Monday, October 29, 2018  |   Email   Print

Seven Year-End Retirement Planning Strategies

We’re getting close to the time of year when advisors can really show clients their value, especially when it comes to retirement and tax planning. It’s a time when a lot of poor decisions can be made about required minimum distributions, asset appreciation and Roth conversions. Important exemptions are forgotten. People confront penalities for bad behavior. They miss deadlines and important opportunities on things like charitable deductions.
Advisors can demonstrate their value as the year winds down by addressing these seven items in particular.
 
1. Required minimum distributions (RMDs). This is an annual IRA ritual well known to financial advisors, but I still get the calls when the distributions fall through the cracks or there are computational errors. Remember that clients who miss their required minimums get hit with a costly 50% penalty on any distribution amount they should have taken.
 
It’s true that the penalty can often be waived by the IRS. But who needs that anxiety in the first place?
 
Advisors should know every client who is subject to RMDs by year’s end. You’ll have your regulars—those clients over 701/2 years old who take their RMDs each year. But you should also look out for other clients who may fall into this category who might not be as obvious, including those who fall into the category for the first time. This group includes newcomers to the 701/2 club, or sophomores who suddenly have two RMDs this year (their first and second) and required distributions for IRAs or Roth IRAs that they have inherited (these include trusts that are IRA beneficiaries). Roth 401(k)s are also subject to required minimum payouts (though Roth IRA owners aren’t).
 
2. Qualified charitable distributions. The Tax Cuts and Jobs Act of 2017 gave taxpayers help in the form of an expanded standard deduction. But at the same time, many clients will now no longer be able to deduct their charitable contributions because they will probably not itemize their deductions. If your clients with IRAs subject to a required minimum distribution have not yet taken it for the year (which is likely since many clients take their RMDs near year’s end), contact them immediately to advise them to use the qualified charitable distribution (QCD) provision and make their contributions directly from their IRA.
 
The amount contributed will count toward your clients’ RMD and be excluded from income, creating an “effective” tax deduction in addition to the standard deduction. The QCD only applies to IRAs, not to plans, and only IRA owners or beneficiaries who are at least 701/2 qualify. Donor-advised funds and private foundations are not eligible for the qualified charitable distribution, and nothing can be received in return for the gift. The annual limit is $100,000 per person, per year.
 
If your clients are contemplating a onetime large donation, they can still do the QCD even if the gift exceeds the required minimum distribution amount, as long as it stays under the $100,000 limit. In this case, giving more than the RMD removes more IRA funds that will then not fall under income. QCDs also lower adjusted gross income, which in turn may help you with other tax benefits or deductions. Qualified charitable distributions lower tax bills. But to count for 2018, a QCD must be completed by year’s end.
 
3. Roth conversions. The biggest IRA planning change in the new tax law was for Roth conversions. Beginning in 2018, conversions can no longer be reversed. They will be permanent and the tax will be due once the funds are converted. Roth conversions are still valuable for the right client, but now any conversions contemplated for 2018 must be carefully planned and the tax bill accurately projected. Unlike an IRA contribution, which you can make until April 15th of the next year, to qualify for a Roth conversion this year the funds must leave the IRA or plan by year’s end.
 
Advisors must also take other new tax changes into account when projecting the tax on a Roth conversion, in addition to the usual items such as the taxability of Social Security, increases in Medicare Part B and D premiums, the effect on financial aid for students, etc. Some clients will lose big state tax deductions this year (they were capped at $10,000), and the increased standard deduction may not make up for the loss. Don’t count on big casualty losses either to reduce the tax bill on a Roth conversion, unless they are in a federally declared disaster area. In addition, all of the 2% miscellaneous itemized deductions are gone.
 
For your business clients, check the effect a Roth conversion might have on the new 20% deduction for qualified business income (the Section 199A deduction). While these might be reasons to avoid a Roth conversion, they are only short-term blips in tax planning, because the additional taxes would only be for the year of the conversion. But these issues still need to be addressed before a client commits to a Roth conversion that can no longer be undone.
 
4. Check estimated taxes on RMDs (use withholding). Check to see if clients that may be new to RMDs had enough money withheld or paid in through estimated tax payments to avoid penalties. If these clients came up short on their payments, consider withholding taxes from year-end IRA distributions. The tax withheld is deemed to be paid evenly throughout the year and satisfies the estimated tax payment timing requirements.
 
We have done this as a regular year-end item with our RMD clients when the distribution is the main item requiring quarterly estimated tax payments. We have clients withhold the projected tax due for the year from their required distribution, and they love avoiding the quarterly estimates. Advisors should coordinate with their clients’ tax advisors to see if the IRA withholding can be used to cover other income items during the year. The reason the IRA withholding works so well is that this RMD money is not usually needed. The required minimum distribution often goes right to an investment account. So rather than write tax checks during the year, do it through IRA withholding.
 
Another instance where this has paid off for us is with older or infirm clients who may not be making the required estimated tax payments with the vouchers we send them. In one case, an elderly client of ours could no longer handle making the estimated tax payments and had his son take care of it. But the son was busy and would sometimes make the payments late or not at all—or lose the payment vouchers we sent. Taking withholding from the IRA distribution really helped make this easier for the family, and it eliminates penalties and additional taxes due at tax time. In some cases, we increase the withholding tax to cover not only the year’s tax liability, but also the first quarter of the next year, which means there’s no balance due by April 15th. This eases pressure on the clients.
 
4. Check estimated taxes on RMDs (use withholding). Check to see if clients that may be new to RMDs had enough money withheld or paid in through estimated tax payments to avoid penalties. If these clients came up short on their payments, consider withholding taxes from year-end IRA distributions. The tax withheld is deemed to be paid evenly throughout the year and satisfies the estimated tax payment timing requirements.
 
We have done this as a regular year-end item with our RMD clients when the distribution is the main item requiring quarterly estimated tax payments. We have clients withhold the projected tax due for the year from their required distribution, and they love avoiding the quarterly estimates. Advisors should coordinate with their clients’ tax advisors to see if the IRA withholding can be used to cover other income items during the year. The reason the IRA withholding works so well is that this RMD money is not usually needed. The required minimum distribution often goes right to an investment account. So rather than write tax checks during the year, do it through IRA withholding.
 
Another instance where this has paid off for us is with older or infirm clients who may not be making the required estimated tax payments with the vouchers we send them. In one case, an elderly client of ours could no longer handle making the estimated tax payments and had his son take care of it. But the son was busy and would sometimes make the payments late or not at all—or lose the payment vouchers we sent. Taking withholding from the IRA distribution really helped make this easier for the family, and it eliminates penalties and additional taxes due at tax time. In some cases, we increase the withholding tax to cover not only the year’s tax liability, but also the first quarter of the next year, which means there’s no balance due by April 15th. This eases pressure on the clients.
 
5. Split inherited IRAs by year’s end. If your client, an IRA owner, died in 2017 and had multiple individual beneficiaries named on a beneficiary form, then they can each use their own life expectancy for calculating required minimum distributions (the stretch IRA) if the inherited IRAs are split into separate shares before the end of this year. Make sure this is done, otherwise the beneficiaries will be forever stuck using the age of the oldest beneficiary, even if they split their shares in a later year. The split must be done by the end of the year after the IRA owner’s death.
 
6. You should know how to time a 10% penalty exception. If any of your clients had to withdraw early from their IRAs, they may qualify for an exception to the 10% penalty. If they do, the payment qualifying for the exception must be made in the same year as the IRA (or plan) distribution. This is sometimes missed at year-end, which voids the exception and forces your clients into a 10% penalty that could have been avoided. This would likely affect those who needed the money and cannot afford that penalty on top of their tax bill.
 
For example, let’s say you have a client named Maria, age 52, who needs to pay a college tuition bill for her son by the end of the year. She charges the tuition on her credit card in December 2018, and then in January 2019, when the credit card bill comes in, she takes an early distribution from her IRA, thinking she qualifies for the education exception for the 10% early distribution penalty for IRAs (the education exception does not apply to company plan distributions, only IRAs). But she does not actually qualify.
Maria will still owe the 10% penalty because the payment of the tuition (charged and considered paid in December 2018) and the January 2019 IRA distribution were not in the same year.
 
Check to make sure that clients who took an early withdrawal that would qualify for an exception from the penalty will actually qualify and not run afoul of this “same year” rule. It may sound arcane, but there have been several tax court cases on this point where the penalty exception was lost.
 
7. Check the status of lump-sum distributions for the net unrealized appreciation tax break. The tax break for net unrealized appreciation (NUA) in employer securities can cut a client’s tax bill dramatically. This tax break is for clients who own their own company’s stock in their 401(k). If that stock is highly appreciated, it can qualify for the lump-sum distribution tax break on net unrealized gains. This will be triggered by some event—the employee leaves the company, reaches age 591/2, dies or becomes disabled—at which point all the company plan funds must be distributed in one year (any year after the year of the event). If you have a client that may qualify for this big tax break this year, check to make sure that all plan funds have actually been withdrawn before year’s end. Non-company stock funds can be rolled over tax free to an IRA and the company stock goes to a taxable account. Tax at ordinary income tax rates is paid on only the cost of the stock and the appreciation is not taxed at all until the stock is sold. When it is, the net unrealized appreciation is taxed at the lower long-term capital gain rates, regardless of how long the stock was held.
 
Finally, while you are doing your annual RMD checkup for clients, check their beneficiary forms for all of their retirement accounts, even those you are not currently managing. Beneficiary form problems are rampant and costly. Providing this kind of valuable service may plant the seed for clients to eventually move all of their accounts to you. 

 
Ed Slott is a CPA and recognized retirement tax expert and the author of many retirement focused books.
 

 

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