Year-end Financial and Retirement Planning Tips

From Roth IRA conversions and taxes to employee benefits and your 2021 budget, here’s your checklist of easy, smart money strategies
Author:
Publish date:

It’s December. And that means time is running out to take advantage of strategies to secure your financial future. Here’s a look at some 2020 year-end tips to consider:

Consider a Roth IRA Conversion

2020 has been described as the perfect year in which to do a Roth IRA conversion? What’s that? It’s when you take a distribution from your traditional IRA and transfer it into a Roth IRA.

You would, of course, pay taxes on the distribution from your IRA at your ordinary income tax rate. But once the money is inside your Roth IRA it will grow tax-free and distributions from that account will be tax-free as well.

Why is it a good time consider a Roth IRA conversion? One, income tax rates are comparatively low. The lower income tax rates passed in 2017 are scheduled to expire at year-end 2025; however, some industry observers have noted that taxes may rise even sooner due to rising deficits exacerbated by the pandemic relief measures, according to Percy Bolton, a retirement management advisor with Percy E. Bolton Associates.

What’s more, he notes in an email, if the value of your IRA remains below its pre-pandemic value, the tax obligation on your conversion will be lower than if you had converted prior to the downturn. And, if your income is lower in 2020 due to the economic challenges, your tax rate could be lower as well.

“Any or all of these factors may make it worth considering a Roth conversion, provided you have the funds available to cover the tax obligation, he wrote.

How do you convert your traditional IRA to a Roth IRA?

According to the IRS, you can convert your traditional IRA to a Roth IRA by:

  • Rollover: You receive a distribution from a traditional IRA and contribute it to a Roth IRA within 60 days after the distribution (the distribution check is payable to you);
  • Trustee-to-trustee transfer: You tell the financial institution holding your traditional IRA assets to transfer an amount directly to the trustee of your Roth IRA at a different financial institution (the distributing trustee may achieve this by issuing you a check payable to the new trustee);
  • Same trustee transfer: If your traditional and Roth IRAs are maintained at the same financial institution, you can tell the trustee to transfer an amount from your traditional IRA to your Roth IRA.

A conversion to a Roth IRA results in taxation of any untaxed amounts in the traditional IRA. The conversion is reported on Form 8606 PDF, Nondeductible IRAs. See Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), for more information.

Additional resources:

Review Beneficiary Designations

Nicole Gopoian Wirick, a certified financial planner with Prosperity Wealth Strategies, says 2020 year-end tax planning provides unique opportunities given the possibility for tax reform under the Biden administration, coupled with changes to how beneficiaries inherit IRA assets under the SECURE Act.

The first step, she says, is to review all beneficiary designations to confirm they’re still aligned with your intentions and overall estate plan. “Under the SECURE Act, most non-spousal beneficiaries of an IRA are required to liquidate their inherited IRA by the end of the 10th year after inheritance, paying ordinary income tax on the distributions as they occur,” she says. “Before this legislation, most non-spousal beneficiaries were able to stretch distribution over their life expectancy -- a period typically much longer than 10 years.”

The new legislation, however, forces most beneficiaries to recognize more taxable income faster, driving up their tax bracket.

So, if you have charitable intentions, consider, says Gopoian Wirick:

  • Naming a charity as the beneficiary of your IRA, because charities do not pay ordinary income tax on distributions, assuming the entity is a qualified 501(c)(3) organization, and,
  • Naming individuals (children, nieces, nephews) as beneficiaries of Roth IRA assets, which have tax-free growth and distributions, and taxable assets (e.g., trusts, brokerage accounts) since they enjoy a step-up in cost basis at the date of death.

“This is a way to maximize your gifts to charity and your loved ones,” he says. “The takeaway is that not all investment accounts, including IRAs, are created equally and the taxability of each account must be evaluated individually and collectively as part of your overall estate plan.”

Fund your 529 and Retirement Plans

If you’re trying to fund your child’s or children’s college education, funding a 529 plan before year-end would be a good idea, said Marguerita Cheng, the CEO of Blue Ocean Global Wealth. “Some states do offer their residents specific tax deductions or credits for contributions to 529 plans,” she said.

According to James Shagawat, a certified financial planner with AdvicePeriod, 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, you can make a lump sum contribution of up to $75,000 to a beneficiary's 529 account, and elect to treat it as if it were made evenly over a five-year period, gift tax-free,” he says.

If you have an employer retirement plan, such as a 401(k), you may be able to save more but must consult with the plan provider as the rules vary as to when you can make changes, says Shagawat. The maximum salary deferral contribution to an employer plan is $19,500, plus the catch-up contribution if age 50 or over is $6,500 per year. The deadline for employer-sponsored retirement plans is Dec. 31.

Of note, if you’re self-employed, it’s never too late or too soon to set up a retirement plan, Brooke Salvini, CPA/PFS member of the AICPA PFP Executive Committee, said in a release.

According to according to Salvini, some plans must be established before Dec. 31, but you can postpone funding until 2021 and still claim the tax benefit on your 2020 tax return.

If you have an HSA, you may be able to contribute $3,550 ($7,100 for a family) and an additional $1,000 if you are age 55 or over, says Shagawat.

For his part, Mark Cannon, a certified financial planner with Ameriprise Financial, recommends increasing the amount you set aside in your FSA for 2021 if you set aside too little for this year and anticipate similar medical costs next year.

Of note, the deadline to make contributions to your traditional and Roth IRA is your tax return filing deadline (not including extensions). For example, you can make 2020 IRA contributions until April 15, 2021.

Review Your Employee Benefits

Will you have a balance in your flexible spending account (FSA) before the end of the year? If so, consider, says Shagawat, the following options your employer may offer:

  • Some companies allow up to $550 of unused FSA funds to be rolled over into the following year.
  • Some companies offer a grace period up until March 15 to spend the unused FSA funds.
  • Many companies offer you 90 days to submit receipts from the previous year.
  • If you have a Dependent Care FSA, check the deadlines for unused funds as well.

Did you meet your health insurance plan's annual deductible? If so, consider, says Shagawat, incurring any additional medical expenses before the end of the year, at which point your annual deductible will reset, he says.

Plan Your Estate

The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries -- effective beginning with deaths in 2020, said Brandon Opre, a certified financial planner with TrustTree Financial. “Anyone with a retirement account needs to review these changes and how they impact their plans,” he said. “Most estate plans will also need to be updated at a minimum, and some scrapped altogether -- particularly those naming a trust as a beneficiary of an IRA.”

If a trust is the named beneficiary of your IRA and company retirement plan, Opre recommends converting those IRAs to Roth IRAs or withdrawing IRA funds now and purchasing life insurance.

Consider too, says Cannon, gifting using the annual gift tax exclusion before the end of the year. The annual federal gift tax exclusion allows you to give away up to $15,000 in 2020 to as many people as you wish without those gifts counting against your $11.58 million lifetime exemption. (After 2020, the $15,000 exclusion may be increased for inflation.)

This exclusion, says Cannon, cannot be carried over “so, if you are going to do gifting next year, you might start that process earlier.”

Review Your Life Insurance

Since the SECURE Act, Opre says life insurance has proven to be an even more valuable estate planning vehicle than inherited IRAs. Why? “Insurance proceeds are income-tax free and can also be estate-tax free,” he said.

The thought process here is drawing down IRAs during one’s lifetime in a series of distributions — paying tax at current low rates, over several years. These withdrawals can also help cover annual RMD requirements.

Some other considerations:

  • After-tax funds can be used to purchase life insurance.
  • If a trust is needed, the life insurance can be paid to an insurance trust (ILIT).
  • This strategy reduces current income tax by eliminating RMDs on IRA funds withdrawn.

Review Your Budget

Review your income, spending, and savings in 2020. “Depending on what happened in 2020, 2021 could be a chance to get back on track or to continue the path they are on,” says Gage Paul, a certified financial planner with Western Reserve Capital Management.

Once you have reviewed 2020, you can look towards 2021 and estimate your income and expenses for the upcoming year. “Forecasting for the entire year will allow them to account for expenses that may not occur monthly but are ‘lumpy’ expenses that happen throughout the year, such as property taxes and insurance premiums,” he says. “From there, they can allocate their “net income” to long-term and short-term savings goals. After their expenses and savings goals are funded any remaining income can either be saved or spent at their discretion.”

By doing this in 2020, you are setting yourself up for success in 2021. “So, when Jan. 1, 2021 rolls around they can focus on implementing the plan they have laid,” says Paul. “Adjustments will likely need to be made during the year as things unfold, but they can reference their plan and make course corrections as necessary.”

Do you have a big, hairy audacious financial goal?

It’s easy to get caught up with day-to-day concerns, says Sean Pearson, a certified financial planner with Ameriprise Financial. “It might be hard to imagine saving 10% or 20% for retirement at your current income,” he says. “Or what about an investment or vacation property? More often than not, big changes don’t happen overnight. Even the things that seem to occur in a short window of time, usually come from seeds that have been germinating in the ground for some time before we see green shoots.”

So, what would it take for you to achieve a big, hairy audacious financial goal? “If you had five or seven or 10 years, could you build to that over time?” he asked. “A lot of people look at their financial situation and can easily point out of the things they may not be able to achieve from where they are today.”

But the difference of where they are versus where they want to be is usually attainable with some time and planning. “Is that a new job that pays more?,” asked Pearson. “Might that new job require some education or training? Are your biggest bills really the things that you feel most passionately about in life? Sometimes big goals, with some time to plan and achieve them, are more impactful than small steps like reducing your coffee intake or streaming service budget when done independently of a larger financial plan.”