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Tag: RMD

Roth Conversion – A valuable tool to consider before year-end

By:  Scott Fain

This year has been a challenge for many, and though we are certainly not out of the woods yet with the Coronavirus, the election, and other factors, many are glad to see the end of 2020 coming soon.  During these times, planning must go on.  As we move into the fourth quarter, it is a good time to evaluate the potential for Roth conversions before year-end.  

Roth conversions allow you to convert funds currently held in tax-deferred traditional IRAs to Roth IRAs, which then grow tax free.  Currently there is an income limitation and an annual maximum for direct contributions to a Roth IRA, but there are no limits on Roth conversions.  The process of converting the IRA to a Roth IRA involves recognizing the amount of the conversion as income in the current year.  Though an important tool to consider every year, 2020 offers particular opportunities.

Roth Conversion Considerations in 2020:

  1. Annual Required Minimum Distributions (RMDs) have been waived this year.  Roth conversions could be processed in the amount of the otherwise planned income from the waived RMDs.
  2. Various industries have seen lost wages and unemployment during 2020 due to the Coronavirus.  During this unfortunate time that many people have lower income, Roth conversions can be considered to take advantage of the lower tax bracket for the year.
  3. The current tax rates are set to sunset in 2025, unless Congress acts to change that.  Given the stimulus package this year along with other factors, there is certainly reason to expect that Congress will allow those rates to return to pre-2018 levels.  Roth conversions could be utilized to lock in today’s tax rates.

Other Considerations:

  1. Bracket Conversions – A common approach is to look at your current marginal tax bracket and your expected income to identify the amount of room allowable for additional income in that bracket.  For example, a married filing jointly couple with $250,000 in taxable income in 2020 could convert up to $76,600 and remain in the 24% tax bracket.  This can be evaluated each year to fully utilize the current tax bracket, without pushing into the next bracket.  Note – it is important to consider the impact on Medicare premiums, taxability of Social Security, and the trigger of the 3.8% net investment income surtax.
  2. Secure Act – As a result of The Secure Act enacted in January of this year, most non-spouse beneficiaries of IRAs will be required to distribute the funds out of the accounts within ten years.  Prior to the Act, most of those non-spouse beneficiaries would have been able to distribute the balance over their lifetimes.  This change can have a significant impact on the taxation of the income, as the distributions over a shorter period will often push the beneficiaries into higher tax brackets.  Consideration should be given to utilizing the account owner’s tax bracket through Roth conversions to transfer that balance to tax free accounts for the beneficiaries.
  3. Tax Surprises – An important part of retirement income planning often involves leveling out income.  It is often overlooked that, in addition to the impact on marginal tax brackets, spikes in income can cause increases in Medicare premiums and the taxability of Social Security benefits.  For a married couple, these increases can be further magnified by the death of the first spouse to die.  The change from the married filing jointly tax rate schedule to the single schedule can cause the rates to increase more rapidly at lower breakpoints.  Utilizing systematic Roth conversions, particularly prior to the start of RMDs, can be an effective tool to level income.
  4. Open the Door for Backdoor Roth Contributions – Roth conversions can be utilized to “zero out” existing IRA balances to allow for back door Roth contributions.  As mentioned previously, there are income limitations and annual maximums for direct contributions to Roth IRAs.  However, the backdoor Roth Contribution can be an effective strategy for higher income individuals wanting to contribute to their Roth IRAs.  This involves contributing after-tax dollars as a non-deductible contribution to your traditional IRA, and then immediately converting those funds to your Roth IRA.  Again, the income limitations do not apply to the conversions.  This strategy works best when a client has no current IRA balance.  Otherwise, the conversion is considered to be proportional across all IRA dollars and will cause taxation and cost basis tracking going forward.  The initial conversion of the IRAs to Roth IRAs simplifies the process.
  5. Leave Room for Charity – Clients who are charitable should take into consideration their future charitable intentions.  Portions of IRAs planned for qualified charitable distributions (QCDs) should NOT be converted to Roth IRAs.

It is important to note that there is no one-size-fits-all investment strategy, retirement plan, or Roth conversion recommendation.  Decisions can often have unintended consequences that should be considered.  If you have questions or want to know if a Roth conversion would be a good fit for you, please discuss the concept with your financial and tax advisors.

www.CapSouthWM.com

Investment advisory services offered through CapSouth Partners, Inc., d/b/a CapSouth Wealth Management, an independent Registered Investment Advisory firm.  CapSouth does not offer tax or legal advice.  Please consult your tax or legal advisor before making decisions that may have tax or legal consequences. This article is of a general nature only and should not be construed as individual advice.

Inherited Accounts Under the CARES Act

Tucked into the gigantic “Coronavirus Aid, Relief, and Economic Security” (“CARES”) Act were two key changes you should know about, regarding required minimum distributions (RMDs). Both were designed to give people more control over their money and to help manage selling investments during an emergency.[1]

One provision allows retirees to forego taking RMDs from Individual Retirement Accounts (IRA) or 401(k)-style plans this year.

The other provision allows people who have inherited 401(k)s, IRAs or Roth IRAs to suspend distributions in 2020 (while RMDs don’t apply to people with Roth IRAs, they do apply to investors who inherit Roth accounts).

Let’s take a look at a couple of examples.

  • Let’s say an account holder has been taking RMDs from an inherited account for a number of years using the life-expectancy method set by the Internal Revenue Service.  The account holder can forgo a distribution in 2020, and resume distributions in 2021.
  • Suppose an account owner passed away on January 1, 2020, and left the IRA to an adult child. The new 10-year rule would start in 2021. The beneficiary would have until the end of the 10th year to withdraw the entire account.[2]

Important Note: If you have already taken a distribution from an IRA or 401(k)-style plan this year, you may be able to roll the funds back into the plan. But if you have already taken a distribution from an inherited IRA, you may not be allowed to put that money back. Keep in mind, the CARES Act is a 335-page bill, and some of the provisions are open to interpretation. Please contact your tax or legal professional to understand how it might impact your situation.

Big picture, these rule changes are meant to help Americans who may be struggling with the economic, emotional, or physical toll of COVID-19. In a tough time, these provisions of the CARES Act give account owners some flexibility that may provide some relief.

To further discuss inherited accounts under the CARES Act, contact CapSouth at 800.929.1001. To learn more about CapSouth Wealth Management and the services we provide, contact a local CapSouth office or visit our website at www.capsouthwm.com.

Investment advisory services are offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable.  CapSouth does not guarantee the accuracy or completeness of the information.  This material has been prepared for planning purposes only and is not intended as specific tax or legal advice.  Tax and legal laws are often complex and frequently change.  Please consult your tax or legal advisor to discuss your specific situation before making any decisions that may have tax or legal consequences.

This article contains external links to third party content (content hosted on sites unaffiliated with CapSouth Partners). The policies and procedures governing these third-party sites may differ from those effective on the CapSouth company website, as outlined in these Disclaimers. As such, CapSouth makes no representations whatsoever regarding any third-party content/sites that may be accessible directly or indirectly from the CapSouth website. Linking to these third-party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.


[1] The Wall Street Journal, March 25, 2020.

[2] Forbes.com, March 30, 2020. Under the SECURE Act, your required minimum distribution (RMD) must be distributed by the end of the 10th calendar year following the year of the Individual Retirement Account (IRA) owner’s death. Penalties may occur for missed RMDs. Any RMDs due for the original owner must be taken by their deadlines to avoid penalties. A surviving spouse of the IRA owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the IRA owner, and children of the IRA owner who have not reached the age of majority may have other minimum distribution requirements.

CapSouth Partners, Inc., dba CapSouth Wealth Management, is an independent Registered Investment Advisory firm. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences.

What Does the Required Minimum Distribution Mean?

You spent decades saving for retirement. A long time ago, you understood and took to heart the advice about the importance of your retirement savings. You’ve just turned 70, and you’re proud of your financial achievements.

You worked hard; you sacrificed, and now you’re retired and doing well enough so that you don’t have to take money from your retirement savings. After all, you’re still healthy and strong, and you’d prefer to let your retirement investments grow even more. And, besides, you don’t really need it right now.

The truth is, federal rules require you to begin making regular withdrawals from certain retirement savings accounts once you reach 70½. It’s called the Required Minimum Distribution, and it’s the minimum you have to withdraw per year. In other words, you don’t have a choice.

The RMD rule applies to certain plans.[i]

Once you reach 70½, you have to start making withdrawals from IRAs, SIMPLE IRAs, SEP IRAs, and other retirement accounts. Roth IRAs are exempt from the requirement until the account owner dies.

Here are two important provisions:

  • You may withdraw more than the minimum required amount.
  • Withdrawals are normally considered taxable income. Exceptions include money that was previously taxed (basis), is considered tax free (Roth distributions), and Qualified Charitable Distributions (QCDs).

Calculating the RMD.

You calculate the RMD for a year by dividing the account balance at the end of the preceding calendar year by the number from an IRS distribution table (“Uniform Lifetime Table”). For more information, go to https://www.irs.gov/retirement-plans/plan-participant-employee/required-minimum-distribution-worksheets.

The link directs you to select between two options:

  • A worksheet to calculate your withdrawal if your spouse is more than 10 years younger than you.
  • A worksheet for everyone else.

Date to receive RMD.

The date to receive your first distribution varies depending on the type of retirement account.

For IRAs (including SEP and SIMPLE IRAs), it’s April 1 of the year following the year when you reached 70½. So, if you reach 70½ in 2019, you have until April 1, 2020.

For 401(k), profit-sharing, 403(b), and other defined contribution plans, it’s the same as mentioned above or when you retire, whichever is later.

Dates to receive successive RMDs.

You must make account withdrawals every year by December 31. The calendar year after you reach 70½ you may have to make two withdrawals, by April 1 and another by December 31. To avoid having to pay taxes on both those payments, you may take the first withdrawal in the year you reach 70½ before December 31. That way the income falls into two separate tax years.

Penalties for waiting to take withdrawals.

If you don’t take withdrawals or don’t take adequate amounts, you may face 50% excise taxes on the amounts that are not distributed.

The government may require you to report the excise tax by filing “Form 5329.” “Form 5329 instructions” provides additional information about the excise tax.

If you would like to discuss your current financial needs, we’re happy to talk. Please contact us (800) 929.1001.

Investment advisory services are offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information.  This material has been prepared for planning purposes only and is not intended as specific tax or legal advice.  Tax and legal laws are often complex and frequently change.  Please consult your tax or legal advisor to discuss your specific situation before making any decisions that may have tax or legal consequences.

This article contains external links to third party content (content hosted on sites unaffiliated with CapSouth Partners). The policies and procedures governing these third party sites may differ from those effective on the CapSouth company website, as outlined in these Disclaimers. As such, CapSouth makes no representations whatsoever regarding any third party content/sites that may be accessible directly or indirectly from the CapSouth website. Linking to these third party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.

 

[i] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds

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