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1. Tune Up Your Portfolio

ADD REBALANCING TO YOUR ANNUAL TO-DO LIST

Thanks to a bull market in stocks that has stretched deep into its second year, stocks have trounced bonds since March 2020, when the relentless climb began. As of early October, the S&P 500 index has more than doubled, compared with a 4.2% return for U.S. bonds, as measured by the Bloomberg U.S. Aggregate Bond index. But there’s a potential downside to the big rally: Many investors might be holding a bigger stake in stocks than their risk tolerance calls for. And that could make portfolios more vulnerable to a stock market downdraft.

There’s an easy fix: Rebalance your portfolio to get your asset weightings back in line with your desired allocation. “Rebalancing prevents you from taking unintended risks,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

Start by tallying up the total dollar value of the stocks, bonds and cash you hold in your taxable and retirement accounts. If you own a fund that invests in both stocks and bonds, such as a balanced fund or target-date fund, review the fund’s latest holdings to see how much it holds in each major asset class. To find out your current asset mix, calculate the percentage of each asset class relative to your total portfolio. For example, if you have a $1 million portfolio and $750,000 is now held in stocks, your equity stake is 75%.

A portfolio that started out in March 2020 with 60% stocks and 40% bonds now is closer to 75% stocks. Trim stock holdings that have gone up in value the most and funnel the proceeds into bonds or cash to get your portfolio back to your target weightings. To minimize your tax bill for sales in taxable accounts, consider offsetting gains by lightening up on losers (see the next page).

TAKE ADVANTAGE OF VOLATILITY

A relatively calm 2021 stock market turned volatile in a big way this fall, with a number of nail-biting days. When stock prices bounce around, dollar-cost averaging, a strategy that involves investing a set amount at periodic intervals, helps in two ways. First, it lowers your average cost per share because you buy more shares when they are cheaper. Second, it takes the emotion out of investing—a challenge when volatility dominates the headlines.

Say you put $1,000 per month into a stock that starts out at $25 a share, then dips to $12.50 the next month before jumping back to $20 and then to $30 in months three and four. After four months you’d own 203 shares at an average cost of $19.70 each. Had you invested the whole $4,000 at once, you’d have paid $25 a share for 160 shares. Perhaps more important, committing to automatic monthly installments would have kept you from second- guessing yourself when the stock hit a low ebb.

PREPARE FOR HIGHER INTEREST RATES

Rock-bottom interest rates have been a fixture of the fixed-income market for years. But a gradual liftoff is under way. The Federal Reserve has signaled it will begin to reduce its purchases of Treasury and mortgage-backed bonds, and it could start hiking its benchmark short-term rate in 2022. “My guess is one rate hike at the end of 2022 and three rate hikes for 2023,” says David Kelly, chief global strategist at J.P. Morgan Asset Management.

Long-term rates, more responsive to expectations for strong economic growth and rising inflation, are already higher, with 10-year Treasuries yielding 1.6% in early October, up from less than 1% at the start of 2021. “Yields will move higher, irregularly and over time,” says Bob Doll, chief investment officer at Crossmark Global Investments. “The pattern we’ve seen so far is two steps up, one step back, then two steps up.”

Because bond prices dip when rates are rising, income investors face a challenge. With Treasury bonds, choose short maturities, which are less sensitive to rate swings. Or stick with assets that hold up relatively well in a rising-rate environment. Doll likes TREASURY INFLATION-PROTECTED SECURITIES, which you can purchase directly from Uncle Sam at http://www.treasurydirect.gov or via a low-cost fund such as SCHWAB U.S. TIPS ETF (SYMBOL SCHP, $63).

Other options include floating-rate notes (bank loans with interest rates that reset higher when market rates rise) or high-yield corporate bonds. These are riskier IOUs. The team at T. ROWE PRICE FLOATING RATE (PRFRX) is topnotch; VANGUARD HIGH-YIELD CORPORATE (VWEHX) takes a cautious approach. Hybrid securities, sharing characteristics of both stocks and bonds, are worth a look now. Consider VIRTUS INFRACAP U.S. PREFERRED STOCK ETF (PFFA, $25). For more on preferreds, see “Income Investing,” on page 34.

2. Lower your tax bill

BENEFIT FROM YOUR GENEROSITY

Since the 2017 tax overhaul doubled the standard deduction, the majority of taxpayers no longer itemize on their tax returns. But if you make a charitable contribution before December 31, you may be eligible for a modest deduction even if you don’t itemize.

For the 2021 tax year, people who take the standard deduction can deduct up to $300 of cash donations to charity. The $300 amount is per person, so if you’re married, you can deduct a total of $600 on your 2021 tax return.

The deduction is limited to cash contributions—donations of clothing and household goods to your local Goodwill aren’t eligible. Contributions to donor-advised funds aren’t eligible, either (see “Your Guide to Giving,” on page 66). Keep a record of your contribution with your tax documents. For donations less than $250, you need a bank record, such as a canceled check or credit card statement. For donations that exceed $250, you should obtain a written acknowledgment from the charity that shows the date of the contribution and the amount and states whether you received any goods or services in exchange for your donation.

If you still itemize, you can deduct charitable contributions made before year-end on Schedule A of your 2021 tax return. As was the case in 2020, itemizers can deduct donations of up to 100% of their adjusted gross income. Ordinarily, the cut-off is 60%, but that limit was removed for the 2020 and 2021 tax years (although there’s still a 100%-of-AGI limit on all charitable contributions). Donations to donor-advised funds aren’t eligible for the higher limits. However, high earners may want to postpone major charitable gifts, for reasons we explain in the box on page 46.

KEEP MORE OF YOUR INVESTMENT GAINS

The stock market delivered another effervescent year in 2021, and if you sold some of the winners in your taxable accounts, you’ll be required to share a portion of your bounty with the IRS. Investments held for less than a year will be taxed at ordinary income tax rates, which range from 10% to 37%. Investments you’ve held longer are taxed at long-term capital gains rates, which range from 0% to 23.8%.

The most effective way to reduce your tax bill is to ditch some of your underperformers before year-end. If you sell investments that have fallen below their purchase price, you can use those losses to offset your gains. After matching short-term losses against short-term gains, and long-term losses against long-term gains, any excess losses can be used to offset the opposite kind of gains. If you still have some unused losses, you can use up to $3,000 to offset ordinary income and roll over any leftover losses to the following year. Once you sell an investment at a loss, you must wait 30 days before reinvesting in the same security or buying a substantially identical investment.

Even if you’re ordinarily a long-term investor, you may want to make some strategic sales in your taxable account if you’ll be eligible for the 0% capital gains rate. For 2021, single filers with taxable income of up to $40,400 are eligible for the 0% rate (it’s $54,100 for head-of-household filers and $80,800 for joint filers).

Keep in mind that your gains could boost your income above the 0% threshold, so you may want to sit down with a tax professional and calculate the amount of gains you can take before your income exceeds the cut-off. And if you’re retired, note that capital gains could also increase taxes on your Social Security benefits.

DON’T BUY A TAX BILL

During the month of December, many mutual funds pay out dividends and capital gains that have built up during the year. If you own shares on what’s known as the ex-dividend date, you’ll have to pay taxes on the payouts, even if you reinvest the money.

Before you invest in a fund, call the fund company or check its website to get the date and estimated amount of year-end distributions. The estimates are often reported as a percentage of a fund’s current share price. A distribution of 2% to 3% of the share price probably won’t cause you a lot of tax headaches, but if the fund estimates it will pay out 20% to 30% of the share price, wait until after the distribution to buy—or consider investing in a different fund.

CALCULATE YOUR CHILD TAX CREDIT

The monthly advance child tax credit included in President Biden’s $1.9 trillion coronavirus stimulus has helped millions of parents put food on the table. But depending on your circumstances, it could result in an unwelcome tax bill next year.

The American Rescue Plan, which was enacted in March, increased the maximum amount of the child tax credit to $3,000 (from $2,000) for children 6 to 17 years old and to $3,600for kids 5 years old and younger. The bill also directed the IRS to pay half of the total credit amount in advance through monthly payments issued this year from July to December.

But here’s the rub: If the advance payments exceed the amount you’re eligible to receive when you file your 2021 tax return, you could end up with a tax bill. This wasn’t the case with the stimulus checks: If you received an overpayment, you didn’t have to pay it back.

If your modified AGI for 2021 doesn’t exceed $40,000 for single filers, $50,000 for head-of-household filers or $60,000 for married couples, you won’t have to repay any overpayment amount. But if you don’t qualify for that safe harbor, there are a couple of scenarios that could result in an overpayment of your child tax credit.

The IRS is using taxpayers’ 2020 tax returns to calculate their tax credit. If your 2021 income increased to the extent that your eligibility for the tax credit is partially or completely phased out, you could end up with a tax bill when you file your return. This calculation is complicated by the fact that there are two phaseouts in effect. The higher tax credit ($3,000 to $3,600) phases out if your modified AGI exceeds $75,000 for single tax returns or $150,000 for married couples. Families who have modified AGIs above those thresholds are eligible for the regular credit of $2,000 per child, but the credit phases out when their MAGI exceeds $200,000 for singles or $400,000 for married couples.

Similarly, you could have an overpayment if your filing status has credit for fewer children in 2021 than you did in 2020. (That can happen, for example, if you claimed your child as a dependent on your 2020 tax return but your ex-spouse claims the child as a dependent for 2021, a common arrangement among divorced couples.)

If you’re concerned about overpayments, there may still be time to avert a tax bill (or reduce what you owe). You have until November 29 to opt out of your December payment by going to http://www.irs.gov/credits-deductions/ child-tax-credit-update-portal.

3. Boost your retirement savings

MAX OUT RETIREMENTACCOUNT CONTRIBUTIONS

You have until December 31 to stash the maximum $19,500—or up to $26,000 if you’re 50 or older by the end of the year—in a 401(k) and until April 15, 2022, to contribute the maximum $6,000 (or $7,000 if you’re 50 or older) for 2021 to your IRA. Contributions to 401(k) accounts aren’t included in your taxable income. If you’re not eligible for a workplace retirement plan, or your income falls below specific thresholds, you can deduct contributions to a traditional IRA. In both cases, your contributions will lower your 2021 tax bill.

If you were self-employed or had a side hustle in 2021, you can save even more in a tax-advantaged account. As both employee and employer, for 2021, you can contribute up to $58,000 ($64,500 if you’re 50 or older) to a solo 401(k) plan, which is available to anyone with self-employment or freelance income. Your contributions can’t exceed your self-employment income for the year. You have until December 31 to make the employee share of your contribution and until April 15, 2022, to contribute as an employer.

Alternatively, you could contribute to a SEP IRA, which allows individuals to put away up to 20% of net self-employment earnings, with a $58,000 maximum. The deadline to both establish and fund a SEP IRA for the 2021 tax year is April 15, 2022.

Usually, withdrawing money from a traditional IRA before age 59½ results in a 10% penalty (the penalty also applies if you withdraw earnings early from a Roth IRA, but contributions can be withdrawn anytime without repercussions). The 2020 Coronavirus Aid, Relief and Economic Security (CARES) Act, however, permitted penalty-free withdrawals of up to $100,000 from an IRA or 401(k) in 2020 regardless of your age. You owe no federal income tax on the withdrawal if you put the money back into your account within three years of the date you received the distribution. (You may file an amended tax return to reclaim any tax you’ve already paid.) Consider repaying at least a chunk of the withdrawal amount this year. Or you can spread income tax on the distribution evenly over three years. If you took advantage of this provision, make sure that you account for the portion of tax you owe for 2021.

CONSIDER A ROTH CONVERSION

Especially if you think that your income tax rate will go up next year, you may want to convert your traditional IRA to a Roth IRA now. You’ll pay tax on the deductible traditional IRA contributions that you convert, but all withdrawals from the Roth are tax-free once you reach age 59½ and have owned the account for at least five years. Plus, you don’t have to take required minimum distributions from a Roth. For more on Roth conversions, see the box on page 46.

DON’T FORGET TO TAKE RMDS

Thanks to pandemic-related relief measures, retirees didn’t have to make their 2020 annual required minimum distributions from 401(k)s and traditional IRAs. But you’re back on the hook for 2021. If you were born on or after July 1, 1949, RMDs start at age 72, and you have until April 1 of the year after you turn 72 to take your first RMD; after that, yearly withdrawals are due by December 31. (Those born before July 1, 1949, had to take their first RMD at age 70½.) You can calculate the RMD for your IRAs at kiplinger.com/links/rmd.

TRANSFER IRA MONEY TO CHARITY

If you’re 70½ or older, you can direct up to $100,000 each year from your IRA to an eligible charity through a qualified charitable distribution (QCD). The amount you transfer is excluded from your taxable income, and it counts toward all or part of your RMD for the year. For a QCD to be eligible as an RMD, you must make the QCD by your RMD deadline, which is usually December 31.

Note that changes in the law now allow those 70½ or older who have earned income to contribute to a traditional IRA. If you make tax-deductible contributions to an IRA at age 70½ or later, the tax-free amount of a subsequent QCD is reduced by the amount of the contributions.

4. Manage Employee Benefits

GET THE MOST FROM YOUR FLEXIBLE SPENDING ACCOUNTS

If you are worried about losing funds you’ve set aside in a pretax flexible spending account for health or dependent care—perhaps because you put off medical appointments or your kids have been home during the pandemic—relax. Legislation enacted in response to COVID-19 tweaked rules for FSAs. Instead of losing those funds at the end of the year, employers can modify their plans to allow workers to carry over unused funds through 2022.

Normally, your employer may let you roll over up to $550 of unused funds in a health care FSA for an additional 2½ months (that is, until March 15 of the following year), and you can’t roll over any dependent care FSA funds. But for 2021, employers may provide a 12-month grace period (to December 31, 2022) for both types of flex accounts. That’s particularly significant for dependent care spending accounts, because Congress allowed those FSA holders to sock away up to $10,500 of pretax wages in 2021, up from the standard limit of $5,000.

If your employer doesn’t provide a grace period, keep in mind that depleting unused funds in a health care spending account is easier than using up a dependent care FSA. You can pay for home COVID-19 testing kits, hand sanitizer and masks. You can also use FSA funds to buy over-the-counter drugs, such as pain relievers, cough suppressants and antihistamines. For a full list of eligible items, go to www .fsastore.com/fsa-eligibility-list.aspx. If you’re unsure about whether your employer offers a grace period, contact your human resources department as soon as possible.

BUDGET FOR A HEALTH SAVINGS ACCOUNT

If you have a health savings account (HSA), no need to make a midnight run to Walgreens, because there’s no deadline to use funds in the account. But this is a good time to figure out how much you can afford to sock away next year. For 2022, the HSA annual contribution limit for self-only coverage increases from $3,600 to $3,650. If you have family coverage, the limit rises from $7,200 to $7,300. If you’re 55 or older by the end of 2022, you can put in an extra $1,000 in “catch up” contributions.

To qualify for an HSA, your 2022 health insurance policy must have a minimum deductible of $1,400 for self-only coverage or $2,800 for family coverage. Didn’t max out your 2021 HSA contributions? You have until April 15, 2022, to add to the account.

As is the case with a health care FSA, you can use HSA funds for personal protection equipment, such as masks, and COVID testing kits, as well as other out-of-pocket medical expenses. You can’t have both a health care FSA and an HSA.

5. Protect you credit

CHECK YOUR CREDIT REPORTS

If you haven’t done a credit check-up recently, go to http://www.annualcreditreport .com to download or print your credit reports from the three major credit bureaus—Equifax, Experian and Trans- Union. You can check your reports on a weekly basis until April 2022. When you’re looking over each report, make sure your address is correct and that information about lenders and your payment history is accurate for all of your accounts. For example, each entry should show when you’ve paid your bills and whether the payments were on time. Keep an eye out for signs of fraud, such as accounts listed that don’t belong to you. While your credit reports should look similar, there will be some differences, because some lenders don’t report to all three agencies.

FREEZE OR LOCK YOUR CREDIT

If you want to go a step further to protect yourself from identity theft, consider freezing your credit. When you place a credit freeze on your credit reports, new creditors can’t review them to determine whether you’re eligible for a credit card or loan—and in turn, lenders are unlikely to grant credit to fraudsters posing as you. When you need to shop for credit, you can temporarily lift the freeze. Depending on the credit agency, you may need to keep track of a PIN that you’ll use to confirm your identity when you want to temporarily lift or permanently remove the freeze. To freeze your credit files, call the toll-free number listed on the report you have from each bureau. Placing a freeze is free.

Another way to protect yourself that’s less dramatic than a credit freeze is to place a lock on a credit card you no longer—or hardly ever— use. You can take care of that at your credit card’s website or with its app. If you still want to use your credit cards but are concerned about fraud, find out if you can add a layer of protection by creating a virtual credit card number to use while shopping online (for more details, see the next page).

BE VIGILANT FOR FRAUD

A credit freeze or credit card lock won’t prevent thieves from stealing your information via a data breach or from committing fraud that doesn’t require your credit, says Rod Griffin, senior director of consumer education for Experian. Review credit card and bank statements, and keep track of records connected to unemployment benefits and other stimulus measures.

Unemployment-benefits fraud skyrocketed during the pandemic as millions filed for benefits for the first time. Most victims don’t discover that their information has been compromised until they receive a Form 1099-G from their state informing them that they owe taxes on benefits the scammer received in their name. You can protect yourself by creating an account at your state’s unemployment website, even if you’re not filing for benefits. Once you’ve created an account, it’s much more difficult for a scammer to create one using your information. However, swindlers have taken advantage of looser verification procedures during the pandemic, so take steps to protect your personal information.

6. Save for College

CONTRIBUTE TO A 529 PLAN

The smart way to save for college is in a 529 plan. Earnings in the account grow free of federal and state taxes, and the beneficiary of the account (your child, grandchild, the child of a friend or even you) can use the money tax-free for college tuition, room and board, and fees.

All states (except Wyoming) and the District of Columbia offer a 529 plan. More than 30 states and D.C. also offer a state income tax credit or deduction for contributions to a 529 account. Many plans require you to make your contributions by December 31 to take a deduction for the year, although some give you until the tax-filing deadline.

The maximum amount you (and your spouse, if you file jointly) can deduct varies by state. For example, New York residents filing an individual New York State tax return can deduct contributions to a New York 529 plan of up to $5,000 per year, and a married couple filing jointly can deduct up to $10,000 per year, according to Savingforcollege.com. In Pennsylvania, the limits are $15,000 for individuals and $30,000 for couples filing jointly.

ENJOY MORE SWEETENERS

Some states have additional incentives for residents to save. A total of 15 states now offer matching contributions, seed money or other financial incentives for residents who invest in their 529 plans. For example, Colorado’s College Invest 529 plan will match contributions up to $500 a year for five years, as long as the beneficiary is 8 years old or younger when the parents sign up and the family’s adjusted gross income is 400% or less of the federal poverty level ($106,000 for a family of four).

Although these incentives may encourage more families to opt for a 529 plan in their home state, you should still shop around, with a focus on plans with low fees and solid investment options, says Emory Zink, an associate director at research firm Morningstar. That’s especially true if your state doesn’t offer a tax break for contributions—or if your state offers a tax deduction for contributions to any other state’s plan.

Most of the states that offer the tax break let you take it only if you contribute to your own state’s 529. However, several states—Arizona, Kansas, Missouri and Pennsylvania—give you the break for contributing to any state’s account. To find Morningstar’s top-rated plans, go to http://www.morningstar .com/articles/1006084/the-top-529- college-savings-plans-of-2020.

MAKE IT A HOLIDAY GIFT

About two-thirds of the states that offer a state income tax deduction for 529 college savings plan contributions let anyone who is a resident of that state take a deduction, even if you don’t own the account—whether you’re a parent, relative or friend. The remaining states let you deduct contributions only if you’re the account owner. In that case, you could open an account for the beneficiary so you can qualify for the deduction, even if her parents already have an account for her. (To check up on your state’s rules, see Savingforcollege.com.)

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