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At the end of every year, there’s an opportunity to make smart financial moves to reduce taxes, increase net investment income and decrease portfolio risk.
Some of these financial moves are especially timely. They’re enabled by federal legislation and temporary changes in tax rules aimed at easing pandemic-related financial distress. Some other year-end moves are suggested by the change in presidential administrations in January.
So, here are some potential financial moves you need to consider.
Borrowing money from your 401(k) plan. The CARES Act gives accountholders what will probably be a once-in-a-lifetime chance to borrow up to $100,000, penalty-, interest- and tax-free for three years. Sure, this would be additional debt, but if you’re laid off, this could pay living expenses until you get back to work and help you keep your home.
Accelerating charitable giving to 2020. Donations are normally limited to 60% of the giver’s adjusted gross income. But the CARES Act removes this limit for 2020, permitting taxpayers to deduct 100% of charitable donations that qualify under IRS rules. So if you’re planning to donate this year and next, you can reduce your taxable income by telescoping all of this giving into 2020 and writing those checks this month.
Realizing capital gains and offsetting losses in your investment portfolio. If you have net realized capital losses for the year, it’s important to know that you can’t use them to reduce your taxable income by more than $3,000 in a given year. The remainder of these losses can be carried forward to the following year.
Coordinating your capital gain/loss harvesting strategy with your tax planning. If you expect to be in a higher tax bracket next year, it’s normally advisable to carry capital losses forward as much as possible to offset capital gains in 2021.
However, President-elect Joe Biden is generally expected to seek an increase in the capital gains tax rate, though he has indicated that substantial increases would apply only to those earning more than $1 million annually. If you’re in this category and you don’t feel lucky, you may want to take all 2020 capital gains possible this year to avoid a higher tax rate that might come in 2021.
But it’s not only wealthy investors who can benefit from strategically harvesting their capital gains/losses this year, because capital gains rates for all tax brackets are now historically low — and may never be this low again.
Making portfolio adjustments if necessary, to maintain your original asset allocation, which may have been thrown askew by high market volatility this year. In rebalancing to restore your intended allocation (e.g., 80% stocks/20% bonds), this would probably mean selling highly appreciated stock positions while these stocks are up and then buying investments that are down, in accordance with your allocation plan.
Like stock prices, bond prices may never be higher — and these high prices go hand in hand with current paltry yields. So, consider trimming your bond holdings if your asset allocation permits. And if your risk tolerance can handle it, you may want to use the cash to buy promising stocks with depressed values.
Setting up a trust for your heirs and funding it this year to take advantage of current IRS rules. Biden has talked about substantially reducing the lifetime gift/estate-tax exclusion amount (currently $11.58 million for singles and about $23 million for married couples). Setting up a trust and funding it now can freeze the exclusion amount at the current levels.
Further, wealthy individuals looking for ways to give away money to make loved ones happy and reduce estate size (and tax exposure) should remember that they can give up to $15,000 apiece each year to as many people as they choose without paying gift tax or decreasing their lifetime exclusion amount.
This is a great way to give money without triggering a tax impact, but this perennial opportunity disappears at the end of each year. After all, you can’t take it with you.
Using some of your time in quarantine to make a will. An estimated 6 out of 10 American adults don’t have a will. While it may not seem like a pressing matter now, your heirs will appreciate your making your wishes clear in advance.
Consideration for heirs also involves executing medical directives in the event you become incapacitated. Estate-organizing books, such as “I’m Dead, Now What?” from Peter Pauper Press, include blanks for instructions for estate executors regarding specific situations and account passwords and document locations, making it easy for them to clean up financial affairs and fulfill bequests; you just fill it out. Aside from watching broadcasts of football games played in empty stadiums, what else do you have to do in quarantine?
Of course, your consideration of all these moves should come in the context of your personal financial scenario, short- and long-term goals and investment risk tolerance. But if any of these moves are beneficial and appropriate for your situation, you should act now because they expire at the stroke of the new year.