Do a little portfolio housekeeping before the year ends.
Investors should always do a little portfolio housekeeping as the year ends. That’s especially the case in 2020, which has seen volatile market swings and legislation passed by Congress to help the economy rebound. A lot of the usual money moves for investors focus on reducing tax burdens, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act included some unique, beneficial changes for investors this year. Whether the CARES Act will be extended into next year is unclear, so investors would be wise to make certain decisions while they can. Here are eight of the best money moves investors should make as 2020 nears its end.
Review your required minimum distribution.
One of the CARES Act’s biggest changes allows retirees to forgo taking their required minimum distributions from their qualified plans. When the stock market plunged in the first quarter, it meant people who normally were required to withdraw money from their retirement investment portfolios would be hit hard. Congress waived this requirement, and stock indexes have rebounded. Now retirees have a choice, says Terry Sawchuk, founder of Sawchuk Wealth. He errs on the side of taking the cash, especially for retirees in the 12% income-tax bracket, which is around $80,000 for those married filing jointly. “The ability to skip RMDs can be very attractive,” he says. “I actually think it’s not the year to skip RMDs. We’re really unclear as to what the future holds, but what I do know is that the tax rates are very low and people should take advantage of that.”
Open a Roth individual retirement account.
Retirees who might otherwise skip RMDs because they don’t need the money could instead open a Roth individual retirement account and invest that money, Sawchuk says. By taking the RMD amount as a regular distribution, you would still pay the tax on it, but that money could be converted into a Roth IRA. The money can be invested, and the gains grow tax-free. “You’re taking advantage of this really low tax rate,” he says, noting that current income-tax brackets are set to expire in 2025. He suggests that couples who are married filing jointly in the 22% tax bracket, which goes up to around $171,000, can also take advantage of conversion. “The 22% tax bracket is still really low,” he says. Even for non-retirees, converting some money to a Roth IRA from traditional IRAs may be a good idea for investors over age 59 ½ since they won’t pay the 10% penalty on withdrawals.
Fund a health savings account as a potential investment vehicle.
Investors with high-deductible health care plans should consider opening or continue funding to the maximum a health savings account. High-deductible plans are generally defined as having a minimum deductible of $1,350 for an individual or $2,700 for a family. Individuals can save up to $3,550 and families up to $7,100 in an HSA for 2020. HSA funds roll over annually if they’re not spent and can be invested. Like a Roth IRA, earnings aren’t taxable when withdrawn if used for health care expenses. HSAs are investment vehicles and can help investors meet their deductibles if they need health care. Dick Pfister, CEO of AlphaCore Capital, says funding these are a high priority. “HSAs are definitely something that you should always be thinking about, and it’s probably front and center given what’s going on with COVID,” he says.
Invest monetary gifts into life insurance policies for beneficiaries.
Parents who give annual monetary gifts to their children can give up to $15,000 a year without paying taxes. Depending on the parents’ age and health status — and whether the children need the money immediately — Sawchuk says parents could instead buy a life insurance policy, which has “astronomical leverage” to earn money. For parents who are 50 and reasonably healthy, a one-time purchase of a $15,000 life insurance plan could eventually become $200,000 or $300,000, while regular annual contributions of $15,000 could reach $1 million in tax-free death benefits for their children. It takes approximately 20 years of paying premiums for a healthy 50-year-old male to fully fund the policy. “There’s almost no way you could take $15,000, invest it each year, and get anywhere near where you could get with a life insurance policy, particularly with zero risk,” he says.
Take advantage of tax-loss harvesting.
The volatile stock market caused many investors to lose money this year. Even though stock indexes have rebounded, Pfister says “there’s definitely going to be some losers in your portfolio because the market (has) been driven by five to 10 big winners in the tech space.” That gives investors the chance to take advantage of tax-loss harvesting — selling stock positions at a loss to offset your liability for a capital gains tax. Pfister says value-style investments such as those in the financial and energy sectors saw losses of up to 50%. According to him, investors can sell those vehicles and find holdings with similar exposure so they don’t modify their holdings too much.
Top up tax-sheltered accounts.
Pfister says investors should take full advantage of tax-sheltered accounts such as 401(k) and 403(b) retirement accounts and 529 college-savings plans. “These should always be topped up in any given year, and this goes back to that general philosophy that tax rates most likely are going to go higher,” he says. “So the more you can get into tax-exempt wrappers like 401(k)s and 529s, the better.” Employees can contribute up to $19,500 annually to 401(k)s, with those 50 and older able to do catch-up contributions of an additional $6,000. Investors can contribute up to $15,000 to a 529 plan without triggering gift taxes. Some states allow money in 529 plans to also be used tax-free for qualifying K-12 education expenses.
Open a donor-advised fund.
Andrew Rosen, president of?Diversified Lifelong Advisors, says charity-minded investors who have appreciated stock could open a donor-advised fund. Think of donor-advised funds as a charitable investment account. Investors can put in cash and securities to get the immediate tax deduction, and donors can avoid paying capital gains taxes on appreciated securities. The funds can be invested for tax-free growth and donors can make grants whenever they wish. “Donor-advised funds are a killer strategy,” Rosen says. Donor-advised funds are considered irrevocable trusts, so once investors move securities into the fund, they cannot take them back out. Donors can deduct up to 60% of their adjusted gross income for cash donations and 30% of their adjusted gross income for securities and other appreciated assets.
Rebalance your portfolio.
The market volatility has caused asset allocations to come out of alignment this year, Rosen says. In addition to returning their portfolios’ overall allocation balance to normal — such as a 60% stock, 40% bond position — investors may also want to make tactical changes within those allocations, he says. With a new presidential administration taking office, Rosen says there may be a greater emphasis on alternative energy sources versus traditional fossil-fuel based industries, and there could be a “cleaner trade program with China” compared with “Trump’s sort-of ‘America First’ policy.” Rosen says investors could consider making shifts within their portfolio allocations, but they should leave the overall balance between equities and bonds the same.
Eight best money moves for investors as the year ends:
— Review your required minimum distribution.
— Open a Roth individual retirement account.
— Fund a health savings account as a potential investment vehicle.
— Invest monetary gifts into life insurance policies for beneficiaries.
— Take advantage of tax-loss harvesting.
— Top up tax-sheltered accounts.
— Open a donor-advised fund.
— Rebalance your portfolio.