Prepping for the Holidays? Include Your IRAs, Too

Autumn leavesI really don’t like shopping, but my wife, Jill, comes from a legacy of shoppers which has now been passed onto our three teenage girls. So, sometimes parental duties require my involvement, (especially when my credit card is needed). It was Jill’s birthday last week, so off my young ladies and I went to the Mashpee Commons in search of a present for Jill. As we were walking down the main drag of the Commons I saw a sandwich board in front of one of the shops advertising how many shopping days were left until Christmas.

“That’s ridiculous!” I blurted out. “Columbus Day was just last week! We’re not even at Halloween yet.”

My oldest daughter Maeve, now a senior in high school, rolled her eyes at me reproachfully and informed me that Christmas merchandise had been in some stores since before Labor Day. It seems that retailers are getting an earlier and earlier start on the holiday season every year.

Maeve’s assertion was supported a little later that day by our friends Rod and Maddie. They’re an older couple from Sandwich who are retired now but still get around quite a bit. Maddie said that Maeve was correct – she’d seen some retailers staging their Christmas holiday merchandise in August!

Regardless of the holiday cheer retailers are trying to force on us earlier and earlier each year, there is change in the air. Rod and Maddie are feeling it too. Rod told me that he had to push the thermostat up a notch or two now that the nights are getting colder. Whether we like it or not, the end of the year is approaching. Rod and Maddie are looking forward to traveling for the holidays; then they’ll end up in Florida until the weather warms up on Cape Cod next spring.

Rod and Maddie have kids and grandkids spread out from Boston to North Carolina. So they end up doing quite a lot of traveling between now and the end of the year. Between Thanksgiving and Christmas, Rod told me that they only have two weeks where they’re not on the road.

The couple is not complaining, though – with their family so spread out; they know each moment is a precious gift they shouldn’t take for granted. By New Year’s Day, Rod and Maddie will have arrived at their vacation condo in Naples, soaking up the rays and enjoying the pleasant Florida sunshine.

I got to thinking about the encroaching end of the year. I suggested to Rod and Maddie that now is the best time for them to initiate some end-of-the-year housekeeping when it comes to their Individual Retirement Accounts (IRAs). If you’re in the same boat as Rod and Maddie, now’s a good time to make sure you’ve got all your ducks in a row when it comes to your retirement savings.

This year it’s especially important to keep an eye on things because of changes imposed by the Tax Cuts and Jobs Act (TCJA) signed into law last December.

The first order of business, I suggested, was to make sure that they’re set with this year’s Required Minimum Distributions (RMDs) from their IRAs. Rod, who turned 74 this year, knows this routine – he’s already had to do this a few times since he turned 70 ½. But Maddie is a few years younger than him and turned 70 in January, so this is the first year she’s required to take RMDs from her IRA.

Rod and Maddie had, in past years, carefully itemized deductions on their tax returns. The TCJA dramatically increased the standard deduction available to taxpayers – from $13,000 to couples filing jointly like Rod and Maddie to $24,000. The change has simplified their tax filing status, but it’s also hindered their ability to claim charitable contributions.

Rod and Maddie don’t need the income from either of their IRA distributions, even though they’re required to take them because of their ages. So Rod and Maddie can use the Qualified Charitable Contribution (QCD) provision to take contributions directly from their IRAs instead. In this way, they can reduce their tax liability when it comes time to file.

You see, the amount Rod and Maddie contribute using the QCD provision counts not only towards their RMDs, but it also lowers their adjusted gross income for the year. As a result, making a QCD directly from one’s IRA creates an effective tax deduction in addition to the standard deduction. The annual limit is $100,000 per person, per year, but this must be done by the end of the year for it to count.

Wise investment management on Rod and Maddie’s part has caused their tax rate to rise in retirement, compared to what it was while they were still working, as they’ve pivoted from wealth accumulation to wealth distribution. Like some investors in the same boat, they’ve sought to offset this by converting some of their IRA investments to Roth IRAs instead.

Unlike traditional IRAs, you can continue to make contributions to Roth IRAs after age 70 ½. What’s more, Roth IRAs do not impose RMDs, either. Roth IRA withdrawals can be made tax-free, once you’ve reached age 59 ½ or become disabled, and you’ve had one Roth IRA open for more than five years.

Roth conversions are treated as taxable distributions, but federal income tax rates on Roth conversions are presently more favorable than they have been, as a result of the TCJA. They will be at least through 2025, so investors like Rod and Maddie are wise to examine their current status with their tax professionals to see if they can benefit from a Roth conversion.

There’s an important caveat to consider, however: One of the big changes in the TCJA for investors to be mindful of involves the elimination of Roth conversion “recharacterizations” or reversals. This financial tool enabled investors to undo a Roth IRA conversion after the fact. That’s been helpful in certain circumstances, such as when the value of your IRA drops dramatically after you convert it when additional taxable income pushes you into a higher tax bracket, or if you find yourself unable to pay income taxes on the conversion, for whatever reason.

Roth conversions remain an appropriate tool for many investors, but the Tax Cuts and Jobs Act has eliminated recharacterizations starting this year. That means that investors must be extra vigilant to make sure that conversions are planned appropriately and that taxes are accurately projected.

Because of the myriad changes imposed by the TCJA, the IRS encouraged working individuals to update withholding allowances to make sure they don’t underpay or overpay taxes this year. In fact, the IRS set up a Paycheck Checkup calculator on their website to help keep taxpayers on track. But retirees aren’t off the hook, either. Retirees receiving pensions, annuity checks and Social Security payments are also encouraged to make sure they’re taking out enough tax – or they could owe more, and a penalty to boot.

Rod and Maddie are smart investors who have worked hard, saved, and invested appropriately to create a comfortable life in retirement. They are taking the time before the holidays to get into full swing to make sure they’re ready for the end of the year and the years to come.

Like Rod and Maddie, I hope that you’ll be vigilant and stay alert because you deserve more too!

Have a great week!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@old.cutterfinancialgroup.com.

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