by Samantha Pahlow, AWMA®, CTFA
Senior Vice President
Portfolio and Wealth Management
2020 has been a unique year, to say the least. It has been a wild ride of politics, pandemics, and social unrest. We know that most of us are happy to see an end to this year and look forward to a fresh start in 2021. With that in mind, let’s review some typical year-end reminders as well as ones that are unique to this year. We suggest you take a minute to review this list and, if any topics apply to your situation, discuss them further with your tax, legal, and investment advisors. Although many deadlines are December 31, addressing them soon could alleviate any last-minute angst you may encounter.
Estate Planning — It’s good practice to at least briefly review your estate plan annually. At a minimum, check to see if any major changes have occurred in your goals and the key decision makers in your plan. Additionally, it might be time to employ estate tax planning strategies. We are currently in what many estate planners call, “the golden age of estate planning.” We have a historically high lifetime estate tax exclusion of $11,580,000 per person, low interest rates and many estate tax strategies that work well in the current environment.
This generous exemption is scheduled to fall by more than 50 percent in 2026, but could change sooner depending on future legislation and changes in Congress. For families with taxable estates, this may be the time to take advantage of the high exemption by considering straightforward strategies such as outright gifts to children or grandchildren, or to utilize more complex strategies that take advantage of the low-interest environment, such as grantor retained annuity trusts (GRATs), which provide an income stream to the owner for a period of time and leave the growth to the next generation.
Annual Gift Exclusion — For 2020, each individual can give away $15,000 per recipient without incurring federal gift taxes or using up any portion of their $11,580,000 lifetime transfer tax exemption. This can be an effective way to reduce your taxable estate. Keep in mind that these gifts need to be received and deposited by the recipient by December 31 in order to qualify.
Charitable Tax Planning — This year, the CARES Act brought significant changes to charitable giving tax rules. For example, in 2020 only, charitable donations of cash to public charities (not including donor- advised funds and supporting organizations), can be deducted up to 100 percent of your adjusted gross income (AGI). But, remember with the increased standard deduction many taxpayers find that their typical annual charitable giving does not provide an additional tax benefit. It is important to work with your tax advisor to determine whether charitable tax strategies, such as bunching multiple years of giving into a single calendar year, using a donor-advised fund or making qualified charitable distributions (QCDs) from your traditional IRA, would increase the tax savings associated with your charitable giving.
Gifts May Take Time — Timing is very important for charitable donations made near year-end. As a general rule, a charitable donation is deductible in the year it is delivered to the charity. While transfers of cash can be completed relatively quickly, it is often more tax efficient to donate appreciated assets. And, depending on the type of assets being donated, the method of delivery, and institutions involved, it is often necessary to organize and complete such gifts in early December, allowing ample time for processing and delivery to the charity.
Required Minimum Distributions — Many changes have occurred with respect to required minimum distributions (RMDs) recently. Starting with the SECURE Act in late 2019, which changed the beginning age for taking RMDs to 72 (from 70 ½). Then, in March of 2020, the CARES Act was passed, allowing retirees to skip their RMD for the year 2020. Most individuals who could afford to, chose to skip their RMD for the year, lowering their taxable income and allowing those funds to accumulate inside their IRA for longer. If you skipped your RMD, remember that you will be required to restart your required distributions in 2021. Work with your portfolio manager and other financial institutions to reschedule those distributions.
Roth IRA Conversions — We currently have some of the lowest tax brackets in history, and many retirees find themselves in lower tax brackets due to skipping their 2020 RMD. If you are in a low tax rate year, and expect your rates to rise in the future, you should consider partial conversions of a tax-deferred retirement account to a Roth IRA. Although the conversion will create taxable income in the year of conversion, it can result in long-term tax savings by paying tax at a lower rate in the conversion year than you would on distributions in a future year. This strategy should also be considered any time you will have uniquely low tax year, such as when making a large charitable contribution, are between jobs, or recently retired and not yet claiming Social Security.
Maximizing Contributions to Retirement Plans — While contributions to traditional IRAs and Roth IRAs can be made up until April 15 of 2021, employee contributions to many employer-provided retirement plans, such as 401(k)s, 401(a)s, 403(b)s, and SIMPLE IRAs, must be made by December 31. Review your year-to-date contributions and consider increasing your deferral to reach the maximum allowed contribution by your final paycheck. Be sure to also determine whether any after tax Roth contributions are allowed by your plan. Unlike a standard Roth IRA, higher income will not disqualify contributions to workplace Roth accounts.
Health Savings Accounts — Contributions to health savings accounts (HSAs) must be made by April 15 of the following year. If you have a high-deductible healthcare plan, you may be eligible to open and fund an HSA even if your employer doesn’t sponsor one as a part of their benefit package. These accounts are unique in that they can be triple-tax free. Contributions are deductible (up to annual limits), the funds grow tax-free, and withdrawals are tax-free when used for eligible medical expenses.
Flexible Spending Account Funds — Unlike funds in HSAs, flexible spending account (FSA) funds don’t rollover from year-to-year. Each plan is unique, but generally they are a use-it-or-lose it account and qualified expenses often need to be incurred by December 31. It is not uncommon to overlook funds set aside in FSA accounts, so take a moment to confirm the deadline for your FSA, review any outstanding balances, and plan to use them up before year-end.
529 Plans — If you are planning for the education of children or grandchildren, consider making an annual contribution to a 529 plan. Many states offer a tax benefit in the form of a deduction or credit for contributing to a 529 plan. Some states allow you to make a larger contribution up front and carry the benefit forward to subsequent years. Review the rules for your state plan and consult with your tax advisor to confirm the state tax benefit available.
Strategizing With Your Tax Advisor and Portfolio Manager — Income tax rates, capital gains tax rates, the taxation of Social Security and Medicare premiums are all affected by levels of income. Depending on your circumstances, you may benefit from harvesting capital losses or even accelerating capital gains as part of a multiyear tax and investment strategy. It is also a good time to evaluate your projected income tax brackets for the years ahead and ensure your investment portfolio, specifically your fixed income investments, are designed for the best after-tax return.
Aggressive income tax planning may be in order for those who expect to realize significant capital gains tax and have over $1 million in income. President-elect Biden’s current tax proposal includes taxing capital gains as ordinary income for those with over $1 million in adjusted gross income (AGI). Of course, we don’t know if this tax policy will ultimately be implemented, but an increase from the top current capital gains tax rate of 20 percent to 39.6 percent (both subject to an additional 3.8 percent net investment income tax) has grabbed the attention of investors and their tax professionals.
Discussing these topics and any other changes in your financial situation with your tax advisor and investment professionals will allow them to review and make adjustments if necessary. Exploring these options now rather than waiting until year-end could make your holidays less hectic.
Ferguson Wellman and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.