Tax and financial planning is a year-round proposition. In fact, you can benefit personally from a continuous, 12-month rolling forecast, much like a business does.
What is a rolling forecast?
Rolling forecasts let you continuously plan with a constant number of periods 12 months into the future. For example, on January 1, you would plan what your financial picture looks like each month through January 1 of the following year. When February 1 rolls around, you would then drop the beginning month and add a forecast month at the end of the 12-month period. In this case, you add February of the next year into your 12-month forecast.
The month you add at the end of the 12 months uses the finished month as a starting point. You then make adjustments based on what you think might happen one year from now. For example, if you know you are going to get a raise at the end of the year, your next-year February forecast would reflect this change.
How to take advantage of a rolling forecast
By doing tax and financial planning in rolling 12-month increments, you may find yourself in position to cash in on tax- and money-saving opportunities within the next 12 months. Here are several strategies to consider:
- Plan your personal budget. Will you need to put a new roof on your house? How about getting a new vehicle? Do you need to start saving for your kids’ college education? A rolling 12-month forecast can help you plan for these expenses throughout the year.
- Plan your healthcare expenses. If you have a flexible spending account (FSA) for healthcare or dependent care expenses, forecast the amount you should contribute for the calendar year. Although unused FSA amounts are normally forfeited at year-end, your employer may permit a 12-month grace period (up from 2½ months) for 2021. This means that you could potentially roll over your entire unused FSA balance from 2021 to 2022. Your forecast can help you see the impact of this change.
- Plan your contributions to a Health Savings Account (HSA). When an HSA is paired with a high-deductible health insurance plan, you can take distributions to pay qualified healthcare expenses without owing any tax on the payouts. For 2021, the contribution limit is $3,600 for an individual and $7,200 for family coverage. In this case, you can forecast an increase in contributions and double-check to ensure you have enough money on hand to pay future bills.
- Plan your estimated tax payments. This is often significant for self-employed individuals and retirees with investment earnings. The quarterly due dates for paying federal and state tax liabilities are April 15, June 15, September 15, and January 15 of the following year (or the next business day if the deadline falls on a holiday or weekend). So, if your personal income is seeing a recovery from the pandemic, your rolling forecast will show this and allow you to plan for the estimated tax payments.
- Plan your retirement contributions. If you participate in your company’s 401(k) plan, you can defer up to $19,500 to your account in 2021 ($26,000 if you’re 50 or over). Contributions and earnings compound tax-deferred. As the year winds down, you might boost your deferral to save even more for retirement.
While initially setting up a rolling 12-month forecast can be a bit of a pain, once established, it is pretty easy to keep up-to-date as you are simply rolling forward last month into the future. A well-planned system can often be the first sign of future challenges or potential windfalls!
Understanding how our tax system works can be tricky for anyone. Whether you’re an adult who never paid much attention to the taxes being withheld from your paycheck or a kid who just got his or her first job, understanding the basics can help refine and define questions you may have.
Many schools don’t teach these tax lessons. This results in many people entering life with a pretty incomplete picture of how taxes work, unless someone else takes the time to explain these tax concepts. Here are some pointers to help you or someone you know navigate our tax maze.
Taxes are mandatory!
While we can have a debate about how much each person should pay, there’s no debating that local, state and federal governments need tax revenue to run the country. These funds are used to build roads, support education, help those who need financial assistance, pay interest on our national debt and defend the country.
There are many types of taxes
When you think of taxes, most think of the income tax, which is a tax on business and personal income you earn from performing a job. But there are also other types of taxes. Here are some of the most common.
- Payroll taxes. While income taxes can be used to pay for pretty much anything the government needs money for, payroll taxes are earmarked to pay for Social Security and Medicare benefits.
- Property taxes. These are taxes levied on property you own. The most common example of this is the property tax on a home or vacation property.
- Sales tax. These are taxes placed on goods and services you purchase. While most of this tax is applied at the state and local levels, there are also federal sales taxes on items like gasoline.
- Capital gains taxes. If you sell an investment or an asset for a profit, you may owe capital gains taxes. The most common example of this is when you sell stock for a gain. Capital gains taxes could also come into play with other assets, such as a rental property you sell for a profit.
- Estate taxes. This tax is applied to assets in your estate after you pass away.
Not all income is subject to tax
Most, but not all, of your income is subject to tax.
- While your paycheck is subject to tax, interest earned from certain municipal bonds is not. And the government often excludes things like benefits from the tax man.
- Capital gains taxes have exclusions for gains on the sale of your home and donated stock.
- Estate taxes have an exclusion, so only estates in excess of the exclusion are taxed.
This is why having someone in the know can be really helpful in navigating these rules.
The progressive nature of income tax
When it comes to income taxes, the government gets to take the first bite. The question is how BIG of a bite the government gets to take.
For example, if you only have one chocolate chip cookie, the government’s bite is really, really small. If you have 1,000 chocolate chip cookies, the government takes a small bite from the first 100 cookies, a larger bite from the next 100 cookies, and an even larger bite from the remaining 800 cookies.
This is called a progressive tax rate system. For example, if you’re considered single for tax purposes in 2021, the first $9,950 of taxable money you earn gets taxed at 10%. The next $30,575 you earn gets taxed at 12%. The next $45,850 gets taxed at 22%. Money you earn above this point will get taxed at either 24%, 32%, 35% or 37%.
Understanding the progressive nature of our tax system is a key concept in managing the size of the bite the government takes. That is why tax planning is so important!
Deductions can decrease the government’s tax bite
The progressive tax system is complex because it is manipulated in a big way by our elected officials. This is typically done through credits, deductions and phaseouts of tax benefits.
For example, there is a fairly complex deduction for families with children, and the earned income tax credit is an added tax cut for those in the lower end of the progressive income tax base. There are also credits and deductions for businesses, homeowners, education and many more types of taxpayers.
As you can imagine, the U.S. tax system is very complex with many nuances. Please seek help if you have further questions or are facing a complicated taxable transaction.
As the year draws to a close, there are several tax-saving ideas you should consider. Use this checklist to make sure you don’t miss an opportunity before the year is out.
Retirement distributions and contributions. Make final contributions to your qualified retirement plan, and take any required minimum distributions from your retirement accounts. The penalty for not taking minimum distributions can be high.
Investment management. Rebalance your investment portfolio, and take any final investment gains and losses. Capital losses can be used to net against your capital gains. You can also take up to $3,000 of capital losses in excess of capital gains each year and use it to lower your taxable ordinary income.
Last-minute charitable giving. Make a late-year charitable donation. Even better, make the donation with appreciated stock you’ve owned more than a year. You often can make a larger donation and get a larger deduction without paying capital gains taxes.
Noncash donation opportunity. Gather up non-cash items for donation, document the items, and give those in good condition to your favorite charity. Make sure you get a receipt from the charity, and take a photo of the items donated.
Gifts to dependents and others. You may provide gifts to an individual of up to $14,000 per year in total. Remember that all gifts given (birthdays, holidays, etc.) count toward the annual total.
Organize records now. Start collecting and organizing your end-of-year tax records. Estimate your tax liability and make any required estimated tax payments.
As the end of the year approaches, there is still time to make moves to manage your tax liability. Here are some ideas to consider.
Maximize your retirement plan contributions. This includes traditional IRAs, Roth IRAs, and SEP IRAs for self-employed. Now is the time to maximize the contribution potential for this year and plan for next year’s contributions.
Estimate your current and next year taxable income. With this estimate you can determine which year receives the greatest benefit from a reduction in income. By understanding what the tax rate will be for your next dollar earned, you can understand the tax benefit of reducing income in this year versus next year.
Make charitable contributions. Consider which tax year will benefit most from your charitable giving of cash and non-cash items. Shift your giving into the year that will provide you the most benefit.
Take capital losses. Each year you can net capital losses against capital gains. You can also deduct up to $3,000 in excess losses against your other income. Start to identify which investments may make sense to sell to take advantage of this. If planned correctly, these losses can offset ordinary income.
Consider donating appreciated stock. This strategy gives you a charitable deduction for the market value of the stock, while not having to pay capital gains tax on the charitable gift. If you provide an annual pledge sheet to your church, this can be a great way to maximize your gift while giving needed funds to your church at the beginning of the year.
Retirement plan distributions. If you are age 70½ or older, take your required minimum distributions for the year. If you are retired, but younger than 70½, consider taking tax efficient distributions from your retirement accounts. By paying some tax now, you may avoid paying higher taxes later when you have to follow the minimum distribution rules.
Consider tax legislation. Please recall that tax laws passed in late 2016 made many temporary tax savings permanent and extended others into 2017. So save classroom related receipts if you are a teacher. Consider charitable contributions from your retirement plan if you are a senior. Keep receipts of large purchases to track a potential sales tax deduction.
Three of every four Americans got a refund check last year and the average amount was $2,777, according to IRS statistics. Because the amount of a refund is often uncertain, we may be tempted to spend it without too much planning. One way to counteract this natural tendency is to come up with a plan beforehand to spend your refund purposefully.
Here are some ideas:
Pay off debt. If you have debt other than your home mortgage, a great spending priority can be to reduce or eliminate it. The longer you hold debt, the more the cumulative interest burden weighs on your future plans. You have to work harder for longer just to counteract the effect of the debt on your financial health. Start by paying down debts with the highest interest rates and work your way down the list until you bring your debt burden down to a manageable level.
Save for retirement. Saving for retirement works like debt, but in reverse. The longer you set aside money for retirement, the more time you give the power of compound earnings to work for you. This money can even continue working for you long after you retire. Consider depositing some or all of your refund check into a Traditional or Roth IRA. You can contribute a total of $5,500 to an IRA every year, or $6,500 if you’re 50 years old or older.
Save for a home. Home ownership is a source of wealth and stability for many Americans. If you don’t own a home yet, consider building up a down payment fund using some of your refund. If you already own a home, consider using your refund to start paying your mortgage off early.
Invest in yourself. Sometimes the best investment isn’t financial, but personal. If there’s a course of study or conference that would improve your skills or knowledge, that could be a wise use of your money in the long run.
Give some of it away. Helping people, and being able to deduct gifts and charity from your next tax return, isn’t the only benefit of giving to a good cause. Research shows that it makes us feel good on a neurological level. In fact, donating money activates our brains’ pleasure centers more than receiving the equivalent amount.1
If a refund is in your future, start planning now on how it can best help your financial situation.
1 https://www.wired.com/2010/12/the-science-of-charity
You’ve done your retirement homework. Your assets are reviewed, you have planned your financial needs, and your retirement tax plan is in place. Are you ready to enjoy retirement? Probably, but not without a plan to address what happens to many people after they retire – boredom.
Here are some ideas to make sure your retirement is everything it should be:
Go to school – Many colleges and communities offer classes for retired students. Pick topics of interest and take advantage of this cost effective way to stay alert through learning. Many classes can have built in activities. Examples could be local history classes with field trips, photography classes, writing, and gardening. As an added benefit, you will meet others with your shared interest while you continue learning.
Pick up part-time work – If you are outgoing, why not pick up a few hours at a local retail establishment?
Volunteer – Many retirees volunteer at libraries, museums, and parks. Others volunteer at their local church, deliver meals, and help young people with literacy. The possibilities are endless.
Schedule physical activity – Staying physically active will keep your body and mind in shape. Create a weekly routine that keeps you moving. Volunteer to take the grand kids to swimming lessons while their parents are working. Bike or walk to do everyday chores.
Look for combinations – With a little creativity you can combine some of these ideas. For example, if you coached your kids in soccer why not consider refereeing kids’ games? You might earn a little pay, stay connected with kids, and get some physical activity.
Get Connected – When you retire, many of your social connections will change. This is especially true for work connections and availability of friends that are still working. Look for other ways to make new connections. Use some of the ideas here to actively get connected with others that share your interests.
Blend in your dreams – If you’ve always dreamed of moving to a new place in retirement, you may want to test-drive it first. A dream move may turn out to be different than you anticipated. You may miss your kids and friends. Services and connections you take for granted may become a problem. By renting a place and staying in the new location prior to committing, you will be prepared with a fall back if it does not work.
When would you like to retire? Even if the answer is later versus sooner, most of us would like the freedom to decide. To do this, consider what it would take to create financial independence in retirement. Here are some ideas to help plan for an early retirement.
- Start early – Establish your desire to retire early as soon as possible. Have a discussion with your spouse and loved ones to ensure you have the same retirement date goal. With this stated goal, meeting savings targets and establishing spending priorities get much easier.
- Know what you want to do – Have you always wanted to visit national parks? Do you have a passion for art? If you have a dream that can be fulfilled in retirement, it makes any hardships to get there more tolerable. Once you set retirement goals, creating a plan to get there will have more meaning.
- Pay yourself first – People who retire early have higher savings rates than most of us. Consider saving in excess of 10% of your earnings. To do this might mean holding off on a big vacation once in a while or delaying a major home improvement or purchase. While a hardship, knowing the long-term dividend makes it worthwhile. The larger your savings become, the more flexible you are in acquiring assets that generate more wealth for you.
- No debt and credit cards paid in full – It’s hard to retire early if you are making large loan payments. Having a mindset to save money before you buy something versus taking out loans is the way to go for prospective early retirees. Why pay the credit card company interest when you could use that money during your non-working days?
- Financial independence mindset – Save enough to not have to worry about Social Security or other government programs to take care of you. Said another way, never over-spend your own resources as you will need to depend on yourself and not others for your financial independence.
- Use common sense when investing – Many investment alternatives may no longer make financial sense when compared to the income potential of the underlying asset or property. For example, if you own rental property, determine if the cash flows create a reasonable rate of return for the price you paid for the property. If you use common sense, more of your investments may help generate income in retirement.
- Other resources – Go through a retirement planning process with a qualified expert. This exercise can help you understand what your projected financial needs will be during your retirement years. Project your potential savings. Look into other sources of projected income from pension plans and retirement savings accounts. Create an estimate of possible Social Security benefits. Understand what other resources will be available to you during retirement.
While this list is not meant to be all-inclusive, it should help start the conversation toward your early retirement dream. Remember to ask for help to understand your situation and to develop your own personal plan.
Don’t let the financial burden of this holiday season last until next summer! Use the steps below to help make the most of your holiday spending:
Make a Budget – Set a realistic amount of how much you can spend this holiday season. Remember to include food, gifts, transportation, and clothing costs.
Shop with a List – Make a list of who you’re buying for and set an amount for each person. List gift ideas before you go shopping and try to stick to your list.
Pay with Cash – Don’t shop with money you don’t have and leave your credit cards at home. If you must shop with a credit card, use a low-interest card and use it sparingly!
Comparison Shop – Before you shop, check catalogs and the internet and compare prices on gifts you plan to buy.
Consider Alternative Gifts – Gifts don’t have to be expensive to be meaningful. Consider making meals, providing baked goods for family and friends, spending time with a friend doing something you both enjoy, or volunteering your time to babysit or dogsit.