The final weeks of 2020 present a critical planning window for tax planning options—many that may disappear after December 31. In a year filled with financial and personal struggles, many investors can turn lemons into lemonade by implementing certain strategies.
But, time is running out to do so. Before 2020 comes to an end, here are some of the tax saving strategy discussions I am having with my clients:
1. Roth Conversions. Tax rates are historically low. The national debt is historically high (and growing!). It’s simple math – future tax rates only have one direction to go, and that is up. One way to take advantage of today’s low tax rates is by converting traditional retirement accounts to Roth (aka paying taxes while they are on sale!).
Some things to keep in mind…
- To count as a 2020 Roth conversion, the funds must leave the IRA or company plan by December 31, 2020.
- Consider a series of smaller conversions over time, using up “lower” tax brackets.
- Roth conversions are now permanent, so be certain there are enough funds to pay the taxes before doing the conversion.
2. Coronavirus-Related Distributions (CRDs). This is for Year 2020 only! Created under the CARES Act, this is an exemption from the 10% early distribution penalty for qualified individuals affected by COVID-19. Income can either be spread or repaid to an IRA or company plan over the next three years.
While early access to retirement funds should be considered a last resort, discuss this option with a professional before proceeding. The law was intended to help those in need – not necessarily for tax planning! And the IRS could decide to audit these transactions in the future.
3. Net Unrealized Appreciation (NUA). This applies to those with highly appreciated company stock in a company plan. NUA can allow significant tax savings by utilizing long-term capital gains rather than ordinary income tax rates on those shares. This strategy must be completed as part of a lump-sum distribution following a triggering event.
What is a “triggering event”?
- Age 59½
- Separation from service (not for self-employed)
- Disability (only for self-employed)
4. Qualified Charitable Distributions (QCDs). A QCD is a direct transfer of IRA funds to a qualifying charity—the most tax-efficient way to make charitable gifts. It’s possible to reduce taxable IRA balances at ZERO TAX COST for people age 70 ½ and older before year’s end. The charity gets the full distribution, and the donor doesn’t have to claim it as income—it’s a win-win!
Note: Even though the SECURE Act raised the required minimum distribution (RMD) age from age 70 ½ to age 72, QCDs are still available at age 70 ½.
5. Life Insurance. After the SECURE Act, life insurance has proven to be an even more valuable estate planning vehicle than inherited IRAs. Why? Well, insurance proceeds are income-tax free and can also be estate-tax free.
The thought process here is drawing down IRAs during one’s lifetime in a series of distributions — paying tax at current low rates, over several years. These withdrawals can also help cover annual RMD requirements.
Some other considerations:
- After-tax funds can be used to purchase life insurance.
- If a trust is needed, the life insurance can be paid to an insurance trust (ILIT).
- This strategy reduces current income tax by eliminating RMDs on IRA funds withdrawn.
6. Lifetime Gifting. There are three tiers of tax-exempt gifting:
- Annual exclusion gifts (Up to $15,000 per recipient / per year)
- Gifts for direct payments for tuition & medical expenses (unlimited)
- Lifetime gift/estate exemption for 2020 ($11,580,000 per person / $23,160,000 per married couple).
After 2025, this is scheduled to go back to the $5 million / $10 million levels plus inflation increases— but the exemption could be reduced even sooner! Gifts made now in 2020 lock in today’s gifting limits (as opposed to inheritances received after death).
Some other considerations:
- It pays to use these gifting limits now in 2020, or possibly lose them later.
- Present a 2020 gifting strategy to your clients with large estates.
- Identify opportunities to make tax-free gifts, or reduce the tax on taxable gifts.
7. Estate Planning. The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries—effective beginning with deaths in 2020. Anyone with a retirement account needs to review these changes and how they impact their plans. Most estate plans will also need to be updated at a minimum, and some scrapped altogether—particularly those naming a trust as a beneficiary of an IRA.
Check IRA and company plan beneficiary forms to see if a trust is named. If yes, my recommendations would be to consider:
- Converting these IRAs to Roth IRAs or
- Withdrawing IRA funds now and purchasing life insurance
8. IRA Distributions. Even though RMDs are not required for 2020, investors can start lowering taxable IRA balances before future tax liability increases. In other words – it might make sense to take an IRA distribution anyway! For added benefit, consider moves to more tax-favorable positions like funding cash value life insurance, Roth conversions, and other gifting strategies.
9. Tax-GAIN Harvesting. Similar to its sister “tax-loss harvesting”, year-end is generally the best time for this. If investors have taxable investment accounts, strategically selling winning investments could potentially reduce future taxes. Plus, this harvesting can help reduce concentrated positions and reset cost basis for future opportunities.
10. Everyone can now deduct $300 in donations. If you have the means, and the heart, taxpayers can now deduct up to $300 in charitable donations made regardless if they itemize on their taxes, or not.
Thanks to the CARES Act changes earlier this year, this temporary tax change was made to incentivize people to continue to gift to charity. We know that charities can always use a helping hand, particularly this year.
So there you have it! A list of 10 things that can potentially help out as we wrap up 2020. It’s certainly a busy month for me as I go through this list with clients.
Risk Disclosure: Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.
This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.
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