Happy Thanksgiving! We hope you had a wonderful holiday. While many families were not able to get together as they normally do, the Thanksgiving holiday is still one of our favorites around here. Beyond the great food, family, and football, it is also a time to sit back and reflect on how blessed we truly are. This year has been a beast, no doubt. But despite the virus, the politics, the racial tension, the natural disasters, and even the “murder hornets”, there is much for which to be thankful.
If you are anything like us, the weekend after Thanksgiving is also a special time as we dig out all the old decorations and begin prepping for the Holiday season. Across America, middle-aged men climbed ladders much too tall and rickety to hang lights on their homes (we hope none of you fell!). Trees were put up. Stockings were hung. It is a wonderful time.
But there is one other tradition that comes with this process (at least in our homes). As we dig through the basement and attic, looking for long ago stored boxes of Christmas knick knacks, we also inevitably find things we’d long forgotten, being reminded of projects that need to be completed, and cleaning up and throwing out items we no longer need.
The last month of the year at Insight Wealth Group is a little like this as well. It is a chance to go through your accounts, review what has happened in the last year, and clean up any items which need to be handled prior to the end of the year. December is one of the most important months at our firm, and as we are about to kick it off, we thought we’d spend some time going through a few financial planning items that may be important to you as the year comes to a close.
Required Minimum Distributions
This is normally a time of year when we are harassing each of our clients who must take Required Minimum Distributions from their qualified accounts (IRA, 401(k), etc.). In yet another COVID twist, however, that is not necessary this year. However, there are some important things to remember.
First, a refresher: Required Minimum Distributions are a calculated amount the IRS requires you withdraw from all pre-tax retirement accounts each year once you reach age 72. Please note this is a change from 70 ½ as was previously the law. RMD’s are calculated based on the prior year-end balance in your retirement account and a sliding scale based upon your age. The government’s goal is to have you completely distribute your account balance (and pay taxes on it!) by the time you pass away. Our goal is often to grow the account more quickly than you are forced to withdraw it.
Our traditional process includes proactively sending RMD paperwork to each client who is responsible for taking an RMD during the month of November and collecting those forms and distributing funds in December. The CARES Act, passed in April, changed things this year by giving people a one-year pass on taking an RMD.
This does not, however, mean you cannot take funds from your retirement accounts. It is, after all, your money! So, if you would still like to take a distribution this year, please contact our office and we will start the process for you immediately. For some of you, this may end up being a good year to take a distribution (or Roth conversion – see our next section) as your income may be lower due to COVID.
While RMDs are not mandatory this year, you still have all the tools available to you which have been available in years past. This includes the Roth Conversion.
A Roth Conversion is a voluntary distribution from a traditional IRA (taxed as income) which is then transferred into a Roth account. Once it is in the Roth account, you will not be taxed on future growth or withdrawals.
This is a particularly effective tool when you have years of lower income with expectations of higher income – and a higher tax rate – in the future. It is a particularly good fit for clients who have retired, have significant balances in traditional retirement accounts, but are not yet at the age which would require minimum distributions. The typical process is to calculate a rough estimate (in conjunction with your tax professional) of what your taxable income will be this year. We then settle on a tax rate you are comfortable paying and convert enough to Roth to get you up to this level without going over. Let’s walk through an example for “Client A”:
Base facts: Client A is married, retired, and age 65. They are not yet taking Social Security and have minimal income ($50,000). That puts them in the 12% Federal tax bracket. They, however, have $5,000,000 in retirement accounts. Assuming no growth in their retirement accounts by age 72, their required minimum distribution would be over $200,000. Once you combine their outside income and Social Security, their taxable income at age 72 would be nearly $300,000 putting them in the 24% tax bracket.
Scenario #1: Client could choose to convert $30,000 to Roth this year. This would increase their income by $30,000 but would keep them in the 12% Federal tax bracket. They will pay $3,600 in taxes on this conversion vs. $7,200 if they wait to withdraw it when they reach RMD age.
Scenario #2: This much more aggressive scenario includes the client taking $120,000 in Roth conversion this year, moving them up to the 22% bracket. They would pay $26,400 on this conversion vs. $28,800 in the higher 24% tax bracket. Importantly, this would be a great strategy if you think your income will grow more in retirement (i.e. your account balance grows) since the next tax bracket (32%) starts at $326,600 for those married filing jointly.
There is no perfect answer to the Roth conversion question for one simple reason: none of us can see the future. There are two variables which the client, advisor, nor accountant can perfectly predict: future income and future tax rates. But if you think this may be a useful tool for you, now is the time to discuss as the deadline for a conversion is year-end.
Tax-Loss (or Gain) Harvesting
Let’s be honest: 2020 is not 2019. 2019 was a year of significant gains in portfolios across the board as the market was up nearly 30%. It was a year to be aggressive when dealing with capital gain and loss management in client portfolios.
Just because this year has not been as dynamic does not mean there are not tax harvesting opportunities in accounts. Every year we scour portfolios looking for ways to offset gains in taxable portfolios. We will be doing that again this year.
But it is also a year to look at gains as potentially a good thing. Again, many people find their income in 2020 down. If that’s the case for you – and maybe you’re going to dip from the 20% capital gains bracket (income over $496,600) to the 15% bracket (income below $496,600), it may be a year to take some of those long-standing capital gains you’ve been sitting on in the portfolio. If you think this may be your situation, reach out to your advisor.
We have had numerous PPP Loan conversations with clients throughout the year. Many business owners took these loans which have been a boon to businesses trying to survive lockdowns.
As you may recall us stating before, the taxability of these loans has been a big question. While Congress specifically stated the loan proceeds were not taxable, the IRS has been playing a few games on this as well. They conceded the loan proceeds were not taxable, but then went on to say that the expenses you use the proceeds on (i.e. payroll) would no longer be tax deductible. Essentially, they made the proceeds taxable without them specifically being taxed.
The hope had been Congress would deal with this situation in the next stimulus bill, and the strategy we had been recommending was to wait to apply for loan forgiveness until 2021 so a solution could be worked out. No forgiveness in 2020 would mean you could still deduct those expenses as we wait for a final solution.
It turns out the IRS was on to the game! They came out with a notice earlier this month which said it did not matter if your loan were forgiven – you still could not deduct the expenses paid for with loan proceeds. Ugh.
There is hope Congress can still retroactively fix this issue. There is no taxable benefit today of waiting to apply for loan forgiveness. We would encourage you to do it before year-end. If you need help, our team at Insight CPA has been helping clients and banks work through this process and would be happy to assist you.
Review Retirement Savings
Now is an excellent time to look at your 401(k) contributions for the year. If you have not maxed out your contributions and have extra disposable income, make sure you ramp up your contributions before year-end. If you are putting your contributions in a pre-tax account, this can significantly lower your taxable income for the year.
If there was ever a year where charitable giving has mattered, this is it. There is no shortage of organizations which need your support. But we cannot forget there are significant tax advantages for your gifts as well.
If you are contemplating gifts, there are a few tricks we might suggest you consider:
- Prepay Gifts: If you are planning to make a gift to your favorite charity in the first half of next year, we may suggest you prepay it now. By doing so, you can grow your tax deduction for 2020. There is a specific school of thought on this among accountants today which suggests offsetting years: one itemized deduction and one standard deduction. In this theory, you maximize your contributions during the itemized deduction year and do no deductions in the standard deduction year. In some situations, this can provide significant long-term tax savings.
- Qualified Charitable Distribution (QCDs): Just because there are not Required Minimum Distributions does not mean distributing funds from your IRA to charity cannot be a good strategy this year. Anyone over age 70 ½ can distribute up to $100,000 per year tax free from an IRA or other pre-tax retirement account to a charity tax-free.
QCDs probably deserve their own write up, but we would point this out: If you do not need or want your Required Minimum Distribution, this is an excellent way to reduce your gross income, especially if you use the standard deduction when filing your taxes. It is a way to get the benefit of the charitable contribution deduction without being able to take it directly.
Review Your Estate Plan
We have had many questions this year about estate planning and the timing of doing the work. It essentially revolved around the question of “should I wait to do this if the next Administration is going to change all the rules?”
We now can say – with a fairly high level of confidence – that things like the Estate Tax limits are not going to change for at least the next two years. So now it is time to get to work. Review your plan with your attorney (we can recommend one if you need us to) and make sure any life changes that happened this year are reflected.
Plan Life Events
Are you thinking about buying a car? Or finally getting that knee replacement? Now is the time to start planning, and it may be beneficial to advance the plan before year-end.
For example, let’s suppose you have already maxed out your health insurance deductible and co-pay for the year. If you get the knee replacement done before year-end, it would essentially be free. If you do it on January 2nd, your deductible and co-pay will kick back in.
There is a long list of major life events that should go into this mix as you are looking at your year-end planning. They could include a job change, home or car purchase, business purchase, etc. If you are thinking about big financial decisions, make sure you touch base with your advisor and accountant now so any actions that need to be taken before December 31st can be accomplished.
This list could go on, and on, and on. There is a lot to do as the year wraps up. Just know we are being proactive on the things we can control in your portfolio. And we know December is a busy and important month for our clients. We will be here, at your disposal, to help you work through any year-end planning questions you have. Just let us know!