Whether you are a CEO Founder, entrepreneur or wealth creator, it's a time-honored strategy that rings true: contribute to retirement accounts now and enjoy the accumulation later in life. Certainly, the government’s current tax policies encourage deferring earned income until your "golden years".
At its core, the appeal of the current taxation system is two-fold: 1. Contributions into qualified plans grow tax-free until withdrawn; and 2. Less tax is most likely paid on retirement income when taking it out in later years than when earned.
Strategic tax planning is essential to maximize benefits afforded by the current federal and state tax laws. Here are nuanced techniques that deserve to be explored and, more importantly, exploited.
Timing of RMDs from IRAs or Retirement Plans
RMDs (required minimum distributions) from IRAs must begin by April 1 of the year following the year you turn 70½. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Thus, if you turned age 70½ in 2019, you can (but don’t have to) delay the first required distribution to 2020. Bear in mind that this would mean taking a double distribution in 2020, i.e. the amount required for 2019 plus the amount required for 2020 (the latter due by December 31, 2020).
Bunching RMD income can certainly push you into a higher bracket. However, in some cases it could be beneficial to take both distributions in 2020. A good example is when you have an unusual taxable event in 2019 that already has you in the highest bracket, but 2020 looks like a more modest mid-bracket year.
Converting to a Roth IRA
It has been almost ten years since Congress lifted the AGI-based Roth conversion restriction, making the conversion available to everyone regardless of income level. Yet, it is still one of the most overlooked tax savings opportunities. In certain situations a partial, or sometimes even full, Roth conversion can be very attractive for long-term benefits over immediate savings.
A Roth IRA’s two most extraordinary features are its superior deferral potential and next-generation tax benefits. Unlike Traditional IRAs, Roth IRA owners do not need to take any distributions during their lifetime, thereby letting the balance in their retirement account balloon tax- and RMD-free. Secondly, future distributions from the inherited Roth IRA are completely tax-free to next-generation beneficiaries.
In most cases, a Roth conversion is an expensive proposition since the converted amount is generally included in the gross income during the year of conversion. However, in years with a large loss event, or a relatively flat year with modest income and unusually high business or itemized deductions, it is worth weighing the option of converting part of a Traditional or Rollover IRA into a Roth IRA at a nominal tax cost. Future benefits of such conversion could be enormous.
Qualified Charitable Distributions
Qualified Charitable Distributions (QCDs) from RMDs are another Tax Code provision that was languishing in relative obscurity until the 2017 Tax Act breathed new life into it. The law was introduced by the Bush Administration in 2006 as a two-year incentive for charitably inclined retirees and had suffered continuous expirations and subsequent revivals by Congress for nearly ten years, until it was mercifully made permanent in late 2015.
This provision has often been misunderstood. It allows retired taxpayers over 70½ to re-route all or some of IRA required minimum distributions to a charity of their choice, without having to include the RMD in gross income. However, in the era when most high-net-worth seniors itemized deductions (and could simply donate cash and include as a charitable contribution), the benefits of QCD were tenuous at best. They were mostly relegated to planning around state income taxes that normally don’t allow charitable deductions, like New Jersey or Pennsylvania. Enter the Trump Tax Cuts & Jobs Act.
Starting with 2018, SALT deductions are all but gone, and the miscellaneous itemized deduction like advisory fees are written out of the Tax Code until 2026. On top of that, a retired couple over 65 years can take a standard deduction of almost $27,000, which oftentimes now exceeds their dwindling list of what still qualifies as an itemized deduction. As a result, married couples without a mortgage will not see the same tax bang for their charitable buck, as they were used to in the past. But if they donate their RMD to charity, it will totally bypass their tax return. An added bonus to this approach is that monthly Medicare premiums are based on the previous year’s modified AGI. Omitting the RMD from AGI could save thousands of dollars in future years in reduced Medicare premiums.
Converting IRA Contributions into Deductible Charitable Giving
For those inclined to be charitably generous in the future, but still fully employed now, a new strategy has emerged. If you anticipate that in the years after you turn 70½ you will not itemize your deductions (as discussed above), you can make maximum contributions to one or more traditional IRAs during your working years. This will allow a full contemporaneous deduction on your current return. Then, when you reach age 70½, you can make charitable donations by way of qualified charitable distributions from your IRA, without having to include that portion of the distribution in taxable income. As a result, this strategy allows you, in effect, to convert otherwise nondeductible charitable contributions that you will make after you turn 70½ and in later years, into currently deductible IRA contributions and reductions of AGI, without ever including distributions from these IRAs in your future income.
In summary, current federal and state tax laws around retirement accounts provide opportunities worth exploiting for strategic tax savings, but high-net-worth taxpayers should carefully review their options to see which provide long-term benefits.
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