2021 is drawing to a close, which means many of us are thinking about enjoying the holidays and spending time with our family and friends. It’s also a great time to check in on your finances to make sure you’ve set yourself up for success in the new year. To help you get started, here are six important financial tasks you should consider before the clock strikes midnight on New Year’s Eve.
1. Move excess cash to your investment account
Over the last year, maybe you saved up some extra cash because of cancelled travel plans or altered spending habits during the pandemic. If this sounds like you, you should be aware of the potential for cash drag — especially in times of higher-than-normal inflation. Especially now, holding too much money in cash will cause you to lose buying power. Consider moving your excess cash to an investment account, like those offered by Wealthfront. Our software makes it easy to build long-term wealth, and you can even put your money to work for good in a Socially Responsible portfolio designed around sustainability, diversity, and equity.
2. Consider a Roth conversion
IRAs are a great way to save for retirement. If you’ve been thinking about converting your Traditional IRA to a Roth IRA for the 2021 tax year, the deadline to do so is the end of the year. A Roth conversion allows you to take advantage of the tax benefits of a Roth IRA (namely, tax-free growth growth and distributions in retirement) even if you aren’t eligible to contribute to one directly. There’s also a chance that new legislation could prevent you from executing backdoor Roths or mega backdoor Roths in 2022 and beyond. If you plan to execute a backdoor Roth with Wealthfront in 2021, make sure you request the conversion by December 22, 2021.
3. Harvest your losses to lower your tax bill
Tax-loss harvesting allows you to reduce your tax bill while you maintain the risk and return characteristics of your investment portfolio. Human advisors will often harvest losses manually at the end of the year, but Wealthfront’s software looks for opportunities to lower your tax bill all year long. If you use Wealthfront’s Tax-Loss Harvesting service and have our Classic recommended portfolio, you’re likely to receive tax savings that more than cover your annual advisory fee.
4. Spend down your FSA
If you have an FSA, you may want to spend the bulk of it on qualifying expenses in case you aren’t able to carry it over to next year. Generally, FSAs operate on a “use it or lose it” system, but you should know that legislation from late 2020 means FSA rules are temporarily more lenient this year if your employer opted into the changes. If you previously had a grace period to use FSA funds from the previous year, the grace period to use 2021 money could now last until the end of 2022. If you were previously only able to roll over $550 in healthcare FSA funds from a previous year, that cap could be lifted. You should check with your employer to see if your company adopted these changes.
5. Give a qualified tax-deductible charitable contribution
Now is a good time to donate to a cause you believe in and simultaneously benefit from it on your 2021 tax return. In a temporary measure due to the pandemic, you can claim a qualified deduction up to $300 as a single filer and up to $600 as a joint married filer for cash donations you made in 2021 even if you take the standard deduction. Just make sure the organization you donate to is on the IRS’s list of eligible groups and hold onto your receipts. And if you itemize your deductions, you can claim deductions for qualified donations worth up to 100% of your adjusted gross income in 2021. Normally, the cap is 60%. For more information, check out this IRS resource on the tax benefits of charitable giving in 2021.
6. Consider contributing to a 529
If you have kids, a 529 college savings account (like the 529 plan Wealthfront offers) can be a great way to save for their college education. If you enroll in a 529 early, your savings will have more time to compound tax-free. You can even consider superfunding a 529, which allows you to fund the account with up to five years’ worth of contributions at once without it counting towards your lifetime gift tax exclusion limit. For most states, the 529 contribution deadline is December 31 although in a few states (Georgia, Iowa, and Mississippi) the deadline is in April.
Start off 2022 strong
We hope these tips help you prepare for a financially rewarding future in 2022 and beyond. For more tips on keeping your finances in great shape year-round, check out Wealthfront’s Guide to Financial Health.
The information contained in this communication is provided for general informational purposes only, and should not be construed as investment or tax advice. Nothing in this communication should be construed as a solicitation, offer, or recommendation, to buy or sell any security. Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Wealthfront Advisers or its affiliates endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
Wealthfront Advisers and its affiliates do not provide legal or tax advice and do not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Wealthfront Advisers and engaging in these tax strategies, based on their particular circumstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront Advisers assumes no responsibility for the tax consequences to any investor of any transaction.
The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront Advisers and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term).
Wealthfront Advisers’ investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors. The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes.
Tax loss harvesting may generate a higher number of trades due to attempts to capture losses. There is a chance that trading attributed to tax loss harvesting may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, tax loss harvesting strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against income and distributions. Losses harvested through the strategy that are not utilized in the tax period when recognized (e.g., because of insufficient capital gains and/or significant capital loss carryforwards), generally may be carried forward to offset future capital gains, if any.
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About the author(s)
Chris Hutchins is Wealthfront's Head of Financial Advice Automation, a registered financial advisor, and a millennial money expert. View all posts by Chris Hutchins