As 2021 comes to an end, it’s an excellent time to review your finances for any tax moves that might benefit you. This time of year might be busy with seasonal events and other deadlines, but some opportunities come with an expiration date.
If you need some ideas on where to begin, this list can get you started. Then, through research and discussions with your tax preparer, you can decide what makes the most sense.
Start with a review of your finances. What do you expect your annual income to be, and what are the sources of that income (earnings from work, pensions and Social Security, investments, etc.)? Similarly, tally up any expenses and actions that might impact your taxes. For example, if you have substantial health care costs, or you made contributions to tax-favored accounts, that’s important information.
Any significant tax decisions require input from a tax professional like a CPA. When you do this initial review, it’s smart to provide this information to your tax preparer and ask if they see any opportunities or issues. A second set of eyes might save you some headaches – and some money.
Most importantly, conduct this review with the big picture in mind. It’s easy to focus on minimizing this year’s tax burden as the primary objective. But that could come back to haunt you. If you’re planning for retirement income, sometimes it makes sense to pay taxes intentionally to improve your chances of success.
It’s relatively easy to get a tax break for charitable contributions this year. Because of pandemic-related rules, you can deduct cash contributions to qualifying charities without itemizing in 2021. In other words, those who take the “easy” standard deduction generally qualify.
For most single taxpayers, you can deduct up to $300 for 2021. And married households that file a joint return can go up to $600.
If you want to make bigger contributions (and possibly itemize for a bigger deduction), nonprofits can certainly use your help.
One way to maximize your impact is to give investments that have increased in value since you bought them. For example, if you bought a stock, ETF, or mutual fund that is worth substantially more than your original purchase price, you might be able to give the investment directly to a charity.
To do so, you transfer the shares in-kind to the charity – instead of selling the investment and sending cash (or sending funds electronically).
When you give investments in-kind, you don’t need to sell and pay taxes on your gains. As a result, you might have more to give away.
Those over age 70.5 have an additional option for charitable giving. With a qualified charitable distribution (QCD), you can send funds directly from an IRA to a qualifying charity. With that approach, you get to exclude the distribution from your income, which can be helpful in a variety of ways. Again, since you’re giving away money pre-tax, there’s more left over for your favorite charity.
Retirement accounts and other tax-favored accounts have annual limits, meaning you need to act each year to fully utilize those accounts.
If you want to max out those accounts, but you haven’t done that yet, you may still have time. Workplace plans like 401(k) and 403(b) plans might allow you to adjust your contributions for the last few pay periods of the year. And individual accounts like Traditional and Roth IRAs generally allow contributions until the tax filing deadline in April.
Also, don’t forget about health savings accounts (HSAs) if you’re eligible to contribute. Those accounts have potential triple-tax benefits, and you can typically deduct contributions regardless of your income level.
It might make sense to sell investments in taxable accounts before the end of the year. That’s because any trades you make might lock in gains or losses for the year.
When you “harvest” tax losses, you sell something at a loss to potentially reduce your tax bill. Those losses can offset taxable gains, ultimately reducing or eliminating the gains. Plus, if your losses exceed your gains, you might be able to reduce your taxable income by up to $3,000 per year.
That said, remember that the tax loss rules can be complicated. For example, you need to be mindful of wash sale rules, and you might eventually have to pay taxes when you eventually sell.
If your income is below certain levels, you might be able to sell investments at a gain and avoid capital gains taxes. That is one of the few “free lunches” available, so it’s wise to review this opportunity every year.
If you’re still in your working years, it’s worth reviewing your tax withholding each year. By doing so, you can adjust how much comes out of your paycheck. The goal is to have the right amount withheld each year so that you don’t have a substantial tax bill in April (and you might also prefer to avoid getting a large refund).
The IRS has a handy withholding calculator that can help with this task.
Required minimum distributions (RMDs) are back for 2021. If you’re over 70 or 72 years old, you may be required to take funds out of certain retirement accounts. But that rule was paused for 2020. As a result, you might have disabled automatic distributions or simply forgotten about this important step.
Why is it so important? The penalty for missing an RMD is 50% of the amount you were supposed to take out. So, if your RMD for 2021 is $5,000, you could face a $2,500 penalty.
If you have savings in pre-tax retirement accounts, it might (or might not) make sense to convert some of your money to after-tax Roth savings. When you convert, you pay taxes on pre-tax funds and shift the money to a Roth account. And after satisfying certain requirements, you may be able to withdraw funds from the Roth account tax-free.
Roth conversions are a strategy for prepaying your taxes. That might make sense if you think that tax rates will rise in the future – or if you have a relatively low income this year. If today’s tax rates are acceptable, you can get taxes out of the way now and avoid paying later.
As with any strategy, there are better and worse ways to do it. It’s best to pay the taxes with funds outside of your retirement accounts, and it might make sense to convert in small “chunks.”
Once you get 2021 squared away, look ahead to 2022. It may be helpful to set aside funds for major expenses and retirement account contributions. If you’re still working at a job with a retirement plan, see if it makes sense to increase your contribution amount (maximum limits are higher in 2022).
Finally, keep an eye out for tax law changes. There are several proposals out there that may affect your finances.
Remember that all of the strategies above have specific requirements, and tax rules can change over time. As you explore these techniques (and many others that are not mentioned here), it’s best to work with a CPA or financial planner who is familiar with your finances.
That person can explain the pros and cons of different strategies, and they should be familiar with some of the pitfalls you may face as you manage your finances.
What do you think? Do you try to manage your taxes each year, or do you spend your time and energy on other pursuits (there’s no right or wrong answer – and the value of these strategies is debatable)? Are there any moves that have helped you in the past?