Tap into our expertise. Once a month we publish a blog on various financial planning topics.

KEY TAKEAWAYS:

• Taking two important actions can potentially save you thousands of dollars: review your open enrollment options/elections and a prepare a tax forecast.
• Reviewing your open enrollment options and elections includes reviewing changes to the plan costs, forecasting next year’s medical expenses, and ensuring you take advantage of elective pretax spending accounts.
• Preparing a tax forecast includes forecasting your tax situation for the next two years and, preferably, for when required minimum distributions (RMDs) are required (currently age 72). Matching income to the years with the lowest tax rates may save you tens of thousands of dollars.  

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Prefer video over reading? We’ve got you covered! Watch our YouTube video as we recap this blog post for you:

https://youtu.be/sNvTdZ2uC5A

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The Holiday Season is Here!

We have now entered the final three months of 2021. Soon we will be stuffing ourselves with turkey, various potato dishes, and sweets made from “ secret family recipes¹,” while starting to buy gifts for loved ones (and some not-so-loved ones). It is a busy time, and it’s easy to forget about your finances in all the excitement. But this is also an important time for your finances.

There are two mission critical things you need to work on before year-end.

#1 – Review your benefit elections and 2021 contributions during open enrollment.

It’s hard to estimate the savings possible from selecting the proper healthcare plan because the savings depends on your employer’s plan options, the amount your employer pays of the total cost, the size of your family, and your family’s health. But if you can maximize the flexible spending accounts, at the 24% tax bracket it would save you $3,180 per year in taxes. Just as much, or more, could be lost if the plan is not set up correctly.

For most corporations, open enrollment is usually in November and for one month (enrollment for healthcare under the Affordable Care Act is longer). After that period, benefits are usually assumed not to have changed from the prior year. Elective deferrals for flexible spending accounts, however, are reset to $0, regardless of prior year elections. That is why it is important to review this information as soon as your employer sends it out. You want to assess the changes in the plan’s cost and coverage, as well as take an assessment of your own health.

The best place to start is by looking at your healthcare costs in the prior and current year. You should be able to log into your healthcare insurer’s website, see what you spent last year and this year, and project this year’s spending out to the rest of the year.

If you enrolled in a Flexible Spending Account (FSA) in 2021 and don’t use your entire FSA balance by the end of the year, you will lose the unused amount, so check to make sure you have submitted all expenses. If there is an outstanding balance, look into any medical procedures you have been putting off (like that super fun colonoscopy!). Thanks to the CARES Act Law passed in March 27, 2020, over-the-counter medicine and certain medical supplies can now be reimbursed through your FSA account, so check those expenses as well.

After reviewing the expenses you incurred year-to-date and forecasting them out for the rest of the year, you should have a good estimate of your annual healthcare costs. Very likely next year’s expenses will be similar to what you spend this year, unless you have any changes in health or life changes (like a new baby).

With the information on your annual expenses and the coverage changes/options from your employer in hand, it is now time to compare plans. The best site I have found to compare the costs of health insurance plans is https://health-plan-compare.com/. (We are not affiliated with this site in any way.) If you decide to give it a shot, make sure you see the note that the server will clear your entries if you let the input information sit for a while. It’s super frustrating to lose your work, so be aware.

At this point you should be 80% to 90% confident in a plan choice. Make your choice now. Unless you have a crystal ball, all the information on the future that you’re going to get. And since you have forecasted your medical expenses, set up your FSA when you select your plan. I suggest giving yourself some slack in case you are healthier next year. Consider aiming for 80% of your expenses. You never know, maybe you’ll start going to that gym you’ve been paying for! The IRS limit for health FSAs in 2021 is $2,750 so that will be your max regardless of the calculation.

Note, this is only for FSAs, which are use-it-or-lose-it accounts. Health Savings Accounts (HSAs) are a whole different animal. HSA balances can be invested well into retirement, growing tax free until you need to withdraw from them for healthcare-related expenses in retirement—when your costs will be highest. I won’t go into all the reasons why these are so awesome here, so I will just summarize:

Step 1: Max out your HSA.

Step 2: Do not use unless you absolutely must.

If the detailed two-step process above has you wanting more information, read more on HSAs here. 

The last election to review during open enrollment, if your employer offers it, is the dependent care flexible spending account (separate from your health FSA). If your employer provides a dependent care FSA, you can set aside up to $10,500 per year pretax for dependent care (this is up in 2021 from $5,000 in prior years). It works just like a healthcare FSA; amounts are withheld from your paycheck and then you submit receipts for reimbursement after you pay them. Like an FSA, it is a use-it-or lose-it account, so be careful how much you put into the account. However, if you have small children, daycare costs for one child can quickly blow past even the new higher amount.

It is important to fully utilize your employer’s dependent care FSA because, generally, if your adjusted gross income is above $43,000, this account will be more beneficial than claiming the deduction for the expenses on your tax return (more details on that here). And, no, you cannot submit the same expenses for reimbursement through the dependent care FSA and claim them for the dependent care tax deduction as well.

#2 – Prepare at least a two-year tax forecast

By failing to prepare, you are preparing to fail

– Benjamin Franklin

You need a tax forecast. Period.

Without a tax forecast, how can you possibly know what year-end tax moves you should make? If you do anything without a forecast, you’re using the Hope Plan. As in, “Hope it will all work out.”

The ideal tax rate forecast will cover the next few years, and it will estimate what that tax rate will look like when you are 72 (the first year minimum withdraws are required). Most people work under the assumption that in retirement they will be at a lower income level, and therefore a lower tax rate, but often they forget the impact of both social security and required minimum withdraws. Often taxpayers with modest incomes who were excellent savers find themselves in higher tax brackets than when they were working.

WJL develops for its clients a detailed 5-year rolling tax forecast, along with a forecast at age 72. Our review includes information from current-year paystubs, capital gains from brokerage accounts, social security estimates, and RMD (required minimum deduction) forecasts from our annual comprehensive plans. Most tax preparation software companies offer rough estimates on their respective websites for free.  

Knowing your current tax rate and estimating the future rates may allow you to execute several tax savings moves before year-end and beyond. Below are some of those actions, depending on your forecast.

If you expect to be in a lower tax bracket in current year than in the future, here are some actions you may be able to take:

• Take Roth conversions on an IRA up to an amount that will “fill up” the lower tax bracket.
• Sell investments at a gain to lock in a lower capital gains rate.  To the extent you are in the 12% tax bracket, your long-term capital gains rate will be 0%.
• If over 59 ½, withdraw money from your IRA (or under 59 ½, if you qualify for one of the exceptions) and pay taxes at the lower rate. You can still contribute that year.
• If you separate from your company at age 55 or over, withdraw money from your 401K and pay taxes at the lower rate without paying the 10% penalty. 
• Pay quarterly estimated income tax in January and defer payment of real estate taxes until January (tax deduction limited to $10k).

If you expect to be in a higher tax bracket in the current year than in future years:

• Make additional contributions to your tax-deferred investment accounts (401K, IRA, HSA, etc.).
• Delay deferred compensation to the following year.
• Prepay your January mortgage payment to increase your mortgage interest deduction.
• Utilize a Donor-Advised Fund to “lump” charitable deductions. Donate appreciated securities.
• Pay quarterly estimated state income taxes in December instead of January, and prepay real estate taxes, if possible (tax deduction limited to $10k).
• Sell investments at a loss (up to $3,000 can be recognized in a single year), and use the proceeds to purchase a similar (but not identical) investment to avoid a wash sale (a disallowed loss).

Good Finances Are a Journey, Not a Destination

Making these two annual reviews part of your year-end activities could save you tens of thousands of dollars (possibly hundreds of thousands) over your lifetime. The review and the follow-on actions may initially seem overwhelming, but putting a process in place, or getting professional help, is well worth the time or expense.

If you have any thoughts or opinions about this, please drop me an email or leave a comment.

Until next time, spend less than you make, invest the difference in low-cost index funds, be kind to your neighbors, and you will succeed in reaching your financial goals and in making the world around you a happier place.

If you feel you could use some assistance along the way, please reach out to us.

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(1) Secret Family Recipe: Our holiday tradition is to make gingerbread cookies as a family. As a child, I remember breaking many a wooden spoon attempting to stir the super thick batter. Our “family recipe” dates back to at least 1915 when it was first cited as a recipe for Hum Muds at Girard College. Back then, the men of Girard College (it was all-male back then) would bake gingerbread cookies and use them as currency. It would take another 35 years and 1,300 miles  for the recipe to travel from Girard College to a small farm in Nebraska via Betty Crocker’s very first cookbook in 1950. My mother, living on a farm in Nebraska, received the first print, first edition of the cookbook as a gift, and making these gingerbread cookies has been a family Christmas tradition ever since (although we’ve added quite a bit of icing since then!).