Following the stock market decline early in 2020, Congress passed the CARES Act on March 27, providing relief for individuals and businesses impacted by the pandemic. One of the provisions was a suspension of 2020 Required Minimum Distributions (RMDs). Individuals who hadn’t taken a distribution yet were no longer required to do so.
For individuals who took a distribution early in 2020, they were given the opportunity to “undo” part or all of that distribution by returning funds to their IRA by August 31, 2020.
Tax Forms for IRA Rollovers
Some taxpayers who took advantage of this rollover to undo that RMD may be surprised to get tax forms reporting the withdrawal.
Example 1: Kendra turned 75 in 2020 and had a $30,000 RMD at the start of the year. She took her distribution on February 1, 2020, with 10% tax withholding ($27,000 net distribution and $3,000 for taxes). She didn’t “need” the distribution as Social Security and other income covered her entire cost of living. Because she didn’t need the money, she returned the full $30,000 to her IRA on June 15, 2020.
In January 2021, Kendra was surprised to receive a Form 1099-R since she returned the entire amount and knew she shouldn’t owe taxes on it. The Form 1099-R reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports code 7 for a “normal distribution.”
How to Report the 2020 Rollover
Since Kendra returned the entire $30,000 withdrawal listed on her tax return, it won’t be included in her taxable income. However, she will need to report both the withdrawal and the rollover on her tax return.
In her case, the full $30,000 will be reported on line 4a of Form 1040, with $0 reported on Line 4b. She will also write “Rollover” next to line 4b. In her case, the $3,000 that was withheld for taxes will still be reported with other tax withholding and will impact her ultimate refund or balance due.
How to Report a Partial Rollover
Example 2: Jane turned 76 in 2020. She also had a $30,000 distribution that she took on February 1, 2020, with 10% tax withholding ($27,000 net after $3,000 for taxes). On June 15, 2020, she returned $12,000 to her IRA instead of the full $30,000.
In January 2021, she received a 1099-R that also reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports Code 7 for a “normal distribution.”
In Jane’s case, she will also report the full $30,000 on line 4a. She will report $18,000 on line 4b ($30,000 original distribution minus $12,000 returned to her IRA in 2020). She will also write “Rollover” next to line 4b. The $3,000 withheld for taxes will still be reported with other tax withholding as usual.
Taxpayers who returned some or all of their distribution in 2020 will receive Form 5498. They likely will not receive this form until May 2021—after the April 15 tax filing deadline. This form will be used to report the amount returned to the retirement account in 2020 and verify the rollover reported on the 2020 tax return. The taxpayer does not need to wait (and should not wait) for the Form 5498 before filing their taxes. This is simply an information form so the IRS can verify what was reported on the tax return.
Exception from the Usual Rule
It’s important to remember that all of these rollovers are a one-time exception in 2020 from the usual rule. Typically, this type of rollover can only be done once per rolling 365-day period and must be completed within 60 days of taking the withdrawal. Also, RMDs are generally specifically prohibited from this type of rollover.
Individuals who returned RMDs in 2020 to avoid having to include the withdrawal in their taxable income will still receive a tax form showing the distribution and will have to report it on their tax return. When reported correctly, the amount returned will be excluded from their income as intended.
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.
The Tax Cut and Jobs Act (TCJA) passed at the end of 2017, and the Setting Every Community Up for Retirement Enhancement Act (SECURE) passed at the end of 2019. These both made significant changes to annual tax-planning strategies.
The COVID-19 pandemic and the CARES Act relief package that followed created a new layer of complexity. Unfortunately, many taxpayers miss opportunities for significant tax savings.
Here are six moves to consider making before the end of the year to potentially lower your taxes both this year and in years to come.
Take the Standard Deduction Later. The new tax rules nearly doubled the standard deduction and eliminated many write-offs, limiting the benefit of itemizing deductions for most taxpayers. However, you can optimize your deductions by “bunching” itemized deductions in a single year to get over the standard deduction threshold and then by taking the standard deduction in the following year.
Example: Instead of giving $10,000 to charity annually (which will likely leave you with the standard deduction anyway), gift $50,000 every 5 years. This will give you a greater tax benefit in the first year while still claiming the standard deduction in the other years to maximize tax savings.
Pre-Pay Your Medical Expenses. Have major medical-related expenses coming up? You can potentially maximize the tax deduction by paying out-of-pocket medical expenses in a single calendar year—either by pushing payments out to the next year or pulling later expenses into this year.
A surprising number of medical expenses qualify, including unreimbursed doctor fees, long-term-care premiums, certain Medicare plans, and some home modifications.
Note: Medical expenses are an itemized deduction, so this strategy may be best used with the “bunching” strategy described above, including possibly paying medical expenses in a year you maximize charitable donations.
Give Money to Your Favorite Charity Right Now from Your IRA. If you’re over 70 ½, you can make up to $100,000 of annual Qualified Charitable Distributions (QCDs) directly from your IRA to a qualifying charity. Even better, for retirees who don’t need to take their Required Minimum Distribution (RMD) each year, these qualified charitable distributions count toward the RMD but don’t appear in taxable income.
Even though the CARES Act allowed RMDs to be skipped in 2020, you can still make a QCD this year.
Note: QCDs must be made by December 31 to count for this tax year.
Take Advantage of Years in a Lower Tax Bracket with a Roth Conversion. A Roth conversion can permanently lower your taxable income in retirement by converting tax-deferred assets (IRA / 401k) into tax-free assets in a Roth account. It is best to do this in years where you are in a lower tax bracket than you expect to be in the future.
Example: If a taxpayer at age 63 is in the 12% tax bracket, then moving $10,000 from an IRA to a Roth account will owe an additional $1,200 in taxes. That same taxpayer at age 73 may be in the 24% tax bracket due to Social Security, pension, and RMD income they didn’t have at 62. Taking that same $10,000 from an IRA will now result an in additional $2,400 in taxes.
Optimize Your Investment Portfolio to Improve Expected After-Tax Return. Prior to the TCJA, you could write off some fees you pay for investment management. The TCJA did away with that deduction. There are still ways to pay fees with pre-tax dollars that may make sense depending on the types of accounts used.
Likewise, some investments will be more tax efficient, and other investments will be less tax efficient. Where possible, move the most tax-efficient investments into a taxable investment account and the least tax-efficient investments into a tax-advantaged retirement account. The goal is to determine an ideal overall allocation, even if each individual account has a slightly different allocation.
Both strategies above can potentially help maximize the after-tax return on investments.
Optimize Your Retirement Contributions. The most important step you can take right now to reduce your taxes this year may be to review how and where you’re making retirement contributions. You may be missing out on critical tax savings (and investment growth) if you’re not optimizing your contributions.
Potential retirement account strategies people often miss include Solo 401k for self-employed individuals, backdoor Roth contributions, or “mega” backdoor Roth contributions at certain large employers.
Everyone’s situation is different, and today’s retirement environment is complex. Working with a financial professional who coordinates with your CPA can help ensure you’re not missing any opportunities to optimize your portfolio and pay less in taxes.
Because of the pandemic, many companies are trying to rapidly reduce their workforces. Boeing recently offered their voluntary layoff (VLO) to encourage employees near retirement to do so. Other companies will resort to traditional layoffs.
What should you do when you find yourself unexpectedly retired—whether voluntarily or not?
Assess the Situation—Review Your Numbers
Retirement is a major life change for everyone—even more so when it happens unexpectedly. The first step financially is to get a clear picture of your assets. This includes investment accounts and savings. It also includes debts like credit cards and mortgages. In addition, you’ll want to identify current or future sources of income such as pensions or Social Security.
Next, you’ll want to be clear about how much you’re spending. Free or low-cost tools like mint or YNAB can help you easily track how much you’re spending as well as categorize your expenses. That may make it easier to see if there are ways to reduce costs, if needed.
Knowing your minimum monthly costs is a major part of determining if you have the resources to retire successfully or if you need to find another way to work and earn money before retirement.
If you’re unexpectedly retired, identify if you need to reduce your expenses. Some of those reductions may happen automatically—most families aren’t spending as much on travel right now—while other reductions may require more planning.
You’ll want to account for healthcare costs. For some, employers may continue to provide health coverage until Medicare begins at age 65. For others, health insurance will have to be purchased either through COBRA to maintain the current health insurance or through the individual markets. These policies can cost significantly more than when the employee was working, although by carefully structuring income, it may be possible to get subsidies to reduce this cost.
Identify if you need additional sources of income. This may come from part-time employment. It may also come from reviewing your Social Security strategy. Social Security benefits can begin as early as age 62, although doing so will permanently reduce your benefit. Take time to compare the tradeoffs of starting your Social Security benefit at different ages.
Finally, review your investment allocation. You’ll want to make sure you have an appropriate percentage providing stability (cash, CDs, short-term bonds) to protect you from the fluctuation of the market when you need the money. With a retirement period of 30 years or more, stocks will likely be an important part of your investment strategy, too.
Do Some Tax Planning
It’s important to identify what mix of accounts you have. IRA, Roth, and taxable accounts are all taxed differently. It’s often best to spend from the taxable account first, then the IRA, and save Roth accounts for last, although there may be times where it’s better to use a mix from different types of accounts each year.
Many early retirees temporarily find themselves in a lower tax bracket because they don’t have a salary and they haven’t yet started Social Security. This may be a time to take advantage of Roth conversions. Moving money from a traditional retirement account to a Roth account now, while you’re in a lower tax bracket, can significantly reduce taxes over your lifetime.
Planning Beyond Money
When a major change like this occurs, it’s important to take care of your finances. It’s also important to take care of your mental health. Retirees often have years to plan for this major life change. Because of the pandemic, many are making this change suddenly and unexpectedly.
It’s essential to take the time to set a new routine and identify new hobbies or other activities to incorporate into your life.
When retirement is unexpected, it doesn’t have to be scary. Building a financial plan to determine if you’re on track to meeting your goals, to discern what adjustments should be made to help you reach those goals, then to execute that plan can help provide the peace of mind brought about by a successful retirement—even when it comes sooner than expected. If you want help with this process, reach out to us.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation.
Now we’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries. Here is our first of six installments on charitable giving.
In my estate plan, I’m planning to leave some of my assets to charity. What should I be mindful of with the passage of the SECURE Act?
Perhaps the largest consideration is which assets the charitable donation should be made from. While IRAs and other traditional retirement accounts have always been a good choice, the SECURE Act increases the value of using these accounts for charitable giving.
For an individual with traditional retirement accounts, Roth accounts, and taxable assets outside a retirement account wanting to give to charity from their estate, the preference would be:
Traditional IRA: Make charitable donations from here. Even if only part of the account is gifted to charity, the decreased remaining balance will reduce the taxable income the beneficiary realizes each year.
Roth IRA: Leave these to individuals instead of charities. Even though Roth IRAs still have annual RMD, the income removed from a Roth account will not be taxable for the beneficiary.
Taxable Accounts: Individuals should be preferred over charities. There is no requirement to take income in a given year, and the beneficiary likely received a step-up in cost basis, minimizing the tax impact when used.
If your goal is to both leave money to charity and create an annual stream of income for a beneficiary that lasts longer than the 10-year rule for new inherited IRAs, a charitable remainder trust may accomplish these goals.
As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.
Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.
Chris: I was initially hired as an associate advisor in 2014. I was still doing my CFP studies at the time, so being able to do advisory work concurrently with my studies really prepared me for the financial advisor role at Merriman. I completed the CFP course and became a financial advisor about two years ago and started to manage my own clients. Besides being a financial advisor, I also manage the associate advisors. It’s nice to see the initial group of advisors I first managed in this role are now wealth advisors or have moved on to different roles within Merriman. I’m currently managing a new group of associate advisors at Merriman. They’re still relatively new, and it’s a lot of fun to guide and mentor them.
Renske: What do you love about your job?
Chris: I love my coworkers, and I like the regular client interaction and the feeling I get knowing we’re making a big difference in people’s lives. I love that I never feel bad in the morning going to work. I’ve experienced that in previous jobs, but right now, when I wake up, it’s always a positive feeling. The thing I love the most about my job is figuring out how to solve complex problems for my clients through research, inquiring, and working with my co-workers. It’s really cool to learn more — especially about problems I don’t know the solutions to initially — and then go back to inform and implement the solutions for my clients.
Renske: Tell me a little bit more about your family life.
Chris: I am originally from the Kansas City area, and so is my wife, Katharina. We’ve been married for 12 years. She is a veterinarian. She used to work for the army as a vet, which had us living in South Korea for a few years. Once she quit working for the army, we moved to Washington. We are the proud parents of 2 daughters. Samantha is three and Evelyn just turned one. We’re very outdoorsy and love to go on hikes, take backpacking and camping trips, and go bike riding. My three-year-old is now able to cycle by herself and joins me when I go for a run, which is a ton of fun. We don’t have any pets at the moment. We always had cats and dogs, but since our last dog passed away, we promised each other to not get any more pets until the kids are a little older.
Renske: What’s your ideal date night?
Chris: Ooh my! I have not seen a single movie in 2018 from beginning to end! Before we had kids, we used to go to see plays and musicals fairly often. We’re hoping that soon we’ll have some more time and energy to go out on dates together again.
Tax documents are arriving and it’s time to get organized. This is the first year that incorporates changes from the Tax Cuts and Jobs Act passed in December 2017. These are some of the biggest changes to the tax code in 30 years. (more…)