Despite new challenges brought on by COVID-19 in 2020, retirement planning remains a core part of financial security. All retirement planning is deeply personal. It is not just about saving money, reducing taxes, or having money that lasts a lifetime – it is about accomplishing goals and living with dignity throughout life.
Because of this individualized aspect of retirement planning, there is no one size fits all solution. Due to the changing nature of 2020 and the passage of the CARES Act, a Covid-19 relief bill, you might want to consider several planning strategies before the year runs out to better work toward your goals.
1. Required Minimum Distribution Planning
If you are well versed in retirement planning, this planning tip for the end of 2020 might surprise you since the CARES Act, passed in March of 2020, waived most requirement minimum distribution (RMD) requirements for the year. This means for those over age 72 – the new RMD age ushered in by the SECURE Act in 2019 – there is no required minimum distribution due from IRAs or defined contribution plans like a 401(k). Additionally, most inherited retirement accounts, like IRAs and 401(k)s, are not subject to RMDs for 2020. This means if you normally push your RMD off to December of the year, you can choose to not take any distributions for the rest of the year.
This is where personalized planning kicks in. For instance, if you are in a lower-than-usual tax bracket this year, you might consider withdrawing some money from your IRA that would have otherwise been an RMD in a normal year. This will allow you to distribute that money at a lower tax rate than if you wait until next year. In some cases, it might be wise to take only 10-50% of your normal RMD to keep your tax burden lower.
This type of planning requires a long-term focus. Because the CARES Act waived most RMDs for 2020, you have more control and flexibility over your retirement distributions than most years, so don’t let that go to waste.
2. Roth Conversions
Consider the benefits of Roth conversions before the end of the year. Converting money from a traditional IRA or 401(k) to a Roth IRA is about paying taxes now instead of in the future.
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For a retiree subject to RMDs, it can be challenging to do effective and tax-efficient Roth conversions, because you need to take the RMD out before converting any money from that account. This can raise your taxes to a point where a conversion might no longer make sense.
However, since RMDs are suspended for 2020, you might consider converting the amount that you normally would have taken as an RMD. This allows you to shift more money into the tax-free Roth IRA instead of leaving the money in the taxable account to be taxed in the future.
If your income dropped in 2020, or you were unemployed for a large portion of the year, it might be a good year to do a Roth conversion. The reason? You might be in an abnormally low tax bracket. This means you could convert money at a lower tax rate than typically expected, allowing your Roth funds to grow tax-free, assuming you hit certain requirements at the time of distribution.
While you can do a Roth conversion at any time, if you want the conversion to be taxed as 2020 income, you need to do the Roth conversion by the end of the year. If you wait to do the conversion on January 1, the income will show up in 2021.
Before doing a conversion, you must consider many factors, including your long-term goals, tax situation, tax diversification needs and estate planning needs. As in anything tax planning or retirement planning related, it is smart to talk to a tax or financial planning professional before engaging in Roth conversions, so you understand the full impact as it relates to your retirement and personal financial goals.
3. Charitable Giving Strategies
When, how, why and to whom all matter when it comes to giving. It is important to note that most people do not give primarily for tax or financial purposes but due to a desire to make an impact. However, tax and financial considerations can play a role.
First, you need to find a connection with the charity that you want to support. One of the primary reasons for not giving more money to charity is a lack of connection to a charity. So, if you are charitably inclined, have a deep connection to the intended impact, and feel financially capable of doing so, you can then get to the next level of efficient giving.
2020 represents a unique time for strategic charitable giving. Due to fewer people itemizing after the Tax Cuts and Jobs Act, many people do not benefit significantly from a tax perspective when giving to charity. To counter a bit of that, the CARES Act allowed for up to $300 deduction for standard deduction filers. For the majority of the country that is not itemizing, this is a unique above-the-line 2020 deduction for charitable contributions. This might encourage some to donate to church, school or other charity.
Additionally, the CARES Act raised the deduction cap for 2020 from 60% of an individual’s adjusted gross income to 100%. Maximizing cash gifts to 501(c)(3) public charities to hit 100% of AGI in 2020 is likely not the best strategy, but it does allow for some larger gifting-related tax benefits in 2020.
Qualified charitable distribution (QCD) are one of the most efficient and effective ways to give from retirement accounts.
After age 70.5, you can use a QCD to send up to $100,000 a year per person directly from an IRA to a qualified 501(c)(3) public charity. Couples could each contribute $100,000 from their respective IRAs, and the money would not be included as taxable income. It would also offset any RMDs up to that amount. Since many can’t itemize their giving, QCDs are a way for those over 70.5 to get a similar tax outcome, as none of the distribution from the traditional IRA would be subject to tax.
While RMDs were suspended in 2020, QCDs are still allowed. Sending money directly to a qualified charity from your IRA could be a more efficient way to give if you are over 70.5, especially if you are not itemizing.
For some, charitable gift planning might include a decision to not give in 2020. I know that charities won’t love this message, but people who lost jobs or income might need to wait until their financial situation improves until they decide to give again. We don’t want to offset future retirement security, because we gave away too much money earlier in life.
Additionally, if your taxable income is very low in 2020, but you expect it to be higher in 2021, you might want to wait to give in 2021 to get a better tax deduction for your charitable giving, assuming you can itemize.
For others, waiting until 2021 to give might be a smarter strategy because of the temporary RMD suspension. For instance, if you use QCDs to offset RMDs, you might want to hold that QCD until January of 2021 when RMDs are once again in effect. This strategy could allow you to double up your giving in 2021, essentially pushing what you’d like to give in 2020 to next year, still with that $100,000 limit in place, and perhaps offset even more of your RMD for 2021.
Think Long Term
Retirement planning is part of personal finance, and personal finance is, as its name states, deeply personal. Everyone’s situation is unique, and no tax, giving, or retirement strategy fits or benefits every person the same way. Look at your long-term goals under the options available with today’s laws, strategies, products and solutions.
2020 has been a challenging year, but don’t let it distract you from doing the right planning that can help with your future retirement security.