2021 Exciting Year-End Financial and Tax Checklist

Wow, another year almost in the books! As we wind down 2021, now is the time to make sure we are on track with our financial goals. Remember how we started with Your 2021 Guide to Actually Saving Real Money? Let’s examine a few crucial steps with this year-end financial and tax checklist.

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How’s That Emergency Fund?

A couple of weeks ago we examined how, despite all appearances, America is flush with cash. Hopefully you guys are all gainfully employed or otherwise happily retired.

As usual, I would build and maintain a solid emergency fund of three-to-six months of living expenses. Some of you investing sharks out there will insist on all money in the market, and I’m not here to debate that. For most though, I’d argue the psychology of at least a little cash is going to feel like a hot tub dip during life’s unexpected events.

Always expect the unexpected.

Tally the Income

Now is the time to start estimating total annual income for year-end 2021. W2 wage earners and those who are self-employed should be able to closely approximate ordinary income at this time. Consider any interest, qualified dividend income, long- and short-term capital gain distributions, etc.

For interest and qualified dividends, we generally use the previous year 1099 as a basic starting point.

Also, Vanguard has now published preliminary year-end fund distribution estimates (year-end capital gains distribution declarations). A final version will be published on December 9, 2021. These charts are useful for dialing in capital gains distributions for those that are selling shares or realizing dividends. Note: even if dividends are reinvested, those proceeds are still taxable.

Adjust Withholding and Determine Approximate Marginal Tax Rate

The tax rate system is about as well understood as….well, things that are poorly understood. It’s taken me a long time to “get it,” but I still prefer a good online calculator.

Year-End Withholding: Don’t Overpay or Underpay, My Friends

Historically, and at any point in the year, I’ve enjoyed using this IRS Tax Withholding Estimator. This tool is not only useful for seeing your tax burden, it’s also wonderful for dialing in your tax withholding throughout the year to land on owing $0*. This estimator is very thorough, so set aside some time and have all your paystubs, other income sources, and even a recent income tax return handy.

To be clear, this tool won’t spit out your marginal tax rate exactly. It is, however, useful for adjusting your withholding if necessary to avoid over- or under-paying on taxes for the remainder of 2021.

*As an aside, many folks confuse a tax refund as Uncle Sam giving them money. Exciting! What is really happening is that those folks are overpaying on their taxes throughout the year, giving the government an interest-free loan. The government kicks it back the following year, when those same dollars hold less value, due to inflation. We can do better with that money ourselves, so using this withholding estimator is a great way to neither owe or be owed. Anywho.

Marginal Tax Rate

If you feel most yourself when discussing the nuances of ordinary versus qualified income, you’ll find Go Curry Cracker’s Federal Income Tax Calculator to be a great quick look at total tax burden and tax rate. His calculator even throws in some recommendations for how to optimize.

What Next?

If your marginal tax rate is high (i.e., 22% tax bracket or higher), I would definitely prioritize maxing out those tax-advantaged investment vehicles (401(k), IRA, HSA, etc). We can discuss more on this in a moment.

If, on the other hand, you find yourself in the 10% or 12% tax bracket for whatever reason, you might be in a great position to consider banging out some Roth Conversions. This tactic is especially useful for anyone hoping to spend retirement account funds before the age of 59.5 without tax or penalty. More on this below.

If this all sounds like Greek, then just try and max out whatever retirement accounts you have available to you. There’s proof in the pudding, and that pudding is below.

Maximize Contributions to Tax-Advantaged Accounts

Retirement Plans

For just about anyone, maximizing contributions to workplace retirement plans (401k, 403b, 457, etc.) is a solid choice. If you don’t believe me, ask Diana Crabtree Green. She secured financial independence largely by going steady with her 401k and the like. Nice and steady.

For those on the cusp of a higher tax bracket, contributions to these tax-advantaged accounts are 100% tax deductible, thereby possibly landing you in a lower tax bracket. Either way, you are paying less taxes and investing in your future.

For instance, let’s say Maurice makes $100,000 in gross income. If Maurice maxes out his 401k in 2021 ($19,500), here’s how it works.

$100,000 gross income

(minus)

$19,500 401k contribution

=

$80,500 in taxable income

Ideally, contributions to these accounts were set up early in the year and have been automatically deducted from each paycheck. If you are now deciding that you have margin to go harder on these accounts, increase your contribution to hit the maximum, if you can. If nothing else, please, get the employer match (if one is offered)! Don’t leave free money on the table.

Healthcare Savings Accounts (HSA)

If you have a high deductible healthcare plan (HDHP), these little guys come with an HSA. And lordy lordy, the HSA might be the world’s best retirement account. Yes indeed, for more about the wonderful HSA, check out this.

Now is the time to make sure you will hit your contribution limits. For 2021 an individual can contribute $3,600 and a family can contribute $7,200. Remember, just with the 401k, 100% of HSA contributions are tax deductible. Add that to the fact that they are triple tax-advantaged, and baby, you got a stew goin’.

For us, we’re extra giddy this year because we still plan to max out our contribution to our HSA, which came with our ACA health insurance plan (which by the way, we’re getting paid to be insured). We’ve been sitting on a good stash of cash, so we’ll move $7,200 over to our HSA, further lowering our tax obligation. Thankfully, there is no requirement that you have earned income to contribute to an HSA.

See, isn’t personal finance fun?!

Roth IRA

Ok, now we’re heating up! If you’ve maxed out the 401k (or the like), an HSA, and still have margin to spare, look no further than the Roth IRA.

So, here’s the skinny:

• Roth IRA contributions are not tax-deductible now.
• These contributions are taxed at your current marginal tax bracket, but can grow in the market and be withdrawn (after five years) tax-free.
• Contribution limits: $6000 in 2021
• Those making more than $140,000 (single) or $208,000 (married filing jointly) cannot contribute to a Roth IRA.
• Do you make too much money and want to contribute to a Roth IRA anyway? There’s always the Backdoor Roth. It’s legit. That said, the Backdoor Roth might be on the chopping block in 2022, so consider doing a Backdoor Roth soon!
• Withdrawals: your contributions can be withdrawn anytime, but contributions and earnings can only be taken after age 59 ½ or if funds have “seasoned” for five years like a Jamon Iberico in a musty Spanish cellar. Weird, right? Otherwise, a 10% penalty is applied. Exceptions include first-time home purchases, college expenses, or birth or adoption of small humans. I’d avoid withdrawing from a Roth IRA in wealth-building years at all costs, because then you ain’t buildin’ wealth, brother.
• More on Roth IRA contribution limits and eligibility here

We personally love Vanguard (no affiliation, they’re just great). Open a Roth IRA with Vanguard here.

Year-End Tax Implications

Let’s look back at Maurice, who along with his wife, have maxed out all their tax-advantaged accounts.

Maurice and wife gross income: $100,000

(minus)

Maurice and wife 401k contributions: $39,000 ($19,500 *2)

(minus)

Maurice HSA contribution (family): $7,200

(minus)

Standard Deduction (married, filing jointly*): $25,100

=

$28,700 in taxable income

This is huge! By contributing to these tax-advantaged accounts, two things are happening:

1. Maurice and his wife are investing at least $46,000 in 2021. If you include two maxed-out Roth IRAs, which are not tax-deductible, they are investing upwards of $58,000! Even if they stop investing from there, that $58,000 alone will potentially grow to over $583,000 in 30 years while they sleep (assuming an 8% yearly return). Here’s how money grows in the market.

2. They’ve lowered their tax obligation by tens of thousands of dollars in 2021, which is money back in their pocket. For certain income levels, this could be the difference between marginal tax brackets.

*Aside from romance and undying love and all, the tax benefits of marriage are really quite good. But check the box on the romance/best friend thing first.

Year-End Roth Conversions

Before we recreate the wheel, let’s review The Bold and Beautiful Roth Conversion Ladder. This process is essential for those wishing to spend retirement money that would otherwise be taxed and/or subject to early withdrawal penalties.

By executing a flawless Roth conversion, we can move funds from a previously untaxed traditional retirement account to a Roth IRA, where those funds will continue to grow tax-free and can be withdrawn tax-free. After seasoning for five years, these funds are available for spending, regardless of your age. I’m shaking with excitement. Or caffeine. Or both.

We will be executing our first Roth conversion at year-end, sometime in December.

Here are some key elements to consider:

• A Roth conversion is 100% taxable as ordinary income. If you move $40,000, that’s $40,000 of additional ordinary income.
• Because a Roth conversion is taxable, this process should be done only if you are in a 10-12% tax bracket to avoid excess taxes. It would be silly to be taxed to avoid taxes. Unless of course you really have no other funds outside of traditional retirement accounts.
• These funds are not immediately available for spending. For each conversion, one must wait five years before spending. So, it’s important to execute a Roth conversion anytime you find yourself in a low income tax environment. Little by little, we can move those funds to both minimize our lifetime tax exposure and give ourselves spending flexibility prior to age 59.5.
• For those on an ACA healthcare plan, it’s important to note that Roth conversions contribute to total MAGI. To keep healthcare premiums in check, we must find a balance between desired Roth conversions and healthcare premiums. More on that here.

Anyway, the idea is to complete a Roth conversion by December 31, 2021. We’ve been waiting on the dust to settle on our (minimal) income. We’re aiming for exactly $60,000 in total income (MAGI) for our healthcare premiums. Once we have a pretty solid idea of ordinary and capital gains income, we will fill the rest of the $60,000 bucket with Roth conversions. This will likely be somewhere in the neighborhood of $25,000 – $30,000. Stay tuned for details on this in an upcoming post.

Enroll in Healthcare

Now is the time for open enrollment for both workplace and marketplace retirement plans. For those healthy and otherwise fine with higher deductibles, I’d go with a high deductible healthcare plan with an HSA. Those are your bronze plans, typically. For those in need of more healthcare attention in 2022, consider a silver plan. Obviously, these will come with higher monthly premiums, but lower deductibles and reduced out-of-pocket exposure.

Here’s how we’ve been getting paid to have health insurance in 2021. Despite a kinda scary autoimmune diagnosis for me, we still plan to continue with the plan described in the linked post for 2022. Remember to capture any and all healthy behavior incentives offered by your plan. We get $40 per month for walking the steps we walk anyway. Now I can tell my neighbors I’m a professional walker when they ask why I’m loading the truck with climbing gear on Wednesday morning again.

If you have already reached your deductible, now is a great time to schedule some sort of expensive medical care. What’s 100% covered in December could be 100% out-of-pocket in January.

Child Tax Credit

We don’t have children, so the tax benefits of parenthood are a big blind spot for me. But how I suffer for you, and I did some research (that is probably very obvious to parents).

In 2021 all parents are eligible for the child tax credit, with no minimum income requirement.

Each household can receive up to $3,600 for each youngin’ under 6, and $3,000 for all whippersnappers between age 6 and 17.

Here is more on the 2021 changes to the child tax credit. Basically, be sure to get the full tax credit.

Year-End Donations

Since the standard deduction was introduced several years ago, itemizing deductions has lost its luster. While we still give a good chunk to charity each year, the tax benefits have been negated by the portly $25,100 standard deduction for those that are married and filing jointly.

That said, with the passage of the CARES Act, $300 of charitable giving is tax-deductible without itemizing.

In essence, taxpayers can claim the standard deduction AND still claim $300/person or $600/couple for donations in 2021.

More on Our Investing Strategies:

The CC Family Investing Strategy, Part 1: Philosophy and Asset Allocation

The CC Family Investing Strategy, Part 2: Where Exactly Is Our Money?

Summary

That’s it guys. I sincerely hope that this year has been happy and prosperous for you. There’s so much in this world to get us down, but there are silver linings everywhere. At least pink linings.

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Remember, the best laid plans mean nothing if you can’t take action today. Have questions? Need some feedback? Hit us up on the contact page.

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