By Janelle Fumerola, CFP®, MBA
Regional Managing Director
The coronavirus pandemic has had a major impact on the finances of millions of Americans this year. This could make the process of year-end tax and financial planning especially challenging for many families.
Here are a few areas to pay especially close attention to as you plan your year-end tax and financial strategies for 2020.
Roth IRA Conversions
Roth IRAs can be beneficial because funds grow tax-free, are withdrawn tax-free in retirement and original owners don’t have to take required minimum distributions (RMDs). Converting a traditional IRA to a Roth IRA before you’re claiming Social Security benefits and taking required minimum distributions (RMDs) can be useful because you may be able to realize the income at lower tax brackets.
Due to the CARES Act passed earlier this year, retirees received a reprieve from taking RMDs for 2020 only, creating a one-time opportunity for many to make a Roth conversion at attractively lower marginal tax rates. Be careful how much is converted, however, in order to avoid potentially higher Medicare premiums or exposure to the 3.8% Medicare surtax.
Income Shifting Strategies
During most years, it’s beneficial to try to defer income into the following year in order to reduce current income taxes. The exception to this is if it’s likely that income tax rates will rise in the future. In this case, it may be beneficial to do the opposite: Accelerate income into the current tax year. Given the election results, this might be the preferred strategy for 2020.
Another factor to consider is whether your MAGI fell this year due to COVID-19-related factors like those listed above or not having to take an RMD this year. Your goal should be to maximize the amount of income that’s taxed at the lowest tax bracket. Strategies you can implement to accelerate income into this year include converting a traditional IRA to a Roth IRA, recognizing deferred compensation or capital gains, and exercising stock options.
Charitable Giving Strategies
As you finalize your charitable giving strategies for the year, keep in mind the fact that the CARES Act raised the charitable deduction limit for cash contributions to public charities from 60% of adjusted gross income (AGI) to 100% of AGI. This applies to tax year 2020 only.
Also consider funding a donor advised fund with appreciated securities instead of cash. You can deduct up to 30% of your AGI and gift appreciated securities to eliminate any potential tax on the gain.
And if you’re 70½ years of age or over, you can still make a qualified charitable distribution (QCD) of up to $100,000 to one or more qualified charities. Since the standard deduction was raised by tax reform, fewer people are itemizing deductions when filing their taxes. By making a QCD, you can realize the tax benefits from your charitable donation without itemizing deductions on your tax return.
Retirement Plan Contributions
If COVID-19 caused a disruption to your income due to a job loss, reduction of hours or business closure or slowdown, this might have impacted your total retirement contributions.
However, there might be a silver lining to this scenario: Your income may fall below the threshold for making a tax-deductible IRA contribution in 2020 even if you are an active participant in a retirement plan. For example, for tax year 2020, you can take a full IRA deduction up to the amount of the contribution limit if your modified adjusted gross income (MAGI) is $65,000 or less if you’re single or a head of household, or $104,000 or less if you’re married and file jointly.
Alternatively, you may be able to take advantage of contributing to a Roth IRA. For 2020, single taxpayers with MAGI below $124,000 and married filing jointly with MAGI below $196,000 are income eligible to make full Roth IRA contributions. IRA contributions for 2020 must be made by April 15, 2021.
Note that the SECURE Act changed the rules for deducting IRA contributions for individuals who reached age 70½ after January 1, 2020. These individuals can now make either a Roth IRA or a deductible IRA contribution, assuming they have earned income. This change doesn’t apply just to tax year 2020 — it’s permanent.
Here are a couple more strategies to consider at this time:
• Think about refinancing your mortgage if you haven’t done so yet. Mortgage interest rates remain at historic lows, making this potentially a once-in-a-lifetime opportunity to lock in a low rate that could save you tens of thousands of dollars in mortgage interest over the life of your loan. Or, you could switch to a shorter-term mortgage — such as a 15- or 20-year loan — and own your home free and clear years sooner than with a traditional 30-year mortgage.
• Max out your Health Savings Account (HSA) for the year. You can contribute up to $3,550 to your HSA this year, or $7,100 for your entire family. If you’re 55 years of age or over, this amount is increased by $1,000. But you must make HSA contributions by December 31 for them to count toward the 2020 contribution limit.
Please contact our office if you have more questions about year-end tax and financial planning for 2020 or would like to discuss your situation in more detail.
Materials discussed is meant for informational purposes only, and it is not to be construed as investment, tax or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.