Year-end wealth planning is a process that can include routine tasks, which are generally rules of thumb, as well as situational strategies that you may consider given changes in taxes, legislation, markets, the economy, and more. As we approach the end of 2021 and continue to weather the pandemic and potential tax changes, let’s take a look at ways to fine-tune your year-end planning to make sure you take advantage of strategies that best position your plan not only for this year but also for those ahead.
Routine Year-End Planning
Income taxes. Minimizing taxes by deferring income and maximizing deductions is a key part of year-end income tax planning. This generally includes maximizing contributions to tax-advantaged retirement plans, such as 401(k)s and IRAs. The result is a double advantage: Reducing current-year taxable income and providing tax-deferred growth while the assets remain in the account. Contributing to health savings accounts offers similar tax benefits and may offer the added advantage of tax-free distributions for qualified medical expenses.
Capital gains. If you’ve sold appreciated assets throughout the year, you will want to seek losses that can offset the taxable gain. Known as tax-loss harvesting, realizing capital losses can eliminate or reduce the impact of capital gains. It’s important to note that wash sale rules prevent the repurchase of a “substantially identical” security within the 30-day period before or after a security is sold.
Annual exclusion gifting. Every individual may make tax-free, annual exclusion gifts of up to $15,000—or $30,000 for a married couple—without counting toward the lifetime exemption from federal estate and gift tax. This is a per-person limit, so you can make gifts to as many people as you like.
Your estate plan. Year-end is a great time to be sure your estate plan is complete, including that your beneficiary designations are current and that the plan still meets your wishes for eventual distribution.
Situational Year-end Planning
Supplementing your routine strategies with situational strategies can help further enhance your financial and tax positions. As the end of the year approaches, it’s a good time to ask yourself if you’re playing offense or defense. If this year has been a high tax year, you may be looking to defend against immediate taxation by employing additional tax reduction and deferral strategies that will help decrease your 2021 tax bill. Alternatively, if the year has resulted in relatively low taxable income, or you expect higher rates in the future, there may be an opportunity to play offense and implement proactive strategies that can help improve your long-term tax position. In 2021, situational planning is even more relevant given the proposed changes to tax legislation.
Charitable gifting. If you make annual gifts, you may want to consider bunching charitable donations to maximize deductions in a high tax year. This is particularly useful if your combined itemized deductions do not currently exceed the standard deduction. Bunching several years of charitable donations into one year may increase itemized deductions and reduce taxable income beyond what the standard deduction provides.
In addition, those who itemize deductions may deduct charitable contributions for gifts of cash to public charities up to 100% of adjusted gross income for 2021. If you don’t itemize your deductions, a married couple filing jointly may take an increased deduction of up to $600 for gifts of cash to public charities in 2021; this benefit will no longer be available in 2022.
Accelerating deductible expenses. If you’re anticipating deductible expenses in upcoming years, you may be able to accelerate them by making payments in this tax year. Medical costs and certain interest expenses may fall into this category.
Offsetting ordinary income. If realized capital losses exceed realized capital gains, you can offset ordinary income with up to $3,000 in capital losses in any given year. Capital losses that exceed the $3,000 limit may be carried over to offset capital gains in future years.
Retirement accounts. While contributing pre-tax dollars to tax-deferred accounts should be part of your planning routine, if you are operating in a lower tax year, you may seek long-term benefits from a Roth IRA. Instead of providing tax deferral, after-tax dollars in a Roth grow and distribute free of taxes. High earners may phase out from direct contributions, but Roth conversions are currently available at any income level. The conversion is a taxable event, so consider this strategy carefully. However, if you are in a low tax year, the tax-free benefits could be substantial. If you’re considering a Roth conversion, please note that an earlier legislative proposal may prohibit conversions of after-tax dollars held in retirement plans beginning in 2022, and prohibit conversions for high earners beginning in 2032. As of the time of this writing, that legislation does not appear to have much momentum; the situation is fluid and care should be taken to consider all options.
If you retain large tax-deferred accounts, a relatively low tax year could present an opportunity to reduce the impact of required minimum distributions—RMDs—in the future. RMDs from 401(k)s and IRAs begin at age 72, and are taxed at ordinary income rates. However, if you are in a lower marginal bracket, it may be advantageous to take distributions from 401(k)s and IRAs before they are required. This strategy may help flatten the long-term tax burden of large RMDs. Keep in mind that distributions prior to age 59 ½ may result in a 10% penalty.
Harvesting capital gains. Should you have appreciated assets that exceed losses, you may wish to harvest capital gains as opposed to capital losses. If you’re anticipating higher long-term capital gains rates in the future, you may want to realize gains in a lower tax environment rather than delay the sale into a higher tax year. A potential increase in capital gains tax has been much discussed and proposed. Therefore, it’s important to check with your advisers before acting on this strategy.
Deferring deductions. Instead of accelerating deductions, you may wish to defer deductions this year. The same bunching strategy may apply, but instead of bunching this year, you could make charitable donations in a future, higher tax year. Similarly, delaying deductible expenses, as appropriate, may have a bigger impact on reducing income in future years.
The high lifetime gifting exemption. If your assets are significant enough to have a taxable estate, year-end planning has even more significance. For 2021, the amount exempt from federal gift and estate tax is $11.7 million per person, which means that you may give this amount during your lifetime, free of gift tax, with any unused amount applied against federal estate taxes at your death. However, there is a possibility that legislation may be enacted that may abruptly, and potentially dramatically, reduce the exemption. Previous proposals have suggested the date may be as early as Jan. 1, 2022. If you are considering making a substantial lifetime gift, now is the time.
Your year-end planning review is an important process, especially considering potential new tax legislation and an uncertain market and economic environment. A well-coordinated plan is key to utilizing this year’s opportunities and being prepared for what the future may bring.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Bradley R. Crockett is a National Director of Advanced Financial Planning at Wilmington Trust. Brad is responsible for developing customized wealth management and financial plans for prominent individuals, families, and business owners throughout the country. He works closely with other professional and family advisers to analyze financial positions and develop plans to help clients achieve future personal and financial goals.
Allison Pierce is the Head of Fiduciary Planning Analyst Team at Wilmington Trust. Allison supports the team in developing strategic and holistic wealth planning advice for high-net-worth individuals, successful entrepreneurs, executives, and their families by reviewing and illustrating their current plans, highlighting potential gaps and opportunities for enhancement, and modeling effective tax and estate planning strategies.
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