Heavyweight champ Mike Tyson famously quipped, “everyone has a plan until they get punched in the mouth.”
Well the coronavirus has certainly landed a blow to our collective jaw. And the collective has responded with vigor, from health professionals charging in to treat the ill to our politicians passing massive relief bills. The purpose of this article is to share with you some financial strategies that recent events have made available.
Refinance your mortgage. Not everyone has one, of course. And some are already set at rock bottom rates. But I’ve received calls from fast-acting clients who have secured shockingly low rates. You must always be mindful of the fixed fees, and it’s often not smart for small balance loans. As a rule, each 1 percent drop in interest saves $1,000 per year or $83 a month in interest costs per $100,000 of money borrowed. That’s money that you can spend at your local businesses soon enough. I’m advising most clients to call for rates and then work with me to run their personal numbers.
No Required Minimum Distributions (RMDs). To quote the late great David Bowie, this has been a year of “Cha Cha Cha Changes” for those required to withdraw money from pretax retirement accounts. First, the SECURE ACT moved the required age back to 72 from 70.5. Then the CARES Act suspended all RMDs due in 2020. This is true for inherited accounts as well. Those who took the withdrawal in January must keep the money, unless Congress passes a law allowing otherwise.
Those who took it after February 1, 2020 or later, may be able to put it back and save the tax using a 60-day rollover rule that has been extended to the July 15th tax filing deadline. Consult your qualified tax professional for details on making this happen.
This is good if f you don’t need the money and want to delay the income tax.
Convert Pre-Tax Accounts to Roth Accounts. Retirement accounts such as 401ks and traditional IRAs funded with pre-tax dollars often cause tax pain when unneeded funds are forced out by the aforementioned RMDs. This income can move you into a new tax bracket at force you to pay more than double the standard premium for Medicare’s Part B and Part D. If you’ve experienced a decline in security value, you will pay taxes on the lower value if you convert from a pre-tax account to a Roth account. If the value returns to or surpasses its original value, all gains will not only be tax-free, but they will also escape RMDs. This strategy works well if you’ve been able to avoid your RMD this year. I am frequently asked if an RMD can be converted into a Roth IRA. Prior to this year, the answer is no. This year provides a backdoor to that strategy.
No Hardship Penalty on Pre-59.5 Retirement Plan Withdrawals. Recent legislation not only removed the 10 percent penalty for hardship withdrawals up to $100,000 from pre-tax retirement plans, but it also allows a person to realize the income and therefore pay the tax in equal installment over the next three years. There’s no hurry on this strategy, as it’s available until the end of this year. This potentially provides you with access to funds that could have been locked up for decades for such things as wiping out debt or even funding big purchases such as down payments for real estate. You will pay income taxes on withdrawals and the funds are theoretically earmarked for your retirement, so care should be taken prior to using this option. This is good for people with real hardships and also for people with real desires who have sufficient retirement funds once the money is gone.
Managing your Income for FREE MONEY. The first stimulus bill prompts Uncle Sam to send each adult American $1,200 and $500 for dependent children under 16. There’s a catch, of course, and that’s an income phase out range of $150,000 to $198,000 for married couples and half of that for single people. If you are taking withdrawals from pre-tax accounts, the income generated may cause you to phase out of this benefit. If this is the case, to make yourself eligible, consider stopping them and take money instead from a Roth account, bank or brokerage account. If you made too much in 2019 the government will use your 2020 income and provide the credit when you file your 2020 taxes. What you do with the money is your business, of course.
But I suggested to one person who was worried about draining her Roth IRA to use the $1,200 to pay the income taxes on a 2021 conversion of pre-tax funds to a Roth account. Under some circumstances, this will result in a larger Roth balance than before the withdrawals began.
I started this piece with a pugilist, and I’ll end with insights from a contemporary Trobairitz. As Joni Mitchell sang, she’s “looked at clouds from both sides now.” At present, the coronavirus is a dark cloud brining much disruption and economic destruction. You can’t change that. You can, however, look for the silver linings. I’ve explored some here. If you want to explore any with me—or have others to suggest— please contact me. As always, my goal is to focus on your finances so you can focus on your life.
Mike Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT. He can be reached at mlynch@barnumfg.com or 203-513- 6032.