[As with anything tax-related, see my disclaimers.]
It’s the end of another year. Here are some end-of-year financial “chores” that you might consider as we close out 2020 and head into 2021.
Adjust W2 Withholdings
I track my expected tax burden in a custom spreadsheet and tailor my withholdings to be as close to zero as possible. I’m okay with underwithholding, but I do try to keep it well under $1k of taxes due. I want to avoid any underpayment tax penalty, but cut it as close as I can. In early November, I evaluate my estimated tax for the year and see if I need to adjust my withholding. This year I bumped up my withholding twice to keep me under the $1k window. I’m not too worried about getting it exactly right, nor am I too concerned about giving the government an interest free loan. The amount we’re talking about is noise in the grand scheme of things.
The other aspect of adjusting my withholdings is looking at the future tax year. Last year, I didn’t realize that I would lose the Child Tax credit for my oldest, who had turned 17 in 2019. I thought I had one more year of the credit. In 2021, my second oldest turns 17, so I need to adjust my tax withholding to compensate for a greater tax burden in 2021. This is something I’ll have to think about pretty much every other year for the next decade as my children progress to adulthood.
Finally, because I bunch up my charitable contributions between tax years, each year’s tax burden is a little different and needs adjustment, depending on whether it’s a “charitable year” or not. Why do I do this? To maximize my standard deduction.
Another end of year activity is to finish making any charitable gifts for the year. With the CARES Act passed in March, I can donate at least $300 for deduction and still take the standard deduction, netting about $66 of tax savings. Frankly, I was going to donate the money anyways, so the tax benefit is just additional goodness. Making sure I make the donation by the end of the year maximizes my tax efficiency.
As a side note, if I was put in charge of things, I would kill the charitable donation tax deduction. I don’t believe it increases meaningful charitable donations and is widely abused. Phase it out, I say. Ditto for the mortgage tax deductions.
Adjust 401(k) contributions
I currently max out my 401(k) contributions each year. If you aren’t already there, you might consider bumping up your contributions by 1% until you get there. And if you want to go further, consider front-loading your 401(k) contributions, concluding the maximum contributions well before the end of year. Either way, it might make sense to check in with your 401(k) plan(s), especially if you switched jobs during the year. For example, this year I’m considering switching a portion of my contributions to Roth, anticipating a possible switch from deduction to credit in 2021.
529 Withdrawals and Contributions
Last week, I started the withdrawals from my daughter’s 529 accounts to compensate myself for college tuition and housing costs I paid out of pocket back in August. I triggered the process now instead of next week, wanting to make sure I didn’t put it off until it was too late for it to count against 2020’s expenses. Remember, any 529 withdrawals must happen in the same calendar year as the expense to get the qualified treatment. I closed out the Inflation Protected portfolio account and once that withdrawal clears and I know the exact amount, I’ll trigger a withdrawal from her Conservative Income portfolio for the remaining money.
This is her freshman year and she still has another three-plus years to go. So I also opened another 529 account to maximize the tax benefits for 2020. In Virginia, a taxpayer can deduct $4k per account, which can make a pretty big tax deduction against my state taxes. And this time I chose to open a Total Stock Market index account, worried I might have been too conservative earlier this year.
While you can technically make your IRA contributions anytime before April 15th, you might consider making those contributions earlier to maximize time in the market, similar to front-loading your 401(k) contributions. I didn’t exactly practice what I preach this year, choosing to make our 2020 contributions at the beginning of October. But better late than never.
Another thing to consider is whether you convert any IRA money into Roth. The end of the year is an optimal time to make this calculation as you have a better idea of the tax implications. If it was a lower income year, converting now might save you big tax dollars later.
Tax Loss/Gain Harvesting
Lastly, looking at your other taxable accounts for opportunities to harvest either tax losses or gains is another end of year activity. This year presented some golden opportunities for tax loss harvesting back in March and April and we didn’t really rack up any losses for the remainder of the year. But maybe you did. Or maybe you have the opposite, a lower income for 2020 but tax gains that you can harvest for better tax treatment. Either way, it’s a good time to evaluate your situation. Of course, don’t let the tax tail wag the dog!
Spend Down FSA Accounts
When the FSA benefit year rolls over, any unused dollars are forfeited, so make sure you spend it down. And if you have spare money left over, consider dropping your contribution down to what you think you’ll spend. After all, money in your FSA is still your money, just tax free. It doesn’t make sense to over save in these temporary accounts. This almost slipped my mind because my benefit year ends in September.
Closing Out Unused Accounts
The end of year is also a good time to close out financial accounts that aren’t bringing you joy! Like my Suntrust checking account that will be getting the ax on December 30th. I was only in it for the bank bonus, and I don’t need it weighing down my psyche a day longer than necessary. I’ll need to readjust my direct deposit at work at the same time, since a portion of my paycheck is going into that account to avoid noisome fees.
What do you have on your list of end-of-year financial chores? Anything glaringly obvious I’m missing? I’d love to hear about it in the comments.