We want to continue with our final recommendations of financial tasks you should consider in the next few weeks or early in the new year to improve your financial future.
Gerri talked last week about setting up a charitable remainder trust or donor-advised fund to create a tax deduction. Another option to receive a tax reduction regards your required minimum distribution (RMD).
For 2020, the CAREs and Secure Acts made changes for your RMDs. For those of you that were over the age of 70 ½ and had RMDs for 2020, they were waived. You are not required to take RMDs this year. You will need to restart taking them in 2021. Also, starting in 2020, your new age for RMDs to have to start is age 72.
A way to reduce your taxable income when you must take RMDs is doing a qualified charitable RMD. You can give up to $100,000 directly to a charitable organization. By sending the RMD funds directly to the charity, you do not have to claim it as income on your tax return.
For example, if your RMD is $20,000, you can have your financial institution send that amount directly to the charity of your choice. This means that you do not have to include the $20,000 on your tax return. Depending on your tax bracket, this could be a savings of up to $6,000. It could also potentially decrease the amount of Social Security that is taxable and/or increase the amount of tax-deductible medical expenses, further adding to the tax savings. Since not claiming your RMD would decrease your adjusted gross income, it could potentially lower Medicare premiums if you are close to a Medicare bracket change. Many other benefits can be based on your adjusted gross income, and not having to claim your RMD can potentially impact those dollar amounts.
When do you take your RMD each year? We recommend taking an annual amount earlier in the year rather than later. This means it does not get forgotten if you get sick or busy. It means if you were to die during the year, it creates fewer problems for your beneficiaries in the year of death. If you have not taken your RMD and death occurs, the beneficiaries need to make sure they take it before the end of the year. If you were to pass in December, it leaves a short time for the transfers to occur to the beneficiaries and for them to take the RMD before the end of the year. The penalty for failure to take an RMD is 50% of the amount that should have been taken and was not.
If you do not need your RMD funds, we recommend that you over withhold for taxes. Have 90% or 95% of the amount go to withholding. This can give you extra taxes paid-in to lower future estimated tax payments. This can give you extra taxes paid-in to allow you to do a Roth conversion for other IRA funds. Converting would allow for lower RMDs in the future and further reduce your taxable income.
Taking your RMD early in the year and doing that Roth conversion at the same time means that the growth of those dollars would be in the tax-free Roth IRA account rather than in the tax-deferred Traditional IRA. Cycling through this each year of using your RMD to pay taxes on a Roth conversion helps in lowering your RMDs each year and allows more of the funds to be growing tax-free in the Roth IRA.
Required minimum distributions start at age 70 ½ or age 72 for Traditional IRA accounts and employer plan accounts. A little-known fact – most employers also require that you begin taking RMDs from your Roth account at age 70 ½ or 72. While Roth IRAs do not have required RMDs, employers 401(k) and 457s often have RMD requirements. You may want to consider rolling the Roth portion of your 401(k) out of your employer’s plan and into a Roth IRA to avoid mandatory distributions if you do not need the funds.
You also have the option of rolling your pre-tax portion of your employer’s plan into a Traditional IRA to allow for future Roth conversions. You can do a partial distribution each year for only the amount you want to convert, or you can move the entire account in anticipation of future conversions. If you have after-tax contributions amounts in your employer plan, you can take them and roll that amount into a Roth IRA without any tax liability being incurred.
When you are taking RMDs, as a reminder, you must take an RMD from each account registration type. If you have multiple Traditional IRA accounts, you can add them together and take the amount from one account. If you have 401(k), 403(b), and/or 457 accounts, you must take a distribution from each type of registration. You cannot add different account registration types together and take only one RMD.
As year-end approaches and individuals review their accounts, retirement plans may be the most significant portion of investable assets. For many, concerns about market volatility are creating significant stress. The low-interest rates in the fixed income environment leave some unwilling to move more investments into this asset class. The concern about keeping up with inflation and with taxes in the long term raises stress levels for many.
Some strategies can assist with generating income while reducing dependency on short-term market volatility. We see some individuals gravitating to high dividend-paying stocks to replace lower interest amounts. If the dividends remain the same, you have the income you need while being less concerned about the current stock price. Buying high-quality stocks that have maintained their dividends for extended years are essential when using this strategy. Dividend-paying real estate investment trusts (REITs) can also fulfill this role.
In some cases, individuals are purchasing an immediate annuity for five year period certain. This allows the portion of their stock portfolio to stay invested during that five-year period. Funds come from the guaranteed payments for the five years. Some consider a lifetime annuity for a portion of expenses to reduce the reliance on market invested assets. You may consider reducing market-invested assets by adding an equity-indexed annuity. Others reduce their market exposure by using proceeds to purchase a life insurance policy with or without long term care benefits.
We often recommend using low income-earning investments to pay the taxes for Roth conversions. The anticipation is that you will minimize your taxes in the future, which is a bigger bang for your buck than having funds sitting in a low interest-bearing account.
As a final recommendation for a year-end financial task on your to-do list, review your current debt, especially the interest rates. With this low-interest environment, keeping significant dollars in a savings or checking account while carrying high-interest rate debt may not be the best use of funds. If your income is uncertain or unsteady, having cash may be necessary. If your income is stable, using extra cash to pay down high-interest-rate debt makes sense.
While many institutions are currently forgoing debt payments, it could be beneficial to continue payments. Getting debts paid down while there is no interest being added, especially if the interest is being added to the back-end, means getting loans paid off sooner. It can mean smaller payments when they are reinstated or simply paying them off quicker.
Refinancing a mortgage with a lower-interest-rate home equity loan often makes sense, especially if you can do it with no closing costs, taking no cash out and potentially shortening the loan term. The key is to ensure that the refinancing improves your situation by lowering the interest rate or shortening the term.
Many are unaware that you can re-fi car loans just like mortgages. This time of year, we often see financial institutions running car loan specials. If you can get a lower interest rate, consider refinancing. If your vehicle is paid off and you are carrying some higher interest rate debt, consider taking out a car loan and using the proceeds to pay off the higher interest rate debt.
Maximize your debt savings by paying the maximum possible on the highest interest rate debt. For example, if you have multiple student loans and are not required to make payments right now, make all the payments you can on the loan with the highest interest rate. If you have credit card debt at a higher interest rate than your student loans, maximize the payments there.
There may be many actions you can take to improve both your short-term and long-term financial situation. If you want recommendations based on your personal situation, do not hesitate to contact the office and come to see us.
