As we settle into 2021, it’s time to close the book on a challenging year.
Though it’s safe to say that no one will miss 2020, the pandemic has also taught us several important lessons. For one, pharmaceutical companies have managed to develop a highly successful vaccine in record time. We all appreciate our grocery store clerks, shelf-stackers, and Amazon delivery drivers as essential workers. And perhaps most heartwarmingly, animal shelters are being emptied as people find comfort in rescue pets.
If there is one thing we can take away from the pandemic, it’s that it pays to be prepared. It’s impossible to predict global events of this magnitude, but it’s possible to position ourselves to be as prepared as possible.
Here’s your financial planning checklist with some key money moves to start the new year on a high note.
1. Assess your spending and saving habits
After the chaos of the pandemic recession, COVID has shaken up and made us second-guess our sense of financial security. Beyond the short-term economic shocks, we’re still waiting to see the long-term effects on productivity levels. In 2021, it’s more essential than ever to understand exactly where your money is going. Start by reviewing your savings or debt payoff goals, then develop a spending plan around those goals.
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2. Set a savings goal for 2021
This year, a large proportion of the American population had to pull money out of emergency savings to make ends meet. Some have had to halt or raid their retirement savings.
If you’ve had to depart from your original savings plan, now is the time to regroup and set a new target for 2021. Your savings goal should be your number one budget priority, meaning that you set aside those funds before making any other payments. In other words, pay yourself first.
For instance, if you’ve dipped into your emergency savings this year, replenish that first; you’ll want to save at least six months’ worth of living expenses. If you have other short-term savings goals, like saving for a down payment on a house, set a monthly goal and factor it into your budget.
On the other hand, if you’ve managed to stay within your savings goal, reward yourself by saving for fun. What you save for is up to you; maybe you’d like to take a ski trip, add an outdoor kitchen to your backyard patio, or invest in a great piece of art. Regardless of the goal, figure out how much you need to save, then create a savings account for each goal so you can easily track your progress.
3. Make the most of your year-end bonus
If you’ve received a year-end bonus, don’t be afraid to spend a bit on something that brings you joy. Spend 10 percent on something fun, then allocate the rest toward a financial priority, like funding a 529 College Savings Plan or supplementing emergency savings. (You have until April 15 to max out your IRA.)
4. Maximize your employer 401(k) match
Are you contributing enough to get your full employer match? If you contribute less than your employer is willing to match, you may be passing up free money.
Depending on your financial situation, you may want to meet these key goals before maxing out your 401(k):
- Pay off any high-interest credit card debt
- Build up an emergency fund with six months of living expenses
- Get an adequate health insurance policy
- Get an adequate life insurance policy, especially if you’re married or have children
- Get an adequate disability insurance policy in case you’re out of work for six months or more because of an injury or ailment
- Establish a basic will or trust
- Get a long-term care insurance policy, especially if you’re close to retirement age
5. Consider a Roth conversion
If your earnings were negatively impacted in 2020, consider a Roth conversion for more tax diversification for your retirement income—especially if your distributions could push you into a higher tax bracket. Tax-free income from a Roth IRA also protects you against future tax rate increases, the Social Security tax on excess earnings, and required minimum distributions (RMDs).
You can take advantage of your lower tax bracket by rolling some or all of your old retirement plans into a Roth IRA. Just be aware that if you do convert, you’ll have to pay taxes on the conversion amount. That’s why you should convert just enough to steer clear of pushing your MAGI into a higher tax bracket. You can convert small sums as many times as you want over a period of time.
6. Review your insurance policies
Things change from one year to the next, especially during a tumultuous year like 2020. Your home insurance, life insurance, and other insurance needs will change anytime you go through a major life change or make a significant purchase, like a new piece of jewelry or art.
The easiest way to organize and review your insurance policies? Simply create a one-page policy summary for each policy.
For instance, in 2020, mortgage rates sank down to the lowest levels in history, pushing housing prices up. If your homeowner’s insurance coverage is based on a house valued at $950,000 and it is now worth more than $1,000,000, your coverage may be deficient.
That’s why we recommend an annual insurance policy review—to revisit your coverage and ensure your coverage reflects your needs. You can also add a million-dollar personal umbrella liability policy for a few hundred dollars a year.
7. Review your beneficiary designations
When was the last time you reviewed your beneficiary designations on your bank accounts, investment accounts, life insurance policies, and annuities? Many people forget to update the paperwork after marriage, divorce, or other changes in their family situation.
The problem is, the beneficiary designation is a legally binding document that can override your will. Regardless of your current relationship status, and regardless of the instructions on your current will, the asset will go to the named beneficiary.
This year, it’ll be critical to update your beneficiary designations in light of the SECURE Act, which eliminates the stretch provision for certain IRA beneficiaries. Prior to these new tax rules, non-spouse beneficiaries of traditional IRAs could spread the RMD over their own life expectancies, thereby minimizing their own tax obligations. The SECURE Act accelerates tax collection with a 10-year payout provision for most non-spouse beneficiaries.
Moreover, if you’ve named a trust as the beneficiary of your IRA, that “see-through” trust is also subject to the 10-year rule. Talk to your Financial Advisor about a different kind of trust, called an “accumulation trust,” which could provide a workaround—it gives a trustee the discretion to pay annual distributions to heirs or hold it in the trust. The trustee would be able to spread the distributions over a more extended period, similar to a stretch IRA.
8. Review your estate plan
Contrary to what most of us would believe or prefer, your estate plan is not a one-and-done deal. They occasionally need to be reviewed and possibly amended—and sometimes totally rewritten. You’ll want to check on the following:
- Funding for trusts
- Trustee and agent appointments
- Power of attorney provisions
- Health care directives
Here’s a quick refresher of the landmark events that call for reviewing your estate plan:
- Advancing age. There comes a time when people feel a sense of urgency about reviewing their estate plan to ensure their loved ones are taken care of.
- Serious illness or disability. These events cause us to confront our mortality, and mark a time when people begin to review their estate plans, especially powers of attorney.
- Illness or death of a spouse. If a family member becomes seriously ill or disabled, you should review your plan documents to determine that your loved one will be properly cared for should you pass away. It may take awhile to recover from the tragic death of a loved one, but during this time, you need to take the time to reposition assets for simplified administration of the surviving spouse’s estate, as well as saving on estate taxes.
- Marriage or remarriage. This event calls for a complete makeover of your estate plan. Your new spouse will become your primary beneficiary in your will, trusts, and life insurance policies. If your spouse has an estate plan, you may want to integrate the two plans so they are at least complementary, if not combined. You’ll also need to plan for special provisions for ex-spouses and/or children from previous marriages.
- Divorce. After divorce, you’ll want to disinherit your ex-spouse to some extent, if not entirely. A new or revised estate plan will account for the provisions of your divorce settlement agreement.
- Birth of a child or grandchild. Estate plans are put in place to provide for your descendants, and to protect their inheritance from estate tax liability. Especially if your children are under 18, they must be protected in the event that something happens to you and/or your spouse. Your trustee should be someone who is sensitive to the children’s needs. You’ll also want to appoint a guardian for young children, lest you allow the state to appoint one.
Consider taking advantage of the annual gift exclusion to transfer assets and reduce your taxable estate. You can gift up to $15,000 per individual and $30,000 per couple. Contributions to a 529 college savings plan are considered a gift.
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9. Review your portfolio
From the worst crash in a generation to record highs after reports of a COVID-19 vaccine, it’s an understatement to say that 2020 was an economic rollercoaster.
If you managed to ride out the rollercoaster, parts of your holdings may have held strong during the ride, while other parts may be down.
Here are four year-end strategies to optimize your returns while reducing your tax liability.
Year-End Tax Tips
After significant movement in the market, you’ll want to speak with your Financial Advisor about realigning your assets back to your target allocation. This helps your portfolio maintain its desired risk-return profile.
Tax-loss harvesting is done in conjunction with rebalancing to optimize your portfolio by deliberately selling a stock for a loss. Your capital losses are then harvested for tax purposes and used to offset any capital gains. Use tax-loss harvesting to offset up to $3,000 of income generated throughout the year—losses in excess of $3,000 may be carried forward to future years.
Health Savings Account (HSA)
Review all your medical expenses for the year to see if you’re owed any reimbursements from your HSA. Or, if you plan on postponing your reimbursements to allow your HSA earnings to continue growing tax-free, make sure to document your medical expenses and hold on to your receipts.
Flexible Spending Account (FSA)
The FSA is subject to the “use it or lose it” rule. In general, you’ll be allowed to carry $550 into the following year. Check with your employer to confirm whether you’re qualified for a 2 ½-month extension through mid-March. Review your FSA balance to determine how you can use up the remaining funds to avoid forfeiture. Take a look at your FSA plan rules in light of changes enacted through the CARES Act, which expanded qualified medical expenses to include over-the-counter drugs and menstrual supplies.
10. Plan for required minimum distributions
Be aware of two significant changes made to the required minimum distribution (RMD) rules:
- Under the SECURE Act, individuals who reach age 70 ½ after January 1, 2020 can now wait until age 72 to begin their RMDs.
- Under the CARES Act, RMDs have been waived for 2020. If you took RMDs before the law was enacted in March 2020, you can return them to your retirement account.
11. Make strategic charitable contributions
The CARES Act encourages charitable giving by creating a $300 above-the-line deduction for qualified charitable contributions. This deduction is available to all taxpayers that take the standard deduction on their 2020 return.
If you do itemize, the adjusted gross income (AGI) limit for cash contributions increased in 2020: Individual donors may elect to deduct up to 100 percent of their AGI, up from 60 percent.
If you contribute to supporting organizations or public charities through donor-advised funds (DAF), you may still deduct up to 60 percent of your AGI in cash, and up to 30 percent AGI in appreciated assets contributed to a DAF.
If you are over age 70 ½, you can still donate up to $100,000 each year from your IRA directly to a charity without having to include the distribution in your taxable income.
12. Review your tax withholding
The IRS is constantly changing tax withholding rules. You’ll want to ensure your withholdings are enough to cover your tax liability, but not too much—while receiving a tax refund in the mail may seem like a good thing, it’s nothing more than the repayment of an interest-free loan to the government. You’re much better off investing that money on your own throughout the year.
13. Check in on your credit report
It’s all too easy to let an entire year go by without looking up your credit report. However, especially during the COVID-19 pandemic, fraud and identity theft are on the rise.
You can access your credit report through your bank, but it’s better to review your credit report from all three credit bureaus (Equifax, Experian, and TransUnion)—especially if you plan to take a large loan in 2021. Just order a combined free report from AnnualCreditReport.com.
14. Protect yourself from cyber attacks
A whopping one in four Americans has been a victim of cybercrime, so it’s more critical than ever to shore up your defenses.
If you’re curious about how to lower your risk for identity theft, we interviewed cybersecurity expert Ronald Muhammad on our podcast. Here’s an excerpt from that episode:
Your email serves as the nucleus for your entire digital life. Everything flows through your email—account information, your calendar, your location, your password recovery—so it’s important to spend time making sure that the nucleus of your digital life is protected. Refresh your password on a consistent basis, and use a different password for every account, especially your primary email address.
15. Meet with your Tax Advisor
The beginning of the year is an ideal time to assess your overall tax situation to make sure you’re not paying more in taxes than absolutely necessary.
If you anticipate any changes in your financial situation that may impact your taxes, ask your Tax Advisor about making adjustments to your withholdings.
16. Meet with your Fiduciary Financial Advisor
Finally, schedule a meeting with your Fiduciary Financial Advisor to review your new-year financial planning checklist. Revisit your goals, make sure your spending and saving strategies support those goals, and set up a plan to keep your finances on track. This meeting will set the stage for a financially successful 2021.
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DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities.