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.