As we settle into November, thoughts turn to the end of the year. As they year winds down, there are still things you can do to reduce your 2021 tax bill.
1.) Check Your Withholding
If you were hit with a big tax bill last April it might be because you don’t have enough taxes withheld from your income (or from your pension or IRA distributions). The IRS offers an online tool to help you estimate your tax bill for this year. And, if you need it, you will have the option to change your withholding between now and December 31 to square things up.
2.) Consider Paying 2022 Bills Now
If you itemized deductions, or if you think you will be close to the threshold of $25,100, you may want to prepay deductible expenses. For example:
- You could pre-pay state or local taxes for 2021. (If they are deductible in your state.)
- Review your medical bills. If you have unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, anything over that limit is deductible.
- You could schedule procedures or annual checkups before year end to add to your tax savings.
- For the complete list of medical expenses you could deduct, see IRS Publication 502.
- Prepay college tuition for your child. The American Opportunity Tax Credit, for students who in their first four years of undergraduate study, is worth up to $2,500 for each qualifying student. Married couples filing jointly with modified adjusted joint income of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial amount.
- Prepay tuition for courses you are taking for your own professional development. You may qualify for the Lifetime Learning Credit on your 2021 tax return. The credit is worth up to 20% of your out-of-pocket costs for tuition, fees and books, up to a maximum of $2,000. It's not limited to undergraduate expenses, and you don't have to be a full-time student.
As with the American Opportunity Tax Credit, married couples filing jointly with MAGI of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial credit.
- Contribute to a 529 college savings plan. In my home state of Minnesota , contributions to the Minnesota College Savings Plan may qualify for some state income tax savings.
- Stashing money in a 529 plan before year-end won't reduce your federal tax bill, but it could lower your state tax tab. More than 30 states allow you to deduct at least a portion of 529 plan contributions from state income taxes. In most states, you must contribute to your own state's plan to get the tax deduction, but several states allow you to deduct contributions to any state's plan. Check out your own state's rules at savingforcollege.com.
- Support a person with special needs by contributing to an ABLE account. Theses accounts offer tax deductions on contributions up to $15,000. These contributions allow people with qualifying disabilities to save money without jeopardizing government benefits (ABLE account beneficiaries can contribute more to their own account). You don't have to invest in your own state's plan, but if you're a resident of one of the states that do offer a tax break for ABLE accounts, you can deduct your contribution. For more information, go to the ABLE National Resource Center's website.
3.) Harvest Your Capital Losses
In a taxable investment account, you have a chance to capture tax savings by selling investments that have fallen in value. If you sell a security for less than your purchase cost, the difference can be recorded as capital loss and used to offset any investments sold that year at a profit. Excess losses up to $3,000 can be used to offset regular income. Any additional losses can be carried forward to the next year.
Investors in the bottom two tax brackets (with income less than $40,400 for single filers and $80,800 for joint filers) pay no capital gains tax on investments held for more than a year. If that's the case, it may make sense to sell winning investments tax-free and reinvest to reset the odometer on future gains.
4.) Watch for Capital Gains Distributions
If you own mutual funds in a taxable account, it makes sense to monitor them for year-end capital gains distributions. By law, mutual funds must pay out to their shareholders any gains realized from the sale of stocks or bonds during the year. Check with your mutual fund company for their 2021 capital gains estimates. They should be available starting mid November.
5.) Max Out Your Pre-Tax Retirement Savings
As the year comes to a close, check to see if you can increase your contributions to your employer’s retirement plan. Every worker is eligible to save up to $19,500 to a 401(k), 403(b) or federal Thrift Savings Plan in 2021, plus $6,500 in catch-up contributions if you're better than 50 years old.
Consider saving into the Roth 401(k) account in your company plan. This account does NOT reduce your tax bill now, but it will create TAX FREE income in retirement. All my retire clients get cranky about distributions from traditional retirement accounts when they learn that they need to pay income tax ON TOP of any distribution they make from their traditional accounts.
Check with your 401(k) administrator or your employer's human resources department to see how close your are to hitting the limit and to see how you can bump up your savings.
Even if you are maxing out your company retirement plan, you are still eligible to contribution to an Individual Retirement Account (IRA) for tax year 2021. Each worker, or spouse, can contribute $6,000, plus $1,000 extra for those better than 50 years old, to an IRA account. And you have until your tax filing deadline to make a contribution for 2021.
6.) Open a Donor-Advised Fund
Putting your money or other assets, such as stocks or personal property, in a donor-advised fund allows you to deduct the entire contribution in the year you make it and decide later how you want to dole out grants to charities of your choice. You can open a donor-advised fund at many financial-services firms or community foundations. Contributing one lump sum this year may help lift your deductions above the standard deduction amount and allow you to itemize.
7.) Max Out Charitable Donations (and Declutter) if You Itemize
If you itemize, donating clothes, kitchenware or furniture you no longer need can boost your deductions while helping a worthy cause. You'll base your deduction on the donated item's "fair market value" (or what it might sell for at a thrift or consignment shop) — you can use online tools such as TurboTax's ItsDeductible tool to estimate this value. You will need a written acknowledgment from the organization if you are claiming a contribution of $250 or more (consider snapping a photo of the donation for your records). For donated items valued at more than $5,000 (art, antiques, etc.), plan on providing a written appraisal.
For the 2021 tax year, you can deduct cash donations of up to 100% of their adjusted gross income. Before 2020 and after 2021, the cut-off is 60% of AGI. Donations to donor-advised funds aren't eligible for the higher limits, though.
8.) Donate Cash to Charity if You Take the Standard Deduction
Since the 2017 tax overhaul doubled the standard deduction, the majority of taxpayers no longer itemize on their tax returns. But if you make a charitable contribution before December 31, you may be eligible for a modest deduction, even if you don't itemize.
For the 2021 tax year, people who take the standard deduction can deduct up to $300 of cash donations to charity. The $300 amount is per person, so if you're married, you can deduct a total of $600 on your 2021 tax return.
The deduction is limited to cash contributions — contributions of clothing and household goods to your local Goodwill aren't eligible. Donations to donor-advised funds aren't eligible, either. Keep a record of your contribution with your tax documents. For donations under $250, you need a bank record, such as a cancelled check or credit card statement. For donations that exceed $250, you should obtain a written acknowledgement from the charity that shows the date of the contribution, the amount, and states whether you received any goods or services in exchange for your donation.
9.) Transfer IRA Money to Charity
Taxpayers who are 70½ or older can transfer up to $100,000 from a traditional IRA tax-free to charity each year, as long as they transfer the money to the charity directly.
These distribution count as your required minimum distribution. In addition, a "qualified charitable distribution" will reduce the size of your IRA, which will reduce future required withdrawals, and your tax bill too. Plus, the transfer could help keep your income below the threshold at which you're subject to the Medicare high-income surcharge as well as hold down the percentage of your Social Security benefits subject to tax.
If you decide to make a QCD, do it well in advance of New Year's Eve. To qualify for the tax break, the money has to be out of the account and the check needs to be cashed by the charity by December 31.
10.) Consider a Roth Conversion
Consider converting some money from a traditional IRA to a Roth IRA this year, up to the top of your income tax bracket, especially if you believe your taxes may go up in the future. You'll pay taxes on the conversion (minus any portion that represents nondeductible IRA contributions), but the money will grow tax-free in the Roth after that.
If you convert too much, you could get bumped into a higher tax bracket. And your higher adjusted gross income could increase your Medicare Part B co-pay for next year. So, it makes sense to consult with your tax advisor on your specific situation.
As you look at this list, you very likely have questions. If you want to discuss your situation, follow this LINK to find a time for us to talk.
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- Is the advisor always the client’s advocate – a fiduciary advisor?
- Is the advisor paid by clients, not financial product manufacturer or distribution network? That would be a fee-first advisor.
These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.
A fiduciary, fee-first, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.
Yes, I am a CFP® professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at firstname.lastname@example.org. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.