The year is coming to an end, and you know what that means? It’s time to review your finances and do some year-end financial and tax planning! Yay! [Sarcasm]
Our year-end tax planning and financial review process
Every November (or early December if we’re slacking off), we perform our year-end financial and tax review. Being the personal finance nerd in our household, I generally take the lead on this. However, since my spouse and I combine our finances and share all financial decisions, we have a “money date” to discuss everything once I’m finished. During this time, we go over everything, make changes, and finalize our budget and goals for the coming year. There’s usually wine involved.
Everyone knows they should get annual physical checkups. However, many people forget to check in on their financial goals and investments on a regular basis.
Additionally, we perform our tax planning earlier in the year, and a full mid-year financial review in July
Below are the primary tax and financial items that make up our year-end financial review. I’d encourage you to do each of these things at least annually, if not more frequently.
What should you consider during your year-end tax and financial review?
If you only want to deal with financial stuff once a year, November or December is the perfect time. Doing so will ensure you don’t miss out on any current year benefits that have a December 31st deadline, and will help you to stay on track for your financial goals.
Review your paystubs
I do this every pay period during the start of the year, but then reduce the frequency. During our year-end financial review I double check everything to make sure there are no errors. I’m sure most of us would notice if we were grossly underpaid, but payroll mistakes happen all the time. You may find some errors in benefits or withholdings that are harder to spot just from the net pay that hits your bank account each pay period.
Last year, when I quit my corporate job and went on Mr. RFL’s health insurance in April, his company should have increased their matching contributions to his Health Savings Account (HSA). But they didn’t. The matching contribution is based on whether or not a spouse or children are on the plan (prorated if necessary). It was small dollars, so we didn’t catch the error until our year-end financial review process. The company fixed it, but we would have missed out on an extra $375 if we hadn’t identified the error ourselves. Lesson learned.
Check your tax withholdings
Similar to above, tax mistakes happen all the time, so it’s important to review your tax withholdings before year end. This is one that I look at during our mid-year and year-end financial review, so that any changes can be made timely. You can easily change withholdings, but it often takes a pay cycle or two for changes to go into effect.
You’ll want to check for any crazy errors in withholdings, and that you aren’t significantly under-withholding taxes. No one wants to have too much money withheld, but you’ll ultimately get any extra back at tax time. However, under-withholding on your taxes can result in financial penalties.
If you’ve properly completed your W-4 forms, and you haven’t had any significant changes in income or job status, you’re probably close enough. However, if you or a spouse changed jobs or you’re making significantly more than you projected, you may need to withhold more (or pay estimated taxes on top of your withholdings).
Finish funding tax-deferred and after-tax accounts (Traditional and Roth IRAs, 529 Plans, etc.)
Take a look at the contributions made year to date to any tax deferred accounts. Set up and/or finish funding those accounts before the end of the year.
For most tax deferred accounts, such as an IRA or an HSA, you technically have until the tax filing deadline (April 15, 2022) to make any contributions for 2021. However, if you are opening a new account, you generally must do so before the end of the year (even if you don’t make your contributions until January).
529 Plans differ in that contributions made are never deductible at the federal level. However, they are deductible in several states. Luckily for us, Arizona is one of the few states that allows a deduction even if you don’t invest in the state’s 529 Plan. The deadline for contributions also depends on the state, though most states adhere to a December 31st deadline.
If you have an HSA or Flexible Spending Account (FSA), check your contributions and balances
Health Savings Account
The 2021 contribution limits for HSAs are $3,600 for individuals and $7,200 for families. If you’re planning to max this out, check your withholdings/ contributions made to date, add any scheduled contributions, and compare to these limits.
If you are above the limit, you’ll need to either change your withholding amounts through your employer or complete a form to remove the excess contributions before the tax filing date.
Keep in mind that you can make contributions through employer withholding or directly to your account up to the tax filing date. If you project that you’ll be under the limit, you can always make a direct contribution to contribute more.
Flexible Spending Account
Contrary to an HSA, FSAs are considered “use it or lose it” plans. You can generally only carry over a small amount, but lose anything over that amount. Increased flexibility in carryover amounts was introduced as a part of COVID-19 relief, but it varies by Company. Check with your HR department to make sure you understand your plan’s rules. If you have this type of account, make sure to check the balances and spend that money before December 31st.
Make charitable contributions
It’s been a tough couple of years for a lot of people. If you are one of the fortunate who’ve made it out (relatively) unscathed, considering giving a little more this year.
The IRS recently made it more enticing for people who don’t itemize their tax deductions to give more generously. People taking the standard deduction can now deduct up to $300 for cash contributions made to qualifying organizations ($600 for married filing jointly).
If you give more and itemize deductions, you’ll be able to take the higher deduction, up to 100% of your Adjusted Gross Income in 2021.
Don’t forget to check your state’s rules also, as many offer additional tax deductions or credits to incentivize charitable contributions. For example, our state offers a tax credit for charitable contributions up to $400 for individual and $800 for joint filers. As a reminder, tax credits are dollar-for-dollar reductions to the taxes you owe. That means the first $800 of our charitable contributions each year come out of the state’s pocket, not our own. Tax deductions are good too, but they only reduce your taxable income. The true benefit of a tax deduction is the amount of the deduction multiplied by your marginal (top) tax bracket.
Review your investment portfolio allocation
I believe that investors should perform a comprehensive review of their investments at least once or twice a year. This is to ensure that investments by class are still reasonably close to the targets you set when determining your investment strategy. Your year-end financial checkup is also a good time to take a fresh look at your target allocations and investment strategy, as well as to make any changes to these goals.
Over the year as some asset classes rise and others fall, your investment portfolio can become misaligned with your goals. Reviewing the portfolio allocation across all your investment accounts will help you identify variances from your targets. You can then rebalance your account to bring any outliers back in line with the targets.
For example, let’s imagine that your target portfolio allocation between bonds and equities is 20% bonds and 80% equities. You’ll likely have a further break out of asset classes within each of these categories as well, but let’s stay high level to keep it simple for now. In this example, bonds had a great year, but stocks didn’t. As such, you might end up with something like 25% bonds and 75% equities at the end of the year. When you rebalance, you are essentially locking in some of the gains on the bonds that did well during the year and buying more of the stock that underperformed.
Not only does rebalancing your portfolio help you to stay on track with your investment strategy it can also help you to sell high and buy low.
We revise our investment target allocations and rebalance our portfolio twice a year. You can find our most recent investment targets and allocation in our 2021 Mid-Year review, but we’ll assess this again in late-December.
Review your free credit reports
You know you’re supposed to regularly review your credit reports, right? Of course, you do. If you don’t already do this, adding it to your year-end financial review is a great way to ensure you don’t forget.
Americans are entitled to a free credit report every 12 months from each of the three major consumer reporting companies (Equifax, Experian and TransUnion). You can pull all three reports at once, or use one at a time, spreading them out over the year. As a part of COVID-19 relief, the number of free credit reports allowed per year has been temporarily increased.
You can request a free copy from AnnualCreditReport.com.
Regularly checking your credit is the best way to identify errors or fraudulent activity. If you don’t plan on applying for debt in the near term, you can also “freeze” your credit to make it more challenging for fraudsters to open accounts under your name. Identify theft is a hassle, but the earlier you catch it, the less chance it will severely damage your credit.
Draft next year’s budget & financial goals
One of the best ways to manage your money is to prepare an annual budget and regularly track your spending.
I know it sounds tedious, but whether you stick to a budget or not, tracking your spending is the best way to identify where your money is going. That knowledge is power.
Ideally, you should review your spending and compare it to your budget a couple times a year, including at year-end. I actually do this monthly, but that’s because I share our expenses with you on the blog each month. And, if we’re being honest, I’d do it anyway since I’m slightly obsessed.
Once October (or November) is over, it shouldn’t be too difficult to project out the rest of the year. I then use this information, along with any known or expected changes, to draft next year’s budget.
Once I’m happy with the draft, I’ll sit down with Mr. RFL to go over the budget. Together we make any changes we decide are necessary and come up with our financial goals for the following year.
I’ll share more about our budgeting process and reveal our 2022 budget in an upcoming post.
Have you started your year-end financial review yet?
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Dragon Guy
Very good list of year-end action items. I usually do most of the work the last week of December and beginning of January. In late December I will look at our estimated income and projected taxes, and figure out if we can do any Roth IRA conversions or harvest capital gains. In early January, I will prepare our budget for 2022 and make our HSA contributions for the next year (so in this case 2022). I like to wait until January for the budget so I can use a full year of 2021 expenses the help with the planning process. I always hated having to start the budget process at work in September; the year is only 2/3 over! In years when we were both working, we’d also make our new year IRA contributions in early January. Now that we don’t have much work (if any at all), we’ll wait until before we file our taxes to make any eligible contributions.
Mrs. RichFrugalLife
Thanks for sharing your review process! Always interesting to hear other takes.
We primarily do the budgeting in November and finalize in early December. I usually start around that time because it’s when Mr. RFL’s open enrollment occurs where we have to pick FSA and other contributions, and for preliminary tax planning purposes. Then, I just end up wanting to update the rest of the line items while I’m at it, but I’m nerdy like that. That said, I think once the predictability of W-2 employment is gone (or perhaps after we reach FI), we will likely shift this back a few more weeks. I’m with you on budgeting too early in the year… I understand why it’s necessary, but it always seemed like there were too many “what-ifs” that needed to be built in to make it useful.
Cheap Eco Wanderer
This is exactly what I needed – a step-by-step breakdown of the end-of-year financial tasks I should do. I really like how you broke it down by category and included things I would never even think of, such as checking your paychecks. I always assume they’re paying me the correct amount, but you never know!
Years ago my mother found out she was being slightly overpaid (the horror of a woman making money!) and, while she tried to fight it since it wasn’t her error, she was ultimately forced to pay them back. Although I suppose you could look at it as an interest-free loan from her job!
Mrs. RichFrugalLife
Thank you for the comment. Glad to hear that you found the post helpful! Yeah, we’ve surprisingly found multiple errors in pay and withholdings over the years. Always good to check. Something like what happened to your mother could be devastating to someone who always spends their whole paycheck if the error got to large.