By Jonathan Thomas, CFP, Private Wealth Advisor
The Individual Retirement Account (IRA) has suddenly become a much less attractive wealth transfer vehicle than in years prior. For one, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 has removed the stretch IRA provision. Non-spousal beneficiaries now are required to withdraw the full balance of their inherited IRA within 10 years, rather than over their lifetime. Depending on the value of the assets held in the IRA, this change could have massive tax implications. Secondly, in my opinion, tax rates will likely be higher in the future. Clients with substantial IRA holdings should consider that a large portion of their IRA will potentially be going to Uncle Sam. Here are two actions you can take today to reduce your tax liability or avoid having your beneficiaries carry the tax burden.
Earlier this year, my colleague Joe Zappia and I deemed 2020 to be “The Year of the Roth IRA.” What we really mean by this statement is this is the year you should strongly consider executing a Roth Conversion. With the passing of the Coronavirus Aid, Relief, and Economic Security (CARES) Act by Congress earlier this year, Required Minimum Distributions (RMDs) are now waived for 2020. If you have had a relatively low income year or don’t need your RMD, the Roth Conversion might be for you.
We’ve worked with dozens of clients to convert money from traditional IRA assets to a Roth IRA this year. In some circumstances, it has been a “no-brainer.” Let me explain. Suppose you are a married couple in your 70s, have a large IRA (>$1mm), are primarily living off Social Security and a pension (or some other income source), and plan to leave your IRA to your children, who happen to be doing quite well and are in a high tax bracket. You do not require your RMDs for income—now or going forward. In essence, you will be forced to take out more money than you need, thus paying more in taxes.
Making a sizable ($50-100k) Roth conversion this year will lower the value of your traditional IRA (and the size of future RMDs) whereby the Roth IRA is now completely tax-free. I mentioned earlier that IRAs are fully taxable upon any and all distributions. Roth IRAs are tax-free for you and pass to your beneficiaries tax-free as well. Instead of leaving a fully taxable traditional IRA to your children, you can leave them a tax-free asset. The Roth IRA does not escape the 10-year rule for beneficiaries, but the distributions are tax-free. As for your high-income children—they will be very grateful!
In other cases, it can really depend on several factors. How strong is your financial plan? Is there a chance you will need the money that you would convert? Who are your beneficiaries? What is your income? To discuss more about whether Roth conversions could be a good option for you, contact your advisor.
Qualified Charitable Distributions (QCDs)
One opportunity that I believe is being underutilized is the Qualified Charitable Distribution (QCD). A QCD is a direct payment to a charity from your IRA. While the age of Required Minimum Distributions (RMDs) from IRAs is now age 72, those over age 70.5 can utilize the QCD. There’s really no minimum amount you can give, and the maximum is $100,000/year.
Why would you use a QCD, rather than writing a check or by other means? The QCD comes out tax-free and can fulfill your RMD* for the year. For example, if your RMD was $30,000, you could make a $5,000 QCD and be required to take (and pay tax on) only the remaining $25,000 distribution.
As a reminder: The standard deduction is $12,000 ($24,000 for married couples). Over 90% of tax filers are claiming the standard deduction. Unless you have numerous itemized deductions, you likely aren’t going to get a tax benefit by writing checks directly to charities like years past. If you are, for example, accustomed to giving $5,000 per year, why not claim your normal standard deduction and write the check directly from your IRA, tax-free?
There is almost always a better way to donate to charity than by writing a check. For clients over 70.5 with large IRAs, I believe the QCD is one of the savviest ways to support causes you care about while reducing tax payments over your lifetime.
As you can imagine, there is no magical solution and every client’s situation is different. It is so important to be working with an advisor who can help guide you through these conversations and assist in potentially taking advantage of some of these opportunistic tax-planning strategies. To learn more about how these strategies can help you, contact your advisor.
*There are no RMDs in 2020 from the passing of the CARES Act. But they will be back!
This material is for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. The opinions expressed herein do not necessarily reflect the views of LVW Advisors and are based on economic and market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. Facts presented have been obtained from sources believed to be reliable. Past performance is not a guarantee of future returns.