IRA to a ROTH IRA
If you have lower income than normal in 2020, then it might make sense to convert some or all of your traditional IRA to a ROTH IRA. In doing so, you would pay the income taxes on the money now, at your 2020 rates, so that you could take all withdrawals tax-free in retirement. The great thing is there are no limitations to this conversion.
Another benefit of having your money in a ROTH account is that it is not subject to required minimum distributions as discussed above. Once your money is in a ROTH IRA, you can leave it in there to grow as long as you’d like.
Take Advantage Of Your HSA
If you have access to a health savings account (HSA) with your high-deductible health plan, you can enjoy triple-tax savings with no federal income tax, no state or local taxes, and no Federal Insurance Contribution Act (FICA) taxes. Your contributions are tax-deferred and withdrawals are tax-free for medical expenses.
Since your balances roll over from year to year, you can max out the account without worrying about using it up right away. For 2020, the contribution limit is $3,550 for an individual and $7,100 for a family, with a $1,000 catch-up bonus for those over 55.
If you have a college student, consider paying next term’s tuition before December 31. Any tuition you pay for the first four years of undergraduate study is eligible for the American Opportunity Tax Credit. This can save you up to $2,500 per student on your tax bill depending on your expenses and income. (1) If you are the one doing the studying, you may be eligible for the Lifelong Learning Credit. (2)
Contribute To A 529 Plan
If you’re still working on saving for your children’s college education, then you may benefit from putting some money into a 529 plan before the year’s end. This won’t help with your federal tax bill, but it might lower your state taxes. Many states allow deductions for contributions to the state’s 529 plan and some even allow them for contributions to other plans. (3)
Empty Your Flexible Spending Account
Flexible spending accounts are provided by your employer to allow you to make qualified dependent and healthcare payments pre-tax. However, they are “spend it or lose it” accounts where you can only roll over $500 from one year to the next. If you have a flexible spending account, make sure to spend the money before December 31 or double-check your plan’s rollover deadline so that you don’t lose it. (4)
Max Out Your Retirement Account
Another way to lower your income, and therefore your tax bill, is by deferring that income until retirement. In 2020, you can contribute up to $19,500 to a 401(k) plan, which will remove that money from your current taxable income. If you are 50 or older, your yearly contribution limit goes up to $26,000. You can put up to $6,000 in any type of IRA; $7,000 if you are over age 50.
Take Your Required Minimum Distribution
If you are 72 or older, then you are required to take minimum distributions from your retirement accounts (except Roth IRAs). In the year that you turn 72, you have until April 1 of the following year. After that, the money must come out of your account by December 31.
Normally, failure to withdraw the proper amount will subject it to a 50% penalty tax, so it’s important to make sure you take your required distributions by the end of the year. But since 2020 is far from a normal year, there are different rules. Under the CARES Act, you are not required to take RMDs in 2020. (5) Of course, if you need to take a distribution to pay your bills and maintain your lifestyle, you may, but there is no mandatory withdrawal amount.
Need Some Help?
As you can see, there are a lot of prudent steps that you can take in the last few weeks of the year, even as you celebrate the holidays. If you need help implementing any of these strategies or want to learn more about what we at Haddon Wealth Management do for our clients, call us at (856) 888-1744 or contact us online to schedule a complimentary get-acquainted meeting.
Gregory M. Hart, CFP® is the founder and managing director of Haddon Wealth Management, LLC, a registered investment advisory firm that provides comprehensive wealth management (in-depth financial planning and sophisticated investment management) for clients who value a relationship-driven approach that delivers customized solutions. Based in Haddonfield, New Jersey, Greg works with clients throughout the Delaware Valley, as well as nationwide. To learn more, connect with Greg on LinkedIn, visit our website at www.haddonwealthmgt.com, or call (856)-888-1744 to begin a discussion.