4 Commonly Made Financial Mistakes Young Families Make

As we are halfway through financial literacy month, we want to continue to discuss simple ways to better your financial life. At Sherman Wealth, we focus on helping young couples and families get their finances on the right track, which is why we want to talk about common financial mistakes young couples and families often make in their 20’s and 30’s that come back to haunt them in the future.

One of the first commonly made mistakes we see with our clients is purchasing the wrong insurance products. We see tons of people in their 20’s purchasing whole life and non-level term policies from large insurance companies that are truly not right for them and that they truly do not understand. Oftentimes, it is not until these individuals are starting their families and progressing their careers that they realize they have been losing money with the wrong policy for them. It is very important to discuss with a professional or research what policies are best for you and your family before blindly purchasing the wrong insurance. 

Another commonly made mistake we see among this demographic is not signing up for your company 401(k) and taking advantage of the match. We have seen tons of cases where individuals are not signing up for their company’s retirement plan and matches until five to ten years later, which is giving away a large chunk of your salary benefits and essentially, “free money”. It is always the right move to sign up for your company 401(k) and contribute the full match if your situation allows you too in order to build a strong retirement account.

Budgeting and saving is always a priority when it comes to building your financial portfolio and especially starting a family. In previous blogs, we have talked about the importance of starting and saving from an early age and the power that compounding interest and  “time” in the market has on your money. Whether you are starting your first job or graduating college, it is never too early to start saving, even if it’s only a few dollars per month.

Lastly, another mistake we see individuals making is not contributing to their health savings accounts (HSAs). A health savings account (HSA) can help you lower your taxes as they are triple tax free. Our advice is to always take advantage of these types of accounts if you are eligible, that can help you make the most of your current situation and future. 

By avoiding these four commonly made financial mistakes in your early years, you and your family will be in a much better situation as you embark on the next chapter in your life. As always, speak with your financial professional to ensure you are making the right decision for your particular situation. If you have any questions, please email us at info@shermanwealth.com or schedule a complimentary 30-minute consultation here

Sitting on Cash? Here’s What To Do with It:

In our previous blog, we wrote about how a great deal of American’s households ‘ finances are in surprisingly good shape eight months into the pandemic. While this certainly is not the case for all households, we wanted to discuss options for those who may be sitting on an abundance of cash or have too much money in their checking accounts. 

It’s important to note that if you have more than you need to pay your bills in your checking account, you should consider putting away some of the cash in taxable investment accounts or savings accounts that accrue compounding interest. When choosing a savings account, consider banks that have higher interest rates than your standard bank, which currently have interest rates close to zero. Utilize FDIC-insured accounts such as Max My Interest or Capital One 360. With these record-low interest rates, it’s crucial to get your money into accounts that are maximizing and compounding your dollars overtime. 

Additionally, as the end of the year is just around the corner, think about checking off your financial planning to-do list, which may consist of funding your HSA and/or maxing out your 401(k) and IRA’s for the year. As mentioned earlier, if you have additional cash laying around, make sure to direct those funds into a taxable account.  If you are saving for your children or grandchildren’s college tuition, make sure to contribute to your 529 plans and inquire about all of your options there. Also, if you are considering end of the year charitable giving, make sure to contribute those funds as well. If you have any questions about your financial portfolio or end of the year planning, please contact us at info@shermanwealth.com and we are happy to set up a free 30-minute consultation with you. Lastly, check out our other blogs for more resources.  

 

Why Now May Be a Good Time to Consider a Roth IRA Conversion

The coronavirus pandemic and the upcoming election has created a great deal of uncertainty for investors. Income tax, furloughs, and job loss are lingering over the heads of many. As people are navigating these unprecedented times, they are becoming more and more unsure about where to and how much to invest. But it’s important to keep in mind that regardless of uncertainty in the market, it’s always a good time to invest for your future. 

The recent stock market meltdown may have dented Americans’ retirement savings, but there’s a silver lining: The downturn made one common retirement strategy less costly for investors.

The strategy, known as a Roth IRA conversion, involves changing a traditional, pre-tax retirement account — such as a 401(k) plan or a qualified individual retirement account — to an after-tax Roth fund. This strategy has some unique benefits when compared with its traditional cousin.

To do the conversion, savers would opt to pay income tax now, while markets are down and tax rates are lower under the Tax Cuts and Jobs Act. Investors who own traditional accounts defer income tax on their savings until withdrawing the money in retirement. Roth savers pay tax up front and don’t pay later. Having at least some Roth funds is beneficial for a few reasons, according to financial advisors. Retirees don’t have to take mandatory withdrawals from Roth accounts, unlike traditional IRA investors, who have to beginning at age 72. Taking Roth distributions could also decrease Social Security taxes and Medicare premiums, which are pegged to one’s taxable income.

In addition, there’s the benefit of tax diversification. Like the concept of investment diversification, tax diversification is important because it reduces the risk associated with unknown future tax rates, advisors said. Data suggest investors aren’t greatly diversifying their retirement accounts from a tax standpoint.

Traditional IRAs held around $7.5 trillion at the end of 2018 — almost 10 times as much as Roth accounts, which had $800 billion, according to the Investment Company Institute. Ultimately, investors should peg a conversion primarily to tax rates — if savers believe their tax rate is lower now than it will be in retirement, a conversion makes sense because it will cost less in the long run, according to tax experts. And, contrary to popular opinion, one’s tax rate doesn’t always fall in retirement, they said.

Tax rates are currently low by historical standards and are likely to increase (rather than fall further) in the future, experts said, given the eventual need to raise federal revenue to reduce the U.S. budget deficit, which is larger as a share of its economy than most other developed countries.

If you are considering a Roth IRA Conversion, please consult with your financial advisor  and your EA/CPA or tax preparer to ensure that this decision is the best for your financial situation. If you would like to discuss the potential of a Roth Conversion, please reach out to us and schedule a free 30-minute consultation

 

How Much Retirement Savings Is Enough? Why Couples May Disagree

As couples combine their finances and start to think about savings, it’s common to go back and forth when discussing retirement and long term goals. While one party may be worried that their expenses will be larger than they think, the other may have a different perspective. The most important piece to know is that it’s okay. It’s normal to have a different perspective on your finances and financial future than others, even your spouse. Nobody has the exact same financial situation, so it’s important to figure out what’s best for you and your family. 

The first step is communication. When discussing your finances, it’s important to communicate and feel open about discussing an often uncomfortable topic such as money. To establish short-term and long-term goals that are successful and reasonable, both you and your significant other must feel comfortable to discuss what they believe is fair. 

The Wall Street Journal highlighted an issue that can get overlooked in retirement planning: the financial burdens that women, in particular, face late in life.

Consider: A survey last year by the National Council on Aging and Ipsos, a polling and data firm, found that fully half (51%) of women age 60 and older are worried about outliving their savings. In the same survey, almost six in 10 women (59%) said they are worried about losing their independence.

Why these fears? The answers, in large part, are tied to longevity and health care.

Women, of course, typically live longer than men—about five years, on average—and are more likely to live their final years alone. In 2019, almost half (44%) of women age 75 and older in the U.S. lived alone, according to the Administration on Aging. Living longer and living alone typically give rise to more health problems. And more health problems equate to more medical bills and, potentially, the need for long-term care. In short, women can face expenses late in retirement that are larger and more painful than many couples might anticipate.

In a 2017 report, HealthView Services Inc., a provider of software for retirement health-care costs in Danvers, Mass., calculated that a healthy 65-year-old woman retiring in that year and living to age 89 could expect to pay $306,426 for health care, including premiums for Medicare Parts B and D, a supplemental insurance policy, and all out-of-pocket costs, as well as dental and vision care. A man at the same starting age and living to 87 could expect to pay $260,422. (And those projections don’t include the potential cost of long-term care.)

The good news: There are strategies and tools that can help couples prepare for these outcomes, such as long-term-care insurance, life insurance, deferred annuities and reverse mortgages.

Several calculators can provide ballpark figures about medical expenses in retirement, including those from Fidelity Investments, Optum Bank and ICMA-RC, a Washington-based nonprofit that provides retirement plans and services. In addition, MoneyHabitudes.com has activities designed to get people comfortable talking about their finances.

As you can see from the survey data reference above, both men and women often have different expectations on how much money they need for their future, which is normal. Again, make sure to communicate and research with your partner to insure both individuals are comfortable with their finances and savings. Of course, a good financial adviser also can make a difference. But the most important step is to talk about retirement and how your finances might play out before you get there. If you have any questions, or want to discuss retirement with us, please schedule a complimentary 30-minute consultation.

 

These are your 2021 401(k) and IRA Contribution Limits

The IRS released annual inflation adjustments for 2021 for many tax provisions on Monday, including new income tax brackets and an increased standard deduction. It also announced that contribution limits for 401(k)s and IRAs will not increase next year. 

What Changed?

The following limits are going up for 2021:

  • The annual additions limit for defined contribution plans increases to $58,000
  • The annual compensation limit increases to $290,000
  • The Social Security Wage Base increases to $142,800

The following limits will remain the same next year: 

  • The salary deferral limit for 401(k), 403(b) and 457 plans remains at $19,500
  • The SIMPLE deferral limit remains at $13,500
  • The catch-up contribution limits for 401(k) plans and SIMPLE IRAs remain the same $6,500 and $3,000 respectively
  • The annual additions limit for defined benefit plans remains at $230,000
  • The compensation limit for determining who is a highly compensated employee will remain the same at $130,000

For more 2021 cost-of-living adjustments and 401(k) limits, visit the IRS’s bulletin. If you have any questions, please reach out to us at info@shermanwealth.com or check out our other blogs for more information on 401(k)’s. 

 

Small Businesses Agonize Over PPP Loan Forgiveness

The Paycheck Protection Program (PPP loan) pumped $525 billion in forgivable loans to small businesses from early April through early August. The program has been praised for saving jobs and buoying struggling businesses but criticized for its clumsy rollout, fraud, and for favoring companies with established banking relationships over underbanked ventures. 

In a recent report, the Government Accountability Office urged the Small Business Administration to identify and respond to multiple PPP risks among other recommendations for other agencies to improve the government’s response to the pandemic.

One reason the PPP was so attractive to borrowers was the potential to turn loans into grants. For that to happen, each borrower needed to complete a forgiveness application and submit it to their lender, who would work with them to make it stronger. In a study reported by Politico on September 19th, the agency had received “96,000 forgiveness applications– representing fewer than 2 percent of the total loans– but has not approved or denied any of them.” 

Because of the PPP’s changing rules, there’s confusion around the forgiveness process, says Brian Pifer, vice president of entrepreneurship at advocacy group Small Business Majority, which has about 65,000 members in its network. Multiple trade groups are supporting two bipartisan bills that would forgive PPP loans under $150,000 once the borrower completes a one-page form, according to the American Bankers Association. There’s also broad support to relaunch PPP, though the Brookings Institution is suggesting tax credits would be more effective, Bloomberg News reported

What should a business owner keep in mind about the forgiveness process?  We spoke to Chris Levy, a senior vice president at Pursuit, a community development financial institution which has funded over 7,000 PPP loans totaling nearly $500 million to businesses in New York, New Jersey, and Pennsylvania. Its median loan size was about $20,000. Levy says his institution got money to “the smallest of the small businesses out there–the ones that were really struggling.” 

Levy listed a few pieces of advice for small business owners to keep in mind: 

  1. You Have Some Time. Borrowers understandably are eager to complete the forgiveness application and put the PPP loan behind them, says Levy. You can apply for loan forgiveness as soon as your lender starts accepting forgiveness applications. But you should wait because Congress will likely pass legislation that will make the forgiveness process easier, he says, including automatic forgiveness for PPP loans of $150,000 or less.

While some lenders are accepting applications, Pursuit and many others aren’t yet. “The main reason we’re waiting is because we don’t feel like it’s appropriate not only for us to waste our time but for our borrowers to waste their time going through a super detailed forgiveness application that is only going to get easier,” says Levy. 

  1. Review the rules and basics. You can get loan forgiveness on what you spend on payroll, rent, and other eligible expenses during the so-called covered period—the 24-week period beginning the day you receive the funds from your PPP loan. The rules have changed significantly as PPP has evolved: The minimum amount that must be spent on payroll is 60% (originally it was 75%). You can spend up to 40% on non-payroll costs such as rent, utilities and mortgage interest. The loan maturity is now five years; it used to be two years.

 

Once the 24-week period ends, you have 10 months to submit your forgiveness application to your lender, according to this FAQ from the SBA. You don’t need to make any payments until the SBA makes a decision. If only a portion of the loan is forgiven, or if the forgiveness application is denied, the balance due on the loan must be repaid by the borrower on or before the maturity date of the loan.

 

  1. Chew on this scenario. A business owner who received a PPP loan in April is allowed to wait until December to apply through their lender for forgiveness. The SBA might not make a determination until February. The borrower would not make any payments during that 10-month period. “The deferment period is essentially undefined and will not be defined until the SBA makes a determination,” says Levy. “It allows borrowers more time.”
  2. Stay Calm.  “The one thing we’ve found throughout this whole process—the more patience you have, the better the rules get for you,” says Levy. Keep payroll records as you normally do and communicate regularly with your lender, he says. He urges business owners not to drive themselves crazy. The 3508 EZ form simplifies the rules and should work for almost everyone, Levy says. “It’s really made it that much easier for everyone to obtain full forgiveness. The forgiveness documentation is the same documentation that they had to use when they initially applied, he says. “If they got the loan in the first place, they’ll be able to get forgiveness.

While the coronavirus has put a detrimental strain on many businesses, small businesses have been struggling a great deal. For any small business owners out there, stay calm, educate yourself on the situation and remain positive. The PPP loan has helped so many small businesses stay afloat during this economic crisis. If you have any questions on your small business or its financial situation, we’d be happy to chat. Please reach out to us at info@shermanwealth.com and refer to our other blogs for further resources.

Financial Advice For Parents

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Raising a child in today’s world can cost hundreds of thousands of dollars. As a parent of four children ranging from ages 5 to 16, I can attest to just how expensive kids can be. Besides just the essentials like food and clothes, there are club teams, tutors, dance lessons and so much more. With each additional family member comes new financial considerations and expenses. The importance of planning for these costs before they arise is a key reason why many financial advisors are targeting young families and helping them successfully navigate how to cover their children’s expenses without compromising their own financial security. Here are a few top takeaways from some of these advisors:

SAVING FOR COLLEGE

With a high school junior in our house, it won’t be long before we are paying that dreaded college tuition bill. And, due to the ballooning costs of higher education, this bill is not likely to be a small one! If possible, new parents should try to start saving as soon as they can for their child’s college tuition.The earlier you start saving, the better prepared you’ll be. If you save $500 a month at birth, you should have around $190,000 saved by the time that child reaches 18 (assuming an annual return of 6%). However, if you don’t start until your son or daughter is 10, you’ll only have around $60,000 by the time they graduate high school. Setting up a state-sponsored 529 college savings plan, allows parents to invest money and then withdraw it tax-free, so long as the funds are used for certain education expenses. However, as you prepare for your children’s future, make sure that you remain focused on your retirement saving as well. There are lots of ways to pay for college, but you can only use the resources you’ve accumulated for your own retirement.   

CHILDCARE AND HEALTH CARE

When our first child was born, my husband and I were both working, and trying to find affordable childcare was not easy. Childcare is one of the biggest expenses new parents will face, especially if both parents work. In some cases, one parent will decide to leave their job and take care of the child themselves, especially if the cost of childcare is more than one parent is making. This is exactly what happened when our second child was born, since it was no longer cost effective to pay for childcare for two children with my salary.   

Meanwhile, childbirth and adoption count as qualifying events that allow parents to make changes to their employee benefits outside of the open enrollment period at work. For example, new parents can expect to see their medical expenses rise and those who have access to a flexible savings account and health savings account at work should use them since the money put into an FSA or HSA avoids federal taxation. In some cases, employers offer a Dependent Care FSA, which can be used for costs picked up from a nanny, babysitter or childcare center.

When it comes to health insurance, if both parents work, you should examine which plan will cost less to add the child to. Most doctor visits in the first couple of years are considered wellness visits, which are typically free or very low-cost in most health-care plans today. But, you should look into which plan is most cost-effective in the event of a trip to the emergency room or having to see a specialist – even with good insurance, the price tag of a broken bone is a lot more than you might think!

LIFE INSURANCE

Even though it’s not something most people like to think about, preparing for death is of utmost importance when becoming a parent. Your financial advisor should be able to run various calculations to figure out the amount of protection you would need. Many families make the mistake of only getting life insurance for the main earner, experts say, but both parents should be covered. Many people think that since stay-at-home parent isn’t actually earning anything, they don’t need insurance. However, when it comes to life insurance, you need to evaluate what it would cost to have someone else take care of your children if something were to happen to that parent.  

It is also extremely important to put together estate planning documents, including a will and health-care directives, as well as discussing appointing a guardian in the event of an unexpected life event. When we found out we were expecting our first child, it forced us to have some difficult conversations about who we would want to take of our child and how our assets would be distributed if something happened to us. It’s also important to revisit those questions each time you add another child to your family or if there is another major change to your assets. The guardians you might have written in your will when you were 25 might not be the same guardians you would choose when you are 45. None of these decisions are easy ones, but they are vital to preparing for your life as a parent.

EMERGENCY SAVINGS

With all the additional expenses new parents can face, from diapers to a larger home and mortgage, it’s more important than ever to have a safety net for those unexpected costs. Having children is a good reason to have a bigger emergency fund, simply because there are now more people who are dependent on you financially. Aside from the random home and car repairs that always seem to pop up when you least expect them, now add braces, sports equipment and teenage social lives to the mix. Having some money from each paycheck deposited directly into an account that you don’t touch is an easy way to make sure you are creating an ample emergency fund should you need it.  

There are so many wonderful aspects of being a parent, but it is definitely a costly undertaking. Seeking some financial guidance before you become a parent is always a good idea, but it’s never too late to start planning for your future with a family. If you have any questions about saving for college, choosing the right health plan, putting together your estate documents or anything else related to your financial goals or plans, please contact us.  We offer a free 30-minute introductory consultation and would love to hear from you!  Check out our other blogs for more financial advice and tips.

 

How to Maximize Tax Savings From Workplace Benefits

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When preparing your finances for 2021, make sure to review your workplace benefits for next year before the open enrollment period comes to a close. Your household finances for next year could depend on it. An interesting CNBC article discussed the benefits you can unravel within your workplace health-care and ways to maximize it. 

After one of the most difficult and financially stressful years for many Americans, digging back into the details of workplace benefits like health savings accounts, or HSAs, and flexible spending accounts (FSAs) is probably the last thing you want to do.

Overcome that fatigue and get to it.

Every year, we take a brief look at these options and plans, but COVID-19 has greatly changed the optics of these plans. For some, the coronavirus pandemic had led to much higher medical expenses than expected this year. For others, it has prevented them from accessing health care they expected to use, due to community lockdowns and overburdened health-care facilities. 

Workplace health-care plans require a fresh look going forward, especially after COVID-19. Talk to your HR rep and discuss the details of options open to you. Below we will touch on a few potential options and benefits you should consider. 

The Tax Benefits of HSA’s

First part of your workplace benefits to analyze is HSAs. HSAs, available to savers with a high-deductible plan — that is, one with a deductible of at least $1,400 for self-only health coverage — have three key tax benefits.

First, they allow participants to contribute money to the account either pre-tax or on a tax-deductible basis.

Second, the investable funds accumulate free of taxes. Finally, you can withdraw the money tax-free if it’s used for eligible health-care expenses. You don’t need to spend the balance down each year, as unused funds in the account roll forward, regardless of how much you spend. Employers can also boost your savings with a matching contribution.

The Ins and Outs of Medical FSAs

Medical FSAs share some commonalities with HSAs.Both allow for pre-tax contributions. Balances can also be used on tax-free basis if it’s for qualified medical expenses. In 2020 and 2021, you can contribute up to $2,750 to a medical FSA.

You generally can’t contribute to both an HSA and a medical FSA at the same time.

The major difference between the two accounts is that FSAs have a  “use it or lose it” stipulation that requires participants either spend the money they save or forfeit the funds to their employer at year-end. Firms may choose to let employees roll over some of the money — that is, up to $550 for funds from the 2020 plan year — or they may give them a grace period up until March 15 of the following year to use the funding.

Dependent care FSAs

Another area to analyze within your workplace benefits are Dependent Care FSAs. Dependent care FSAs, which help employees offset dependent and childcare costs, have been dramatically affected by the pandemic and resulting community shutdowns. Generally, a worker can save up to $5,000 in one of these accounts on a pre-tax basis, but again, the funds must be used up by the end of the year or they’re forfeited.

Due to Covid-19, daycare centers in many parts of the country have been closed for much of the year. What’s more, many employees found themselves working from home and taking care of their children themselves, which means they could have hefty balances in these dependent care FSAs.

The IRS addressed this situation by allowing employers to give workers the option of changing the amount they’d normally defer in the middle of the year.

That option may not be available next year, so be thoughtful about the money you commit to these dependent care FSAs as you decide how to proceed in 2021.

Given the crazy year we’ve had, it’s important to take a deeper look at all your options when it comes to your workplace benefits. The coronavirus pandemic has shown us what unprecedented circumstances can cause and the importance of taking advantage of all the benefits that are available to you. If you have any questions, please reach out at info@shermanwealth.com and make sure to also take a look at other tips and advice written in our blogs.  

IRS Finalizes ABLE Account Regulations: Here’s What to Know

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The IRS recently published final regulations for Achieving a Better Life Experience, or ABLE, accounts for disabled Americans. ABLE accounts aim to help people with disabilities and their families save and pay for disability-related expenses. Even though the contributions aren’t deductible, distributions such as earnings are tax-free to the designated beneficiary if they’re used to pay for qualified disability expenses. These expenses can include housing, education, transportation, health, prevention and wellness, employment training and support, assistive technology and personal support services, along with other disability-related expenses.

The regulations come in response to and finalize two previously issued proposed regulations from the IRS. The first proposed regulation was published in 2015 after enactment of the ABLE Act under the Obama administration. The second proposed regulation was published in 2019 in response to the Tax Cuts and Jobs Act, which made some major changes to ABLE. 

Eligible individuals can now put more money into their ABLE account and roll money from their qualified tuition programs (529 plans) into their ABLE accounts. In addition, some contributions made to ABLE accounts by low- and moderate-income workers can now qualify for the Saver’s Credit.

The new regulations also offer guidance on the gift and generation-skipping transfer tax consequences of contributions to an ABLE account, as well as on the federal income, gift, and estate tax consequences of distributions from, and changes in the designated beneficiary of, an ABLE account.

In addition, before Jan. 1, 2026, funds can be rolled over from a designated beneficiary’s section 529 plan to an ABLE account for the same beneficiary or a family member. The regulations provide that rollovers from 529 plans, along with any contributions made to the designated beneficiary’s ABLE account (other than certain permitted contributions of the designated beneficiary’s compensation) can’t exceed the annual ABLE contribution limit.

Lastly, the final regulations offer guidance on the record-keeping and reporting requirements of a qualified ABLE program. A qualified ABLE program must maintain records that enable the program to account to the Secretary with respect to all contributions, distributions, returns of excess contributions or additional accounts, income earned, and account balances for any designated beneficiary’s ABLE account. In addition, a qualified ABLE program must report to the Secretary the establishment of each ABLE account, including the name, address, and TIN of the designated beneficiary, information regarding the disability certification or other basis for eligibility of the designated beneficiary, and other relevant information regarding each account. 

For more information about ABLE accounts or if you have any questions regarding these regulatory changes, please contact us at info@shermanwealth.com or check out our other relevant blogs

Top 6 Tax Tips To Know

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2020 has certainly been an eventful year so far and one that will be remembered for decades to come. Despite the negative impacts of the coronavirus globally, in the world of tax and retirement planning, 2020 has brought opportunities that should be taken advantage of before year’s end. Here are some tax planning ideas to consider before 2020 comes to a close.  

1) ROTH CONVERSIONS

As 2020 winds down, this is the optimum time to project the tax cost of a Roth conversion because most people by this time will have a reliable estimate of their 2020 income and this year’s tax benefits may be the highest ever because of historically low tax rates and possibly lower income due to the pandemic.

Once funds are converted, today’s low tax rates are locked in, plus the funds in the Roth grow income tax free forever and Roth IRAs have no lifetime required minimum distributions (RMDs). Any IRA funds converted will lower these tax-deferred IRA balances and in turn lower the amount of future RMDs that could be exposed to higher taxes.

Some may think they will be in a lower tax bracket in retirement, but that doesn’t often happen, especially after a spouse dies and the surviving spouse sees their tax bills increase when they begin to file as single.

The bottom line here is that a Roth conversion removes the risk and uncertainty of what future higher tax rates can do to your retirement income. Though Roth conversions will still be available in the future, you should still consider doing them in 2020.

2) IRA DISTRIBUTIONS

In 2020, you aren’t even required to take money from your IRA distributions. The Coronavirus Aid, Relief, and Economic Security Act waived required minimum distributions for the year. But even though they aren’t required, you should look into making voluntary IRA distributions anyway because those taking money out of these tax-deferred vehicles in 2020 might be able to do so at lower tax rates.

Since the required minimum distributions are waived for 2020, this presents a one-time opportunity for those subject to the minimums to convert RMDs instead to Roth IRAs (something you can’t normally do). 

Even if you aren’t subject to required minimum distributions, it might pay for you to begin taking taxable distributions to get into the lower tax brackets and begin reducing the future IRA debt that’s building for Uncle Sam. The funds could be used either to convert to Roth IRAs or for gifting or estate planning. For example, the IRA funds withdrawn can be used to purchase permanent cash value life insurance, which after the SECURE Act will prove to be a better estate planning vehicle than inherited IRAs. Like Roth IRAs, life insurance will grow tax free and the eventual proceeds to beneficiaries will be tax free as well which is a good use of IRA funds now. IRA or plan withdrawals taken this year can also be used for gifting to family members.

3) QUALIFIED CHARITABLE DISTRIBUTIONS

Qualified charitable distributions are the most tax-efficient way to make charitable gifts because they reduce taxable IRA balances at no tax cost. The name refers to a direct transfer of IRA funds to a qualifying charity.

The only downside here is that the QCD is only available to IRA owners and beneficiaries age 70½ or older. The distribution is not available from company plans and not permitted to go to donor-advised funds or private foundations. Qualified charitable distributions are limited to $100,000 per year for each IRA owner, not per IRA account. 

Although the SECURE Act raised the required minimum distribution age to 72, the QCD age remains at 70½. This gap means the charitable distributions can begin before RMDs kick in. Even though RMDs were waived for 2020, you can still make these QCDs nonetheless since the charitable distribution still allows you to remove IRA funds at a zero tax cost. If you are giving to charity anyway, and qualify for QCDs, then this is the way you should be doing your giving.

With qualified charitable distributions,  you receive both the standard deduction and the tax benefit in the form of an exclusion from income. An exclusion is better than a tax deduction because it reduces your adjusted gross income, a key figure on the tax return. QCDs are the most tax-efficient way to reduce taxable IRA balances, because they reduce the balances to a zero tax cost.

In addition, there is a provision in the CARES Act that allows for a $300 additional charitable gifting exclusion from income for non-itemizers (for cash gifts).

4) GIFTING

With the exploding deficits and expanding national debt, there is a new urgency for clients to make gifts now, before year’s end, because it may not be an option much longer. Gifts are lifetime transfers as opposed to inheritances received after death.

The 2020 estate and gift tax exemption is $11,580,000 per person ($23,160,000 for a married couple). These figures are scheduled to go back to $5 million and $10 million, respectively, after 2025 (there will also be inflation increases). It pays to use them now or possibly lose them later. These limits apply to lifetime gifts as well as inheritances.

For those who will be subject to a federal estate tax, gifting is less expensive because gifts are tax-exclusive, as opposed to inheritances, which are tax-inclusive. If the funds are left in the estate, the full value of the transfer at death is subject to the estate tax, so the funds used to pay the estate tax are taxed themselves, whereas gift taxes on lifetime transfers are only based on the gift amount received.

There are three tiers of tax-exempt gifting:

  1. The first is $15,000 annual exclusion gifts. These gifts can be made to anyone each year and they do not reduce the gift/estate exemption. These annual exclusion gifts are always tax free—even if the exemption is used up.
  2. Unlimited gifts for direct payments for tuition and medical expenses. These gifts can be made for anyone, the amounts are unlimited, and they do not reduce the gift/estate exemption. These gifts are also always tax free—even if the exemption is used up.
  3. The $11,580,000 lifetime gift/estate exemption in 2020. The IRS has stated that there will be no clawback if these exemptions are used now, even if the exemption is later reduced, so you must use it or possibly lose it.

Gifts made now in 2020 lock in today’s gifting limits. There is no guarantee that these limits will hold up in the future.

5) UPDATING ESTATE PLANS AFTER THE SECURE ACT

The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries. This is effective beginning with deaths in 2020, so it is imperative to check your IRA and company plan beneficiary forms to reveal what may be the largest single asset in your estate plan.

Most non-spouse beneficiaries will be subject to the new 10-year payout rule, meaning that the entire inherited IRA will have to be withdrawn by the end of the 10th year after the IRA holder dies.

This includes most trusts named as IRA beneficiaries, and you might need to make changes; for example, most conduit trusts will not work as originally planned since the entire inherited IRA will be left unprotected in trust after the 10 years. Many of these trusts will have to be upgraded to discretionary trusts to maintain the trust protection beyond the 10 years. But even then, the inherited IRA funds will still be taxed when that decade has passed, and that tax will be at high trust tax rates for any funds remaining in the trust and not distributed to the trust beneficiaries.

One solution here is to convert these IRAs to Roths to eliminate the post-death trust tax exposure or withdraw IRA funds now and purchase life insurance, which is a better and more flexible asset to leave to a trust.

You should review any IRA estate plans, which begins with a beneficiary form review. Check to make sure that contingent beneficiaries are named and up to date. Make sure that the estate plans will still accomplish your goals after the changes brought about by the SECURE Act.

6) W-4 UPDATES AND WITHHOLDINGS CHECK

The federal income tax is a pay-as-you-go tax. Taxpayers pay the tax as they earn or receive income during the year. Taxpayers can avoid a surprise at tax time by checking their withholding amount. The IRS urges everyone to do a Paycheck Checkup in 2020, even if they did one in 2019. This includes anyone who receives a pension or annuity. 

The best way to make sure you are withholding the right amount is to use the Tax Withholding Estimator on IRS.gov. The Tax Withholding Estimator works for most employees by helping them determine whether they need to give their employer a new Form W-4. They can use their results from the estimator to help fill out the form and adjust their income tax withholding. If they receive pension income, they can use the results from the estimator to complete a Form W-4P, Withholding Certificate for Pension and Annuity Payments PDF. To change their tax withholding, employees can use the results from the Tax Withholding Estimator to determine if they should complete a new Form W-4 and submit to their employer. Don’t file with the IRS.

These 2020 year-end retirement, tax and estate planning moves will enhance your retirement savings that will soon be exposed to potential tax increases after 2020. Given the current state of our economy, it is best for you to consider these options now, since it’s likely many of these things will be changing in the near future. These tips have been prepared for informational purposes only and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Check out our website for more information!