As bad as it has been financially for many individuals, 2020 does provide some unique tax opportunities for those who have traditional IRA accounts. These range from converting traditional IRAs to Roth IRAs, retirees making larger-than-normal IRA withdrawals and the decision whether to take advantage of the required minimum distribution suspension for 2020. Let’s look at these prospective tax strategies to see if they might apply to you.
Conversion of a Traditional IRA to a Roth IRA
The first opportunity to explore is converting your traditional IRA account to a Roth IRA account. The reason you might want to do that is a Roth IRA provides tax-free accumulation and, once you reach retirement age, tax-free distributions. A traditional IRA provides tax deferral of earnings, and the distributions are taxable.
Since distributions from a Roth IRA are not taxable but those from a traditional IRA would be, you generally pay tax on the amount converted (after all, the government isn’t going to allow both the tax deduction when contributing to a traditional IRA and tax-free withdrawal from the Roth on the converted amount). Thus, a conversion provides the most benefit in a year when your income is low, and as a result, you receive a lower tax rate. Timing is key, and 2020 may be a low-income year when you might find it appropriate to convert some portion of your traditional IRA to a Roth IRA.
Conversions can be tricky, and once made, they cannot be undone. If you reside in a state with state income tax, the conversion may also be taxable by the state. If you are considering a conversion, it might be appropriate to call for an appointment so that this office can help you analyze your conversion options properly or develop a conversion plan that fits your particular circumstances.
Required Minimum Distribution Suspension
For 2020, the government has suspended the requirement for certain older* taxpayers to take required minimum distributions (RMDs) from their retirement plans and traditional IRAs. Just because the requirement to take RMDs has been suspended doesn’t mean you shouldn’t take a distribution in 2020.
That decision should be based on two issues:
(2) Secondly, sound tax planning.
Generally, this strategy is for individuals older than 59.5 and not subject to the 10% early withdrawal penalty. However, there are times when paying the 10% penalty may even be worth it for younger individuals when the tax saving is large enough.
It is important to understand that we are talking about retirement funds; just because they can be gotten out of a traditional IRA or qualified plan for a low tax doesn’t mean they shouldn’t be set aside in a savings account for future retirement needs.
These opportunities are easily overlooked, and it can be complicated to figure out the conversion or distribution amount to optimize the tax benefits. If you have questions or would like this firm to assist you in determining the strategy that best fits your needs, please give this office a call.
*If not for the COVID-19 suspension, 2020 RMDs would be required by taxpayers who turned age 70½ prior to 2020 or reach age 72 in 2020.