Afford Anything - PSA Thursday - Year-End Tax Moves to Finish 2020

Episode Date: December 24, 2020

Welcome back to PSA Thursday, a weekly-ish segment in which we talk about how to handle money, work, and life in the year that is 2020. Today, we focus on the importance of end-of-year tax planning before you ring in 2021. We cover these tips: Open a retirement account  Adjust your tax withholdings Check your 529 Plan  Make charitable contributions Why this could be a good year to make a Roth conversion Spend down the balance in your FSA For more information, visit the show notes at https://affordanything.com/psathursday Learn more about your ad choices. Visit podcastchoices.com/adchoices

Welcome to PSA Thursday. This is a weekly-ish bonus segment of the Afford Anything podcast in which we talk about how to handle money, work, and life in the context of 2020. If you are a new listener, here's what you can expect. These PSA Thursday episodes are nothing like our normal episodes. They have no intro music, no outro music. They're intentionally kept ad-free. There's no production value.

They're typically much shorter than our normal episodes. they are hyper-focused on one specific, actionable topic that relates to life in 2020. Today is our Christmas Eve episode, and we're going to be talking about the most cheerful holiday topic ever, end-of-year tax planning. Wow, leave it to a financial podcast to really know how to get into the holiday spirit. So this show comes out on Christmas Eve. You've got a week left to make any financial moves that you need to make before the December 31st tax deadline. other people refer to that as New Year's Eve, but over here we refer to that as the tax deadline. Specifically, tax moves, not tax filing.

So, what move should you make before the deadline hits? Here are a handful of suggestions. Number one, if there are any retirement accounts that you need to open so that you can make contributions for the year 2020, make sure that they are opened before December 31st. For example, if you want to open a Trad IRA or a Roth IRA, you can still make contributions in 2020. Up until the tax filing deadline of 2021, you can still make contributions prior to the tax filing deadline in 2021 that can be retroactively applied to your contribution limits to calendar year 2020, but the account must be open before December 31st.

So in 2021, like in January or February, you can't open an account and then make retroactive contributions for 2020. So if you're planning on opening new accounts, make sure that that happens before December 31st. That's number one. Number two, do a total financial checkup. There's a pretty darn good chance that your income has shifted in the year 2020. I won't say most of us, but many of us, millions of us, regardless of whether you are a full-time W-2 employee or you're a full-time entrepreneur, there's a darn good chance that some fluctuation happened to your income. And if not to you, then it happened to your spouse's income, to your sibling, to

your best friend, to your neighbor. Given those income fluctuations, you may want to adjust your tax withholdings so that you don't end up either paying a giant bill or getting a way too big of a refund in 2021. So take a look, if you're W2 employee, take a look at your year-to-date payment column within your pay stub, see how much money you've made. And if you need to adjust those withholdings, make those adjustments this year, make those adjustments prior to New Year's Eve. If you received unemployment and you have untaxed unemployment payments, but you are now currently drawing a paycheck, you can adjust your withholding to have extra taken out for those last few weeks of the year

now that you're working again, and that can spare you from having to pay a large sum for those untaxed unemployment payments down the road. So that's tip number two. Take a look at how much you've made this year and adjust. year withholdings if necessary. Tip number three, if you're contributing to a 529 plan, number one, check to see whether or not you receive a state income tax deduction or credit for your 529 contributions. And number two, if so, check to see whether or not you're subject to a December 31st deadline.

Basically, here's the deal. Contributions to a 529 plan are not tax deductible at the federal level. But more than 30 states plus Washington, D.C., offer a state income tax deduction or credit for contributions to a 529 plan. Of those states that offer that, many of them have a December 31st deadline if you want your contribution to qualify for a state income tax deduction or credit for that given calendar year. There are some states that will allow you to have up until the tax filing deadline in 2021 to have contributions, qualify for the state income tax deduction or credit retroactively to 2020, but for the bulk of the states that do offer some type of state income tax deduction or credit, the deadline is December 31st. And so this tip number three is kind of a multi-step process. Number one,

this only applies to those of you who are making contributions to a 529 plan. So those of you who aren't, now you have some fun trivia to tell your friends. Second, for those of you who are contributing to a 529 plan, you'll need to check to see whether or not your state offers a state income tax deduction or credit, because many states don't. Step three is that if they do, you need to check the deadline. And then if that deadline ends up being December 31st, step four is to shovel money into the 529 plan as much as your state guidance would give you a deduction or credit for prior to December 31st. So it's a multi-step. This is what, tip number three, but it's a multi-step tip.

And again, your deadlines and your benefits are going to depend on your state. So all of that bundled together is tip number three for your end-of-year tax planning moves. Tip number four, make some charitable contributions. I don't have to tell you we're in the middle of a global crisis, a global health and economic crisis. And this is a year in which charitable giving, I think, is on a lot of this. Certainly it's on my mind is more important than, ever. Now, the CARES Act, which was passed in the spring, provides a $300 deduction for income taxes for your charitable giving, regardless of whether you take the standard deduction

or whether you itemize. So previously, like in 2019, it was the case that if you made a charitable contribution that was not large enough that it would propel you into a position in which it makes more sense to itemize your taxes, if you made a charitable contribution, but you still took the standard deduction, then you effectively, in 2019, wouldn't get to write off that contribution. They changed that with the CARES Act of 2020, where you can get a $300 deduction for giving, even if you take a standard deduction. Of course, if you want to give more than that, if you want to give more than $300, you can always choose to do so, and one of my favorite vehicles for it is called a donor advised fund. We did a PSA Thursday episode several months ago where we went in

depth about how to open and manage a donor advised fund. But essentially, if you open a donor advised fund, you can contribute appreciated assets such as stocks or index funds that have accrued capital gains. You can donate those appreciated assets into a donor advised fund and you can write off the entire appreciated value of the asset. You're not just writing off the cost of the cost, basis, you're writing off the current fair market value of the asset, which means that you avoid paying capital gains taxes, you avoid the tax burden that would come from realizing the gains on those appreciated assets, and all of that money, that untaxed money, then goes to charity. So you're not passing the tax bill on to charity.

You don't have to pay it, and the charity doesn't have to pay it. Again, I'll refer you to the episode that we did that was all about donor advised funds for an in-depth look at how to set one up. But if you want to do that, if you haven't set one up yet, if you've spent this year thinking, yeah, I really should, but, you know, I'll get to it later.

Well, you've got a week left. So make sure that you open a donor-advised fund. Mine is at Schwab, Schwab charitable, but Vanguard and Fidelity also have options. Again, we'd cover all of this in that episode about donor-advised funds, which I will link to in the show notes. Show notes are available at afford-anything.com

slash PSA Thursday. And if you are not sure whether you will be taking a standard deduction or itemizing your deductions, one way to make sure that you itemize is by front-loading future years' worth of charitable contributions into this year, thus making such a big contribution to your donor-advised fund that it sends you over the top into charitable contribution arena in which, of course, you'll be itemizing, it wouldn't make sense not to because you're giving so much into your donor advised funds that obviously you would itemize because of the amount that you're giving. So if you have the financial capacity to do that, of course, this has been a very tough year for a lot of people.

Many people are unable to pay their own bills, much less think about large charitable giving. But if you are in a position in which you can give a large sum of money, or is, you I mean, it doesn't even have to be huge. But if you're in a position in which you can give an amount of money, one of the most tax-efficient ways to do so is by setting up a donor-advised fund, by front-loading several years' worth of contributions of charitable giving into that fund if you have the financial capacity to do so at this time. And if all of that seems a little bit too far out of reach,

then remember, you can, at a minimum, give $300, and you'll be able to write that $300 off regardless of, regardless of whether you itemize or whether you take the standard deduction. So at a minimum, minimum level, $300 is something that everybody who has the financial capacity to give at least $300 is able to get a tax benefit from. So that is tip number four. Either set up a donor advised fund or at least make a $300 contribution to charity or more. Tip number five, if you are age 72 or older, or if you know somebody who is, maybe a parent or a grandparent who is, then you or your parents or grandparents have in the past needed to take out required minimum distributions known as RMDs from your traditional IRA accounts.

Well, that's on pause this year. So it used to be the case that you had to take out that RMD by December 31st or you would, face big, big penalties. This year, there is what's known as the RMD vacation. I know. I'm making finance sound like so much fun. We refer to New Year's Eve as the tax move deadline. We refer to not having to take out a big RMD as a RMD vacation. We're real nerds here. Anyway, there's an RMD vacation this year. It's the only vacation you're getting in 2020. And because of this RMD vacation, that means that your federal income tax is likely to be quite a bit lower. You're not withdrawing that money, therefore that money is not taxable, therefore you might be in a lower tax bracket,

which means that this could be a good year to make a Roth conversion. Since in 2020, you're in a lower tax bracket than you normally are. So if you're over the age of 72, or if you know someone who is, talk to your CPA. or talk to your financial planner and find out two things. Number one, find out what the RMD pause, the RMD vacation, means for your expected taxes in the year 2020. And number two, if those taxes are lower, if you're in a lower tax bracket this year, which likely you might be, then see if making a Roth conversion is the most appropriate next step. And by the way, this really applies to anybody who is in a significantly lower tax bracket this year.

If your income has taken a hit, if you run a business and your business is just not doing as well as it otherwise would have been, and so you're in a significantly lower tax bracket this year, or if you are an employee who had their wages cut or who was out of work for a while, or if you're not getting the commissions or bonuses that you typically get, if for any, reason the volatility of 2020, the income volatility, has pushed you into lower earnings and therefore a lower tax bracket this year, this might be a good time to make a Roth conversion, to convert money that's in your traditional IRA into a Roth IRA and to capture that at a time in which you're in a lower tax bracket, to take advantage of that lower tax bracket while you've got it. And finally, and this last one isn't actually a tax planning move, but it is an end of year

financial move, if you have an FSA account, which is a flexible spending account that is meant to cover health-related expenses and is set up through your employer, if you have an FSA account, then check your balance and make sure that you have spent down the money in that account by December 31st. You can roll over up to $500 in an FSA to the following year. Other than that, the rest of it gets lost to the government. Now, Let's make the important distinction that an FSA and an HSA are very, very different things. An FSA is a flexible spending account. It is meant to be spent, which is why you lose it.

It's use it or lose it. That's the reason why you lose most of the balance other than 500 bucks at the end of the year. By contrast, an HSA is a health savings account. It is meant to be saved, which is why it's designed as an amount that you save and that you carry on in perpetuity. it's designed as a savings account. So if you have an FSA, a flexible spending account, make sure that you spend what's in the spending account. Use it or lose it.

So those are year-end tax planning tips for the closeout of 2020. This has been nobody's favorite year. And I am looking forward to saying goodbye to 2020 with all of you. I understand that it is, if you try. truly think about it irrational to believe that life will magically change when the clock strikes midnight on January 1st, 2021. But heck, symbolism is always irrational and yet it's pretty great anyway. So I'm going to enjoy celebrating alone in my apartment, celebrating New Year's 2021. And I hope all of you are as well. But in the meantime, happy Christmas Eve for those of you

who are celebrating. In very 2020 style, I will be having Christmas dinner on Zoom. I will be alone having dinner through Zoom with my family. So for all of you who are spending the holidays on Zoom, I'm with you. This is such a 2020 way to close out the year. But hopefully, 2021 will be better. We'll be more social. We'll be more connected. We'll be able to see each other face to face. In the meantime, we just have to get through this winter, and we have to get through the winter safely. I think we do have light at the end of the tunnel, but we need to survive the winter first. So, a Merry Christmas and Happy Holidays to all of you who are reflecting on the year that

we just had and making big plans for the year ahead. My name is Paula Pant. This is the Afford Anything podcast. You can find the show notes at Afford Anything.com slash PSA Thursday. you can also subscribe to the show notes at afford anything.com slash show notes, have it delivered directly to you. And I will catch you in the next episode. See you then.