As 2020 comes to an end, we look forward to what 2021 will bring. We hope more happiness, less uncertainty, stronger relationships, and more time together will take place. With only a few weeks left in 2020, we would like to remind you there are some steps you can take to make the most of this year financially.
Gifting to Family Members
- Annual gifts including gifts to 529 plans – the maximum an individual can gift in 2020 without reducing their lifetime exemption amount ($11.58 million) is $15,000. This amount is also known as the annual gift tax exclusion amount. Additionally, a special lump-sum contribution rule exists for 529 plans where an individual can gift five years’ worth of the annual gift tax exclusion ($75,000 in 2020) in one year to a 529 and elect to spread the amount out over five years.
- Hypothetical Case 1 – Mr. and Mrs. Smith want to gift to their son and daughter-in-law. Mr. Smith can gift $15,000 to his son and $15,000 to his daughter-in-law. Mrs. Smith can gift $15,000 to her son and $15,000 to her daughter-in-law. The total amount of non-taxable gifts is $60,000.
- Hypothetical Case 2 – Mr. and Mrs. Smith want to fund a 529 for their granddaughter who will be attending college in five years. They want to gift the largest amount so it can grow tax-free for college expenses in a relatively short amount of time. Mr. or Mrs. Smith can contribute $75,000 individually or $150,000 combined and elect to spread this amount over five years. They will not be able to gift $15,000 to their granddaughter (in cash or through 529 contributions) until after five years.
- Roth accounts for young professional children – One of the most tax efficient type of retirement accounts is a Roth IRA in which after-tax dollars can grow tax-free. Many young individuals who are working part-time or full-time jobs do not contribute to a Roth IRA even though they can contribute up to $6,000 or the amount of their earned income for the year. Additionally, individuals who are under a certain income threshold can both contribute to their 401k as well as make Roth IRA contributions.
- Hypothetical Case 1 – Mr. and Mrs. Lee’s son is home for the summer from college and has taken up a part-time job. He earned $5,200 in wages for the summer so he or his parents can contribute to a Roth IRA in his name for that amount.
Gifting to Charity
- $300 above the line deduction – An above-the-line deduction is a deduction that can be taken in addition to the standard or itemized deduction amount; however, the deduction cannot be counted twice. The CARES Act allows for an individual or married couple filing a joint return to take an above-the-line deduction for up to $300 in donations to a 501(c)(3) organization.
- Hypothetical Case 1 – In 2020, Mr. and Mrs. Brown donate $300 in cash to a qualified 501c3 organization so do not have to pay federal taxes on this amount.
- Donations of Cash or Appreciated Assets to Donor Advised Funds – Charitably inclined individuals with donor-advised funds can deduct up to 60% of their Adjusted Gross Income (AGI) for cash contributions to their fund and 30% of their AGI for contributions of appreciated assets.
- Hypothetical Case 1 – Mr. and Mrs. Patel have 500 shares of XYZ stock which has a current value of $100,000 and $70,000 worth of unrealized, long-term capital gains. They donate $25,000 every year. They decide to front load fund their donor-advised fund with the 500 shares of XYZ. They do not have to pay taxes on the gain and also take a deduction up to 30% of their 2020 AGI.
- Retirement Conversions – The CARES Act has waived Required Minimum Distributions (RMDs) from retirement accounts for 2020. This waiver provides a rare opportunity for individuals to replace the income recognized through RMDs with a Roth conversion. Roth conversions are not only advantageous for those in RMD mode; individuals who have capacity to recognize income at a low tax rate can convert an amount up to the tax bracket limit and enjoy tax-free growth.
- Hypothetical Case 1 – Mr. and Mrs. Garcia usually have a combined annual RMD amount of $45,000 and are in the 12% tax bracket. Since they do not have to take their RMD for 2020, they decide to convert $45,000 to a Roth IRA and pay taxes at the 12% tax rate so they can lower their RMD amount for subsequent years, pay taxes at a historically low tax rate, and create a tax-free account for legacy planning.
- Hypothetical Case 2 – Mrs. Williams is a 28-year-old who was just notified of a large raise which will take effect in 2021. She and her husband are currently in the 12% tax bracket but the raise will propel them into the 22% bracket. Mrs. Williams has $15,000 in a traditional 401k and her plan allows for in-plan Roth conversions. Mrs. Williams converts the $15,000 to Roth funds and pays taxes at 12% on the conversion. When she retires at 62 years old, her Roth amount, averaging a 5% annual growth rate, has grown to a tax-free amount of $78,800.22.
- Tax Harvesting – With one of the sharpest recoveries in market history, individuals may have a substantial capital gains tax liability looming for the 2020 tax year. Short-term capital losses can offset short-term capital gains. Long-term capital losses can offset long-term capital gains. Net losses of either type can then be used to offset gains of either type.
- Hypothetical Case 1 – Mr. and Mrs. Perez have a projected capital gains liability of $62,000 for 2020. One of their investment accounts holds securities with an unrealized loss of $18,000. They can realize this loss and use it to reduce their capital gains liability and, therefore, pay less in capital gains tax.
These are just a few examples when it comes to planning strategies. The planning team at Acumen is here to help if you have any questions. Please remember that due to increased processing times, we need to execute any strategies well before year end to ensure they are processed in time. Smart financial decisions year after year help increase the probability of financial success. As Warren Buffett says, “The more you learn, the more you earn.”
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