Financial planning is often pictured in graphic images as an upwardly sloping straight-line path that moves seamlessly from Point A to Point B. People set financial goals, develop a plan, “work the plan” by taking action to reach their goals, and review and revise the plan every so often or when major lifestyle changes occur.
While this approach can sometimes work well in normal times, the past year has been anything but normal as a result of COVID-19.
Many personal financial plans (e.g., jobs, education, moving, travel, retirement dates) “blew up” amidst layoffs, lockdowns, lost loved ones, and lives fraught with uncertainty. In addition, legislation and the law of supply and demand (e.g., the current U.S. housing market) presented opportunities that nobody could have foreseen, much less planned for.
A better graphic image for the financial planning process for many people, especially during the past year, is a tangled ball of yarn.
Five examples are presented, below, of “accidental” financial planning opportunities that were not on most people’s radar screens until recently. They could not have been included in personal financial plans previously because they were not feasible, not applicable, or did not exist under previous tax laws.
All of these strategies have arisen in some way, shape, or form as a result of the pandemic and may be useful to consider during the months ahead, if applicable:
Deploy Tax Savings from Unemployment Tax Leniency
Under the American Rescue Act (ARA), signed into law on March 12, many taxpayers are exempt from income tax on up to $10,200 of unemployment benefits that were received during 2020. Normally, this money would be fully taxable as ordinary income (i.e., at a taxpayer’s regular marginal tax rate, like wages, salaries, and tips) on federal tax returns. This tax break was a last-minute addition to the ARA that few people saw coming and came a month into the 2020 tax filing season.
Most people probably had taxes withheld on their unemployment benefits or sent the IRS quarterly estimated payments in expectation of a future tax liability. As a result of the ARA tax law change, they could now save $1,000 or more on their income taxes (depending on their tax rate and other income sources), resulting in a larger refund or a smaller tax bill. For example, $9,000 in unemployment benefits in the 12% tax bracket = $1,080 (9,000 x .12). This is a nice chunk of change to save or repay debt with.
Take Tax Credits Available as a Result of Reduced Income
Some taxpayers may qualify for income tax breaks in 2020 that they previously earned too much income for. An example is the Earned Income Tax Credit (EITC), which maxes out at $15,280 ($21,710) of adjusted gross income (AGI) for a single taxpayer and married couple filing jointly with no children and $41,756 ($47, 646), $47, 440 ($53,330), and $50,594 ($56,844) with one, two, and three or more children, respectively.
Maximum credit amounts for zero, 1, 2, and 3 or more children are $538, $3,584, $5,920, and $6,660 for 2020 tax returns. A tax credit is a dollar for dollar reduction in tax liability (e.g., $6,000 tentative tax bill minus $3,584 EITC = $2,416 final tax bill). For the first time ever, perhaps, taxpayers who always earned more than the maximum AGI for the EITC may qualify if they lost income as a result of the pandemic. The tax savings could provide funds for an emergency fund or debt repayment.
Use a Big House Profit To Pay Off Accumulated Debt
Some homeowners who lost income and got behind on mortgage payments are cashing out during the current “red hot” housing market. In one case that I know of, a home seller who owes over $18,000 in arrearages on a federally backed FHA mortgage and has no money with which to repay it when the foreclosure moratorium expires on June 30 will make about a $60,000 profit as a result of selling the house in a bidding war. After paying back the mortgage arrearage and home selling expenses, the seller will walk away with about $20,000 after less than two years of homeownership and will “punt back” to apartment living until household finances stabilize.
Use a Big House Profit and Downsizing to Build a Retirement Nest Egg
Similarly, people who planned to move and downsize anyway and lack sufficient retirement savings can benefit from selling their home in the current sellers’ market and moving to something smaller. They essentially become cash buyers who are better able to compete for new housing in the area where they live or elsewhere. In addition, the spread between their old home’s price and the cost of a new one provides income for future living expenses. For example, $300,000 of home sale profit placed in a balanced mutual fund with an 6% average return will throw off about $18,000 of annual income.
Increase Savings and Philanthropy
Some Americans have experienced financial silver linings that they could have not anticipated as a result of COVID-19: increased income due to demand for their industry sector or work skills and/or reduced expenses such as commuting costs, child care, and other expenses. Like home sale profit and income tax breaks, increased cash flow provides an opportunity for increased savings, debt reduction, or both.
There are also new opportunities for philanthropy. On 2020 tax returns, married couples filing jointly or singles who do not itemize can deduct $300 in cash contributions to qualified charities. In 2021, the tax write-off for couples increases to $600. In addition, the 60% of AGI cap on donations made by itemizing taxpayers is suspended in 2021 to encourage philanthropy for coronavirus relief.