Year-End Tax Planning for 2021

By JoAnn Huber

November 16, 2021

Year-End Tax Planning for 2021

Key Points – Year-End Tax Planning for 2021

  • Year-End Tax Planning Strategies for People Still Working
  • Tax Planning Strategies to Keep in Mind for Those on the Verge of Retirement
  • How Do Tax Planning Strategies Differ for Retirees?
  • Tax Planning Strategies to Consider for Widows Who Lost Their Spouse This Past Year
  • 16 minutes to read | 39 minutes to watch

With 2022 right around the corner, now is the time to review year-end tax planning strategies for 2021. Dean Barber and JoAnn Huber share strategies to strongly consider for people who are still working, those who are four to five years from retirement, retirees, and for widows who lost their spouse within the past year.

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Year in Review for 2021

A lot of uncertainty with various spending and tax planning proposals has made it difficult to do forward-looking financial (and tax specific) planning. In this odd year that has been 2021, some things have changed for how tax specialists like Huber have gone about their work, while other things have been constant.

“I wish I had my crystal ball and knew what the laws were going to be. Will they be effective in 2022 or be retroactive?” Huber said. “Will there be changes? There is all this uncertainty, so we don’t know. But the one thing we do know is that is still crucial to do tax planning. Regardless of what might happen, we need to say, ‘This is what we know today,’ and focus on that to do good tax planning.”

Year-End Tax Planning Strategies for Workers

A great deal of the uncertainty we’ve faced in 2021 has stemmed from the lingering effects of COVID-19. In this case, let’s look at the pandemic’s impact on people’s wages in 2021 since that directly effects year-end tax planning strategies for workers.

“Some people didn’t have income at the beginning of the year,” Huber said. “There were people that were still unemployed. Maybe it’s a lower earning year, so you might want to look into a Roth conversion. Have you made their elections to contribute to a flexible spending account or health savings account for next year? Are there withholding amounts you need to be at?”

How the Advanced Child Tax Credit Factors In

Of course, many people who are still working have children. Thanks to the advanced child tax credit that was passed, some people are receiving a monthly check of half of the extra child tax credit. The amount of that check depends on the number of kids you have and what your income was last year. Huber explains that there are several reasons why the advanced child tax credit can impact people in different ways.

“For some people who have higher income this year, you might have to pay back that credit,” Huber said. “Or some people have been taking that credit on their tax return when they file so they don’t have a tax amount due. Since they received it early, they won’t have it as a refund. Therefore, it could throw things off for people who are still working.”

The advanced child tax credit is another reason why it’s important for workers to monitor their income. If you’re close to $150,000 of adjusted gross income, one year-end tax planning strategy to consider is delaying a bonus or stock options.

What About Making a Deductible IRA Contribution—Even If You’re Already Contributing to a 401(k)?

This is a valid question from Dean, but JoAnn points out that most people contributing to a 401(k) aren’t eligible to make a deductible contribution once they get to those income limits. There is another year-end tax planning strategy that can still come into play with this, though. JoAnn has talked to some people about reaching out to their employer and increasing the amount going into their tax-deferred retirement plan since the IRA option won’t be available to them.

Another Question from Dean: Can You Defer Your Entire December Check into Your 401(k) Plan?

Well, that depends on the plan since each 401(k) plan has its own rules. Some employers will also you to do this, while others limit you to deferring a certain percentage of your check. That’s why Huber encourages you to check with someone in human resources with your employer and determine your options.

Looking Ahead to Next Year: Roth Contributions or Traditional Contributions?

This is something that JoAnn says should be done every year, and the end of the year is a good time to do it. If you use the Roth contribution to your 401(k), whatever goes into your 401(k) will reduce your compensation dollar for dollar. The pay is still reduced by the same amount when using the traditional contribution, but the amount of taxable income is less. The obvious question then becomes, how do you know which one to choose?

“One trap that many people fall into is when they’re looking into that current year tax savings,” Barber said. “I can get more saved with the same amount of deduction from my paycheck than if I was doing the Roth.”

The Importance of a Long-Term Perspective

A crucial component that you need to have when making your decision about a Roth or traditional contribution is a long-term perspective.

“I’m paying tax on it if I put it in today, but it’s going to grow tax free or until I take it out. It’s hard to do that without looking at the financial plan,” Huber said. “You can make assumptions, but you never know what’s going to happen with the tax rates. Most people say they will go higher in the future, but if you have a very high taxpayer right now that will eventually be lower, they might want to stay traditional. Some people also say they have the cash and will pay it now even if they’re in a lower tax bracket later.”

The Rude Awakening: Your Tax Bracket May Be Higher in Retirement

One all-too-common misconception that Dean has seen is the assumption that people will be in a lower tax bracket when they retire. It doesn’t help that Congress, the IRS, and even the financial services industry can put pressure on people to put as much money as possible into a tax-deferred account.

“The primary people that Modern Wealth Management works with are people nearing retirement or in retirement. The rude awakening that they all have is that their tax bracket isn’t going down. In some cases, it’s going up and becoming more complex,” Barber said. “If you’ve done a good job of saving for retirement and don’t want your lifestyle to change, you’re probably not going to be in a lower tax bracket in retirement.”

Flexible Spending Accounts and Health Savings Accounts

Before we move on to discussing year-end tax planning strategies for those approaching retirement, let’s go over Flexible Spending Accounts and Health Savings Accounts. Both are accounts to put funds in and save for healthcare, but there is one big difference between them.

With an FSA, whatever money you put into it must be used during the year or you’ll lose it. For Health Spending Accounts, you can put money in and you don’t have to use it within a year. The money can stay in and grow year after year and grow.

“Both of them give you a tax deduction and are usually done through the employer plan. With the HSA, you can contribute up until April 15 of the year following the tax year. You can do a retroactive contribution to that. There are a lot of people that are looking at HSAs to put savings aside for retirement. We all know that healthcare expenses are so expensive once you have to pay your own insurance.”

Year-End Tax Planning Strategies for People Who Are on the Verge of Retirement

Many of the same year-end tax planning strategies that we’ve just discussed will be the same for workers who are within four to five years of retirement. However, there are some different tax planning strategies for those on the verge of retirement.

“So many of the people we’re meeting with are clients and prospects coming in that have so much in that tax-deferred account,” JoAnn said. “They need to start looking into putting money into a taxable account to have funds to do Roth conversions or to live off of once they retire.”

Tax Diversification Is Key

The Modern Wealth Management team looks into this for workers who aren’t quite yet on the verge of retirement as well, but it becomes imperative the closer you get to retirement.

Nearing retirement also means that you’re likely in your peak earning years. From a year-end tax planning strategy perspective, Dean often sees his America’s Wealth Management Show co-host, Bud Kasper, immediately begin thinking about Roth conversions for those people.

“He’s like, ‘Roth, Roth, Roth, Roth, Roth. Always do the Roth,” Dean said. “I’ve ran into several scenarios of people who are in that final five years or so of their careers who have saved money outside of their 401(k). They have a taxable account, a little bit in Roth 401(k), and some traditional 401(k). It usually makes sense for them to switch back to traditional to get the deduction in the higher bracket. Then, in the early years of retirement, let’s spend down the money that’s already been taxed and take that as an opportunity to convert some of that money that’s in a 401(k)/IRA into a Roth in a lower bracket.”

The two critical questions to ask in this scenario are:

  • What’s the tax rate today?
  • What will the tax rate be in the future?

Those questions are imperative to ask so that you will be paying the least amount of tax.

“That tax diversification is so important to make sure you have money in different types of accounts to create flexibility once you retire. When you’re working, you have your wages and there’s not a whole lot you can do to reduce that amount,” Huber said. “Once you’re retired, you have money in the tax-differed and tax-free accounts. You can make year-end tax planning strategies to know how to withdraw and keep those taxes lower.”

Keeping Your Cost Basis in Check

Dean has also observed that most people who are nearing retirement have done a good job of saving. He wants those people to realize that this is a time of year where they should be looking at their cost basis on the assets that they own within different brokerage accounts.

“Is there anything in there that you should do some tax-lost harvesting on? Do you own mutual funds and know what the mutual funds capital gains are going to be this year?” Barber said. “What’s your cost basis on that and are there any adjustments that can be made in the overall investment strategy that would help from a tax perspective without hindering the investment strategy?”

Rebalancing Is an Investment Strategy

JoAnn points out that she doesn’t want tax to be the main emphasis on that. She wants to be looking at it from an investment standpoint. If there is someone with a loss that they can recognize, it might make a lot of sense to do that, especially if they have a lot of gains that can offset it.

“The stock market has been doing exceptionally well for the most part recently, and a lot of people have gains in their accounts. Do we go ahead and recognize some of that, reset the basis, and reassess the risk?” Huber said. “If someone is approaching retirement, do we need to capture some of that gain and set it aside so if the market does crash, we’re not having to take money out at a market low. We’re taking some out at a market high.”

Charitable Donations as a Tax Reduction Strategy

Another thing that people can do with appreciated securities is use them for charitable donations. They can also be gifted to children or grandchildren to get rid of some of that gain, and someone in a lower tax bracket can take it instead.

Projecting Income in Retirement

When people are a few years out from retirement and trying to save money in a traditional or Roth 401(k) or a taxable account, Social Security and pensions are a couple of things that start getting bigger on the retirement radar. However, that all depends on your financial plan.

“It all goes back to that financial plan. We have to figure out when the pension will kick in,” Huber said. “Sometimes if someone retires early, that pension can keep growing. Does that person want to start once they take early retirement or let it grow for a few years? It’s the same with Social Security. Do you want to take it at 62, full retirement age, or wait until 70? There are a lot of factors we are looking at.”

The Time of Life Where You Inherit Money

As mentioned earlier, appreciated securities being gifted to children or grandchildren is something to keep in mind for people who are nearing retirement. On the flip side, those people should also realize that it’s a time where they will likely inherit money.

“When you say the words ‘kids,’ what comes to mind for a lot of people is young kids. But the average age where people are inheriting money is in the mid-50s up to about 70,” Barber said. “Let’s take into account the recent tax law change with inherited IRAs with year-end tax planning and your financial plan. If you inherit an IRA, the entire IRA needs to be emptied thanks to the SECURE Act and 10-year rule on inherited IRAs. It’s December 31 of the 10th year following the year of death.”

When Dean and company start talking to people about year-end tax planning strategies, they also must understand if there will be future inheritance for their clients. They also need to be aware of what kind of inheritance it will be. It could be real estate, stocks and bonds, IRA assets—the list goes on. That’s one of many reasons why tax planning can get confusing.

“We have so many clients who think they’re going to wait until they retire to do a Roth conversion. But then they have a parent die and inherit an IRA. Suddenly, they need to take out the beneficiary IRA amount,” JoAnn said. “We’re trying to do that balance and figure out what needs to happen, but there are always moving parts. We need to put everything together, but it’s complicated.”

JoAnn’s Tax Planning Pet Peeve

Speaking of complicated, there’s one specific thing that she says is her number one tax planning pet peeve. That’s people who wait until the last minute, don’t have everything put together, and neglect to communicate what has happened and think will happen with their tax plan.

“It doesn’t hurt me,” Huber said. “However, I feel bad knowing that it hurt them and knowing that there would have been a better answer.”

It’s important to understand that most financial decisions will eventually show up on your tax return. It’s difficult for people to realize the implications of their financial decisions with how confusing the tax code can be.

“They don’t want to pay interest because they don’t want to throw that money away, but they have no problem paying an extra 10% tax on it or more because of taking it all out,” JoAnn said. “That’s where we want people to communicate so we can show them that the interest they might pay will be a lot less than what they’ll pay in taxes. Let’s find that balance and come up with a strategy to get those funds out to you. Can we keep you in your current tax bracket without your taxes and Medicare premiums?”

It Comes Back to Tax Diversification

This all circles back to the importance of tax diversification. Having funds in traditional 401(k), Roth 401(k), and taxable accounts make it so you don’t feel forced when making big investments.

“People might go into retirement with that tax diversification, but then think they can go buy all these things they want with what they have in their cash account,” Huber said. “They drain that account and don’t realize that they’ve put themselves in a tax corner because everything is tax differed. We want to be watching that account and keeping it balanced, even as we’re going through retirement.”

Year-End Tax Planning Strategies for Retirees

When we mention retirees for our next demographic of year-end tax planning strategies, we’re not talking about recent retirees. They will have similar strategies as the people who are nearing retirement. Those year-end tax planning strategies will change, however, once you hit the age of 70.5.

Qualified Charitable Distributions

Why 70.5, you ask? That’s when Qualified Charitable Distributions come into play.

“I think QCDs are one of the nicest rules in the tax code besides the Roth,” JoAnn said. “Most people with the standard higher deduction after the Tax Cuts and Jobs Act are taking the standard deduction rather than itemizing, so there isn’t a tax benefit from giving. QCDs allow people to send money directly from the IRA to charity, but they never need to include that amount in income.”

What Will Happen to Your Tax Situation If Your Spouse Dies?

There are all sorts of benefits related to QCDs, including Social Security not being taxable and Medicare premiums not being higher. JoAnn hasn’t seen anyone hurt financially from QCDs, but there is one specific thing from a tax perspective that Dean advises retirees to be prepare for to avoid financial hardships. You need to ask yourself, “What will happen to my tax situation if my spouse passes away?”

People should play that what-if scenario a long time before retirement since there are changes with being a single tax filer.

“With a lot of people we work with, the surviving spouse goes to a higher tax bracket. It’s hard because they’ve lost their spouse’s Social Security—the lower amount between the couple drops off and you keep the higher one,” Huber said. “The expenses for living don’t drop that much. Suddenly, they have similar Required Minimum Distributions and income, but the tax brackets for a single taxpayer are about half of what they were for a joint-filing couple. Not only are you hitting the bracket higher, you get less taxed at the lower brackets.”

Back to Why Where Your Contributions Go Matters

This ties back into year-in tax planning strategies you should be considering shortly before retirement. It’s pivotal to make sure that the surviving spouse will be in the lowest possible tax bracket.

“For people who are five years out from retirement, it’s another reason to look at the difference between making a Roth 401(k) and a traditional 401(k) contribution,” Dean said. “In the early years of retirement, think about spending some from the taxable account and doing conversions from traditional to Roth.”

It ties into to pensions as well. When you’re claiming pensions, taking a spousal benefit is something to consider in case your spouse dies. Roughly 50% of Modern Wealth Management’s clients inquire about the firm because they want to ensure that their spouse is taken care of financially if they pass away before their spouse does.

“You’ve got someone who is astute and does most of the retirement planning,” Barber said. “However, they understand that there could come a point where they can’t make those decisions cognitively or they pass away.”

The emotional effects that ensue after a loss of a spouse are difficult enough to deal with. That situation can become even more difficult if it’s compounded with a lack of financial planning.

Year-End Tax Planning Strategies to Consider for Widows Who Lost Their Spouse This Past Year

When you’re doing your year-end tax planning, it’s an optimal time to double check your beneficiaries on your retirement accounts.

“We’ve seen so many horror stories where people didn’t have the right beneficiary designations on their retirement account,” Barber said. “They might have set up a trust and say one thing on that, but the beneficiary form on the IRA or the 401(k) says something totally different. The beneficiary forms will always trump the trust or the will.”

Avoiding the Snags that Can Come Along with Inheritance

Inheritance can feature several tricky scenarios that can oftentimes be avoidable. Dean had an example that immediately came to mind for this topic.

“We’ve seen scenarios where a client’s parents had an IRA somewhere else, but the beneficiary was to John Doe’s estate. That’s a train wreck,” Barber said. “Suddenly, they’re going to be probated, there’s no way to inherit the IRA, and it’s all going to be taxable. Beneficiary designations at that later point in life are something that should be checked annually.”

A Great Holiday Gift Idea

While it might not be a traditional holiday gift, checking your beneficiary forms could be a better present than your children or grandchildren could ever ask for. It can be a major headache if it’s not set up correctly.

Meeting with an Advisor Is a Must for Those Who Have Lost a Spouse This Year

For those who have lost their spouse in the past year, JoAnn says that it’s a must to meet with a financial advisor before the year ends.

“We need to figure out what you need to do this year because it’s your last year of filing joint. We’ll do a good-sized Roth conversion for you because this is it on the lower tax brackets,” Huber said. “If there are medical expenses, that gives even more room to do things. Oftentimes there is at least a partial step-up in basis for that, so that helps. We don’t want to miss an opportunity for you that you’ll never have again.”

An Example of How a Partial Step-Up in Basis Can Be Easily Missed

That partial step-up in basis can easily be looked over, but you don’t want to miss out on it. For example, let’s say a husband and wife have a joint account with a trust and are co-trustees. Then, one spouse passes away, but the surviving spouse doesn’t do anything with the account.

Fast forward a couple of years later. The surviving spouse meets with an advisor, who asks them if they’ve met with the custodian of the account to get a step-up in basis on half of the account based on the date of the spouse’s death. The answer was no from the surviving spouse.

“We hope we catch these scenarios while doing tax returns. We’ll go back to the custodians and say that it needs to be adjusted,” JoAnn said. “Sometimes people will have it going to a trust. It will no longer be in the surviving spouse’s name, but instead in the trust. There are a lot of things that need to be done when someone dies, so you need to make sure you’re following the trust if you have one. It’s telling you the rules to play by.”

Everything Needs to Work Together

It’s critical for the investments, estate plan, and tax plan to all work together. It makes a world of difference for a professional with expertise in each category to collectively understand what is happening with the retiree (or near retiree).

“Where people fall into traps and make mistakes is when they have an attorney, CPA, an investment person, and maybe an insurance person that don’t talk to each other,” Dean said. “It can be very problematic when they don’t have any clue what each other are doing. If the individual is left to decipher what to do, that’s where all the mistakes get made.”

What’s more, that individual often isn’t operating at an optimal level because they’re dealing with a loss of a spouse. That’s where the team of professionals can help through the emotional stress and make those financial decisions. Unfortunately, there are other professionals in the industry who have their own interests at heart rather than the surviving spouse’s. It’s important to have good relationships with those professionals so you can trust them and don’t get taken advantage of.

“It’s one of those things where it’s so the rules with year-end tax planning strategies can be so complicated that people get scared or embarrassed of not knowing the rules. That prevents them from coming in and talking to us,” Barber said. “We understand that it’s complicated. There are even times when we need to say we’re 95% sure on something but need to go back and do more research so we get the right answer. Don’t be embarrassed and think that you should know this because this isn’t something that most people should know.”

The Main Year-End Tax Planning Strategy Takeaway

While year-end tax planning strategies can be complicated, they’re a critical component to the financial plan. They can be much better understood with the assistance of CFP® professionals.

“Year-end tax planning is unique for every individual and couple. There is no one checklist that can cover it all,” Dean said. “You really need to have an active financial plan created to have an efficient year-end tax planning strategy. That tax planning strategy needs to be a multi-year.”

To learn more about what year-end tax planning strategies work best for you, schedule a complimentary consultation with one of our CFP® professionals. We can visit with you in person, by phone, or by virtual meeting.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.