Episode Summary

Today on Agile Finance Radio, we will discuss five things to do before year-end to keep your finances on track and a perfect way to give yourself a gift!

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Key Points

  • Discover five things that you should do now before we run into 2021.
  • Learn about a little known option in some 401(k) plans that will allow you to save much more and get ready for retirement.
  • See how you can bunch deductions to exceed the standard deduction and reduce your taxable income.
  • Listen toward the end to hear two bonus items for year-end planning.


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Show Summary

Here are 5 things to do to keep you finances on track and a perfect way to give yourself a gift!

1. Max out Your 401(k)

This is one of the best ways to save for retirement. Not only does it defer taxes, which reduces your taxable income now, and that could help in another way and I’ll get to that in a minute. A lot of companies match a portion of your 401(k) contribution. That’s a 100% return on the matched contribution. You’ve got to take advantage of that free money!

There could be other options as well with your 401(k) plan. Depending on your income and taxes other strategies could benefit you and boost your retirement savings. A ROTH 401(k) could be a good option if you are early in your career if you are in a lower tax bracket. But the Roth 401(k) has other things to consider as well.

Another thing to check into is more and more companies are starting to allow after-tax contributions to their 401(k) plans. This allows you to go beyond the contribution limit which is $19,500 for 2020. If you are over 50, you can contribute an additional amount of $6,500 with the catch-up contribution.

The 401(k) tax code allows up to $57,000 in total contributions. Most people don’t know this because they only hear about what they can contribute. But your employer match doesn’t count against what you can contribute and neither do after-tax contributions and that’s what that extra amount is for.

So, $57,000 minus your contribution and the employer match, leaves the amount that you can contribute in after tax contributions. This is a huge advantage to be able to save in a retirement vehicle when you need to do some serious catching up on your retirement savings.

There are income limitations to traditional and ROTH IRAs, but not the after-tax 401(k). You could say, well I can make an after tax contribution to an IRA. That’s true, but it’s limited to $6,000 or $7,000 if you are over 50. This isn’t even close to what you can put away in the after-tax 401(k).

This is a strategy I recently put in place with one of my clients and it allows us to put money to work in a tax deferred account, but even better we can roll that over to a ROTH since it’s after tax contributions. Definitely look into this to see if it’s an option for you.

It’s a win, win, win!

2. Manage Your Bracket

On to the second item. I already alluded to this one earlier and it’s managing your tax bracket. The way our tax system works, it is based on income brackets. The first part of your income is taxed at 10%, the next bracket at 12% and on up to 37%. The more you make the more you are taxed.

If you are sneaking up on the next tax bracket, it might be worth trying to keep your income below that threshold so you aren’t taxed at the next level when it could be avoided.

Tax management is more about deferring income so you can take advantage of the tax bracket. Think of it as trying to reduce taxes in high income years and take advantage of that income in a lower income year.

For example, let’s say you have some stock you want to sell. And that sale is going to put you over into the next tax bracket or maybe the highest bracket because of a bonus you already received. You might decide to delay that until the first of the year since you know you won’t receive that size of bonus next year.

Contributing to a 401(k) is one of the ways to reduce your taxable income and keep you further away from the next tax bracket. You can also sell any assets that are at a loss, commonly called tax loss harvesting, that will offset some of the income you have from any gains that you’ve recognized.

Something to keep in mind and know where you are at tax wise. I don’t let the tax tail wag the dog. Meaning if I’m up big on an investment and I want to take some profits and reduce risk, I’ll do it. Paying some taxes is better than ending up with no profit if the market turns.

Watch Our for the 3.8% Surtax

Also, it’s important to be aware of another not so talked about tax. The Medicare surtax. This tax is on the lesser of net investment income or the modified adjusted gross income (MAGI) over $250,000 for couples filing jointly or individuals over $200,000.

This is one of the areas that you can treat like a tax bracket breach. If you are close to going over the MAGI limits, make sure you max out your 401(k), contribute to an HSA if you qualify. You can also look at your taxable investment accounts. You could consider tax free municipal bonds or using a different type of account where the taxable interest and dividends could be tax-deferred.

3. Check your Tax Withholding

Next is to review your tax being withheld from your paycheck. I know that some of you enjoy getting back a big tax refund.

If you’ve been getting back a large tax refund, you might want to think about adjusting your tax withholdings and start putting that money into your retirement, savings, debt reduction or living your life. Anywhere except giving the government a free loan.

For some of you, I know it’s a psychological thing. You like knowing that every tax season you are getting a bonus. At least that’s how you think of it. It’s not a bonus, but I get it.

If that’s you, I’m just suggesting you reframe your thinking and purposefully put that money somewhere else. If you still want to spend that money because that’s when you go on Spring break, that’s okay. Have the amount from each pay check automatically transferred into a savings account and at least you’ll earn a little extra.

4. Maximize Deductions

With the Tax Cut and Jobs Act (TCJA) law changes, fewer people qualify for itemizing deductions. The majority of people now use the standard deduction.

However, if you still have say charitable deductions and medical expenses, consider focusing your expenses in one year if possible. For example, say you have high medical expenses this year and you know you’ll need to incur additional expenses soon. Try to keep those in one year so you can exceed the standard deduction and reduce your taxable income.

With just a little planning you can make a difference in keeping more of your hard earned income!

5. Roth Conversions

If you have some traditional IRAs, you might want to consider converting to a Roth IRA. This one can be a bit tricky to understand if you are making the best decision and you’ll find all kinds of opinions on the internet on whether you should or shouldn’t use a Roth.

My position is I don’t know what the future holds when it comes to taxes (and neither does anyone else). So why not position part of my portfolio to tax-free instead of just tax-deferred?

There are also other advantages to a Roth like not having to take out the money via the required minimum distribution at 72, like a traditional IRA. And if you need a large amount for a major purchase, pulling it out of a tax free account could be much more advantageous than a taxable account. Especially, if it’s going to push you into a different tax bracket.

This is definitely a strategy you should be looking at in lower income years. It’s worth considering and looking into to see if it makes sense for your situation.

Already Retired?

I did mention that there would be five things, but here’s a couple of bonus things to consider if you are already retired.

1. Contribute to Charity from Your IRA

If you already contribute to a charity, consider making it from your IRA. If you have a traditional IRA and are already taking required minimum distributions (RMDs), then you can direct those distributions to a charity. The amount that is qualified for a charitable contribution reduces your taxable income since it reduces the amount of your RMDs.

2. Receiving Social Security?

If you’ve already started taking social security you probably know that up to 85% of your Social Security benefits can be subject to tax. Just like the other areas of our tax code, there are defined limits for individuals and joint filers that you should be aware of and use that to your advantage to manage your income and expenses if possible.

For example, if you are near one of the social security income brackets, you could take distributions from a Roth IRA that aren’t subject to the Social Security income. Or you can donate to charity as discussed earlier if you don’t need the income. If you are well over the income limits, there’s not much you can do. Be glad that you have a substantial income and don’t have to depend on Social Security for your day to day living.

Final Thoughts

Most people are thinking about ways to grow their income or investments, which is an important thing to do. However, most don’t realize how significant a tax-smart plan is to protecting and unlocking more value today and also for the future.

If most of your assets are tied up in tax-deferred accounts, you may be surprised how much tax you could end up paying in the future. It might be a good idea to have a review of your situation and see if balancing between taxable, tax-deferred, and tax-free might be a fit for you.

If that’s you, then head over to agile finance radio.com and select the work with me option. You can schedule a free assessment call with me, and we can talk about your unique situation.

That does it for this episode of Agile Finance Radio. Tune in next time as we discover more ways to win with money, gain at life, and ultimately retire with confidence.