The United States of America and the world at large are still grappling with the health and economic effects of the COVID-19 pandemic, and while the health ramifications of the pandemic shouldn’t be understated, the economic consequences have also been severe. As 2020 draws to a close, here are a handful of useful tips that could help individuals lessen their tax burden this year.
Save into a Retirement Plan or Retirement Account
This is one of the surest ways to not only reduce taxable income every year, but to also save for retirement. In 2020, individuals who are active participants in a 401(k) plan through their employer can contribute up to $19,500 of their income to the plan. Individuals older than age 50 can contribute an additional $6,500 into the plan for a total of $26,000 in 2020. Contributing to an Individual Retirement Account (IRA) is another option that will help individuals save for retirement while reducing taxable income. In 2020, the Internal Revenue Service (IRS) allowed individuals with earned income to contribute up to $6,000 per year to an IRA. Individuals 50 years and older can contribute an additional $1,000 to the account. Another benefit to contributing to an IRA is that a working spouse can contribute an additional $6,000 ($7,000 for spouses over 50 years old) per year to an IRA on behalf of a non-working spouse. When contributing to an IRA, keep in mind there are contribution limits if the individual and/or spouse currently contributes to another retirement plan like a 401(k). Individuals have until April 15 of 2021 to contribute to an IRA for the 2020 tax year.
Skip Required Minimum Distributions in 2020
Individuals who contribute to tax-deferred retirement plans and accounts including 401(k)s, IRAs and 403(b) plans are generally required to take mandatory distributions at age 72 (age 70½ for individuals who turned 70½ before December 31, 2019). The Coronavirus Aid, Relief and Economic Security Act (CARES Act), signed into law on March 27, suspended Required Minimum Distributions (RMDs) for 2020. This suspension means that individuals who would normally be required to take RMDs this year but can afford not to take them, can avoid taking those taxable distributions and can continue to potentially earn tax-deferred gains in those accounts. For individuals who have reached RMD age, the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which went into effect on January 1, removed the age limit to contribute to a traditional IRA. This means those individuals can defer taking RMDs in 2020, and they are also able to save into an IRA this year on a tax-deferred basis.
Use Losses to Offset Capital Gains
Financial markets in 2020 have been volatile, and some investment accounts have seen losses this year. While losing money on investments is never the goal, these losses can be used to offset gains. In addition, any losses greater than $3,000 can be carried over to future years. Tax-loss harvesting can be used to offset short- and long-term capital gains and reduce taxable income. When implementing this strategy, it is important to understand which investments are being sold and what the potential impact will be on the portfolio and investment goals. It is also critical to understand the IRS wash-sale rule. This rule prohibits investors from deducting losses from sales or trades and then repurchasing the security or substantially identical stock or security within 30 days of the sale.
Additional Tax-Saving Tips
A few more tips for further tax savings are:
– Individuals who are self-employed may have the flexibility in deciding when they receive income. Accelerating or decelerating income to a year when taxes could be lower could reap potential tax savings.
– Some individuals who have been laid off during the pandemic may have been offered severance packages. Individuals laid off later in the year may have the ability to push the receipt of those severance payments into 2021, when their taxable income could be lower.
– Under the CARES Act, taxpayers younger than age 59½ and impacted by the coronavirus may be able to withdraw up to $100,000 from a qualified retirement plan by the end of 2020 sans the 10% early withdrawal penalty. Since the contributions and the gains to a qualified plan are tax-deferred, taxes will be payable on the distributions. These individuals are also able to take out a loan from certain plans of up to 100% of the account balance or up to $100,000, whichever is less. Loans from retirement plans will have to be paid back. Keep in mind that taking early distributions or loans from retirement accounts can have a negative impact on retirement.
While some of the above tips may help reduce an individual’s tax burden in 2020, it is always advisable to speak with a tax advisor and financial planner to fully understand the potential tax ramifications of these types of decisions.
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Insight Wealth Strategies, LLC (IWS) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.