Every year, Americans circle April 15 on their calendars and begin the annual ritual of fretting about their taxes.
While you should rely on a tax professional for specific recommendations, tax time is also the right time to run through your personal financial checklist, said Kimberly Bridges, director of financial planning at BOK Financial.
“I use tax time as my annual reminder to review my financial situation to compare this year to last year and consider what’s changed,” she said. “It keeps me accountable for any changes I want to make like increasing my retirement and other savings (to coincide with a raise, perhaps), adjust withholdings and even updating beneficiary designations.”
Bridges offered six areas for you to consider:
1. Tax withholding. “Maybe you realize you didn’t get 2020 quite right and you are going to have to pay more than anticipated, so now is the time to fill out a new withholding form or increase estimates to get it adjusted for 2021,” Bridges said.
2. Retirement contributions. If you are contributing to a 401(k), are you getting the full benefit of an employer match? “Now is a good time to check your contributions along with your allocations to ensure they still align with your goals,” Bridges said.
If you have earned income, you can contribute up to $6,000 to a traditional IRA in 2020, and you can make that contribution up to May 15. You also may be able to contribute the same amount in your spouse’s name if they don’t have a retirement plan through their employer.
While Roth IRA contributions are never tax deductible, contributions to traditional IRAs may be deductible, dependent on factors such as income, tax filing status and access to an employer-sponsored plan. In addition, certain taxpayers may qualify for a “Saver’s Credit” for making eligible contributions to a retirement plan.
3. Educational savings. Families contributing to a 529 plan may be able to reduce taxable income on their state income taxes. More than 30 states offer a deduction or credit for 529 plan contributions with a Dec. 31 deadline, but a few offer an April deadline to benefit the previous year’s taxes.
Oklahoma offers a generous state income tax deduction on 529 plans of up to $20,000 for a married couple filing jointly—and typically gives them until April 15 to make the contribution. “Make sure you know the rules for your state, especially with the filing extension,” cautions Bridges,“Some require use of the state’s own 529 plan to receive the deduction.”
4. Savings check. This annual routine is also a good time to check in on your budget. What’s the state of your emergency fund? What are you spending money on?
“If clients didn’t do so at the start of the year, I encourage them to take a good look at their spending and savings plan,” Bridges said. “February and March are popular months for bonuses and raises to kick in, creating an ideal opportunity to increase your savings.”
5. Medical expenses. If your company offers a high deductible health plan and a health savings account (HSA), are you fully funding that savings vehicle? Contributions to an HSA are tax-deductible and tax-deferred, and can be made up until April 15.
“If you have access to an HSA, it’s a great savings tool,” Bridges said. “Medical expenses can add up quickly and having that pool of funds available to cover insurance deductibles, co-payments and out of pocket expenses is a nice perk to a high deductible plan. Many clients also choose to save those funds for medical expenses in retirement, opting to pay current expenses with after-tax dollars in order to benefit from tax-free compound earnings in their HSA.”
In addition, if you itemize your deductions and incurred medical or dental expenses last year, you may qualify for a deduction for expenses paid for you, your spouse or your dependents—but only if they exceed 7.5% of your adjusted gross income. To qualify, you must not have paid these expenses out of your HSA.
6. Financial gifts. Philanthropically minded individuals who donate to nonprofit organizations should be aware that the CARES Act introduced a standard deduction change for cash donations and higher deduction limits for those who itemize on their 2020 taxes. Through 2021, individuals who contribute cash to a public charity and itemize tax deductions may deduct up to 100% of their adjusted gross income.
“Even if you didn’t take advantage of the charitable cash donation deductions in 2020, note that the opportunity has been extended through 2021,” said Karla Guerrero, financial planner at BOK Financial.
For those who have already reached retirement and are receiving required minimum distributions (RMD), you should note that qualified charitable distributions can satisfy the RMD requirement up to $100,000 during 2021.
“Taking the route of a qualified charitable distribution can help accomplish your philanthropic goals while helping to keep your required minimum distribution from being included as income for tax purposes,” said Ross McKinney, trust officer at BOK Financial.
In addition, if you plan to gift money (which is different than a charitable donation) to someone during the year ahead, note the $15,000 per person limit to align with the annual limits and avoid the need to file a gift tax disclosure.
Gifts have both an annual exclusion and a lifetime exclusion. If you exceed the $15,000 level, you’ll need to disclose the gift.
“The yearly ritual of meeting tax deadlines may not be a favorite annual occurrence, but your financial advisors and tax professionals are there to support you through the process in keeping it all straight,” said Bridges.