Year-End Taxes for Retirees

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Christine Benz: Hi, I'm Christine Benz for Morningstar. We're coming into the home stretch of 2020, and that gives retirees a little bit more time to improve their tax position for the year. Joining me to share some strategies on that front is Tim Steffen. He is advisor education senior consultant for Pimco.

Tim, thank you for being here.

Tim Steffen: Thanks, Christine.

Benz: We have this hiatus on required minimum distributions for 2020. Let's talk about what had been a vexing question for some investors who took their RMDs early. What are their options if they want to get the money back into the account?

Steffen: Whenever you take money out of an IRA, you always have a 60-day window in which you can return that money to the account, assuming you hadn't previously done one of those 60-day rollovers in the prior year. So, if you haven't done one of those in the past, you've always got a 60-day period to put that money back. Because the rules on waiving RMDs came out a little bit later in the year and many people had already passed that 60-day window, they did offer a blanket extension for everyone to be able to put the money back. That expired, I believe, at the end of August. So, that window has also passed. So, if you're somebody who took money out of an IRA and you didn't get it back during one of those windows, you may still have one option left to be able to return that. And again, this is something that came out of the CARES Act earlier this year. It's called a coronavirus-related distribution.

Basically, what that is, it's an opportunity to take money out of an account penalty-free and be able to spread the income over up to three years or either tax it all in the current year or tax it in equal parts over 2020, 2021, and 2022. But then, the relevant part here in this case is that you can also return that money back to the IRA as long as you do so within three years of the date that you took it out. So, people who took money out of their IRAs earlier this year, anticipating RMDs, didn't get it back in time for any of the other deadlines may qualify for this coronavirus-related distribution rule, which would allow them to put the money back. It's not a blanket thing. You have to have been somebody who was impacted by the virus. You were sick, a family member was sick, your business shut down, you lost your job, your kids couldn't go to school, you lost daycare, or something like that. There's a number of exceptions, and they're fairly loose, it appears, but that may be an option for somebody who wants to put money back into the retirement account that didn't do it earlier in the year.

Benz: Good to know. Many retirees do find themselves, because there aren't any required minimum distributions, in what maybe a temporarily low tax bracket for 2020. What strategy should they be considering to potentially take advantage of that?

Steffen: This may turn out to be a lower year for people who weren't forced to take money out of their IRAs and therefore didn't take it. Some people may have still taken money out because they needed it to live on. It just wasn't an RMD this year. But if you were somebody who didn't need to, so you didn't need the money so you didn't take anything out, yeah, this could be a relatively lower income year for you.

So, take advantage of that. That's an opportunity for you to maybe do some extra planning. A couple of things you would consider would be pushing some deductions out of this year into a year where they might be taxed or provide you a larger tax benefit. We can talk more about some of that in a bit. But the other opportunity that's out there is you're in a low bracket, take advantage of being in that low bracket. Who knows when you'll be back in there again? Maybe recognize some additional income. That might mean you have the opportunity to recognize some capital gains at a lower tax rate than you might ordinarily, maybe even as low as the 0% that's out there.

The other thing that people are considering is Roth conversions. Roth conversions have gotten a lot of talk this year because of some provisions that came out of the SECURE Act and some other things that have made them a little bit more attractive, but they really make a lot of sense in years when your income is artificially low. In other words, lower than it might be in a normal year, and you can take advantage of doing a conversion at a lower tax rate. So, that would be a real strong one for people to consider that want to take advantage of these lower income years.

Benz: Good to know. Now, let's talk about the qualified charitable distribution. That is still an option in 2020 even though there aren't any required minimum distributions. And in the past, those two things have kind of gone hand in hand. Can you walk us through that and when you might consider that QCD even though you don't have to take a required minimum distribution?

Steffen: Let's just do a quick explanation what the qualified charitable distribution is. This is that rule that came out several years ago that allows people to take money directly from an IRA and transfer it to a charity. You don't give it to yourself and then to the charity. You don't reimburse yourself for gifts you previously made. It goes right from the IRA to the charity. When that happens, you don't have to report that as a withdrawal from the IRA. You don't get a tax deduction for that gift either, but based on some of the newer tax laws, very few people itemize their deductions anyway. So, you might not have been getting a benefit for that charitable gift to begin with, but the money goes directly from the IRA to charity. And then, a couple of the benefits are--we talked about it's not taxable. It can also account toward your required minimum distribution for the year. So, those who are subject to RMDs could take the money out and have that count as their RMD.

Now, a couple of big things that have changed in that: One is the RMD age was moved up to 72. That was a change in the SECURE Act from last year that did not impact qualified charitable distributions. Those can still be made once somebody turns 70.5. Important note: It has to be after you turn 70.5, not the year you turn 70.5, but after that day. You can still do a qualified charitable distribution even if you're under the RMD age.

The other thing, as you said, there are no RMDs this year. So, if there's no RMD, does it make sense to do a qualified charitable distribution? I would say, in some cases, yes it might. For example, if you're somebody who doesn't itemize, you want to give money to charity, but you're not somebody who takes the itemized deduction, you're going to use the standard deduction. In that case, you don't get a tax benefit for your charitable gifts. So, a qualified charitable distribution is a way to move some money out of the IRA on a tax-free basis. So, maybe take advantage of that.

The other group that might benefit from doing a QCD would be the opposite of that first group. These are people who give a lot of money to charity and are exceeding some of the thresholds on deducting. Remember, you can only deduct or only offset a certain percentage of your income with charitable gifts, depending on what you give. Somebody who's over those thresholds could maybe use the qualified charitable distribution to move even more money out of their IRA to charity. That can be a great opportunity for folks to still get some tax benefit for their charitable gifts when they might not have otherwise done so. And the fact there's no RMD this year? Doesn't mean you can't do it. It's still a great opportunity for some folks.

Benz: Good to know. The last thing I want to cover with you, Tim, is estate planning. What kinds of things should be on retirees' radar as they're thinking through their estate plans, which often go hand in hand with tax-planning considerations?

Steffen: Sure. Well, as we get to year-end, the one that always pops to mind is the annual gift exclusion. That amount is $15,000 this year. So, that's the amount that any individual can give to any other individual with no tax consequences at all. It's $15,000 this year. We just found out it's going to be $15,000 again for 2021, so no change in that amount over these two years.

Another thing to think about as we get toward year-end, and this is a direct result of what came out of the SECURE Act about a year ago, is review your beneficiary designations. The impact of beneficiaries of retirement accounts--the rules have changed dramatically. So, it's really important you understand exactly who the beneficiaries are in your retirement plans because their ability to access that money during retirement has changed. You want to avoid things like "will" or "estate" or having no beneficiary. Or maybe you've got a beneficiary, but you don't have a successor. So, all those things are important. Review your beneficiary designations on your retirement accounts plus your life insurance and anything else, your transfer on death accounts, all of those should be reviewed.

It's a good time to look at all other aspects of your estate plan as well. Take a look at things like powers of attorney, living wills, healthcare directives--especially important this year with all the talk about illness and flu and all that--really make sure your healthcare directives are up to date and current with your family situation, where you live, all of those kind of things.

And then, of course, we've got the potential for maybe some law changes coming in next year under the Biden administration. There's been talk about some fairly significant changes to the estate tax rules, a dramatic lowering of the lifetime exemption. Currently, it's roughly $11.5 million per person. There's been talk that might fall to as low as $3.5 million, plus the tax rate could go from 40% up to as high as 45%. And maybe we lose the basis adjustment at death that we've all come to rely on for wiping those capital gains out upon the death of an investor.

There's a lot of things that are on the table that could happen next year. A lot of uncertainty as to whether any of those are going to happen. So, when it comes to estate planning, what I tell folks is, take care of some of the basic blocking and tackling, the gifting, the beneficiary designations. The big things, really think carefully about that, because of the uncertainty with the estate tax law changes. You don't want to do anything that's too permanent that you can't undo because we don't know exactly what the rules are going to be in the future. So, be aware of them, talk to your estate attorney, get their take on things, and then figure out what makes sense for you. Maybe you can find a nice strategy in the middle somewhere that lets you take advantage of some potential changes without being too big of a commitment on your side, but definitely worth taking a look at.

Benz: Tim, always great advice. Thank you so much for taking the time to be here with us.

Steffen: Thanks, Christine. It was great to see you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.