Financial Planning

Year End Planning for 2021

It is that time of the year again – crisp fall air and holidays approaching – which is also time to revisit your year-end planning checklist. Here are some planning strategies that can be used to reduce your tax exposure and help organize savings, gifting, and charitable donations.

You may have read about potential tax legislation from Congress which is a work in progress – we have described a few key potential changes at towards the end of the article.

  • Review beneficiary designations: We recommend that you check your beneficiaries on your employer retirement accounts and retirements accounts held away from your employer (IRA, SEP IRA, i401(k), Roth IRA), especially if you have had life changing events in your family – birth, marriage, and death are some examples.
  • Maximize contributions to 401(k): This will help reduce taxable income in the current year, but be mindful of your contribution limit.
  • Contribute to an IRA or Spousal IRA: Note that this depends on your and your spouse’s incomes and if you or your spouse are covered by employer plan.
  • Flex Spending Account (FSA): Fund this account to use pre-tax dollars for medical expenses or dependent care. However, remember that these are use-or-lose dollars!
  • Health Savings Account (HSA): If you are signed up for a high-deductible health plan, this allows pre-tax contribution – and when used for qualified medical expenses, they are tax free.
  • Roth IRA for children who had earned income: If your child has earned income in 2021, they are eligible to contribute up to $6,000 or their gross earnings, whichever is lower into a Roth IRA.
  • Required Minimum Distributions (RMD): The CARES Act waived Required Minimum Distribution (RMD) requirements for 2020 only. If you are of eligible age, be sure to take your 2021 RMD before year end, including required distributions from inherited IRAs.

If you are over 70 1/2, you can consider making Qualified Charitable Distributions from your IRA directly to public charities to satisfy the RMD requirements (up to $100,000 per taxpayer).

The SECURE Act (passed in December 2019) increased RMD age requirements  to age 72 for those not already required to take RMDs in 2019 as a result of reaching age 70 1/2.

  • Annual gifting: The IRS allows you to give away a certain amount of property without incurring taxes or requiring gift tax reporting every year. For 2021, you can gift up to $15,000 to as many people as you wish by utilizing this exclusion.

In terms of an optimal estate planning strategy, it’s best to gift assets that are likely to appreciate significantly after the gift is made. Why? Because the assets that have depreciated in value below their cost create an opportunity for you to take a loss on the asset and offset any gain you may have.

When it comes to helping a family member by contributing to their medical or education expenses, you can pay the amount due directly to the institution, without any limit. This amount will not be included towards the annual gift limit ($15,000) for the beneficiary of the gift.

  • ​Funding 529 plans: Some states consider 529 contributions tax deductible. Please reach out to us to check if you are eligible for this tax deduction on contributions made.
  • The CARES Act allows charitable contribution of cash up to 100% of AGI (Adjusted Gross Income) in 2021: Taxpayers can deduct cash charitable contributions in tax year 2021 up to 100% of their adjusted gross income. Please note the 100% limitation does not apply to cash donations made to donor advised funds or private foundations.
  • Funding Donor Advised Fund (DAF) account: If you plan to give funds/assets to charity, it may make sense to open a DAF account. You can group a few years of planned giving into one year and claim an immediate tax deduction. Eligible securities that can be donated to a DAF are appreciated stocks, mutual funds, cash or non-publicly traded assets such as private business interests, cryptocurrency and private company stock.
  • Allowance of Partial above the Line Deduction for Charitable Contributions: In typical tax years, charitable donations were only tax deductible if you itemized deductions. However, the CARES Act has created an above-the-line deduction of up to $300 for qualifying charitable contributions made in cash, per person. ($600 for a married couple filing jointly).
  • Tax Loss Harvesting: This strategy helps minimize any taxes owed on capital gains or regular income. Sometimes an investment that has lost value can still help your portfolio; if an investment drops you can deduct that loss, which helps boost your overall investment returns.

For a married couple filing jointly, up to $3,000 per year in realized capital losses can be used to offset capital gains tax or taxes owed on ordinary income. Losses larger than $3,000 can be carried over to the next year indefinitely and used to offset future gains.

Planning for Potential Changes to Tax Law

The final tax bill has not been passed by Congress yet – so we do not know what will be included in the final version or when it will be approved. In its current state, the bill’s primary focus is on corporations and high net worth taxpayers, with its impact lessening as the tax brackets go down.

  • One of the proposed changes is to create a new top income tax bracket of 39.6%, and a new top capital gains tax bracket of 25%, for those with incomes over $400,000 (single) or $450,000 (married couples).
  • One recommendation, if we do see an increase in tax rates for 2022, is to consider accelerating income into 2021 and deferring deductions to 2022, so that you pay taxes on income at a lower rate this year.
  • For capital gains, the changes may be retroactive to September 14, 2021, leaving no room for a change in strategy.
  • Another proposed change is around additional taxes and limits on IRAs proposed for the ultra-wealthy, which will apply to only a limited selection of taxpayers.

However, there are some other changes that would apply more broadly if passed.

“Backdoor Roth” strategy: this may get eliminated going forward. In short, this is the strategy where a taxpayer who earns too much to contribute to a Roth makes an after-tax contribution to a traditional IRA, and then turns around and converts that account to a Roth IRA shortly thereafter. This loophole has been debated for years and may finally be closing.  If you’re phased out of the Roth IRA contribution, you might want to do one last backdoor Roth conversion before year-end.

Estate Taxes: Under current law the $11.7 million estate tax exemption was set to “sunset” and return to the old $5 million level in 2025. We may see this “sunset” moved up to 2022, with the exemption adjusted for inflation to something in the neighborhood of $6 million. Older taxpayers with larger estates may consider making irrevocable gifts to heirs before year-end, to reduce the size of their estate at death.

Child tax credit: This credit may be expanded permanently, increasing from $2,000 to $3,000, or $3,600 for children under age 6.  It will begin to phase out for households with income above $400,000.

While one or more of these tax planning strategies may be suitable for you, we know that everyone’s situation is unique. Please reach out to us to have an in-depth conversation about which financial moves are right for you.