Tax planning is all about tax efficiency, making sure the various pieces of your financial plan work together in the most tax-efficient way. Tax planning is especially important in retirement; if you can keep your tax liability as low as possible in your golden years, you can keep more of your hard-earned money in your pocket.
An important thing to note about tax planning is that it’s not something to do one time and forget about. This is an ongoing process and should be part of your comprehensive retirement plan.
Skip RMDs in 2020
The CARES Act was signed into law at the end of March to provide relief to people and businesses impacted by the coronavirus pandemic. While there was a lot of attention given to the $1,200 stimulus checks many Americans received, there hasn’t been a lot of talk about other aspects of the law that impact retirees specifically.
Required minimum distributions have been suspended for 2020, meaning retirees who own a qualified account, like an IRA or 401(k), and beneficiaries taking distributions from an account do not have to withdraw money this year. This includes anyone who turned 70½ in 2019 and would have had to take their first RMD by April 1, 2020. The CARES Act gives those people relief from their 2019 and 2020 RMDs. The two biggest benefits to skipping your RMDs this year are keeping that money in your account to grow and avoiding the taxes that are due when you withdraw money and count it as earned income.
If you’ve already taken your RMDs but don’t need the money, you can put that money back into your account to avoid counting it as income this year. Keep in mind, you only have a 60-day window to do it; the money must be put back into the account by Aug. 31, 2020. If you’ve taken all or part of your RMD for 2020 and want to understand your options, talk with your financial adviser before the August deadline.
Max Out Retirement Contributions
Beyond the immediate tax benefits of maxing out your retirement contributions, saving money early and often is an important part of increasing your retirement security. You can contribute up to $19,500 in your 401(k) in 2020 and up to $6,000 in your IRA. Those 50 and older can add an extra $6,500 to their 401(k) and an additional $1,000 to an IRA.
How much you contribute to your retirement accounts during your working years — and the types of accounts you contribute to — will impact how much you pay in taxes both now and in retirement. Contributing to a traditional 401(k) or IRA reduces your taxable income for the year. The money you put into these accounts grows tax deferred until you withdraw it in retirement.
The SECURE Act, which took effect on Jan. 1, allows you to continue putting money into your IRA at any age as long as you are still working. In the past, you could not contribute to an IRA after age 70½. The new rule gives you a valuable tax benefit now and helps you save more for retirement. Depending on whether a Roth IRA will benefit you in retirement, this new rule also gives you more time to convert your traditional IRA to a Roth IRA while you’re still working.
Convert to a Roth
Speaking of Roth IRAs, there is a great opportunity right now to convert your tax-deferred accounts, like traditional IRAs and 401(k)s, to tax-free accounts, like a Roth IRA. The balance in your traditional IRA or 401(k) account might be down due to the volatility we’ve experienced this year; combine that with our historically low tax rates and the taxes you’ll pay on the conversion now could be lower than in the future. You’ll owe the IRS when converting money from a traditional IRA to a Roth IRA, but you will withdraw that money tax free from your Roth in retirement. I have never heard anyone complain about tax-free retirement income!
Roth IRAs play an important role when it comes to tax diversification. A mix of tax-deferred, tax-free and taxable accounts (like your brokerage and savings accounts) will help you better control your tax liability in retirement; you gain more flexibility over how much money you withdraw and from which account.
If you’re curious about whether or not a Roth conversion could benefit you, talk with your tax professional and financial adviser about your options.
Tony Drake is a CERTIFIED FINANCIAL PLANNER™and the founder and CEO of Drake & Associates in Waukesha, Wis. Tony is an Investment Adviser Representative and has helped clients prepare for retirement for more than a decade. He hosts The Retirement Ready Radio Show on WTMJ Radio each week and is featured regularly on TV stations in Milwaukee. Tony is passionate about building strong relationships with his clients so he can help them build a strong plan for their retirement.
How to Buy Stocks
Not everyone knows how to buy stocks, even as investing in the stock market becomes more and more popular. This four-step plan can help.
By Will Ashworth Published
One Key Rule for Understanding 2023 RMDs
RMDs Required minimum distribution (RMD) rules can be confusing, but there is a guideline that can help.
By Kelley R. Taylor Published
Five Simple Year-End Tax Tips to Set Up a Successful 2024
If you wait until the new year, you may miss out on some valuable tax planning strategies. Here’s what you need to know before closing out 2023.
By Julie Virta, CFP®, CFA, CTFA Published
Six Estate Planning Tips for Younger Generations
Millennials and Gen Zers are taking their estate planning seriously. These tips can help make the process seem less daunting.
By David Weinstock, CFP®, AEP®, CPA Published
Year-End Tax Planning for a Financially Healthier Retirement
Getting your tax ducks in a row for the end of the year can decrease your tax liability and make the most of your income, now and in retirement.
By Ryan Marston, Investment Adviser Representative Published
Where to Start Financially After a Life-Changing Diagnosis
Dealing with an illness, yours or your child’s or that of another loved one, is hard enough without adding financial duress. Here are some considerations and suggestions for covering expenses.
By Stephen B. Dunbar III, JD, CLU Published
Six Ways to Prepare for Widowhood and Protect the Surviving Spouse
No one wants to have to plan for losing their spouse, but having plans in place and knowing what to do when the time comes can alleviate at least some of the stress.
By Tyler Hill, Investment Adviser Representative Published
Creating a Blended Family? Three Key Steps to Consider
Blended families can make your finances and estate extra complicated, but you can head off some of those issues with careful planning.
By Adam Frank Published
Do You Need Disability Insurance?
If you work for a living, the answer is yes, so don’t overlook protecting your biggest asset. Open enrollment season is the perfect time to assess your options.
By Frank J. Legan Published
Retirement Planning in a Time of Inflation and High Interest Rates
Today’s challenges make retirement planning even more complicated than usual, but it’s not all doom and gloom.
By Ken Moraif, MBA, CFP®, CRPC® Published