In the final two weeks of 2020, financial advisors have an opportunity to add a lot of value for their clients through tax planning, according to Ed Slott, president of Ed Slott & Co.

In fact, advisors have several different tax-oriented action items with which to engage clients, said Slott in “7 Best Strategies: Year-End Retirement Tax Planning,” a December webcast sponsored by Financial Advisor magazine.

The current year offers some unique opportunities for tax planning, said Slott, due to historically low income tax rates and provisions related to Covid-19 relief legislation passed earlier in the year but which will likely expire permanently at the end of December.

“We don’t know what the future is going to be, but we do know about the budget deficit,” said Slott, noting that in 2020 alone there has been a $3.3 trillion deficit in federal spending. “We’re in the worst shape, deficit- and debt-wise, since the end of World War II,” when the top marginal income tax rate peaked at 94% to help pay for the war effort.

The following are Slott's seven best year-end tax planning strategies:

No. 1 – Roth IRA Conversions
As a result of the CARES Act coronavirus relief legislation, clients over age 72 will not have to make required minimum distributions (RMDs) from their traditional tax-deferred retirement accounts, said Slott, which may make a Roth IRA conversion an even better idea today than it would normally be.

“Even if RMDs are waived, should clients take a distribution voluntarily for a Roth conversion? Maybe,” said Slott. “To take advantage of these low rates, maybe it pays to pay some tax money now, lower that IRA balance and thus lower their future RMDs which would be based on the lower balance. Then you have freedom as to what you would do with the money, for Roth conversions, or to move to a cash-value life insurance. This is an opportunity today that the window is closing on.”

Normally, RMDs can’t be directly converted from a traditional account to a Roth account, said Slott, which makes the process of moving money between the two types of accounts more costly and potentially time consuming. Because there are no RMDs in 2020, the amount a client may have been required to take can just be converted to a Roth account instead.

The one caveat is since 2019’s SECURE Act eliminated the ability to recharacterize Roth conversions, advisors need to be sure their clients will be able to pay taxes on any money distributed from their traditional retirement accounts.

No. 2 – Coronavirus-Related Distributions (CRDs)
CRDs are not a planning vehicle per se, but there is an urgency to them because the provision making possible penalty-free distributions from traditional retirement accounts expires on December 30.

“If a client needs money, the last place I would take money from is a retirement account, but these are clients who are desperate,” said Slott. “A CRD allows retirement withdrawals to be made up to $100,000—that’s in aggregate, not per account—exempt from the 10% early distribution penalty for those under 59-and-a-half.”

For clients over 59-and-a-half, a CRD is still worth considering because they can spread that income over three tax years and they have the option of re-paying some or all of it within three years.

However, to qualify for the CRD a person must have suffered health or illness-related impacts or financial harm from the pandemic.

No. 3 – Net Unrealized Appreciation (NUA)
The net-unrealized appreciation rule only applies to people with company stock in their company retirement plan, and taking it a step further only applies to the stock that is inside their company retirement plan. Still, it may be hugely beneficial to those holding highly appreciated company stock within their plan.

“It has to be a lump-sum distribution, and everything has to come out in one calendar year, so there’s not much time to start this process,” said Slott. “The company stock gets withdrawn in-kind into a brokerage account, and the client only pays taxes on the cost basis. Appreciation is not taxed until it is sold, and when it is sold, it will be taxed at the long-term capital gains rate.”

Non-company stock securities within the plan can then be rolled over tax-free into a traditional IRA or converted to a Roth account.

After a decade-long bull market, many clients may have highly appreciated employer stock in their retirement accounts.

To take a NUA distribution, a client must have reached age 59-and-a-half, or have separated from employment, or have suffered death or disability.

No. 4 – Qualified Charitable Distributions (QCDs)
QCDs are another useful way to reduce the balance of traditional retirement accounts and lower the future tax burden for clients, but the account owner or beneficiary must be age 70-and-a-half or older.

“It’s a direct transfer from the IRA to a qualifying charity,” said Slott. “When funds go to the charity, they’re then excluded from income. This is valuable because most of your clients get no tax benefit out off the gifts they’re currently making.”

IRA owners can make up to $100,000 in QCDs per year, but QCDs are not available from company plans and cannot go to a donor-advised fund, a private foundation or a supporting organization.

Because the 2017 Tax Cuts and Jobs Act increased the standard deduction, fewer charitably inclined clients qualify for itemized deductions, said Slott. QCDs are one way advisors can help clients realize a tax advantage from the kind of giving they’re already engaging in.

No. 5 – Life Insurance
“As a tax advisor, I have to tell you that the tax exemption for life insurance is the single biggest benefit in the tax code and most people don’t use it enough,” said Slott.

In 2019, the SECURE Act eliminated the “stretch IRA” strategy, Slott said, which allowed certain beneficiaries of a traditional IRA to “stretch” their required distributions over their own life expectancy, resulting in lower annual distributions and a lower income tax burden.

Now, most IRA beneficiaries are required to distribute all of the account’s assets and pay income taxes on those distributions within 10 years of their inheritance.

The tax advantages of IRA trust strategies, like the conduit trust, were also neutralized by the SECURE Act, said Slott, making life insurance planning even more valuable for clients.

“The big benefits of life insurance is that you get money to the beneficiaries at zero tax cost,” he said.

No. 6 – Lifetime Gifting
Most people inclined toward giving to family and friends don’t realize the huge benefits of gifting, said Slott.

“Client are always looking for ways to transfer wealth to children and grandchildren at zero tax cost if possible,” he said. “There are huge benefits to making gifts rather than just leaving the property at death.”

Slott described three tiers of gifting, adding that almost every client should qualify for at least one tier of gifting in 2020:

• Annual exclusion gifts of $15,000 per year per person. These are tax free, but “if you don’t use it, you lose it,” said Slott.

• Exemptions for direct payments. These are unlimited, but must be direct payments to educational or medical institutions to cover the expenses of a loved one, said Slott.

• The lifetime gift exemption. This is also the estate tax exemption, but Slott notes that clients can use it during life as well as after death, and it may pay to use it now while the exemption is a historically high $11,580,000.

No. 7 – Estate Planning After the Secure Act
Because of the lasting impact of 2019’s SECURE Act, the end of 2020 is an ideal time to revisit estate planning in general because so many estate plans relied on the stretch IRA strategy.

“The first thing you want to do is see what a client’s estate plan is,” said Slott. “Check their beneficiary forms—have they named a trust? Do they have contingent beneficiaries?”

Under the SECURE Act, the only beneficiaries who can still stretch an IRA throughout their life expectancy are surviving spouses, minor children of the deceased, disabled beneficiaries, chronically ill beneficiaries and individuals not more than 10 years younger than the IRA owner. Everyone else is subject to the 10-year payout rule.

“Trusts may not work anymore, they may be subject to high trust tax rates,” Slott said. “Convert these traditional IRAs to Roth IRAs, withdraw the funds, do life insurance. These are your action items. It’s up to you to contact your clients now before some other proactive advisor does.”