F.I.T. Focus - 3 Year-End Tax Planning Opportunities for the Savvy Investor
As an investor, continually evaluating tax planning opportunities throughout the year is an integral part of any effective financial plan, but there are special considerations to make as the year comes to a close to maximize your refund or minimize your liability. The following are some useful strategies to consider:
1) Maximize Contributions for your Tax-Advantaged Retirement Account, 529 Plan and/or Health Savings Account
Many investors fail to take advantage of their annual retirement, 529 plan, and Health Saving Account contribution limits, missing out on reducing their taxable income while saving for the future. Let’s take a look at each:
- Retirement - If you are employed and have access to a workplace retirement plan such as a 401(k), 403(b), and 457, you can contribute up to $19,500 to your plan this year, and if you are age 50 or older, you can save an additional $6,500. Contributions must be made by December 31, 2020, to reduce your income and impact your 2020 taxes. Depending on your income level and whether a workplace plan covers you (or spouse), you may be eligible to make traditional IRA contributions and further lower your taxable income. Contributions up to $6,000 can be made with an additional $500 if you are 50 or older and must be made by April 15, 2021.
- Education - When it comes to saving for future education, a 529 plan is a great way to save as after-tax contributions grow in a tax-deferred manner. Distributions are then tax-free if used for “qualified education expenses.” Depending on the amount of the contributions, many states also provide an income tax deduction made into a 529 plan. Still, contributions need be made by December 31st to be eligible, and federal gift tax rules apply.
- Healthcare - If you have a high-deductible health insurance plan, you may also contribute to a Health Savings Account (HSA). HSAs are often considered the most tax-advantaged accounts available, as the savings immediately reduce your taxable income, grow tax-deferred, and can be distributed tax-free if used for qualified medical expenses. For 2020, contribution limits are up to $3,550 for single coverage or $7,100 for family coverage, including any employer match. Like an IRA, HSA contributions need to be made by April 15, 2021.
2) Strategically Contribute to Charity
Before 2020, the only way you could receive a tax benefit for your charitable contributions was to itemize deductions. Under the CARES Act, taxpayers can take an “above the line” deduction of up to $300 for cash contributions. Beyond that, if you itemize deductions on your tax return, donating to your favorite qualified charitable organization is an excellent way to reduce your taxable income while also doing good. While it is typical to donate cash and/or goods outright, for investors, there are several alternative options to explore:
- Contribute to a Donor-Advised Fund (DAF). This strategy allows donors to allocate a lump sum of funds to be distributed to various charities over multiple years. Though the funds may be dispersed over time, donors can take a deduction in the current tax year. The DAF works especially well if an individual has earned a higher than average income, wants to manage charitable donations over time, but is seeking to offset the income immediately.
- Gift long-term appreciated investments as opposed to cash and avoid paying taxable gains.
- If you are age 70 1/2, consider making a Qualified Charitable Distribution (QCD) directly to a qualified charity from a traditional IRA. Amounts distributed as a QCD, up to $100,000 per annum, are excluded from taxable income and can be used to offset taxable required minimum distributions (RMDs) from IRA accounts in the current year. Under the CARES Act, RMDs are waived for 2020.
3) Harvest Losses in Taxable Accounts
Harvesting capital losses in an investment account by selling securities in a tax loss position will help offset any realized gains within your portfolio. You are also permitted to deduct up to $3,000 of net realized losses against income on your tax return each year. Any excess net realized losses could be carried forward into future years.
Like with any plan worth implementing, preparation is essential—especially when time-sensitive moves and deadlines are involved. Additionally, beyond tax-efficient investment strategies, there are plenty of other tax savings strategies to consider, such as deduction bunching, deferring income, accelerating expenses, and many more. As we approach the end of 2020, you should consult with your advisors to review what strategies might make sense to implement and hopefully reduce your 2020 tax bill in the process.
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