4th-Quarter Tax-Planning Tips for Retirees

Susan Dziubinski: Hi, I'm Susan Dziubinski from Morningstar.com. It's hard to believe it's already fall. And that means the fourth-quarter tax-planning season will be here before you know it. Joining me to share some items that retirees should have on their radar in this year's final three months is Christine Benz. She's Morningstar's director of personal finance.

Christine, thanks for joining us today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Now, we're talking about the tax returns that we're going to be filing in April 2020. So why are we talking about tax planning now?

Benz: The issue is that you really have to make your moves to reduce your tax bill in that tax year. So, if we're talking about the return we'll file in April of 2020, well that's for the 2019 tax year. So, if we're going to take any steps to try to lower our tax bill, most of them--with a few small exceptions, like IRA contributions--need to happen in 2019 itself.

Dziubinski: One of the most pressing issues or topics that's top of mind for retirees is required minimum distributions. And you've talked about before how retirees can use RMDs to improve their portfolios. What do you mean by that?

Benz: Well, retirees love to hate their RMDs. Especially a lot of our audience where you've got affluent people, they see that their RMDs cause their tax bills to go up. But the way that you can use RMDs--required minimum distributions--to your benefit if you're subject to them, is to take a look at your portfolio and use the RMDs to withdraw from those assets that were problematic for one reason or another. So, a common situation right now is many retirees are probably a little bit equity-heavy in their portfolios relative to their targets. So, use the RMDs to derisk the portfolio in that spot, pull from that portion of the portfolio or maybe you have some holding that for whatever reason is just problematic. You've had a manager change, for example, and you're not that enthused about it. Well pull your RMD from that fund instead. Use it to improve your portfolio.

Dziubinski: Now, there's also a technique that charitably minded retirees can use that relates to RMDs, right?

Benz: That's right, this is such a great technique. It's called a qualified charitable distribution. And the basic idea is that you can pull up to $100,000 from your IRA, steer it directly to the charity or charities of your choice. And so this is the RMD amount that you otherwise would have taken and spent or reinvested somewhere, you're sending that RMD directly to the charity of your choice. And the benefit is that it doesn't affect your adjusted gross income--it goes directly to the charity. So, it's a particularly great strategy in light of the fact that with the tax law changes, many fewer taxpayers, retirees or otherwise, will be deducting--itemizing their deductions. And so that means that they won't be able to have their charitable contributions count toward that itemized deduction. The QCD, or qualified charitable distribution, is a way to get that charitable giving working for you from a tax standpoint.

Dziubinski: Let's pivot a little bit towards retirees who aren't yet tapping into their, taking their RMDs, and with the tax law changes, what do they need to know sort of about charitable giving now?

Benz: Well, it's trickier because many fewer taxpayers are itemizing. And so one strategy, especially for people who are giving significant amounts to charity is to use what's called charitable bunching, or charitable clumping. And the basic idea is that you are being really deliberate about your charitable giving. You are saving up your contributions and using them in years when you will, in fact, be itemizing. So rather than giving year after year, and giving smaller amounts, you're giving larger amounts in single years and getting some bang for your buck in terms of being able to itemize them on your tax return. The standard deduction, the higher standard deduction, makes itemizing less attractive for many taxpayers at this point. But if you do cluster those charitable gifts together, you may be able to get over that standard deduction threshold.

Dziubinski: Now, what are some other things that retirees need to keep in mind regarding other deductions that maybe they used to be able to take, that they're not able to take anymore?

Benz: Well, that's the tricky part. There are a lot of deductions that may go by the wayside because your standard deduction is higher than you can get with your itemized deduction. My advice is to still save all those receipts for your healthcare expenses, for your property tax outlays, all of the things that may be subject to caps. For example, save it all and take a good look at it at the end of the year. You may be surprised that you're able to exceed the standard deduction thresholds. Don't assume that the higher standard deduction means that you don't have to save those receipts. I would save them and take a tally of what your itemized deductions look like.

Dziubinski: Another ritual in the fourth quarter, usually in December, is what we call mutual fund capital gains distribution season, and they haven't been too pleasant the past couple of years. What do you--what do you think we should be looking for expecting this this year?

Benz: Well, I think it probably will be another tough year, Susan, because a lot of the trends that have fueled these big capital gains distributions are still in place. So namely, you've had a generally pretty good equity market and you have funds, actively managed funds in particular, that have been seeing big redemptions as we've seen investors moving to passively managed products. The net effect of that is that for investors and taxable accounts, well, they've been getting these big capital gains distributions that in turn they own taxes on. I would expect that the 2019 tax year won't be a lot better than what we've seen in the recent past. But I would also urge investors to check their cost basis. If they own one of these, I call them a serial capital gains distributor where you've got a fund that's been doing this year after year.

Well you have been getting a step up in your cost basis to account for the fact that you've been getting this capital gains distribution, and you've had to pay taxes on it. So, you may find actually, when you look at your adjusted cost basis, the things look better than you might think. And that it might not be that bad an idea to sell the holding, if you wanted to sell otherwise, the tax burden associated with selling may not be all that terrible. So, take a look at that, that might be at least a small silver lining if you have had to contend with some of these big distributions in the past.

Dziubinski: So is there anything that we can be doing to lessen the tax pain?

Benz: Well, sometimes investors, try to get preemptive if they see one of these capital gains distributions coming, they might sell preemptively. That can make sense, actually if you wanted to sell the position otherwise, but again, remember that you're contending with two sets of tax costs. One is the distribution and the taxes due upon it. The other is the taxes that are due on your own sale of the security. So again, check your cost basis, if you've been getting the adjustments, selling may not be such a bad idea after all.

Dziubinski: Well, Christine, thank you very much. It does make sense to be talking about taxes now rather than waiting until April, so we appreciate it.

Benz: Thanks, Susan.

Dziubinski: From Morningstar.com I'm Susan Dziubinski. Thanks for tuning in.