Let’s Welcome the Season of Hope!
Many believe that Thanksgiving Day opens the doors to welcome the “Season of Hope.” There is often a sense of vibrancy in the atmosphere between this day and the end of the year.
Maybe this is partially due to the Christmas lights and the flames from the menorah at Hanukkah. Regardless of your faith or lack thereof, I think you may agree with me that there is some joy from the brightness at this time of year.
Moving along — There’s much we can do before the year ends; I hope to shed some light on what you may already know.
As a result of the 2020 pandemic — a vast number of taxpayers in 2020 are faced with lower taxable income and low tax liability.
This is one of two (2) pandemic-specific articles; in this article, I will discuss tax planning surrounding Roth retirement conversion. In the next article, I will discuss the implications of under-paying taxes.
RETIREMENT SAVINGS: ROTH CONVERSION
A Roth IRA (“Roth”) is a type of retirement savings that allows individuals to withdraw their savings tax-free; it is widely used and often recommended by financial advisors. Roth allows our retirement savings to grow tax-free since contributions are made with after-tax dollars, unlike the traditional IRA retirement savings option that defers the taxes — ie, the tax is due in the future. In summary, with Roth, we pay the taxes now and with Traditional, we pay the taxes later. Before I continue, each option has its benefits from a tax-planning viewpoint; and can be uniquely beneficial to the saver.
Roth conversion in its simplest form consists of moving money from the tax-deferred savings bucket to the taxable savings bucket (in so doing we tell the government to tax us now using the current tax rate and allow our savings to grow tax-free).
Roth conversion can be a great tax-planning strategy in a period of low income and low taxes. For most taxpayers, 2020 is a lower-income year.
So, who are the individuals who are most likely to benefit?
The individuals who are most likely to benefit are taxpayers in a low tax bracket in 2020, and those who may foresee earning much more income in future years.
I discussed conversion from traditional IRA to Roth IRA; that is switching your past contribution from one bucket to the next. New contributions to a Roth may also benefit in a year with low income and a low tax rate.
For self-employed and/or pass-through income earners, consider making a Roth IRA contribution rather than a traditional IRA for 2020 — this may be possible if you generally make your contributions later in the year or before you file your tax returns (note, the account must be set up or open in 2020 in order to delay contribution) — this is common with SEP retirement savers. Please check with your financial advisor to discuss your Roth savings options.
401K Retirement savers – Please check with your employer’s selected administrator to find out if your plan offers you the ability to convert or contribute to a Roth IRA.
Tax implications of Roth Conversions — work with your financial advisor:
•Once you convert, you can’t undo – Roth conversion is permanent.
•Once you convert, the tax bill is due.
•You must leave the traditional IRA account by December 30, 2020, to qualify for the tax conversion.
On a related topic — RMD — taxpayers who are generally required to take a distribution each year (i.e. RMD) can also benefit if one is in a lower tax bracket than in previous years. Consider a withdrawal from your RMD in 2020. Yes, you read that correctly — It is true that, under the CARES Act, no RMD is required in 2020. However, this does not mean you are not allowed to withdraw. If your 2020 income is very low and you are likely to fall in a much lower tax bracket (after the withdrawal), why not consider a withdrawal of the 2020 RMD and pay a lower tax on it, rather than paying a higher tax debt in the future?
So how do I get started?
First, you would need to have a close estimate of your total income for 2020. If your income is from multiple sources you may want to consider using the service of a financial advisor and tax professional to prepare a tax liability projection.
Next, in order to assess your tax rate — you can use the 2020 tax brackets table enclosed to see which tax bracket your income may apply to you — there are still four (4) tax brackets from 10% to 25% with relatively low tax rates. For example, if your taxable income is approx. $40K and $80K (single and MFJ, respectively) your tax rate is as low as 12%.
Please see all tax brackets and status in the enclosed link from Kiplinger, here.
If you want to consider at least one of these options, act on it now. The great King Solomon reminds us that timing is important — In the Good Book, he penned (Proverbs 6:4), “Don’t put it off; do it now! Don’t rest until you do.”
In closing, I hope I was able to shed some light that will allow you to choose the savings option that is better for you. As always, the ultimate decision is yours.
Thank you for reading.
The Masterpiece Accounting Group web, blogs, and articles are not rendering legal, accounting, or other professional advice. Tax strategies and techniques depend on your specific facts and circumstances. You should implement the information in this newsletter only with the advice of your tax and legal advisors.