2020 Year-End Financial Planning You Should Be Doing Now
By David K. MacLeod, CFP, CFA
If you’re like me, you are ready for 2020 to be over. Break out the champagne, sing Auld Lang Syne, and cheer the Times Square ball drop. But it’s not even Thanksgiving, yet. And there are some year-end financial planning opportunities you can still do that could make a difference for years to come.
Here are a few ideas you can use. Be forewarned: there’s an excessive number of acronyms in the article below.
CHARITABLE GIVING
Your mailbox is probably starting to fill up with appeals from nonprofits that would like you to contribute money before year-end. Here are some things to think about as you make decisions on how to make those contributions.
Due to tax law changes in the last couple of years, most people don’t get to itemize their deductions anymore, which means that many charitable contributions don’t help reduce your taxes.
The CARES Act that Congress passed in March allowed for a new charitable deduction that can be claimed if a taxpayer takes the standard deduction. Unfortunately, the limit on this new “above the line” deduction is only $300.
Qualified Charitable Distributions
We’ve helped many of our clients preserve the charitable deduction by sending money from their IRA to fund charitable gifts. This is called a qualified charitable distribution or QCD.
Giving money to charity this way is almost always helpful if it works for you. You need to be over age 70 ½ and planning to donate no more than $100,000. As long as you’re in that situation, it’s usually better to give money to charity this way than to write checks to the charity out of your checking account.
There are other potential benefits involved with QCDs. Because the money that goes to the charity never gets reported as income, it reduces your adjusted gross income (AGI).
IRMAA Is Not A Family Friend
Lowering AGI can potentially help reduce or eliminate that nasty “tax” that the government euphemistically calls an “income-related monthly adjustment amount,” or IRMAA for short. The IRMAA applies to people the government considers high earners and can effectively double or even triple your Medicare cost.
There are other items on your tax return that must reach a percentage of your AGI to be deductible (like medical expenses, for example). Using QCDs to do your charitable giving makes it easier to climb over this floor to possibly take advantage of a medical tax deduction.
Giving Appreciated Assets
Another way to make more tax-efficient gifts is to give appreciated assets to charity, instead of giving cash. If you own a stock that you purchased over a year ago (let’s use Apple as an example) and it has gone up substantially since you bought it, giving it away and rebuying it with the cash you would otherwise have given to a charity increases your basis in the stock you’ll continue to own.
Here’s how that can work:
Assume you own Apple stock worth $30,000, for which you paid $10,000 over a year ago.
You want to make a $30,000 donation to the Salvation Army.
You can either write them a check or give the shares of Apple to them.
Our advice in this case would be to give away the Apple shares and then take the $30,000 from your checking account and buy $30,000 of Apple stock.
Your tax deduction will be the same either way, but you’ll end up owning stock with a $30,000 basis, instead of stock with a $10,000 basis and a $20,000 gain that you might eventually pay tax on.
Donor Advised Funds
A related approach would be to give the Apple stock to a donor-advised fund, or DAF. These funds allow you to transfer shares into them and immediately get a tax deduction.
The kicker is that you don’t have to distribute the money out of the DAF to charities until you want to do that. So, you can fund the DAF with a relatively large donation and then take as long as you want to parcel it out to your charities of choice.
Last, but not least, on the charitable deduction front is the strategy of “bunching” your donations. Because of that higher standard deduction mentioned earlier, many taxpayers can get to the point of itemizing their deductions only if they bunch two years’ worth of deductions into one year.
If you start this strategy with a double donation in 2020, you’ll make no donations in 2021, then another double donation in 2022. We’ve paired this strategy with a donor-advised fund so that you can continue giving money to your charities consistently out of the DAF, but the tax-deductible donation you make is only to the DAF every other year.
OTHER TAX PLANNING
Roth IRA Conversions
Unlike traditional IRA and 401(k) accounts, Roth IRAs [and Roth 401(k)s] are unique in that they allow not just tax-deferred growth, but completely tax-free growth. The possibility of being able to put money into a Roth IRA, letting it grow for 10, 20, or 30 years, and never having to pay any taxes on it ever again is a very compelling idea.
A Roth conversion allows you to turn an existing traditional IRA (or a portion of the balance) into a Roth IRA. Since you are taking money out of a traditional IRA, you will have to pay taxes (but no early withdrawal penalty) on the distribution amount in the year the conversion occurs.
Roth conversions are allowed regardless of income level. So even if your income is high enough to exclude you from being able to make a Roth IRA contribution, you would still be allowed to do a Roth conversion.
It might make sense for you to take advantage of this if your income is down in 2020. If you expect your taxes to be higher in future years than it will be this year, consider doing a Roth Conversion before year-end.
Portfolio Losses
The end of the year is always a good time to look at your portfolio to see if there are any investment losses you can take to offset your investment gains. Even though most investments have recovered from the lows reached in the spring, you might be carrying stocks or other investments that have gone down in value since you bought them.
We always like to look at the silver lining of the dark cloud and use those losses to our clients' advantage. If, by some chance, you have more losses than you can use in the current year, you can “bank” those losses and use them to offset future gains. They carry forward forever. You can also use up to $3,000 of investment losses as a deduction against ordinary income per year.
Retirement Plans
There are some year-end deadlines related to retirement plans that might help your tax situation. Specifically, 401(k) plans need to be set up before the end of the year, even though they sometimes can be funded until the tax deadline arrives in 2021.
So, if you’re self-employed and have had a good year financially, you should consider setting up some kind of plan to shelter some of the profit you have. Our go-to choice here is typically an individual 401(k). They offer the ability to shelter a large amount of profit, and yet they’re inexpensive and flexible in their requirements.
Eclectic Associates is a fee-only fiduciary financial advisory firm in Fullerton, California. Feel free to call us if you have any questions related to the points raised above. We’d be happy to talk to you to see if we can help with your situation.
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