Since early March, we have been keeping you updated on the Coronavirus/COVID-19 outbreak, with corresponding market volatility, portfolio management/market perspective and this is our response from a financial planning perspective.
In the short term, we know that this is a very difficult time, and that you are likely feeling anxious on many levels. We also know that you are trusting us to remain composed and to advise you based on our experience, research, and analysis; not emotion, speculation, or the 24-hour news cycle. Your financial success still depends on the disciplined execution of a well-reasoned plan. And the past months extreme equity action has presented some unique planning opportunities that may be worth discussing. Before making any changes to your plan we will want to ensure that you:
- Have an emergency cash reserve for up to 6 months of living expenses
- Have three to five years of spending allocated to cash or fixed income as part of your overall portfolio asset allocation
- Will not need the funds you will be investing for three or more years (so that they have time to grow).
Provided those liquidity conditions are met, we see potential value in exploring the following 6 Financial Planning and Tax opportunities:
1. Roth Conversions
With equity market values depressed from the recent tumult, it may make sense to convert all or a portion of your traditional IRA (pre-tax dollars) to a Roth IRA (post-tax dollars). The recent passage of the CARES Act makes this strategy even more attractive. For those subject to the required minimum distribution rules, you normally must withdraw your RMD before you convert any funds to a Roth IRA. The CARES Act eliminates the requirement to take RMDs for 2020, allowing you to initiate the conversion without first having to withdraw your RMD. There are many factors to consider before proceeding with this and your accountant should be involved in this decision to help you weigh the tax consequences. Some of those factors include:
- How the conversion will impact your tax bracket (amount converted is treated as ordinary income and may push you into a higher bracket)
- Whether your increased income from the conversion will impact your income-related healthcare costs (e.g. Medicare premiums and health insurance costs under the Marketplace)
- How you will pay taxes resulting from the conversion (best to use funds outside of the IRA for maximum growth)
With those considerations in mind, the benefits of a conversion include:
- Longer tax-free growth – Since there are no required minimum distributions (RMDs) from a Roth IRA, your account can grow tax-free for a longer period.
- Tax-free withdrawals – Withdrawals from a Roth IRA are not subject to income tax, and this is true for your beneficiaries as well. Although your beneficiaries will be required to take distributions from their inherited Roth IRA, and now with the SECURE Act, they must take their distributions out over a 10-year period (with some minor exceptions), their distributions will still be tax-free.
- Read more about Roth IRA's and see how they compare.
2. Family Gifting
With lower market values, now may be a good time to consider making gifts of stock or front-loading cash gifts to 529 accounts.
- Stock Gifts – Because the value of the stock is lower, you can give more shares away, allowing you to leverage the transfer of wealth to the next generation.
- 529 Contributions – You may contribute up to five years’ worth of annual exclusions gifts ($75,000 per donor per child), provided you do not make additional contributions over the next five years. Front-loading your contributions gets the funds invested into the 529 account sooner and while the market is low.
If you’re a Maine Resident and you open an account for a loved one, you can receive grants with the Next Gen Plan you can receive up to $300 in grants annually
3. Delay your Required Minimum Distribution
As most of us well know, experiencing a negative sequence of returns in the early years of retirement can have very profound and asymmetrically negative consequences on future retirement income. Simply put, it’s hard to stay the course and allow your investments to recover if you need to remove the investment from the retirement account.
The Secure act suspends all RMDs owners and beneficiaries may have due in 2020. It also allows an RMD that was paid to an owner to be rolled-back into the IRA or plan, subject to existing rollover rules. Unfortunately, beneficiaries do not have an indirect rollover option as only direct transfers can be made. Interestingly, IRA or plan beneficiaries currently in a five-year payout will have an additional year (out-in-six) as 2020 no longer counts as an RMD year.
4. Charitable Deductions
In times of crisis, many people turn to charities for aid. The CARES Act does two things to help.
- Allows individuals who do not itemize to deduct up to $300 if made to qualifying charities.
- Increases the 60% of AGI limitation for cash contributions to 100% of AGI for tax year 2020 for those who itemize.
The CARES Act extends each taxpayer a $300 deduction of cash to qualified charities, churches, etc. (not donor-advised funds or supporting organizations) for those who do not itemize for tax returns beginning in 2020. It appears that this change is permanent in the act, although it was initially intended only for 2020. Stay tuned for future guidance from the IRS.
- Read about Charitable Giving Trends
- Have a Rollover IRA? See how donations act as an advantage to your account
5. Fund HSAs, IRAs, Roth IRA’s, 401(k)’s etc...
Make Roth, SEP and or Traditional IRA Contribution for tax year 2019 as the deadline is delayed until July 15, 2020. This allows anyone who receives CARES Act rebates and doesn’t need the additional monies to contribute them to a traditional or Roth IRA, if eligible. If you already fully funded those accounts, you can contribute for 2020. The SECURE Act removed the 70 ½ maximum contribution age for individuals with earned income up to or exceeding the amount to be contributed to their IRA.
6. Pre-Retirement Allocation Rebalancing
With this decline in the market, pre-retirees should review their retirement accounts and consider rebalancing their target equity allocation. As the value of stocks in your retirement account have likely decreased while bonds remained stable, your overall equity allocation is likely reduced. An adjustment will bring you back to your target.
If your retirement is many years away, you might even consider increasing your overall retirement account’s equity allocation, following an asset-liability framework that considers your Required Minimum Distribution start date. Under the new SECURE Act, anyone born after July 1, 1949 does not have to take RMDs until age 72. With an asset-liability matching framework, any funds needed within two years should be invested in cash and short-term bonds, while funds needed within three to five years should be invested in intermediate-term bonds. For any funds not needed for five or more years, the investment objective should be growth, with an emphasis on stocks.
We are committed to guiding our clients through these trying economic and social times. As always, we welcome the opportunity to discuss these options as well as any other issues or concerns you might have.
This newsletter is intended for educational purposes only. For financial planning advice specific to your needs or for further information, please consult your financial advisor. Securities and advisory services offered through Registered Representatives of Cetera Advisors LLC, member FINRA, SIPC, a broker dealer and registered investment advisor. Cetera is under separate ownership from IIS Financial Services.
Image credit: “image-asset” Oregon Community Credit Union, 2019, https://www.myoccu.org/sites/default/files/component-image-block/home_personal_invest_financialplanning_block_940x500.jpg