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Financial and Tax Planning Strategies to Consider Before Year-end

Dec. 22, 2020   |   Updated 11:49 AM ET

Year-end has traditionally presented opportunities for individuals and families to realize savings by implementing certain financial and tax planning strategies and this year is no different. Here are a few ideas to consider between now and the end of the year.

Max out your retirement plan contributions. This is not only a great way to boost your retirement nest egg — it could also result in valuable tax savings. 401(k) deferrals reduce current income, which lowers income taxes, and you might be able to deduct IRA contributions if you meet certain conditions.

For tax year 2020, you can contribute up to $19,500 to your 401(k), or $26,000 if you’re 50 years of age or over. And you can contribute up to $6,000 to a traditional IRA this year, or $7,000 if you’re 50 years of age or over. These contributions don’t have to be made by December 31 — you have until your tax-filing deadline (including extensions) next year to make 401(k) and IRA contributions for tax year 2020.

Contribute to your Health Savings Account (HSA). If you have more money left over after maxing out your retirement plan, consider contributing it to your HSA. For tax year 2020, you can contribute up to $3,550 to your HSA, or $7,100 for your entire family. If you’re 55 years of age or over, the limits are $4,550 and $8,100. Unlike 401(k) and IRA contributions, HSA contributions must be made by December 31 to count toward the 2020 contribution limit.

Minimize taxes on mutual fund purchases. Most mutual funds distribute the bulk of their net realized capital gains toward the end of the year, especially in December. If you’re planning to purchase mutual funds in a taxable account before the end of the year, find out if the funds will make large capital gains distributions before year-end. If so, the distributions may be subject to tax in 2020, which could result in a big tax hit this year.

In this case, it might be wise to wait until after the distribution date before you invest in a fund. Or better yet, purchase the fund in a tax-advantaged account like a 401(k) or IRA. You won’t pay taxes on dividends or capital gains distributions in the year they’re received as long as the funds aren’t withdrawn from the account.

Plan year-end charitable gifts. The Coronavirus Aid, Relief, and Economic Security (CARES) Act raised the charitable deduction limit for cash contributions to public charities from 60% of adjusted gross income (AGI) to 100% of AGI for tax year 2020. Also, you can still make a qualified charitable distribution (QCD) this year of up to $100,000 to one or more qualified charities if you’re 70½ years of age or over. Making a QCD will allow you to realize the tax benefits of charitable donations without itemizing deductions on your tax return.

Another strategy is to create a donor-advised fund (DAF). With a DAF, you can make tax-deductible contributions to one or more qualified charities. Instead of cash, consider donating appreciated securities you’ve owned for more than one year. You can deduct the fair market value of the securities on your 2020 tax return and also avoid paying capital gains taxes on the appreciation.

Rethink income shifting strategies. In most years it makes sense to defer income into the following year in order to reduce income taxes now. But if it’s likely that income tax rates will rise in the future, the opposite strategy might be smarter: Accelerating income into the current tax year. Given the election results, this might be the preferred strategy for 2020, especially for taxpayers in the highest tax brackets.

You can accomplish this by recognizing deferred compensation or capital gains, exercising stock options or converting a traditional IRA to a Roth IRA before December 31.

Be sure to speak with a tax professional and financial advisor about your specific situation before implementing these and other financial and tax planning strategies.
 
 
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