5 Year-End Tax-Planning Steps to Consider Before the End of the Year

Before the year ends, it’s a good idea to set aside some time to review tax-planning strategies. Some of them could help reduce your tax burden or even give you a larger refund in 2021.

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Key Takeaways

  • The end of the year is a good time to think about long-term financial goals and get your taxes in order

  • Consider increasing 401(k) contributions and other simple year-end tax strategies

  • Federal COVID-19 pandemic relief led to rule changes on RMDs for IRAs and 401(k) retirement accounts 

Year-end tax planning is something you don’t want to get lost in the holiday rush, particularly considering what 2020 brought us. For example, federal COVID-19 relief led to rule changes on required minimum distributions (RMDs) for individual retirement accounts (IRAs) and 401(k) retirement accounts. Other aspects of year-end tax-planning strategies remain similar to previous years. Are you caught up? Let’s find out.

“It’s always a good idea to start getting your taxes in order at this time of year,” said Lisa Greene-Lewis, a CPA and tax expert for TurboTax. “This year, the COVID-19 pandemic poses a few potential different twists for U.S. taxpayers, and overall, the sooner you get started on year-end tax planning, the better your chances of avoiding a tax surprise when you file your taxes.”

Here are a few tax-planning and tax-saving strategies to consider before December 31 to potentially help reduce your tax burden (or maybe even get you a larger refund in 2021):

1. Increase Your 401(k) Contributions

Beyond COVID-19 implications for taxpayers, several other top tax-planning strategies endure from year to year. These include hiking contributions you make to employer-sponsored retirement plans and other tax-deferred retirement accounts that are taken out of your paycheck before taxes, helping lower your taxable income. If your employer matches your contributions, increasing your 401(k) contributions can help you avoid leaving free money on the table.

For 2020, the maximum 401(k) salary contribution for an employee is $19,500 for those under 50 and $26,000 for those 50 and older. If you’re an employee who receives a W-2 form, you should generally make any 2020 contributions by December 31 (other types of compensation may have different deadlines).

2. Consider Converting Your IRA to a Roth IRA

With traditional IRAs, contributions are typically made with pretax dollars and can grow tax free. However, withdrawals are usually fully taxable. With a Roth IRA, money is contributed with after-tax dollars, so you can take “qualified distributions” that are tax free.

In general, a qualified distribution is one made after you turn 59 1/2, or under certain exemptions (such as to buy a first home, or if you became disabled). Also, Roth contributions are subject to a five-year holding period before they’re considered “qualified” for tax-free distribution.

The tax savings from an immediate reduction in taxable income should be compared to the alternative. Take a moment to calculate how much tax you’d pay on those funds versus the tax you may face on the gains when you withdraw the money in the future. You may find that a Roth could offer significant savings, so it might be worth converting your IRA to a Roth IRA now.

You have until April 15, 2021, to make IRA contributions for 2020, but the sooner you get your money into the account, the sooner it can be invested. For the 2020 tax year, you can contribute a maximum of $6,000 to an IRA, plus an extra $1,000 if you’re 50 or older.

COVID-19-Related Changes to RMDs

There are at least two key tax items in this category you should keep in mind. First, the Setting Every Community up for Retirement Enhancement (SECURE) Act, passed in late 2019, raised the starting age for RMDs from 70 1/2 to 72 as of January 1, 2020. Secondly, in March, the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act added “rollover relief” provisions affecting RMDs from IRAs and 401(k)s.

The CARES Act enabled any taxpayer with an RMD due in 2020 from a “defined-contribution” retirement plan to skip those RMDs this year, the Internal Revenue Service (IRS) said in a June statement. This includes anyone who turned age 70 1/2 in 2019 and would’ve had to take the first RMD by April 1, 2020 (the waiver doesn’t apply to defined-benefit plans).

Anyone who already took an RMD in 2020 from certain retirement accounts “now has the opportunity to roll those funds back into a retirement account following the CARES Act RMD waiver for 2020,” as long as they meet the requirements for 60-day rollover, the IRS said. Read more about what the COVID-19 stimulus means for individual taxpayers on the Intuit TurboTax Blog.

3. Consider Flexible Spending Account (FSA) Funds

Make sure you’re timely about submitting FSA expenses by the end of the year, unless your FSA allows you to roll funds to the next year (check with your employer to verify). An FSA allows you to set aside tax-free money to pay for certain out-of-pocket health care costs. Typically, the funds are a “use it or lose it” proposition with a deadline of December 31.

Spending these funds doesn’t directly lower your taxes, but remember, the purpose of the FSA is to provide tax savings when you contribute. If you don’t spend the funds, you lose not only the tax benefit, but the funds set aside as well. FSAs can apply to a broad array of expenses, though the IRS can change what expenses qualify.

4. Consider Tax-Loss Harvesting and Charitable Contributions

Any losses from selling stocks, bonds, or mutual funds can be used to offset taxable capital gains, a practice known as tax-loss harvesting. The size of the potential benefit from tax-loss harvesting depends on your income level and the amount of your short- and long-term capital gains (minus any current losses you may have already realized, or any losses carried forward from other years).

Also, if you make a charitable donation before December 31, you may be able to write it off on your 2020 taxes. That means you can support causes you’re passionate about and potentially trim your tax liability or realize a deduction.

Charitable giving is one possible offset to the tax implications of a Roth conversion. Although a Roth conversion may increase your income, charitable contributions have the opposite effect, if you can take the deduction. It’s also possible to combine tax-loss harvesting and charitable contributions.

5. Bunch Your Deductions

If your total deductions exceed the standard deduction, and therefore don’t justify itemizing, consider “bunching” deductions, particularly in categories where you have to cross a minimum threshold.

For example, you might decide to bunch your deductions on alternating years, meaning you’d take the standard deduction one year. Then, the next year, if you managed the timing of your purchases carefully, you’d likely surpass the standard deduction. You could also bunch charitable contributions by increasing donations in the years you plan to itemize and decreasing them in the years you plan to take the standard deduction.

Year-End Tax-Planning Strategies for 2020: See the Big Picture

The end of the calendar year is an opportune time to pause and reflect, a mindset that applies to your taxes, household budget, retirement plans, and other financial items and goals. Is your house in order, and are you on track to meet your targets?

It’s natural to have questions about taxes, and it’s OK to not have all the answers. If you have any tax questions, you can visit the TD Ameritrade Tax Resources center or the Intuit TurboTax Tax Reform Hub. Please remember that TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.

Follow this year-end tax-planning checklist.

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Key Takeaways

  • The end of the year is a good time to think about long-term financial goals and get your taxes in order

  • Consider increasing 401(k) contributions and other simple year-end tax strategies

  • Federal COVID-19 pandemic relief led to rule changes on RMDs for IRAs and 401(k) retirement accounts 

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