2020 sure was a unique year. There were many events that we will remember for a long, long time. 2020 also presented some unique financial provisions that led to mistakes unrelated to market anxiety. Some of these errors were riffs on golden oldies but some were new compositions.
The CARES Act waived the need for Required Minimum Distributions (RMD) for older taxpayers, providing an opportunity for less taxable income and lower tax bills. The thinking went, “I don’t need it and don’t have to take it, so I won’t take it and I’ll save some money on taxes.” While that makes sense, retirees should have asked, “Even though I am not required to take a distribution, should I take money out anyway?”
For many, the answer should have been “yes.” We helped more clients voluntarily take distributions or execute Roth conversions this year than in any I can remember. In many cases, the income was taxed at a low rate and gross income was low enough to avoid triggering some of the extra costs of a higher gross income like Medicare premium increases due to IRMAA.
For some clients, the lack of RMD made capital gain harvesting attractive. For several of our married couples, some of those gains were not taxed at all.
Another retiree mistake came from the many who usually find it more convenient and flexible to pay much of their tax liability through withholding payments from IRA distributions rather than making quarterly estimated payments. With the RMD waiver, such taxpayers that did not make any distributions also did not make the planned withholding payments. If the withholding from retirement account distributions covered taxes for other income or activity, the taxpayer can be subject to penalties and interest for underpayment.
Retirees aren’t the only ones with potential withholding issues. President Trump issued an executive order in the fall allowing for the deferral of payroll taxes. This gave certain workers a boost to their take home pay. However, the mistake we are seeing is that some workers are mistaking deferral for a waiver. They did not realize they would be paying the payroll taxes in 2021 in addition to the payroll taxes on their 2021 income and will soon face a reduced cash flow.
Some people servicing student loans blew an opportunity. Federal student loan payments have been on deferment with no interest accruing. For some this is helpful because they have been laid off or suffered a drop in income. However, for others, the now voluntary payment has some people choosing not to make payments at all even if their cash flow has not been affected by Covid. Most are simply not assessing their situation, but a few are banking on forgiveness legislation.
Not paying down the balance can be a mistake because today’s zero percent interest rate presents the best opportunity they may ever have to make progress paying down these loans. When the deferment ends, the typically not so great interest rates of student loans will return. Better that interest gets charged to a lower balance than a higher one.
Whenever markets sink, you hear some common pieces of advice such as it is wise to harvest tax losses. For some people this is not good advice. A client forwarded a blog post recently from a guy who harvested $20,000 in losses back in the Spring to offset $20,000 in gains he took early in 2020. He didn’t want out of the markets so to avoid the wash sale rules, he bought similar holdings. He was very proud of his swaps, maintaining his risk profile and “beating Uncle Sam.”
What he describes is something a lot of advisors recommend for their clients, and we had in fact made tax motivated swaps for our client. However, there were some notable differences.
The author bragging about their frugality, said they live comfortably on a combined income of $70,000. Hmm. If they had $70,000 in income and $20,000 in gains, his was a wasted effort. The tax code says that losses are first used to offset capital gains. After applying a standard deduction, joint filers with $70,000 of income would not pay tax on $20,000 of long-term gains. The loss harvest did nothing for his tax bill.