As we enter the beginning of the ending of 2020, I can only think of the Grateful Dead lyric, “what a long strange trip it’s been.” And while I couldn’t blame anyone for being Dazed and Confused these days, I want to point out a few simple year-end strategies that may have a big financial impact on you.
Given that taxes are most of my client’s largest expense, it’s no surprise that most strategies focus on tax related moves.
Do the Bracket Bump
Move number one. Bump your bracket. My dad fed our family as a general contractor specializing in underground construction. He won or lost jobs at blind bids, at which he put in a price he was willing and committed to completing a job. On bid day, I’d have two questions for him upon his return from the office. (These would usually be asked as I racked for a game of eight ball after putting Merle Haggard on the stereo.) First, “did you get the job?” If he said yes, I follow up: “How much did you leave on the table?” This refers to the gap between his winning bid and the next lowest, that is, the amount of money he could have earned and still secured the contract. Leaving too much green on the table turns a win into a psychological loss.
I’ve brought this concept to my financial planning practice, in which I encourage clients not to leave anything on the table if they find themselves in low tax brackets. The U.S. tax code is extremely progressive, which means if you can keep your “taxable” income modest, you will pay very little income tax. For retirees, this may mean they are in the 12 percent bracket in early years only to jump to the 22 percent with RMDS kick in in later years. Don’t waste the low 12 percent bracket.
The simple strategy is to “Bump” your income to take full advantage of it. Options include taking a withdrawal and investing it in a non-qualified account or converting it to a Roth IRA and never paying tax again. Each of these strategies will pay off big in future years for you or your heirs.
IRMAA is Not Just a Hurricane
How to you feel about paying extra for Medicare? You most certainly will, without any extra services, if your Modified Adjusted Gross Income (MAGI) exceeds $87,000 per person in 2020. Earn $87,100 and you’ll pay $840 a year more for Medicare Part B and D. That’s a take rate off 740 percent! There are other income thresholds as well.
This is Income-Related Monthly Adjustment Amount (IRMAA) and she’s often triggered by unwanted RMDs once you mature to age 72. The simple solution is to plan, in advance, to lower RMDs. If the threshold is $87,000, consider withdrawing or converting pre-tax retirement assets to Roth IRA assets to approach but not exceed this threshold. If you find yourself paying IRMAA, make sure you use the entire allotted bracket. Call it IRMAA optimization.
It’s not driven by taxable income so traditional charitable contributions will not lower it. People who are 70.5, can send non-profits money directly from an IRA, a Qualified Charitable Contribution (QCD), which will reduce their income.
Do the Roth Conversion
Roth conversions are both a tool and a strategy. They are a tool for IRMAA optimization and bracket bumping. They can be a strategy to take advantage of stock market dips, converting and therefore paying taxes as temporarily depressed prices. The simple strategy is to optimize tax brackets or Medicare limits and keep a keen eye for distress in financial markets. That’s the time to strike for big results.
It’s Harvest Season
Look for year-end tax-loss or gain harvesting. Under current tax code, you always pay lower taxes on capital gains than on your earned and ordinary income. Better yet, if you fall into the 12 percent bracket you will pay nothing, zero percent, my favorite tax rate. One strategy involves selling losing investments to offset other gains or even $3,000 of ordinary income. This should be an ongoing not just a year end strategy, but year-end provides the last chance to deploy it. Another less intuitive strategy is to only take gains. If you are in the 12 percent tax bracket, this simple move will free up funds or just reset your tax-basis higher at no cost. That may pay off big later.
The COVID Pull Out
2020 offers a unique year-end move: The penalty-free Coronavirus distribution from pre-tax retirement plans up to $100,000. To be eligible, you or a member of your household must either have been diagnosed with COVID or suffered economic consequences from it. If this is the case, you can remove up to $100,000 from an IRA or participating employer plan without the usual 10 percent penalty if you’re not 59.5. It gets even better. You have three years to put the money back and pay zero income tax, as if you never took it. If you plan to spread it out over three years, the first payback will be due prior to filing your 2020 return in 2021.
Working with my clients, an often-expressed sentiment is that 2021 cannot come to soon. Whether or not that’s the case for you, take a few minutes to reflect on some good things in 2020 and some last-minute moves that might benefit you and your loved ones financially.
Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. He can be
reached at mlynch@barnumfg.com or 203-513-6032.
Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services,LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only,does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should conferwith their qualified legal, tax and accounting advisors as appropriate.