5 things to get done before the end of the year. Then kick back with some holiday cookies!
The holidays are my favorite time of the year. They combine year-end reflection, financial analysis, and mountains of baked goods – three of my favorite things in the world! For others who are also thinking about what needs to get done before they kick back on the couch with some hot cocoa and Netflix, here are five major loose ends that are worth your time and consideration.
Update Your Report Card: Three Key Metrics
At the end of the year, I like to check three key metrics and compare them to last year’s numbers. Carve out 15 to 20 minutes to update these numbers and discuss them with your partner (if you have one).
For this exercise, it is incredibly useful to have a single dashboard to be able to view your finances. You can do this by updating excel spreadsheets monthly or use a software tool to help you, whatever works for you. I personally use a free service called Personal Capital which will take you less than 10 minutes to set up, and I highly recommend it.
Here are the three metrics that show up on my report card:
Net Worth – Where are you in total net worth, and how does that compare to where you wanted to be?
Expenses – I like to see my total expenses for the year and then compare them category by category with what I spent last year. You can do this easily in Personal Capital (once you’ve used it for a while so it has built up past data for you) by going into its Expense view and selecting the date range you want to see. It will build you a pie chart with expenses by category for the time period.
I like to compare my annual expenses to last year’s to keep an eye out for lifestyle inflation. Lifestyle inflation is sneaky and – at least for me – has required semi-regular monitoring. If you notice a particular category or two which has crept up higher than your liking, flag them for closer monthly monitoring in the new year.
Wealth Conversion Rate (Savings Rate) – This is a really important metric when it comes to your financial freedom. How good were you at converting the money you earned into actual wealth that stays with you, as opposed to luxuries that disappear out the window the same year they were earned? You can call this your savings rate, but I recently came across someone who referred to it as wealth conversion rate, and I like that better. The way I calculate wealth conversion rate is to divide how much you saved by how much you could conceivably have saved. That means the denominator should essentially be your post-tax income adjusted for any pre-tax contributions you could have made.
Say you made $100k for the year pre-tax. You could contribute $5,500 to an IRA and $18,000 to a 401k. If you had done both, your taxable income would be $76.5k. You jump over to the applicable SmartAsset State Tax Calculator and enter in $76.5k and determine that the post-tax amount you’d keep as a single professional in New York is $54.5k. The denominator of your calculation is potential tax-advantaged contributions + the post-tax amount of remaining taxable income. That would be $5.5k+$18k+$54.5k=$78k. In the numerator, you put how much you actually saved across all those avenues.
Everyone’s family situation is different, which is why I created a table with recommended target savings rates by income. In general, I’d really aim for a 50%+ savings rate if you were single with no kids, and for 30%+ if you have a family, though it also highly depends on how much income you pull in a year.
Max Out Your 401K or Other Employer-Sponsored Retirement Plan (Yes, Even Contractors)
Double check what options are offered through your 401k and whether you are still invested in the option you think is best. Perhaps they started offering low-cost Vanguard funds. Perhaps you set up a 20% commodities fund last year and are scratching your head as to why you did that. Rebalance and reset your ongoing allocations as appropriate. I did this myself. My first year working I had exposure to international equities. By my second year working, I had taken time to examine the actual performance data behind the international thesis and decided it was actually a poor decision. I moved everything to US-funds and have enjoyed great growth since.
If you’re a contractor or an entrepreneur, you have some pretty appealing options to investigate such as a solo 401k or SEP IRA. I prefer and use the solo 401k myself as you get a max contribution of $18k wearing your employee hat, and then the same 25% of total income contribution wearing the employer hat as you would if you’d opened a SEP IRA (note that you wear two hats – as employee and employer – when setting up a 401k). This is strictly superior in my eyes.
Explore and Enroll in Applicable Tax-Advantaged Accounts: FSAs, HSAs, Dependent-Care FSAs
There are a slew of tax-advantaged accounts your employer may offer you. Here are a few to explore:
Health Savings Account
If you are enrolled in a high-deductible health plan, you may be eligible to contribute cash to a tax-deductible account called a Health Savings Account (HSA). For 2017, the IRS defines a high-deductible health plan for an individual as a plan with an out-of-pocket maximum of $6,550 and a minimum deductible of $1,300. For a family plan in 2017, the out-of-pocket maximum is $13,100 and the minimum deductible is $2,600. HSA max contribution in 2017 is $3,400 for an individual and $6,750 for a family.
I believe almost everyone who qualifies and has capital to contribute to an HSA should do so. HSA funds can grow be invested and grow tax-free for you. They carry over from year to year if you don’t use them, so you don’t have to worry about “wasting your contribution.” Furthermore, if you don’t find yourself needing these funds for medical expenses, you will be allowed to withdraw these funds at age 65 for non-medical reasons. It is essentially a glorified tax-advantaged retirement account. In fact, I recommend contributing to an HSA but deliberately not withdrawing from it and rather letting it grow for you – you can use taxable dollars to pay for your medical expenses in the meanwhile.
Flexible Savings Account (Health)
A flexible savings account allows you to park pre-tax dollars in an account to use for medical and dental expenses. Your co-pays, deductibles, teeth cleaning for the year… they all qualify. Note that dollars in an FSA are considered “use it or lose it.” If you do not spend them by the end of the year, you will lose all those dollars. Because of this, you want to do some planning ahead of time to make sure you don’t contribute more than you plan to withdraw in the coming year.
HSA, FSA, or Both?
If you qualify for both an HSA and a health FSA, you may be told you must choose one or the other. Were you aware that some companies actually may allow you to have both? If you have an HSA, typically you would only be able to use the FSA in a restricted fashion for things like vision and dental expenses (not medical). However, if you exceed your deductible on your health plan that year, your FSA can then be transferred to a restriction-free FSA and you can spend those tax-deductible dollars on all the usual health expenses. You can find a little more on that set-up in this Kiplinger’s article. This does require your employer to offer restricted-FSA’s, but it’s worth exploring whether they do. Given that I am giving birth to a child next year, we will most certainly meet our deductible, and so we are looking into taking advantage of both an FSA and HSA for next year. Implementing this setup would shelter another few thousand dollars and keep hundreds more in our pockets.
Enrollment Deadlines: Enrollment deadlines for FSA programs is typically sometime in Q4 of the year preceding the year you would like the benefit, so make sure to check with your HR department as soon as possible. The deadline for opening and funding an HSA carries into April of the year in question. You should of course confirm your understanding of the limitations and requirements of each program as well as their deadlines with your company’s HR team as the information for this article may become outdated or not apply to your specific situation.
Flexible Savings Account (Dependent Care)
For those with dependents – children, a disabled spouse, or the elderly who live with you – are you aware of whether your employer offers a dependent-care FSA? With a dependent-care FSA, you can contribute up to $2,500 if you are an individual or $5,000 if you are married filing jointly into a pre-tax account for expenses like daycare (for adults or children), nannies, and after-school care.
Select and Max Out Your Personal Tax-Advantaged Accounts (IRA, Roth IRA, etc.)
Have you decided whether a traditional IRA vs an Roth IRA makes sense for you, and have you funded it completely?
Technically you have until tax time (April of next year) to complete your funding of these accounts, but it’s entirely possible you’ll forget and I find it’s helpful to lump this in with the rest of my end of year financial loose ends. Plus, it will be working for you for four months more in a tax-advantaged account if you do it now.
For those who would like to invest in a Roth IRA but who do not meet the income restrictions, consider a backdoor Roth IRA. Long story short, there are a lot of interesting options open to you for tax-advantaged personal accounts.
Tax Loss Harvesting
If you are unfamiliar with the concept of tax loss harvesting, there’s a solid explanation in this Investopedia article. If there are stocks you are holding right now that show a paper loss, you can sell them this year in order to offset gains you have seen on other holdings, reducing your tax bill for the year. You can pick up the same security 31 days or more later (you don’t want to trigger what’s called the “wash sale” rule), or you could sell the loser security and buy something immediately that is essentially highly correlated to your old investment so that your exposure/portfolio essentially remains the same, while giving you that tax loss harvesting benefit. For example, perhaps you have an ETF tracking the S&P 500 that shows a $10k loss for the year. You could sell that ETF to realize the loss for tax purposes, and buy on that very same day a similar ETF a similar but slightly different basket of companies. They cannot be identical or “substantially similar,” but they can be highly correlated, for example selling an ETF tracking the S&P 500 and buying one that tracks the NASDAQ or the Dow Jones.
Spend Your FSA Money
As we mentioned above, FSA dollars “use it or lose it.” If you don’t spend those dollars by the end of the year, they are gone. If you find yourself with money left over, you can stock up on extra contacts, a new pair of frames, or other healthcare that you’ve been putting off.
Any other loose-end items that are on your end of year checklist? How is your report card looking for the year?