We have had our share of political conversations around the Cutter supper table lately, and it’s not uncommon for Maeve, Phoebe, and Sophie and Jill and I to have some opposing views. But regardless of political affiliation, I always enjoy the opportunity to engage with them intelligently on the issues that affect our lives. Our most important rule for these discussions is that all of our opinions matter, not just some, even if we don’t agree with each other. I try to teach my kids it is ok to disagree with others . . . just don’t be disagreeable.
As the COVID-19 panic continues to shake up the economy, by extension it may be profoundly changing the outcome of the 2020 elections. It’s certainly giving us more topics for these supper-time talks. Recently, a number of national polls show the Republicans and President Trump fighting an uphill battle against negative unemployment numbers and market volatility brought on by the pandemic. There have been only two incumbent US Presidents in the last 125 years to lose their re-election campaigns. One was a Democrat, Jimmy Carter, and one was a Republican, George H.W. Bush. What they had in common was they were both presiding over a US economy in recession.
This turn of events has me thinking quite a bit about how the presumptive Democratic nominee, Joe Biden, might affect our tax situation if he happens to win the election later this year. Conventional wisdom and history say Republicans typically lower the overall tax bill and Democrats, like Biden, tend to raise the overall tax bill for most folks. This is just one reason why some are questioning what a shift in political power in our nation’s Capitol might mean to their pocketbook, both now and in retirement.
A high-level look at the presumptive Democrat nominee, Joe Biden, shows three key areas where he has expressed the need to raise taxes on individuals. He wants to raise the higher marginal tax brackets; he wants to change the way capital gains taxes are treated; and something that could impact far more people is the elimination of the step-up in basis for those who inherit assets. And with the winds of change swirling inside the Democratic party, Mr. Biden may not stop there.
Donald Trump, the Republican nominee, has not yet published guidance on his plans for taxes or the economy, should he win a second term. However, he did sign The Tax Cuts and Jobs Act (TCJA) in December 2017, which reduced statutory tax rates at almost all levels of taxable income and shifted the thresholds for several income tax brackets. The majority of individual income tax changes are temporary, however, and are expected to expire on December 31, 2025.
In my opinion, this 2025 deadline is one of the primary reasons someone might consider converting from a traditional IRA to a Roth IRA soon, in order to take advantage of the current low tax rates implemented under President Trump. If a conversion is appropriate for you, the end result should be lower taxes paid in retirement. As an added bonus, you are no longer required to take an RMD (Required Minimum Distribution) from those funds when you reach age 72.
You see, with a Roth IRA you fund the account with post-tax dollars and any funds withdrawn in retirement typically come out tax free (assuming you are age 59-1/2 or older and the account has been open for at least 5 years). Traditional IRA’s, on the other hand, are funded with pre-tax dollars. Essentially, you receive a tax deduction in the year of each contribution, and the funds are taxed as they are withdrawn in retirement.
So, to successfully convert a traditional IRA to a Roth, there are specific IRS rules that must be followed in order for the conversion to be considered legitimate. These rules dictate that you cannot take “controllable receipt” of the funds. In simple terms the transfer of funds must happen in a timely fashion.
What typically makes people reluctant to pursue a conversion to a Roth IRA is the fact that they will face a tax bill on the money moving out of their traditional IRA in the year of the conversion. However, despite the initial tax hit, this is a long-term strategy that may still make sense for many folks. At a minimum, the general climate of ordinary income taxes going up probably makes it worth taking a look at a conversion.
There are a few unique circumstances that may make a Roth IRA conversion more appealing right now. For example, if you’ve experienced a job layoff or reduction in income this year (which many folks have as an unfortunate result of the current pandemic), you may find yourself in a lower tax bracket, which could reduce the tax on any converted funds. Also, a decline in your traditional IRA value may allow you to realize an investment loss, further reducing your tax hit.
Now, I’m not suggesting that a Roth IRA conversion is not right for everyone. For example, if you are going to need the money in the next five years you may run the risk of IRS penalties and taxes on distributions prior to the five-year limit. Also, if the rollover amount bumps you into a higher marginal tax bracket for the year of the conversion, the amount of the increase may lessen the appeal of a conversion. So please ensure you reach out to a qualified retirement specialist to understand the questions you need to be asking yourself to see if a conversion is right for you.
Folks, this is just one of many financial considerations we need to be aware of as we enter this election season. Given the potential for significant differences in the economic and taxation policies of the Democratic and Republican candidates, we must be ready to adapt our financial systems to ensure our long-term retirement success.
So as always – be vigilant and stay alert, because you deserve more!
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at jeff@cutterfinancialgroup.com.
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