Committing to an end of year financial check-up is one of the most important financial planning habits that all of us can incorporate into our annual calendars. Daniel Pink’s “When”, offers the idea of temporal landmarks – times of the year or certain dates when we are inspired to take stock of where things currently stand while looking ahead to our goals for the future. While it can be tempting to cruise into the holiday season enjoying the spoils of another year gone by, using these final weeks of the year as a temporal landmark to analyze our current financial picture, critiquing what we did well (and not so well), and taking strides to improve our financial picture can help us to enter the new year with some deserved momentum.
2020 won’t be forgotten anytime soon for an endless list of reasons. Near the top of that list are the enormous financial and economic challenges the country has had to confront as we work our way through Covid-19 pandemic. The passage of the CARES Act in response to the pandemic brought about a slew of one-time planning opportunities for 2020 that we need to consider when going through the usual end of year financial planning process. We will cover some of those here along with some common topics that you should be considering in any year.
What Matters Should I Consider Before the End of the Year?
Get Organized & Assess Your Situation
Take some time to get your arms around everything and ask some questions: Did I achieve my financial goals this year? Did we keep to our budget? Did we save as much as we hoped? Are our expenses still in line with our values? Did I pay down debt? Do I have everything I need for tax planning organized and in the appropriate place? Did the experience of 2020 change or reprioritize our goals and values (and how might those shifts impact our financial picture)? Even if you fell short of some of your goals, use this as a time to get refocused and intentional about what you want to achieve over the next 12 months.
Don’t Leave Money on the Table
FSAs – Do you or your spouse have a Flexible Spending Account (FSA) for health or dependent care? If so be sure to understand the rules of your plan because in many instances you will need to use the balance in the plan prior to 12/31 otherwise those contributions will be forfeited. Some employer health plans allow for a grace period or for some portion of FSA funds to be carried over into the new year so make sure you know the rules of your plan.
Health Insurance Deductibles – Did you meet your health plan’s annual deductible? If so, consider incurring any additional medical expenses before the end of the year, at which point your annual deductible will reset.
401(k) Match – If you are able, have you contributed at least enough to your 401(k) plan to max out your employer’s annual matching contribution? More on this in the next section.
Fill Your Buckets – Goals Based Planning
Retirement Planning – Have you hit your 401(k) contribution goal for the year? It’s always an excellent strategy, if you are able, to maximize your company’s 401(k) match feature. If you have more flexibility to save, the maximum salary deferral contribution to an employer plan is $19,500 in 2020. If you are age 50 or over, you can make a catch-up contribution of up to $6,500.
If you have an HSA account through your employer health plan, have you maximized your annual contribution? In 2020, the contribution limit for individuals is $3,350 while the family maximum is $7,100.
Outside of employer sponsored plans, consider your IRA account options. Do you have the ability to contribute to a Roth IRA? Or could you initiate a Roth Conversion? Roth IRAs are always on a thorough year-end planning checklist but 2020 might make them even more applicable due to historically low tax rates and the possibility, for many of us, that our income was down during the year due to the pandemic. Today’s low tax rates (a result of the 2017 Tax Cuts and Jobs Act) are set to expire after 2025 at the latest but given the country’s skyrocketing debt it’s possible that tax increases come sooner.
As a reminder, a Roth IRA is funded with after-tax dollars, grows income tax-free forever and never has a required minimum distribution (RMD).
College Planning – Can you or a family member contribute to a 529 plan for your child? You can use your annual exclusion amount to contribute up to $15,000 per year to a beneficiary’s 529 account, gift tax-free. Alternatively, a lump-sum contribution of up to $75,000 can be made to a 529 plan and you can elect to treat the gift as it were made over a 5-year period, gift tax-free. Depending on state of residence, there can also be some beneficial tax deduction features for contributing to a 529 plan.
Life Events – Are you saving for something down the road? The birth of a child? A big vacation? A 2nd home to enjoy with your family? If the twists and turns of 2020, or any year for that matter, have presented the opportunity to save more for other/secondary goals be sure to set aside those savings to further fund these goals-based accounts.
Tax Planning Opportunities
Tax planning is the area offering the most opportunity when it comes to year-end strategy and many of the financial and investment related moves you’ll make (like the 401(k) and Roth IRA concepts above) will be done with tax minimization in mind.
IRA Distributions – The CARES Act waived all required minimum distributions (RMDs) including for inherited IRAs in 2020. This presents a one-time opportunity for those subject to RMDs to instead convert the distribution, if they chose to take it, to a Roth IRA (something they wouldn’t normally be able to do).
IRA Contributions – Do you expect your income to decrease in the future? If so, you can consider strategies to minimize your tax liability now. Maximizing your 401(k) contributions (discussed above) is one way to do this and contributing to a traditional IRA is another.
Tax Bracket & Surtax Thresholds – Be aware of where you might fall in terms income tax bracket and potential surtax thresholds. If you are near a threshold, consider strategies to defer income or accelerate deductions.
Manage Capital Gains & Losses – Do you have any unrealized losses in your taxable investment accounts? If so, consider realizing those losses to offset any gains incurred during the year and/or write off $3,000 against ordinary income. If you own mutual funds in your taxable investment accounts that are subject to end-of-year capital gain distributions, be aware of those distribution dates and consider strategies to minimize your tax liability.
Updating Estate Plans and Understanding New Rules
Have there been any changes to your family structure that would require a review and update of an estate plan? If so, consider speaking with your financial advisor to best understand your options.
Changes Caused by the SECURE Act – The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries. If you or someone in your family is listed as the beneficiary on an IRA account it is important to confirm the beneficiary status on those accounts and understand these new rule changes. If you inherited an IRA as the result of a death in 2020, it is likely now subject to the new 10-year payout rule, meaning that the entire inherited IRA will have to be drawn down by the end of the 10th year after the original IRA account holder passed away.
Please feel free to consider our checklist template at the bottom of this post. Not all end of year financial planning checklists will be identical and they should be customized to your unique situation. The most important step is getting started and resolving to tackle these issues before the final weeks of the year pass us by. By doing such tasks, you will often find yourself with some meaningful tax savings and a boost of motivation as you enter the new year.