Labor Day weekend marks the unofficial end of the summer season. For many of us, that means the end of travel, the return of school-related routines, and something of a brief lull before the craziness of the winter holiday season ramps up.
That makes now a perfect time to take action to set yourself up for financial success throughout the rest of the year. After all, it’s a lot easier to make an adjustment in early September than late December, especially if that adjustment involves coming up with a significant amount of cash before a rapidly approaching deadline. We asked these three Motley Fool contributors to recommend investing moves to help you finish 2021 strong and set you up for financial success.
Consider a backdoor Roth IRA before year-end
Barbara Eisner Bayer: There’s no doubt that one of the best retirement vehicles is the Roth IRA where you contribute after-tax money, invest it, and watch your money grow, knowing that you won’t have to pay taxes in retirement when you make withdrawals. But there’s one huge catch: There are contribution limits and income restrictions on who can take advantage of a Roth.
For example, in 2021, single people can only contribute $6,000, but if you’re over 50, the limit is raised to $7,000. But there’s a bigger problem because contributions are limited by your income. For single people earning $140,000 or more, or married couples earning $208,000 or more, no contributions are permitted. Thankfully, there’s a way to get around these restrictions: High earners can do a Roth conversion, also known as a backdoor Roth IRA — which has no income limits at all.
Back in 2010, Congress passed the law that enables people to convert a traditional IRA into a Roth account as long as they pay a one-time tax on the amount they roll over. Then, that money is free to grow. And grow. Billionaires Warren Buffett and Peter Thiel took advantage of this new law, and as of 2018, had amassed $20.2 million and $5 billion, respectively, in their Roths. Clearly, those two chaps know not only how to make money but how to grow it as well.
Here’s how it works: First, make sure your brokerage allows Roth conversions. Then, move the money into a traditional IRA and convert it to a Roth IRA. You have 60 days from the date of the IRA distribution to make the conversion. You can also convert funds already housed in a traditional IRA.
If you’re under age 59 1/2, you must leave the money in the Roth account for five years before you can withdraw it, or pay a 10% penalty. But if you’re over that age, you can withdraw the money at any time, penalty-free.
A backdoor Roth IRA conversion must be completed by December 31. If you’re considering it, begin planning now. It’s a good idea to speak with a financial advisor or tax professional to understand how it will impact your taxes. But if you’ve got enough money to cover the tax hit, it’s a great way to protect and grow your assets.
It’s retirement account funding time!
Eric Volkman: I heartily agree with Barbara that one of the best vehicles for socking away money for the golden years is an IRA. So if you’ve got one, or are planning to set one up, I feel it’s important to plow some of your spare cash into it by the stroke of midnight on Jan. 1.
While all contributions in a particular year can be made through April 15 of the following year (not coincidentally, the tax-filing deadline), it’s prudent to do so by New Year’s Eve. After all, tax time is often busy, stressful, and laborious, and because of that, we can easily forget moves we intend to make.
As previously mentioned, account holders are allowed a maximum contribution every year. For 2021, this was $6,000 for the two most popular IRA types: traditional and Roth IRA. Happily, account holders who are at least 50 years of age can add a “catch-up contribution” of $1,000 to that amount. Another incentive for packing some cash into an IRA is that a tax deduction can be taken for most account types.
IRAs are extremely popular because they are, first and foremost, excellent investment and saving instruments. Early (i.e., pre-retirement) withdrawal of funds is typically penalized, so right off the bat, account holders have a big incentive to keep their money in the IRA.
One of the most surefire ways to profit handsomely from an investment portfolio is to keep the funds in it untouched, allowing their returns to grow and compound.
Once an IRA is either set up for the first time or added to with fresh funding — that’s when it’s time to start earning. A full range of investments is available for account holders; not surprisingly, stocks are enormously popular IRA portfolio fillers.
An IRA is an instrument for retirement saving. Therefore, I’d recommend that those buying stocks for an IRA portfolio weigh it heavily to companies that have proven they can perform consistently well. A largely conservative investment strategy is appropriate here.
I particularly favor dividend-paying stocks; the longer the payout history, the better. One good place to start is the list of Dividend Aristocrats where investors can find regularly profitable and generous names such as Target, AT&T, and McDonald’s.
Make sure you have a plan for Uncle Sam
Chuck Saletta: One of the downsides of successful investing is that Uncle Sam expects to receive a part of your capital gains and dividend income in the form of taxes. Paying what you owe on time is an important part of maximizing what you keep, as slow-paying or not paying can lead to substantial interest and penalties when the IRS catches up with you.
In ordinary brokerage accounts, taxes do not automatically get withheld on profitable trades, so it’s important that you stay on top of things to keep your total costs down. There are three basic tax safe-harbor rules. You need to be covered by at least one of them in order to avoid any penalties, as long as you also true up the rest of what you owe by the April 15 filing deadline. To be covered, you can follow any one of the following rules:
Pay to within $1,000 of what you owe for the year.
Pay at least 90% of what you owe for the year.
Pay at least 100% of what you owed for the prior year (110% if you’re considered a high earner).
Those safe-harbor payments need to be reached via withholdings by the end of the calendar year or via timely estimated payments made quarterly. If you’re covered by a safe-harbor test, then you can true up the rest of what you owe by the April 15 filing deadline without any additional interest or penalties.
In addition, you can also consider tax-loss harvesting. If you close out investments for a loss, you can offset dollar for dollar any gains you took for the year. If your total losses exceed your total gains, you can even claim up to $3,000 in losses against your ordinary income. If you have more net losses than that, the excess will carry forward to future tax years.
When you’re thinking about closing out your losing investments, just make sure you really want to close them out. Stocks can be volatile, and if a fundamentally strong company’s shares are down just because the market threw a fit, its shares can rebound before you have a chance to buy them back.
You can’t claim a loss on your taxes if you reopen an investment on a substantially identical security within 30 days of closing your position for a loss. Doing so would trigger a wash sale and disallow your loss until you closed out the position for real.
Get started now
Labor Day weekend can be the perfect time to take stock of your financial position and make plans to finish the year strong. It’s late enough in the year so that you likely have a good feel for how things will wind up but early enough to make adjustments to give yourself a good chance to see them through. So take advantage of the long weekend and the end of the summer vacation season to put yourself on a great path for a top-tier ending to 2021.
As crazy as it may seem, the end of the year will be here sooner than you think. When that day passes, many of the tools you have to affect this year will fall by the wayside, and the ones that remain often get trickier to use. So get started now, and set yourself up to be much more than satisfied by the way you navigated 2021.
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Barbara Eisner Bayer owns shares of AT&T. Chuck Saletta owns shares of Target. Eric Volkman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.