2020 has been an extremely challenging year: a world-wide pandemic, a significant correction in global equity markets, and changes to how we live our lives. In response to these challenges, the U.S. Government and Federal Reserve took unprecedented steps to stabilize the U.S. economy, resulting in numerous changes and adjustments to the tax code.
With so many moving pieces at play in 2020, year-end tax planning feels especially important this year. And it’s with this in mind that we wanted to share five year-end strategies that should be on the radar of almost every client that we work with.
Regardless of how 2020 has been for you and your loved ones, the team at Strategic Wealth Partners remains ready to support your financial well-being. If you have any questions about the information covered in this article, please reach out to our team.
#1: Reduce and Defer Capital Gains, Where Possible
If you’ve realized capital gains this year, here are some strategies to consider that could offset gains and reduce your tax burden.
When asset prices were down in April, some clients took advantage of the opportunity to tax-loss harvest, and in July, we reiterated the importance of tax-loss harvesting during periods of market volatility. Even though the market has recovered from March lows, tax-loss harvesting can still be an important way to offset capital gains from the year.
Capital Gains Distributions
Throughout the year, many mutual funds will sell assets and realize capital gains. These gains are then distributed to investors and treated as taxable income. Funds tend to publish estimated distribution amounts ahead of time (usually by early December), and we suggest reviewing the expected distribution in order to decide if you’d rather sell the fund before the distribution date to avoid the additional tax hit. Don’t worry! Your team at Strategic Wealth Partners will be reviewing this on your behalf!
#2: Take Advantage of Strategic Gifting
Strategic gifting can be an important part of lowering your tax burden, and it can be broken down into two categories: family gifting and philanthropic gifting.
Family gifting allows individuals to gift up to $15,000 in cash or assets to a single recipient each year without affecting their lifetime gift tax exemption. In other words, a married couple with three children could gift $90,000 to their children in a single year ($15,000 per parent to each child). For people with taxable estates, these annual exclusion gifts are an incredibly useful strategy for transferring wealth without incurring estate taxes.
Markets have rebounded to all-time highs since correcting in March and April, so now is a great time to gift appreciated securities to charity and take advantage of the tax benefits of strategic gifting. Additionally, as my colleague Jill Kaz recently discussed in great detail, RMDs are not required for 2020. If you had already planned to take an RMD in 2020, you might want to consider whether it still makes sense to make a charitable distribution from your IRA this year.
#3: Consider a Roth Conversion
When you move tax-deferred assets into a Roth account, the amount transferred counts toward your ordinary income in the year of the conversion. Depending on the amount transferred, the additional tax burden can be significant; however, the benefit is that by paying taxes now, you have the advantage of letting the funds grow tax-free within the Roth account — and you won’t have to pay taxes on future distributions.
Many of our clients have seen their 2020 income dip due to business closures caused by COVID-19. The upside, however, is that a low-income year can be a great opportunity for a Roth conversion. Since Roth conversions count toward your ordinary income for the year, a conversion may make more sense in 2020 when your income — and your tax rate — is lower than usual. Since RMDs are not required this year, it may also make sense to withdraw your normal RMD amount and move it to a Roth account.
#4: Review Employee Benefit Plan Contributions
401(k), 403(b), or similar plans
The maximum contribution to a 401(k) in 2020 is $19,500 ($26,000 for individuals age 50 and older), so if you’re below that threshold, now can be a good time to make up the difference and lower your taxable income for the year.
Health Savings Account (HSA)
If your employer offers a high-deductible health plan, you may want to consider funding a Health Savings Account, or HSA. An HSA can be used in a similar manner as an IRA, in that contributing to an HSA reduces your taxable income by the amount of your contribution (up to $3,550 per year for individuals or $7,100 for families, plus an additional $1,000 for individuals over the age of 55).
#5: 529 Plan Contributions
If you have children or grandchildren planning for college, a 529 college savings plan can help fund their education while reducing your tax burden for the year. 529 contributions grow tax-free, and they can be withdrawn tax-free as long as the funds are used for qualified education expenses. The tax benefits vary by state, but Illinois residents can deduct up to $10,000 ($20,000 for joint filers) per year from their state taxes by funding Illinois-sponsored 529 plans.
There is some uncertainty about the tax landscape as we head into 2021, largely because it is still unclear which party will control the Senate through 2022. If Democrats win both runoff elections in Georgia, they will have control of the Senate, White House, and House of Representatives. This could alter the tax landscape. However, just as we said leading up to the elections on November 3rd, we advise our clients to plan according to their current financial situation, rather than guessing what may or may not happen in January and beyond.
If you have any questions about implementing the strategies mentioned above, or if you would like a custom consultation on year-end planning, we invite you to connect with the team at Strategic Wealth Partners.