Retirement Planning

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! 

As the coronavirus sweeps the world and people take a step back to look at their finances for the long term, we are seeing that about half of workers don’t have access to a retirement plan at work.  That means that even as 50% of workers can take advantage of automatic payroll deductions and contribute $19,500 or more to a tax-advantaged company retirement plan, about the same percentage is on the outside looking in.

Some of these people may work for companies that offer plans, but are not eligible to contribute because they either don’t meet the criteria or they are part-time employees. Some may be self-employed, which leads to other retirement savings options and others may simply work for a firm that doesn’t offer a plan at all.

So, as people start putting a tighter rein on their finances during this economic recession, it’s important to discuss retirement saving options for those who do not have access to one through their company.  Below we will share several options for people in this situation according to an article by MorningStar.

1) Invest in an IRA.

A good first stop for any worker who has earned income is to simply fund an IRA to the maximum–$6,000 for investors under age 50 and $7,000 for those over 50. Such accounts are very easy to set up, and the money can be invested in a huge array of options. Contributing to an IRA can provide a terrific building block for retirement security. A person assiduously investing $6,000 a year in an IRA for 40 years who enjoyed 6% growth on her money would have a little over $920,000 at the end of the period.

2) Assess whether self-employment accounts are an option.

For people who are self-employed, there are a host of options for tax-advantaged retirement savings. Some of them are quite similar to what 401(k) investors have, except that there can be setup costs and oversight responsibilities. An investment in a conventional IRA, an individual 401(k), a SEP or SIMPLE IRA’s are all good investment ideas.

3) Assess whether an HSA is an option.

While by no means a first line of defense for people without a 401(k), a health savings account is a decent ancillary retirement account option for people covered by a high-deductible healthcare plan.

4) Invest in a tax-efficient way in a taxable brokerage account.

While it’s ideal to invest in vehicles that provide some type of a tax benefit, people without a company retirement plan can also invest tax-efficiently inside of a taxable account. The key is to select investments that incur few taxes on an ongoing basis.

5) Be part of the solution.

Finally, if you work for a small employer that lacks a company retirement plan, consider offering to assist your employer in figuring out how to get one off the ground. Setting up such a plan has gotten cheaper and less complicated in recent years, and your employer may welcome a financially savvy partner to help with some of the research and vetting.

As always, if you have any questions about your current 401(k) or need help investing money in order to supplement a lack of one, please reach out to us and we would be happy to discuss your future financial goals.