The clock is running out on 2020. If you’re like the 83% of Americans who think that 2020 was either just “OK,” “bad,” or “terrible,” you’re probably looking forward to ringing in the new year. But if you have an hour or so to spare before the ball drops, a smart money move before December 31 deadlines can help secure your financial future.
What To Do Before New Year’s Day
Make purchases from your health FSA: Some employers offer health care flexible spending accounts (FSAs) to give their employees a chance to pay for medical expenses using pre-tax dollars. Often, the deadline to make purchases is December 31, although some FSAs have deadlines as late as March 2021 for the 2020 calendar year: you’ll have to check with your own plan provider to figure out what applies. Your plan will have a separate set of deadlines for when you need to submit your claims for reimbursement. Unlike Health Savings Accounts (HSAs), the money in FSAs is normally “use it or lose it,” meaning that you forfeit any money you don’t spend. Not sure what to buy? If you or someone in your family has a period, now is a good time to stock up on pads and tampons, which are a qualifying expense. Sunscreen, lip balm, first aid kits, and condoms can also be purchased with FSA money.
Convert a traditional IRA to a Roth IRA: If you have money sitting in a traditional IRA, or the traditional 401(k) plan of a former employer, depending on your circumstances, it might be smart to go ahead and convert the account into a Roth IRA. You’ll have to pay taxes on the amount of your conversion, but when you get to retirement age, your withdrawals will be tax free. By comparison, if you keep your money in the Traditional IRA, the amount you withdraw will be counted as taxable income when you retire. A Roth IRA conversion is an especially smart move if you had a lower-than-average income in 2020, but have some savings you could use to pay your tax bill.
The younger you are, the more you stand to benefit from converting a traditional IRA to a Roth IRA: the pay-off increases the longer your investments can keep compounding before you reach retirement. But converting to a Roth IRA isn’t for everyone. Charles Schwab and Fidelity both offer calculators to help you figure out whether a Roth IRA conversion makes sense for your particular circumstances. If you’re confident that a Roth IRA conversion is the right move for you, you’ll want to initiate the conversion in whatever year you expect to have a lower marginal tax rate. Do your conversion before the clock strikes midnight on New Year’s Eve to have it counted for 2020.
Offset tax losses and gains: If you sold any stocks for a profit in 2020 you might want to consider offsetting your taxable income by selling money-losing stocks this year. The benefit to offsetting your gains and losses is stronger if you had any short-term capital gains. As Wall Street Journal reporter Neal Templin points out, because of all the market volatility over the past 12 months, 2020 was the “perfect year for tax-loss harvesting.
Donate to charity: Donating to charity won’t make you richer, but research shows that the money we spend helping others makes us happier than the money we spend on ourselves. Whether you want to help feed hungry people in your neighborhood, give the gift of cash to families in poverty, or fight climate change, there’s a good reason to make a contribution before 2020 comes to an end. Normally, you can’t deduct your charitable contributions from your taxes unless you plan to itemize your tax return. But as a part of the CARES Act passed in March, individual taxpayers can deduct up to $300 of charitable contributions made in 2020, even if they take the standard deduction.
Contribute to a 529 plan: If you’re a parent or planning to go back to school, you might be saving for college with a 529 plan. The tax benefits to contributing to a 529 plan vary significantly from state to state, and in some states, the deadline for contributions to be counted for 2020 is December 31.
What Can Wait Until January
Taking early withdrawals from your 401(k): 2020 was a terrible year for many people. On December 4, The New York Times reported that the labor force participation rate dropped last month, as job-seekers got so discouraged that they stopped looking for work. The CARES Act passed in March allowed younger Americans to withdraw from their 401Ks, 403bs, and traditional IRAS without the normal penalty, to avoid punishing people who needed to withdraw some cash under the extraordinary circumstances. That provision was slated to expire on December 31st, but the December stimulus bill extended the deadline. To qualify for the penalty-free withdrawal, you’ll need to meet certain criteria, like a COVID diagnosis, or the loss of income due to the pandemic. Even without the tax penalty though, early withdrawals from your retirement accounts can threaten your retirement security, so without the deadline looming, you’ll want to wait until you’ve considered all your other options.
Contribute to your HSA, Roth IRA or traditional IRA: If you have any cash you can spare, it’s always smart to save for the future. But you don’t need to rush: contributions to IRAs and Health Savings Accounts (HSAs) for tax year 2020 can be made until April 15, 2021.
Living Paycheck to Paycheck?
There are a lot of December 31 deadlines for middle-class and wealthy Americans who want to take advantage of the tax breaks offered by the federal government. But research by the Urban Institute has found that nearly 60 percent of the tax breaks for retirement savings go to people who fall into the top 20% of the income distribution: all the aforementioned perks are out of reach for many working people. If you don’t have a lot in the bank, you’re not alone: more than 40% of adults have less than 3 months of liquid savings. ProsperityNow tracks local and federal laws that would make sure lower-income Americans aren’t unfairly left out of savings incentives, for example, by matching the savings that people make into their emergency funds.
If you’re looking to master the basics of budgeting and personal finance, the new year is a great time to start. Some of the best books on personal finance are available for free at local libraries, often as e-books, or, for an interactive approach, check out Khan Academy.
The information provided above is for educational purposes only. It may not apply to your particular circumstances, and should not be construed as financial advice or tax advice.