As we approach year-end, we want to highlight a few planning items that may make sense for your personal financial situation. You may want to touch base with your financial advisor to discuss the applicability of the items below.
Planning Item 1: Strategic Roth Conversions
Given movements in the market this year and depending on your current financial picture, it may be prudent to convert your traditional IRA (or a portion) to a Roth IRA. Strategic Roth conversions are the transfer (or conversion) of pre-tax dollars in a tax-deferred plan such as an IRA or 401(k), to a tax-free Roth IRA account to maximize after-tax wealth. What makes it strategic is to make these conversions in low tax years or when values of pre-tax assets have declined to maximize the value of the conversion. The goal is to maximize lifetime wealth by reducing taxes over your lifetime. This may be very attractive for people who have retired but are not yet taking minimum distributions from retirement accounts and/or Social Security.
A reason why this is an attractive time is that the value of the IRA assets may be lower than they used to be at the beginning of this year, thus, the cost of converting them to Roth IRA assets from a tax standpoint has declined. You are getting a bigger bang for your buck for your converted pre-tax dollars because of the market decline. By converting, the assets move from an account that will be taxed at ordinary income rates in retirement to a tax-free account. In addition, if you are finding yourself in a lower tax bracket this year than previous years, the effect of making Roth conversions also becomes less costly. If you are in retirement, you want to ensure you are planning around income tax brackets as well as income-related monthly adjustment amount (IRMAA) brackets (premiums associated with Medicare Part B and Part D).
David McClellan, a Forum partner, recently completed a 7-part series of articles with Kiplinger around retirement planning specifically around tax pitfall avoidance and Medicare.
Planning Item 2: Required Minimum Distributions (RMDs) for Inherited Traditional IRAs
We are waiting for clarification from the IRS on a proposed ruling on distributions from inherited IRAs for certain non-spousal beneficiaries where the owner passed away on or after 1/1/2020. The SECURE Act of 2019 required beneficiaries to withdraw the full balance of an inherited traditional IRA within 10 years after death. Initial interpretation of that rule was that you could take those distributions at any time during the 10-year period. Nothing is finalized as of this writing, but there is some indication the IRS may require annual minimum distributions during the 10-year period. The IRS recently indicated there would be no penalty for not taking a distribution in 2022. We are hoping to receive final guidance before year-end on distribution requirements going forward.
You may need to consult your accountant as we approach year-end, and it would be prudent to talk with your financial advisor as we get more clarity from the IRS as to what, if any, distribution from your inherited IRA may need to be made this year if you are affected by this change. We will definitely reach out to those affected when a decision is announced.
Planning Item 3: Tax-Loss Harvesting
Given current market trends, your portfolio may have losses that, if realized, could potentially be used to reduce taxes. Tax-loss harvesting is putting this strategy to work — deliberately selling positions in the portfolio that are at a loss to save on current taxes.
Loss harvesting may make sense if you expect to be in an unusually high tax bracket this year or took large gains earlier in the year. It may also make sense if you expect either of these things in future years — $3,000 in losses can be used to offset ordinary income every year and the balance can be carried forward indefinitely to offset future gains. Keep in mind that loss harvesting only makes sense in taxable accounts, not in retirement accounts.
There are also many times when it does not make sense. If you are currently at a lower tax bracket than you may be in the future, there may actually be negative value for the loss harvest. Also, if you are only recognizing losses on a small part of an asset class holding (e.g., international stocks), those same tax lots eventually are likely the ones you would have sold for withdrawals or rebalancing, which means the tax-loss harvest did not gain you anything long term and potentially created transaction costs today.
Please talk to your financial advisor and accountant to discuss whether this could make sense for you.
Planning Item 4: Timing on Charitable Giving
Despite the market downturn, worthy nonprofit organizations nationwide still need support from donors to fulfill their missions. For clients who wish to support their favorite causes, you may wish to keep the following in mind to maximize the impact of your philanthropic dollars for yourself and for the charities you support:
- If you are over age 70.5, consider making your charitable gifts from your IRA, a strategy known as a qualified charitable distribution (QCD). Individuals can distribute up to $100,000 per year from an IRA to charity, and any QCDs are excluded from taxable income. If you are also subject to RMDs from an IRA, any QCDs count toward that minimum. Note that charities must receive and process the QCD before December 31 to count for 2022.
- Long-term investors likely have highly appreciated securities in their portfolio. Those securities can be donated to charity more tax-efficiently than gifts of cash. You are eligible for a charitable donation at the full fair market value of the securities on the date of the gift, and you avoid any capital gains that would otherwise have been taxed.
Note: Be mindful not to donate securities that have lost value. Instead, sell those shares to harvest the loss and donate the cash proceeds.
- With many taxpayers taking the standard deduction on their tax returns, they receive no tax benefit from charitable contributions. It might make sense to “bunch” several years’ worth of contributions into one year to be able to itemize your charitable contributions on your taxes. Consult with your accountant to determine how much you would need to donate to exceed your standard deduction for this year.
- If you are not sure which organizations to support but you would like to receive a charitable deduction in 2022, consider opening a donor-advised fund before the end of the year. These can be funded with cash or securities and offer tremendous flexibility to your charitable giving. You are eligible for the charitable deduction when you donate to your donor-advised fund, and you can later decide which organizations to support out of that fund. The balance of your donor-advised fund is invested for future growth, which can greatly enhance your giving capacity down the road.
- With interest rates on the rise, certain charitable trusts are offering higher charitable deductions than before. These complex but powerful vehicles can be used to diversify a concentrated stock holding or defer capital gains on the sale of investment real estate, while making a significant charitable contribution at the same time. Contact your financial advisor for more information on whether a charitable trust is right for you.
As you consider your year-end giving, be sure to complete any gifts before December 31 and obtain a donation receipt letter from each charity to substantiate your generosity.
Planning Item 5: IRMAA Appeal Process
If you recently turned 65 and applied for Medicare, you may have been surprised to receive a letter in the mail regarding your IRMAA premium increase. Several years ago, a premium surcharge for Medicare Part B and Part D was implemented based on the modified adjusted gross income on your tax return two years prior to the current year. The surcharge starts at income levels of $91,000 for those filing single and $182,000 for those filing jointly (2020 income levels for 2022 premiums) and there are breakpoints at 5 different income levels.
You may not know that if your income or marital status has changed, you can file an appeal and receive a reduction or elimination of the surcharge. Common reasons for a change in income are retirement or a reduction in employment income, a large capital gain in a prior year or reduced rental or other investment income. You will need to attach documentation — it is a fairly straightforward process with a quick resolution. The appeal form is found on the SSA website and is Form SSA-44.
In addition to appealing the surcharge, it may make sense to implement some tax planning moves to offset the impact or at least plan around it. Your financial advisor can help you navigate your options.