Wealth Planning

Key Year-End Planning Considerations


By Jody R. King, JD, CPA

Vice President & Director of Financial Planning

2020 and 2021 Sign

November 10, 2020

This year has truly been a year like no other in so many ways. But, as like other years, the approaching year-end presents an opportunity to reassess your tax and financial circumstances while taking control of your finances. Below, you will find 11 year-end planning tips to consider over the next few weeks:

1. Recognizing Losses and Taking Gains

Year-end is an opportune time to consider revisiting your capital gains budget for the year, especially in light of the equity markets’ success and recent volatility. Most years if your portfolio contains unrealized losses it can make sense to recognize some of those losses to decrease your overall current-year capital gains tax burden. Recognizing capital losses to offset recognized capital gains, referred to as “loss harvesting,” is an important strategy to consider at year-end. However, if you believe your capital gains tax rates may be higher in 2021 than they are this year, you may want to defer the recognition of losses until January, all while recognizing more long-term capital gains this year.

Your portfolio may include positions that have embedded capital losses, but continue to be good long-term investments. If you are considering selling those holdings now in order to recognize capital losses, you must observe a 30-day window between purchase and sale activity in order to recognize the loss. Complexities such as this demonstrate that it is important to consult your tax and investment advisors to ensure that you follow the required rules and maintain the appropriate market exposures when executing loss harvesting.

2. Itemized Deductions or the Standard Deduction

After the 2017 Tax Cuts and Jobs Act (the Act) fewer taxpayers are itemizing deductions on their individual income tax returns. This is the result of changes to both the standard deduction and to the itemized deduction rules. The 2020 standard deduction is $24,800 for a couple that is married filing jointly, $18,650 for head-of-household, and $12,400 for individuals. In order to benefit from itemizing, deductions must exceed the appropriate standard deduction amount. Now that the deduction for state and local income and real estate taxes is limited to $10,000, the additional amount to reach the threshold can be a combination of deductible medical, charitable, and mortgage interest amounts. Remember that home equity interest is only deductible if the loan proceeds were used for residential acquisition or capital improvements, and are subject to the overall home loan debt limit of $750,000 for residential debt incurred after December 15, 2017, and $1 million for pre-existing debt. The threshold for deducting medical expenses is 7.5% of Adjusted Gross Income (AGI) for 2020 but returns to 10% in 2021.

Keeping an eye on political developments is warranted when making any decisions to accelerate potential itemized deductions into 2020. If it appears that the Democratic proposal to limit itemized deductions to a 28% tax rate benefit could be enacted in 2021, and if your 2020 tax situation would provide you with a tax benefit in excess of that rate, then you may wish to more aggressively accelerate deductions even if you believe your marginal tax rate will be higher in 2021.

3. Philanthropy

This analysis also applies if you are charitably inclined and are considering accelerating significant charitable contributions into 2020. Under the CARES Act, if you will not be itemizing in 2020, you can make a $300 charitable cash contribution directly to a charity to receive an “above-the-line” deduction resulting in a reduction of your AGI. In addition, if you are over age 70½, you can make qualified charitable contributions (QCD) from your traditional IRA of up to $100,000 even though you were not required to take a required minimum distribution (RMD) for 2020 under the CARES Act. By making a QCD before year-end, you reduce the value of your IRA, which in turn reduces the amount of your 2021 RMD. QCDs cannot be made to donor-advised funds or most private foundations.

Although donations of appreciated securities held for more than one year continue to be a tax-advantaged way to make charitable gifts, the CARES Act presents a new opportunity where up to 100% of AGI can be deducted when cash gifting strategies are utilized. This enhanced deduction limit is not available for gifts to donor-advised funds or supporting organizations, which are still limited to 60% of AGI for cash gifts and 30% of AGI for appreciated securities.

If you are itemizing this year but may not be in future years, consider “gift bunching” by accelerating what would be your 2021 or later years’ charitable gifts to 2020. If you are not ready to have the amounts gifted pass to charities immediately, you could also consider contributing to a donor-advised fund, which may allow you to receive the current-year tax deduction while retaining the ability to request that the donated funds be distributed to qualified charities during future years.

Learn More: Minimizing Taxes with Charitable Gift Bunching

Learn More: Fiduciary Trust’s Donor-Advised Fund Program

As always, it is important to consider the various AGI percentage limitations that apply to the charitable deduction in planning your charitable giving.

4. Tax Projections and Estimated Tax Payments

Review your 2020 income and itemized deductions to be sure you have paid in sufficient amounts, either through withholdings, estimated tax payments, or prior year refunds carried forward, to avoid tax penalties. If you are planning to make estimated tax payments, the fourth quarter 2020 payments are due on or before January 15, 2021.

5. Fully Fund Your 401(k)

While working, it is advisable to fully fund your 401(k) or similar retirement plan each year. Doing so will benefit you in the long run by maximizing retirement savings that grow either tax-deferred or tax-free and may help decrease your current tax liability. Even if your cash flow will not allow you to fully fund your plan, making contributions to at least maximize any available employer matching program is compelling. Maximum 401(k) contribution limits for 2020 and 2021 are $19,500, with those who are over age 50 allowed to contribute an additional $6,500. Depending on your situation, you may want to consider taking advantage of a Roth 401(k) feature if offered by your employer. Utilizing a Roth 401(k) will likely result in higher current income taxes, but will provide you with tax-free, as compared to tax-deferred, appreciation on any retirement savings contributed to your Roth 401(k).

If you do not have a 401(k) or are already fully funding your 401(k), consider funding an IRA. The $6,000 IRA contribution limit will apply for both 2020 and 2021, with an additional $1,000 contribution allowed in both years for those over age 50 by year-end. A non-working spouse with an employed partner can also fund their own IRA, subject to taxable compensation requirements.

If you are eligible, consider funding a Roth IRA instead of a traditional IRA. Roth IRAs grow tax free and are not subject to RMDs, compared to traditional IRAs that grow tax deferred and are subject to RMDs once you reach age 72. Please note that all 2020 traditional IRA and Roth IRA contributions must be made by April 15, 2021.

6. Roth Conversions

Although it may never seem like an appropriate time to pay additional ordinary income taxes, paying taxes currently to convert all or part of your traditional IRA or previous-employer 401(k) accounts to a Roth IRA is something to consider. If you believe you will be subject to higher tax rates in the future, you may be better off converting some or all of your traditional IRA to a Roth this year. In exchange for paying taxes today on amounts converted, Roth IRA assets grow tax free and are not subject to RMDs, which generate ordinary income, during your lifetime. Over an extended period of time this benefit can be significant, especially in a higher income tax rate environment. A Roth IRA also creates an income tax free asset that can pass to heirs if the assets are not needed during your lifetime. If you are taking advantage of a Roth 401(k), you should consider at least a minimally funded Roth IRA conversion to start the five-year clock that can allow access to the tax-free growth. Year-end is an excellent time to review your projected ordinary income for the year and understand the projected tax impact of any conversions based on where your actual taxable income is projected to fall within the marginal tax brackets structure. Please note that Roth conversions can no longer be recharacterized, or reversed, once completed.

7. Annual Exclusion Gifts

If you have sufficient assets, and if transferring wealth to the next generation is a goal in your overall wealth plan, you should consider making annual exclusion gifts before year-end. Annual exclusion gifts can be a powerful wealth transfer technique over time. Each calendar year an individual can give up to $15,000 to as many individuals as he or she chooses without utilizing any of his or her lifetime gift and estate tax exemption amount (currently $11.58 million.) That $15,000 combines to $30,000 for married couples who either make separate gifts or choose to “gift split.”

Contributions to a family member’s Section 529 Plan for education can be made with annual exclusion gifts. In fact, you can front load a 529 Plan and elect to spread the gift ratably over a five-year period when you file your gift tax return. If you have a 529 Plan and have incurred unreimbursed qualified educational expenses, you should request reimbursement from the plan before the end of the year. Also remember that up to $10,000 of elementary and secondary school tuition costs can be reimbursed from a 529 Plan each calendar year.

Learn More: Paying for College

In addition to the annual exclusion gifts noted above, an individual can also pay tuition expenses and qualified medical expenses directly to the provider without creating a taxable gift. Tuition includes the cost of education from preschool through graduate school, but does not include non-tuition charges such as room and board or books. Qualified medical expenses include health insurance premiums.

8. Wealth Transfer Beyond Annual Exclusion Gifts

If you have significant assets, you should establish a comprehensive wealth transfer plan that incorporates asset transfers both during your lifetime and at your death. This plan can include outright gifts or loans to family members as well as to your philanthropic interests. If you plan to eventually transfer assets into irrevocable trusts, now may be an appropriate time to begin working with your advisors to draft a well thought out trust with appropriate parties named as trustees. The current $11.58 million lifetime gift and estate tax exemption includes $5.79 million of basic exemption and $5.79 million of “bonus” exemption, with the “bonus” portion scheduled to sunset on December 31, 2025. Once again, keeping an eye on political developments is recommended here as these higher limits could be reduced sooner by Washington. With this in mind, it makes sense to establish a wealth-transfer plan, even if you choose not to execute it immediately, so that you are ready to move forward quickly if it does appear the laws are likely to change as it may be to your family’s financial benefit to transfer significant wealth this year under the known higher exemption amounts.

Learn More: Wealth Transfer in a Low Rate Environment

9. Health Plan, Health Savings, Flexible Spending, and Other Elections

The open enrollment period for Medicare plans, as well as that for most employer-based benefits, often occurs during the last few months of a calendar year. Taking a moment to make sure your current elections are your best options for next year can be time well spent.

If you have a high-deductible health insurance plan, make sure you are fully funding your Health Savings Account (HSA). Funds put aside in an HSA do not need to be spent in that calendar year, but can instead be invested and used for future medical expenses. The HSA limit for 2021 is $3,600 for individuals and $7,200 for families. If you are over age 55, you can contribute an additional $1,000 whether for an individual or family HSA. Please note that if an individual is over age 65 and enrolled in any part of Medicare, he or she is not eligible to contribute to an HSA.

In addition to making contribution elections for 2020 for either Health and/or Dependent Care Flexible Spending Accounts (FSAs), you should review the funds remaining in your FSA account and submit the necessary receipts for qualifying reimbursable expenses. Some plans allow you to carry balances forward to the new calendar year for future expenses, but others do not. Amounts remaining beyond the allowable carryforwards will likely be forfeited, so it is important to properly manage both the use of funds currently in your FSA as well as elections for future contributions. Maximum contributions to a Health Care FSA and Dependent Care FSA for 2021 are $2,750 and $5,000, respectively. If you have an HSA, please also make sure your Health Care FSA is HSA-compatible. An HSA-compatible Health Care FSA will generally limit reimbursement to items related to dental or vision expenses.

10. Estate Planning Documents and Beneficiary Designations

Year-end is also a good time to review your estate planning documents, including your will, revocable trust, healthcare proxy, and durable power of attorney, to be sure that the trusted parties named in the documents are still appropriate to serve and that the document terms reflect your current wishes. In addition, it is a good time to review your beneficiary designations to make sure any IRA, 401(k), or insurance policies name your recipients of choice. You should consider whether changes to the inherited IRA payout rules warrant a change to either your beneficiary designations or to the terms of any trust that is named as the beneficiary of your IRA or 401(k). In addition, it is recommended that you request inforce illustrations for any permanent life insurance products that you may own, so you can review the financial health of your policies.

Learn More: Naming a Trust as IRA Beneficiary

11. Wealth Planning Checkup

Most families are not fully aware of how much they spend. Year-end is an excellent time to review annual credit card, bank, and other statements in order to understand your current spending and assess how that fits in with your overall financial health. If you have debt, year-end can be a great time to review how you are managing your debt.  If you have significant upcoming expenses, such as college tuition, year-end is an appropriate time to make sure you are on track to meet your funding goals.  It is also an appropriate time to review your credit reports from the three major credit reporting agencies and consider freezing your credit.  We find that our clients benefit from working with us to establish a wealth plan. This is a good opportunity to gather information to facilitate the preparation of a plan, with the goal of creating a basis from which you can make informed decisions.

Learn More: Identity Theft: What You Don’t Know Can Harm You

Learn More: Wealth Planning: Is Your Financial House in Order?

As you consider your year-end tax and wealth planning, we encourage you to consult with your tax advisor to review the specifics of your situation. As always, you should also feel free to discuss these planning opportunities with your Fiduciary Trust officer. Please contact us if you would like to be introduced to one of our officers.

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Disclosure: The opinions expressed in this article are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute investment, legal, tax, or accounting advice and clients should discuss any proposed arrangement or transaction with their legal or tax advisors.

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