2021 Year-End Checklist: Moves to Maximize Benefits and Minimize Taxes

Step to Consider

Benefit to You

Did you have or adopt a child this year? You can take a qualified birth or adoption distribution.

The Setting Every Community Up For Retirement Enhancement (SECURE) Act created a new in-service distribution option of up to $5,000 to help pay for expenses for a qualified birth or adoption. This qualified distribution, although taxable, is not subject to the 10% early withdrawal penalty that otherwise applies to pre-age 59½ distributions, and the funds can be rolled over at a later date. Learn more here.

Take advantage of the saver’s credit if you are eligible.

The saver’s credit is a nonrefundable federal income-tax credit, available to individuals with an adjusted gross income (AGI) of less than $66,000 in 2021, who make tax-deferred contributions to a 401(k), 403(b), 457(b), SIMPLE IRA, SAR SEP, and 529 ABLE Accounts, which can reduce an individual’s AGI. In addition, the credit is available for contributions to a traditional or Roth IRA. The maximum annual contribution eligible for the credit is $2,000, and the maximum credit is 50%, making the maximum saver’s credit $1,000.

Fully fund your employer- sponsored retirement plan.

In 2021, you can defer a maximum of $19,500 into your 401(k), 403(b), 457(b), or Thrift Savings Plan (TSP). This limit is an aggregate of all pre-tax and/or Roth contributions. Plus, individuals age 50+ can defer an additional $6,500 in “catch up” contributions.

TIP: 457(b) salary deferrals are not coordinated with deferrals made to a 403(b) or 401(k) plan. You can fully fund your 403(b) or 401(k) without reducing the contribution limits to a 457(b). Participation in both plan types offers a tremendous opportunity to maximize contributions and double your salary deferrals.

EXAMPLE: In 2021, an individual participating in both a 457(b) and a 403(b) or 401(k) can defer up to a total of $39,000 ($19,500 into a 457(b) plus $19,500 into a 401(k) or 403(b)). In addition, individuals age 50+ can defer an additional $6,500 per plan for $13,000 in catch-up contributions.

Fully fund your IRA.

Although you have until April 15, 2022 to contribute to your IRA for the 2021 tax year, why not fund it now? Virtually anyone with reportable (earned) income can fund a traditional IRA up to $6,000 ($7,000 including the age 50+ catch-up contribution) in 2021. Not everyone, however, is eligible to make Roth IRA contributions. Roth IRAs carry statutory, maximum income levels, and investors must satisfy an annual income test. There are no maximum age restrictions on Roth contributors. Plus, the SECURE Act repealed the rule preventing otherwise eligible individuals to fund a traditional IRA in the year they attain age 70½. Therefore, beginning with tax year 2020, an otherwise eligible individual can contribute to a traditional IRA regardless of their age.

TIP: A spousal IRA is an exception to the (earned) income requirement and is available to those married couples where one spouse has no earned income. The spousal IRA only applies to those (married) couples that file a joint tax return.

Fully fund your SIMPLE IRA.

In 2021, you can defer a maximum of $13,500 into your SIMPLE IRA. Participants age 50+ may make an additional catch-up contribution of $3,000, for a total of $16,500. By participating, you are eligible to receive a non-forfeitable, immediately vested, employer-funded contribution in the form of a 3% match or 2% non-elective contribution.

Contribute to a Roth IRA for a child.

There is no minimum age to establish a Roth IRA. A child regardless of age who has reportable earned income is eligible to establish and fund their Roth IRA. Once established, the IRA can be funded by anyone, up to the amount earned by the minor. 

Have the “back-door” Roth discussion.

A backdoor Roth IRA is a retirement savings strategy where you contribute after-tax funds (nondeductible) to a traditional IRA, which virtually everyone can do, and then immediately convert the funds to a Roth IRA.

Roth IRA eligibility is means tested—that is, an investor must satisfy an annual income threshold as set by the IRS. For you to contribute directly to a Roth IRA, your income must be under a threshold dependent on your tax filing status. However, high-income earners, regardless of the amount of household income, are eligible to convert funds to a Roth IRA.

Check to see if you “overfunded” your IRA.

It’s a common occurrence to contribute more to your IRA than allowed. "Excess contributions" typically occur when you unintentionally deposit funds that are not permitted. Common errors include contributing more than the maximum annual contribution limit, not satisfying Roth income-eligibility, and funding an IRA with an ineligible rollover such as a required minimum distribution (RMD) or a hardship withdrawal—neither of which is permitted.

Tax law permits excess IRA contributions to be withdrawn without penalty—if corrected within the tax-filing deadline (including extension). If not corrected by the deadline, the excess contribution plus earnings are subject to a 6% penalty for every year the excess remains in the IRA. Reviewing all your IRA account activity for the past year with your financial and/or tax professional can help you avoid this scenario and additional taxes and/or penalties.

Check if you made a nondeductible (after-tax) traditional IRA contribution.

If you did, it is essential that you or your tax professional file IRS Form 8606 “Nondeductible IRAs.” You can obtain the form and learn more here.

How do you determine if your traditional IRA contribution is tax deductible? A number of variables—including tax filing status, modified adjusted gross income (MAGI), and whether an individual and/or their spouse are active participants in a workplace retirement plan—determine whether a taxpayers’ contribution to their traditional IRA is tax deductible.

Participation in an employer-sponsored plan, such as a 401(k), 403(b), 457(b), TSP, SIMPLE, or SEP IRA, does not affect IRA eligibility or contribution limits. However, participation may affect whether your IRA contribution is tax deductible. Learn more here. 

Check if you took a distribution from a Traditional IRA.

The tax liability of an IRA distribution (e.g., normal, RMD, Roth conversion), once basis (after-tax) funds have been accumulated, is reported on IRS Form 8606 “Nondeductible IRAs.” An IRA owner  is required to file Form 8606 in those tax years that a nondeductible contribution was made and, in any year that funds are distributed (including a conversion to a Roth IRA) from any IRA that contains nondeductible (after-tax) dollars.

For tax purposes, all IRAs (except Roth IRAs) are considered a single IRA regardless of where the account was established (for example, different IRA providers)) and distributions are taxed proportionately or “pro-rata,” partly from your pretax (tax-deductible contributions plus earnings, if any) and partly from your nondeductible (after-tax) IRA funds. In other words, when there are after-tax dollars held in a traditional IRA (including Rollover IRA, SEP, and SIMPLE) and the entire IRA balance (across all IRAs) isn’t distributed, the amount of the distribution subject to income tax is based on the ratio of after-tax dollars to total IRA assets (across all IRAs, including rollover IRA, SEP, and SIMPLE) at the end of the year. This is commonly referred to as the “pro-rata” rule. See my article for more on nondeductible (after-tax) contributions.

Determine if making a Roth IRA conversion in 2021 is right for you.

Conversions are made on a calendar-year basis, and a Roth conversion must be completed by year-end (December 31) to qualify for 2021. In other words, there is no such thing as a prior year Roth conversion.

IRA owners can convert as much or as little of a traditional IRA (including SEP and SIMPLE) to a Roth IRA as they want; although the amount of funds converted (minus any basis) is subject to income tax (federal and state, if applicable) in the year of conversion. The conversion amount is taxed at your marginal tax bracket. Furthermore, IRS Form 8606 must be filed to report a Roth Conversion

TIP: Converting to a Roth account is irrevocable. The Tax Cut and Jobs Act of 2017 repealed the recharacterization of a Roth conversion. For more on the elimination of recharacterization, see my column.

Review your age and what you are eligible for/required to do

RMDs were waived for 2020 but returned in 2021. Anyone age 72 or older as of December 31, 2021, must take their RMD by year-end to avoid a 50% penalty tax.

If you’re turning 72 in 2021 and taking your first RMD, you can delay taking it until April 1, 2022. However, you will be subject to two RMDs in 2022 (your delayed 2021 RMD and 2022 RMD). For each subsequent year, your RMD must be taken by December 31.

Are you planning) on using net unrealized appreciation (NUA) strategy this year?

If you hold highly appreciated company stock in your 401(k), NUA is a tax-planning strategy that allows you to pay ordinary income tax on the cost basis when distributed. The difference between the two amounts (NUA) isn’t taxable until the shares are sold—and at favorable long-term capital gains rates—even if sold within a year.

NUA treatment requires a taxpayer to satisfy several rules. One requirement is all plan funds must be distributed by the end of the year. In other words, if funds remain (in the plan) at the end of the year, the lump sum distribution requirement will not be satisfied. For more on the NUA strategy, see my column.

Ensure your beneficiary designations are in order.

Retirement accounts generally are not subject to probate; therefore, the beneficiary designation on file versus a will is what prevails. Did you get married this year? Divorced? Did a previously designated beneficiary predecease you? Birth of a child? Adoption? Any of these life events could affect your beneficiary designation.

Review and, if necessary, update your beneficiary forms for all your retirement accounts. Are the correct individual(s) designated to receive the benefits? If you are unsure who to name as your beneficiary (primary or contingent), discuss your estate planning needs with your financial professional.

If you inherited an IRA in 2020, be aware of payout requirements.

Inheriting an IRA (traditional, SEP, SIMPLE, Roth,) may require the beneficiary to take annual distributions (i.e., stretch) or may be required to fully distribute assets under a specific number of years. The payout schedule for example, depends on several factors including the named beneficiary (spouse, non-spouse, estate, charity, etc.), age of the account owner upon death. Learn more here.

Review qualified charitable distributions (QCD) from IRAs requirements.

QCDs are a tax-free, direct transfer of funds up to $100,000 annually from your IRA, payable to a qualified charity. QCDs count toward satisfying your required minimum distributions (RMDs) for the year if certain rules are satisfied. QCDs can be made from traditional IRAs, Roth IRAs, and inactive SEPs and SIMPLE IRAs belonging to account owners or beneficiaries age 70½ or older. Find out how the SECURE Act may affect QCDs.

TIP: The SECURE Act changed the start of RMDs to age 72. Notably, an otherwise eligible individual can still do a QCD at age 70½.

For those who do make a QCD, be aware that although the amount of these distributions will be reported on IRS Form 1099-R, there is no code signifying the distribution is a QCD. As such, QCDs can easily be missed on a tax return, resulting in a taxable IRA distribution. Therefore, it’s up to the taxpayer to properly report the QCD as tax-free on his/her IRS Form 1040.

TIP: Since a 2021 QCD must be received by a qualifying charity by December 31, 2021, waiting until the end of the year is not prudent.

If you did a 60-day rollover in 2021, verify its timely completion.

Verify that the 60-day rollover was completed timely. You should also confirm that only one 60-day IRA-to-IRA rollover per account owner was done in a 365-day period (not calendar year). The rule prevents an unwanted IRA distribution from being rolled back into the same or another IRA via a 60-day rollover if another IRA-to-IRA 60-day rollover has been completed during the past 365 days.

TIP: IRA owners who received multiple distributions can still roll over the funds while bypassing the once-per-year rollover rule by rolling the second (or more) distributions to a non-IRA employer-sponsored retirement plan (i.e., 401(k), 403(b), etc.) that accepts roll-ins. Alternatively, if a plan rollover option is not available, you still can receive benefits by doing a Roth conversion (not subject to once-per-year rollover rule), although funds will be subject to income tax.

If you are taking substantially equal periodic payments under section 72(t)

Taking substantially equal periodic payments (otherwise known as 72(t) payments) allows IRA investors under age 59 ½ to access their IRA funds without being assessed the 10% early distribution penalty tax. However, these payments are subject to several stringent rules, such as payments must be taken annually and must continue for at least five years or until you are age 59 ½, whichever period is longer. Learn more here.

Consider funding a Coverdell Education Savings Account.

The deadline to establish and/or fund a Coverdell ESA for 2020 is April 15, 2022. The total contributions for the beneficiary cannot exceed $2,000 in any year, no matter how many accounts have been established. Any individual can contribute to a Coverdell ESA if the individual's household income (MAGI) for the year is less than $110,000. For married couples filing joint returns, it increases to $220,000. Learn more here.

Fund a 529 ABLE Account for a disabled person

Section 529 ABLE (Achieve a Better Life Experience, also known as 529A) accounts are tax-advantaged accounts for individuals, who become disabled before age 26, that help pay for qualified disability expenses without affecting eligibility for benefits such as Medicaid.

TIP: If the designated beneficiary makes the contributions, he/she will now be able to claim the Saver’s Credit  as well (which is normally only available for contributions to retirement accounts).

Learn more about 529 ABLE Accounts here.

Health Savings Accounts (HSAs)

Contribute to an HSA.

You may be eligible to contribute to a HSA if you are enrolled in a high-deductible health plan (HDHP). HSAs are triple-tax-advantaged savings accounts that are designed to be used for future medical costs. In 2021, an eligible individual with single coverage can contribute $3,600, whereas the limit is $7,200 for those with family coverage. In addition, a $1,000 catch-up contribution is available to those individuals age 55 and older.

TIP: Once you determine the maximum allowable HSA limit, contributions can be made anytime between January 1 and April 15 of the following year. For example, you can make a 2021 HSA contribution as late as April 15, 2022.

Learn more here.

If you had 2021 activity in your HSA, you need to file a form.

You are required to file Form 8889 “Health Savings Accounts”  and file it along with Form 1040. HSA activity includes contributions (including those made by your employer) and distributions.

Did you inherit a HSA in 2020?

A HSA requires an account owner to name a beneficiary, just as you would with an IRA or 401(k). And like retirement accounts, the individual you name inherits the HSA after your death. You can name anyone as beneficiary…your spouse, non-spouse, estate, etc. Naming a HSA beneficiary follows a number of guidelines for employer-sponsored retirement plans and IRAs—but that is generally where the similarity ends. Learn more here.

For Small Business Owners

Distribute SIMPLE IRA plan notifications to your eligible employees.

Employers that sponsor a SIMPLE IRA are required to distribute notices to eligible participants providing plan information such as the opportunity to make or change salary deferrals, summary plan description, and employer contribution formula (3% match or 2% non-elective) for the following year. The election period is generally the 60-day period immediately preceding January 1 of a calendar year.

Comply with the SIMPLE IRA “exclusive plan” rule.

A SIMPLE IRA must be the only qualified retirement plan an employer maintains during a calendar year (called the “exclusive plan rule”). However, if no contributions are made, and no benefits accrue to an existing qualified plan (e.g., 401(k)) during this time, the employer will satisfy the requirement.

For more information on the exclusive plan rule see my column