As 2020 comes to a close, we are about to close the book on a challenging year. If there is one thing the pandemic has taught us is that it pays to be prepared. While we can’t predict what may happen in the coming year, we can position ourselves to be as prepared as possible. Here is your year-end financial planning checklist with some key money moves to finish the year strong and set yourself up for success in 2021.
1. Review your spending and make a budget
For many people, the chaos of the last year has upended their budgets and spending habits. This year it’s more essential than ever to review your spending and evaluate where your money is going. It’s also time for a budget reset so you can track your spending going forward. Start by reviewing your savings or debt payoff goals and then developing a spending plan around those goals.
2. Review your savings plan and set goals for 2021
If your savings plan got off track or you had to dip into your emergency fund, set a new target for 2021. Your first priority should be to ensure your emergency fund is on track. At a minimum, you should have six months of living expenses tucked away. If you have other short-term savings goals, such as saving for a down payment on a house or car, or building an emergency fund, set the monthly goal and build it into your budget. Ideally, your savings goal is your top budget priority, meaning you set aside those funds before making any other payments. In other words, pay yourself first.
3. Top off your retirement plan
If you participate in a 401(k) plan, be sure to contribute enough to take full advantage of your employer matching contribution. You have until December 31 to make any last-minute contributions up to $19,500. If you turned 50 this year, you are eligible for an additional catch-up contribution of $6,500.
If you have an IRA, you have until April 15 to scrape enough money together to maximize your contribution up to $6,000 plus another $1,000 if you are 50 or older.
A significant change this year from the SECURE Act is the repeal of the maximum age for contributions to a traditional IRA. Effective January 1, 2020, individuals with earned income during the year can contribute to a traditional IRA regardless of their age. Whether or not that contribution is tax-deductible depends on the individual’s modified adjusted gross income (MAGI).
4. Consider a Roth conversion
If you experienced a drop in earnings in 2020, consider taking advantage of your lower tax bracket all or a part of your pretax retirement plans into a Roth IRA. You may want to consider a Roth conversion if you want more tax diversification for your retirement income, especially if the income from your retirement plans could push you into a higher tax bracket. Tax-free income from a Roth IRA also protects you against future tax rate increases, the Social Security tax on excess earnings, as well as having to make unneeded withdrawals due to the required minimum distribution rule.
You should certainly consider a Roth conversion for any old 401(k) plans you’ve left behind with a former employer.
Just be aware that if you do convert, it will trigger a tax on the conversion amount. The key is to convert just enough to avoid pushing your MAGI into a higher tax bracket. You can convert small portions as many times as you want over time.
5. Review your insurance coverages
Any changes to your financial circumstances should warrant a review of your insurance coverages to ensure they still reflect your needs. For example, a healthy housing market in many parts of the country this year pushed housing prices up. If your homeowner’s insurance coverage is based on a house valued at $350,000, and it is now worth more than $400,000, your coverage may be deficient. You should also review your coverage if you made any significant purchases, such as a new piece of jewelry or art.
If you haven’t checked your liability coverage recently, this would be a good time to do so. Typically, the liability coverage provided through your homeowner’s and auto insurance policies is limited. You should consider purchasing additional liability coverage to protect all of your assets. You can add a million-dollar personal umbrella liability policy for a couple of hundred dollars a year.
6. Review your beneficiary designations
Make sure to review all your beneficiary designations If your family circumstances have changed. That includes your retirement plans, life insurance policies, investment accounts, and bank accounts. It’s important to remember that your will is subordinate to your beneficiary designations, so make sure the two are coordinated.
This year it would be essential to update your beneficiary designation in light of the SECURE Act legislation, which eliminates the stretch provision for certain IRA beneficiaries. Previously, non-spouse beneficiaries of traditional IRAs could spread the RMD over their own life expectancies, thereby minimizing the tax consequences. The new law accelerated tax collection and now requires most non-spouse beneficiaries to distribute the entire account within a 10-year period.
The new law also affects individuals who name trusts as beneficiaries of their IRA as a way to control the distribution of assets to their heirs. Under the Act, these “see-through” trusts are also subject to the 10-year rule, rendering them ineffective and potentially costly to the beneficiaries.
A different kind of trust called an “accumulation” trust could provide a workaround because it gives a trustee the discretion to pay annual distributions to heirs or hold it in the trust. Under the 10-year rule, all IRA assets must be paid into the trust within ten years, but the trustee can spread the distributions over a more extended period, much like a stretch IRA.
7. Review or create your estate plan
It’s always a good idea to review your overall estate plan and fiduciary designations to ensure they are still aligned with your wishes. You’ll want to check on the funding for trusts, review trustee and agent appointments, review power of attorney provisions and health care directives.
You should also consider gifting opportunities to take advantage of the annual gift exclusion — $15,000 per individual and $30,000 per couple – to transfer assets and reduce your taxable estate. Keep in mind that contributions to a 529 college savings plan are considered a gift.
8. Review your investments
It was an especially volatile year in the stock market. If you managed to ride out the rollercoaster, parts of your portfolio may have done reasonably well, while other parts may be down. Use these two year-end strategies to optimize your returns while reducing your tax liability.
Rebalance your portfolio
A strong market like the one we are now experiencing can bring great returns, but it can also increase your risk if your asset allocation no longer reflects your investment profile. That’s why it’s important to rebalance your investment portfolio, including your 401(k), once a year or after there has been significant movement in the market. When you rebalance your portfolio, you are merely realigning your assets back to your target allocation to maintain your desired risk-return profile. At its simplest, you sell securities that have become overpriced and buy securities that have declined in value. If you work with an investment advisor, portfolio rebalancing is typically included in their services.
Some 401(k) plans have an automatic rebalancing feature. If your plan does not, check with your plan sponsor for tools or resources that can help you keep your target asset allocation in place.
Tax-Loss Harvesting
Tax-loss harvesting is a strategy performed within the rebalancing strategy to optimize your portfolio by deliberately creating losses. The process involves selling a stock for a loss. That generates a capital loss, which is harvested for tax purposes and used to offset any capital gains. It can also be used to offset up to $3,000 of income generated throughout the year. If your losses exceed $3,000, they can be carried forward to future years.
After the stock is sold, another stock can be purchased to take its place in the portfolio. While it’s possible to repurchase the same stock, you have to wait at least 31 days to comply with the IRS wash-sale rule. The stock cannot be “substantially identical” to the stock it is replacing.
What to do with your Health Savings Account
If you contribute to a health savings account (HSA), you benefit from triple tax savings:
- Pretax contributions saving you on taxes now
- Tax-free earnings on investments inside your HSA
- Tax-free withdrawals when they are used to pay for eligible medical expenses
This is the time to review all your medical expenses for the year to see if you are owed any reimbursements from your HSA.
Alternatively, if you plan on postponing your reimbursements to allow your HSA earnings to continue to grow tax-free, make sure your medical expenses are documented and backed by receipts. You are allowed to delay reimbursement for as long as you have the account, so if you don’t need your HSA money to cover medical expenses, you can let them stay in your account and accumulate tax-free.
What to do with your Flexible Spending Account
If you have a flexible spending account (FSA), you have until the end of the year to spend the money in your account on eligible medical expenses or lose it. Most plans allow account holders to carry $550 into the following year. However, some employers provide for a two-month extension – through mid-March – to deplete the account. Check with your employer to confirm whether it offers such a provision.
You should be checking your FSA balance now to determine how you might be able to utilize the funds to avoid forfeiture. You should also review your FSA plan rules in light of changes enacted through the CARES Act earlier in the year, which allows tax-free withdrawals for over-the-counter drugs and menstrual supplies.
9. Plan for Required Minimum Distributions
There were two significant changes made to the required minimum distribution rule. The first came with the enactment of the SECURE Act, and the second came with the CARES Act. Under the SECURE Act, individuals who reach age 70 ½ after January 1, 2020, can now wait until age 72 to begin their RMDs.
Under the CARES Act, RMDs have been waived for 2020. Anyone who took RMDs before the law was enacted in March 2020, have the opportunity to put them back into their retirement account.
10. Making charitable contributions
There are some significant changes for charitable contributions in 2020 as a result of the CARES Act. For taxpayers who don’t itemize, they may now deduct up to $300 in charitable contributions “above the line,” taken against your adjusted gross income (AGI).
If you do itemize, the AGI limit for cash contributions was increased for 2020. Individual donors may elect to deduct up to 100 percent of their AGI, up from 60 percent.
If you contribute to supporting organizations or public charities through donor-advised funds (DAF), there are no changes. You may still deduct up to 60 percent of your AGI in cash, and up to 30 percent AGI in appreciated assets contributed to a DAF.
The CARES Act also did not make any changes to IRA qualified charitable distributions (QCD). If you are over 70 ½, you can donate up to $100,000 each year from your IRA directly to a charity without having to include the distribution in their taxable income.
Any charitable contribution must be made before December 31 to be allowed as a deduction for the 2020 tax year.
11. Make sure your withholding enough from your paychecks
The IRS is constantly changing the rules on tax withholding from your paycheck. This is the time to review your tax withholding in view of what you expect to pay in taxes in 2021. You want to ensure your withholdings are enough to cover your tax liability, so you don’t have to cut a check to the IRS. You also want to ensure they’re not withholding too much. While tax refunds may seem like a good thing, they are nothing more than the repayment of an interest-free loan to the government. You are much better off investing that money on your own throughout the year.
12. Review your credit report
It’s easy to let an entire year go by without checking in on your credit. However, with identity theft on the rise, your end of year financial planning should include checking your credit report. You may have access to your credit report from one of the credit bureaus through your banking relationship, which is fine. But it’s essential to review your credit reports from all three credit bureaus, especially if you are planning for a significant borrowing event in 2021. You can contact each of the credit bureaus for a free credit report (one per year), or you can order a combined free report from AnnualCreditReport.com.
13. Protect your passwords
With identity theft and cyber fraud victimizing one in four Americans, it’s more critical than ever to shore up your defenses. Your first line of defense in preventing cyber assaults is to protect your passwords. The key is to only use strong passwords and avoid using them more than once. How do you do that? Download a password manager that remembers your passwords, so you don’t have to. Some password managers will create new passwords for you on the fly and then store them for future use.
14. Meeting with a tax advisor
Your year-end financial planning checklist should include scheduling a review with your tax advisor. In addition to discussing the items on this list with tax implications, the year-end is an ideal time to assess your overall tax situation to ensure you are properly taking advantage of the tax code. If you anticipate a change in your financial circumstances that will impact your taxes, now is the time to make the necessary adjustments to your withholdings.
15. Meeting with a financial advisor
Finally, schedule a meeting with your financial advisor to review your year-end financial planning checklist. The best and highest use of a financial advisor is not only to help you address many of the issues on your checklist but also to be your financial coach. A coach is someone who shares your goals, helps develop strategies to achieve them, and, most importantly, holds you accountable for your actions and decisions. Have that meeting before year-end to set the stage for a financially successful year in 2021.
