Clock ticking on 2020 year-end tax-saving strategies

Year-end is the perfect time to do tax planning. And what a tax year 2020 has been! Let’s review the urgent items that can still be taken advantage of before the New Year’s ball drops.

Covid-19-related distributions, loans

The CARES Act, passed in March 2020, changed the rules for certain distributions and loans from retirement plans for people who have experienced adverse financial consequences due to Covid-19.

To qualify, you, your spouse or dependent must have tested positive for Covid-19 or have experienced a financial hardship due to Covid-19.

The CARES Act allows up to a $100,000 distribution exemption from defined contribution plans like a 401(k) and IRAs if the distribution occurs due to a Covid-19 hardship. Qualified distributions are exempt from the 10% early withdrawal penalty for individuals under 59½ and the mandatory 20% tax withholding from qualified plans like a 401(k).

Income can be taxed proportionally over three years starting in the year of distribution and/or can be paid back if redeposited into an eligible retirement account within three years of the date of the distribution.

The CARES Act allows the current plan loan repayment date to be delayed for up to 12 months.  If no additional legislation is passed, this will expire Dec. 31, 2020.

Charitable gifts

Anyone who is charitably inclined in 2020 can take advantage of donating up to $300 in cash to qualified charities and deduct that without itemizing. This is referred to as an above-the-line deduction. This temporary exemption expires on Dec. 31, 2020.

RMDs waived in 2020

Required minimum distributions, or RMDs, were waived in 2020.

For charitable folks, one way to take advantage of this is by doing a qualified charitable distribution, or QCD, to give money to charity tax-free. This can only be done by donors who have an IRA and are 70½ or older.

A QCD is a distribution from an IRA direct to a qualified charitable organization and is limited to $100,000 a year. The benefits are that the donation counts as an RMD; it is not counted as taxable income to the donor and the charity gets their money. It’s a win-win.

Low-income year advantages

Your household income may have been reduced in 2020 due to the elimination of required minimum distributions or job loss. 

Lower income equals lower taxes, opening a window of opportunity for taking capital gains or doing a Roth conversion while keeping you in a lower tax bracket. 

By playing this tax game, one tries to figure out when one can pay the least in taxes. 

These smart money moves you make this year can help reduce taxes now and give you greater planning flexibility when you will be required to start Social Security and distribute from pre-tax retirement accounts.

More on Roth conversions

With increasing national debt and now Covid-19, there are many who argue that taxes have only one direction to go – up. While that remains to be seen (maybe Santa will bring me a crystal ball for Christmas?) planning with an eye for taxes is an integral part of ongoing, comprehensive financial planning.

One favorite strategy is the Roth conversion. This is a relatively simple technique to convert pre-tax money to after-tax money and pay taxes at the time you think it will be the most beneficial to you, typically a low-income year.

It has the added benefit of diversifying the different buckets of money you ultimately have (taxable, pre-tax, after-tax).

The thing to remember is you will owe ordinary income taxes on a conversion. You’ll want to pay taxes with money from outside of the Roth to maximize the conversion.

Business owners who can control their company retirement plan options may want to allow for Roth conversions within their plan for added flexibility.

Small business retirement plans

For some small businesses, 2020 was a banner year, and now reducing taxes is top of mind.

It can be hard to cough up additional expenses or deductions late in the year but here is one: Start a 401(k) plan. 

Although not unique to 2020, plans must be started by year end. 

Not only can employer contributions lower the business tax liability, they also can help the owner and employees save for their retirement. With a flexible plan design, it can open the door to a backdoor or mega backdoor Roth, a creative way for high-income taxpayers to fund a Roth.

Unless additional legislation is passed, these temporary changes for 2020 are gone for good by the time they start playing “Auld Lang Syne.”

Taxes are complex, changing quickly and should be considered within your personal situation and financial goals. 

But don’t let the tax tail wag the dog.

A fiduciary, fee-only comprehensive financial planner can help you evaluate tax saving strategies within the context of your greater financial life. 

Angie Furubotten-LaRosee is a certified financial planner, speaker, podcaster and founder of Avea Financial Planning LLC, a Richland-based financial advice and investment management firm for women nearing or in retirement.

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