Hopefully, you are reviewing accounts for tax harvesting of losses, considering Roth conversions, working to maximize itemized deductions if you are going to itemize, and getting your paperwork organized.
As we prepare to ring out the 2020 calendar year and ring in the 2021 calendar year, there are some general financial moves that you may want to consider that could improve your financial situation in the future.
First and foremost, since there are only a few days left – have you reviewed your Medicare plans that you have in place and are comfortable that what you have is still your best option? Are you on a Medicare Supplemental with a Part D co-pay? Are you using a Medicare Advantage and have Medicare Part C? Are you confident that you have chosen the right plan? There is no one right plan for everyone. Consider your out-of-pocket expenses and the doctors and the specialists you use. You need to consider if you are only concerned about local coverage or if you need national coverage or international coverage. Would you prefer regular premiums that cover most of your costs or lower premiums with the risk that out-of-pocket expenses may be higher if something happened in the upcoming year? There are many considerations in determining your better options and what was good last year may not be the most appropriate this year. Make sure you review your plan before open enrollment ends and consider if a change is warranted.
With heavier-than-normal volatility in the market this year, many mutual fund companies were forced into selling some investments that they may not have wanted to sell to generate needed cash. These sales may have higher capital gains attached. We often see abnormally high capital gain distributions in years of higher volatility. While this is not a tax concern for retirement accounts, if you have investments in individual, joint, or trust accounts, you may be facing a larger than normal capital gain distribution. This will result in a larger than expected tax bill.
Buying into a mutual fund this time of year can be all about the timing. If you are purchasing mutual fund shares, consider waiting until after they have paid out their capital gain distribution for the year. Purchasing a fund today that pays a distribution tomorrow means an immediate tax consequence. The share price will generally decrease to reflect the distribution so that the overall account value may change little. However, you are stuck with taxable income this year and a tax bill to be paid. Consider waiting until after a fund has made those distributions before investing to avoid a current-year tax bill related to your purchase.
To avoid that capital gain distribution or even a capital gain on the sale of a stock or mutual fund, consider donating those shares to charity rather than giving cash. The charity receives the stock, can sell it, and is not required to pay taxes on the gain.
Take the example of 100 shares of ABCD stock that you purchased many years ago for $10,000. Today, those shares have a value of $20,000. You are looking to make a $10,000 donation to a local non-profit. If you sell 50 shares to get the $10,000, you will have a tax bill upwards of $2,000, depending on your tax bracket. You then either must come up with the $2,000 of tax money from other sources or only give the non-profit $8,000 so you can pay the tax bill.
If, instead, you donate those 50 shares to the local non-profit, you have given them a value of $10,000. You have no tax bill to pay. The non-profit can sell the shares and get the $10,000 without owing any taxes. Many non-profits have investment accounts set up to accept those shares and have made the process relatively easy. Contact the non-profit to get the information regarding how to transfer shares to the organization.
Giving $10,000 in one year may or may not entitle you to a tax deduction. With the current higher standard deductions, many individuals no longer itemize. If you would like to take advantage of getting a tax deduction for your charitable contributions, a charitable remainder trust may be a better way to go.
With a charitable remainder trust, the donation is made to the trust account. The deduction is taken in that year. You can choose to make the contributions to the charitable organization over several years. A charitable remainder trust often called a donor-advised fund, is set up with a financial institution.
Use the example that you usually give $5,000 a year to your favorite charity. You could elect to put $50,000 into the trust this year. That $50,000 is a tax deduction for you this year, saving you $10,000 to $20,000 or more in taxes this year, depending on your tax rates. Each year you then request the trust to send your charity $5,000. When the funds are given to the charity, you do not get a tax deduction; that was taken upfront. You can set the remainder of the funds to go to your charity at your death, providing them with a final legacy on your behalf. These funds are also out of your estate for estate purposes.
Giving to a charity can mean getting a tax deduction. You can also give to your children, grandchildren, other relatives, or friends without incurring a tax liability; you also do not get a tax deduction. The annual gift tax exclusion is $15,000. You, and if applicable, your spouse can give any person $15,000 a year without any consequences. I could give my son Mike $15,000. My husband, Lynn, could give Mike $15,000. There would be no reporting requirements for us as the giver or for Mike as the recipient. I could give $15,000 to Mike and $15,000 to my six nieces and have no reporting requirements. If you stay at or below $15,000 per person, no one must report that gift to the government.
There are several advantages to gifting. If I am concerned about estate issues, it gets these funds out of my estate. All future growth on those assets now belongs to the recipient and not the donor. If I am concerned about protecting some assets for an inheritance, by giving them now, I may protect them in the future from needing to be used for long term care expenses. If I want to help with future college expenses, I could gift funds into a college 529. If I want to help with future retirement needs, I could gift funds into a Roth IRA for a child or grandchild if they meet the requirements to fund an IRA account. For a disabled child, I could gift funds into an ABLE account for future expense needs. Gifting, in many ways, allows for a transition of wealth today and potentially avoiding tax implications later.
If I give appreciated assets such as stock or mutual funds, I avoid paying taxes to sell the investment. The recipient does have to retain my cost basis, so when they sell the stocks or mutual funds, they will have a tax consequence. If they are in a lower tax bracket than I am, this is a win for the family since, as a family, we paid less in taxes.
There are many ways to reduce your future tax burden. There are ways to help your favorite cause – whether that is a charity or a family member that you want to assist, some of which can help on taxes today and some of which will help with future tax liabilities. It may take a little more paperwork and effort than simply writing a check or giving cash. The benefits may more than compensate for that. If you are interested in learning more about any of these strategies and if they are applicable for you, please reach out to your financial advisor for your personalized advice.
