What the new tax legislation will look like in the future is anyone’s guess, leaving investors feeling anxious. Covenant Trust talked with Naperville, Illinois tax professional, Linda Kanter, President and Owner of Kanter Tax and Trust Consulting, Inc. who shared some insights to help investors proactively manage their tax situation in 2021 despite the current legislative limbo.
Converting to a ROTH IRA
ROTH IRA conversions are still allowed as of the publication of this article. Converting your 401(k), 403(b) or traditional IRA to a ROTH IRA all at once or as micro-conversions can yield big tax benefits to some investors. 401(k) and 403(b) accounts will need to be converted to a traditional IRA before converting to a ROTH IRA, so extra time will be needed to make the ROTH conversion.
WHAT YOU NEED TO KNOW
- You can convert at any age. Conversions generally make sense for:
- Individuals who don’t need the money right away. Funds converted to a ROTH IRA must stay in the new ROTH account for five years.
- Individuals who are in a low tax bracket (24% or lower). Income tax rates are scheduled to rise in 2026; it’s a good time to take advantage of today’s lower tax rates.
- Individuals who are in a lower tax bracket than their children if their adult children will inherit the retirement assets. There are some exceptions, but most adult children who inherit IRAs or ROTH IRAs are required to empty the inherited IRA or ROTH IRA within 10 years according to the SECURE Act of 2020. This means a potentially large tax bill for beneficiaries if they are in their prime earning years and in a high tax bracket.
- Individuals who are in a high tax bracket but want to pay their taxes now to avoid higher future taxes due on inherited IRAs passed on to children.
- Individuals who want to reduce or eliminate required minimum distributions (RMDs) from their IRAs. Distributing the assets by way of a ROTH conversion avoids ongoing and potentially higher tax payments on those funds since ROTH IRAs do not require RMDs. As you reduce the funds in the IRA, the goal should be to reduce your RMDs.
- Individuals who want to eliminate RMDs and lower their Medicare premiums which are calculated using your annual income amount.
BENEFITS OF CONVERTING TO A ROTH IRA
- You accelerate taking your income at today’s lower tax rate.
- ROTH assets grow and can be withdrawn tax-free.
- ROTH account owners do not need to take an annual RMD.
CAUTIONARY NOTES
- RMDs cannot be converted to a ROTH. Amounts over a taxpayer’s RMD can be converted to a
Roth IRA.
- ROTH conversions count as income in the year the conversion is made. Note that the ROTH conversion could bump you into a higher tax bracket. Sometimes a taxpayer’s income is lower in a particular year which makes ROTH conversions very attractive. Talk with your advisor, look at current income tax brackets, and do the math to determine if converting is right for you.
- Income realized due to a conversion will be factored into your Income Related Monthly Adjustment Amount (IRMAA) and can increase your monthly Medicare premiums significantly. This is where micro-conversions come into play. If you convert small amounts of your IRA to a ROTH IRA annually, you can better control your income and potentially your Medicare premium, too. Take a look at the Medicare Part B income brackets and do the math with your advisor to make the best decision for your situation and consult with your tax advisor.
Taking Traditional IRA Required Minimum Distributions (RMDs)
As we highlighted in our November 11th Holiday Financial To-Do’s blog post, RMDs are back this year and must be taken to avoid penalties. Check if you are old enough to have to take an RMD in 2021.
Harvesting Gains Before Year-end
As in years past, investors can reduce their tax liability by harvesting investment losses on or before December 31. This tax strategy aims to offset capital gains by selling stocks or bonds at a loss, reducing the capital gains taxes you’ll need to pay.
If you still want to own the asset you sold at a loss, you can buy it back, but you’ll need to wait thirty days before doing so. This is called the “wash sale rule,” which prohibits taking a loss on an investment when you buy a “substantially identical” asset within 30 days of the sale. The new legislation may add to the list of assets subject to the wash sale rule in January 2022.
Deducting Charitable Contributions
Leave yourself enough time to transfer charitable gifts of cash, securities and other assets to qualified charities before December 31st. If you itemize, charitable contributions may be deducted from income on your tax form and help reduce your overall tax bill. If you’re not sure to whom you’d like to give a gift, Donor-Advised Funds are a good option for taking the tax deduction now and making the gift decision later.
In 2021, non-itemizers receive a charitable deduction for cash donations made – up to $300 for singles and $600 for married couples filing jointly. Contributions to Donor-Advised Funds or non-cash items do not qualify.
Expect Delays
Like many other businesses, the IRS appears to be very understaffed. 2019-2020 claims are still being processed. Refunds are late coming back to taxpayers. With this kind of significant tax change possible, the IRS is going to be under a lot of pressure. Be prepared for 1099s to be delayed and for 1099B forms to be delivered in early March instead of February. Tax filers may need to take extensions and, most importantly, be patient.
To schedule an appointment with Kanter Tax and Trust Consulting, Inc., contact the firm at 630-632-0097 or reach out to Linda Kanter directly at linda@kantertax.com. Ms. Kanter works as a tax and trust consultant for many investors including Covenant Trust and its clients.
To speak with a Covenant Trust representative about developing an investment strategy that’s right for you, contact Covenant Trust at 800-483-2177.
Disclaimer
The information provided is general in nature, educational and is not a substitute for individual, professional, investment, tax or legal advice. Consult your personal tax and/or legal advisor for specific information. Covenant Trust is incorporated in the State of Illinois and is supervised by the Illinois Department of Financial and Professional Regulation. Covenant Trust accounts are not federally insured by any government agency. Clients may lose principal as a result of investment losses. Kanter Tax and Trust Consulting is also not responsible for losses sustained by anyone relying on this information as personal counsel and assumes no obligation to inform the user of any changes in tax laws or other factors that could affect the information contained in this article.