How much longer will you enjoy the tax benefits from the 2017 Tax Cuts and Jobs Act (TCJA) and the 2019 SECURE Act? It’s anyone’s guess, and it’s critical to squeeze out as much upside as possible before the new Biden administration raises taxes for high-net-worth taxpayers as planned.
Without careful planning, the current tax laws might work against you. These three time-sensitive tax tactics help you avoid creeping into a higher tax bracket — and could result in your lowest taxes for years to come.
STRATEGY #1
Create tax-free income by converting to a Roth IRA while tax brackets are lower
One powerful way to lock in today’s lower effective rate is to convert some of the money in your tax-deferred Traditional IRA to a Roth IRA this year. You’ll owe income tax on the entire amount you convert, which then grows tax-free for the rest of your life.
There are two major potential benefits for converting to a Roth in 2021.
Juice up your retirement funds with a lower tax rate on the conversion, at the same time bypassing probable future tax-rate creep that could have you paying higher taxes in your retirement.
Your Traditional IRA account balance decreases, which in turn potentially shrinks your required minimum distributions at age 72, keeping more of your money in your pocket.
Why now might be a good time to convert: Under the old, higher tax brackets, a married couple filing jointly with an income of $250,000 paid an effective federal tax rate of 23.09%. That dropped to 16.9% under the 2017 tax changes.1 Though the exact numbers are up for debate, we’re likely to see an increase in rates in the near future.
What you need to know before you pull the trigger:
- You might be better off waiting until retirement if you expect a sizable drop in income at that time
- Conversions are now permanent, so unlike previous years you can’t recharacterize if need be
STRATEGY #2
Do more good by amplifying the charitable power of your IRA
Although the required minimum distribution (RMD) age is now 72, taxpayers 70½ and older are still eligible to make a Qualified Charitable Distribution (QCD). Under current rules, up to $100,000 can be withdrawn from your Traditional IRA and sent directly to the qualified charity of your choice, with no tax consequences for you.2
The charity isn’t the only beneficiary of this approach. If you have RMDs this year, you won’t be taxed on the amount you donate. Haven’t started your RMDs yet, but still eligible for the QCD? You’ll shrink your Traditional IRA just as Strategy #1 does, without the taxation on the Roth conversion.
Strategy #3
Overcome the standard deduction limitations
Many taxpayers lost the ability to itemize deductions due to TCJA limitations on state and local tax deductions and the larger standard deduction. We don’t know what future tax changes will mean for your ability to itemize, making 2021 a potentially critical year for deductions.
Fortunately there are several ways you can accelerate expenses and/or deductions into this tax year.
- Stack charitable donations. Rather than granting your usual annual amount, make a larger contribution that covers several years.
- Accelerate or prepay medical expenses before year-end. As a reminder, your medical expenses must be at least 7.5% of your AGI to be deducted. Many expenses can be prepaid, including long-term care premiums, some home modifications, and some Medicare plans.3 Some plans even provide a discount when you pay up front.
- Pay certain taxes this year, for example, your property taxes. If your 2022 taxes are assessed in 2021, you can pay and deduct them in 2021.
Request a personal 1:1 Tax Opportunity Session
About Ember
Ember E. Martin is founder and managing principal at Vested Wealth Advisors, an independent financial planning firm. With over 20 years of investment managing and financial planning experience, plus his CERTIFIED FINANCIAL PLANNER™ (CFP®) credential, Ember strives to help his clients live a high-quality life through customized advice and an unmatched level of personal service and confidentiality. Ember has become known for providing personalized guidance, creative solutions, and results-driven services that go beyond what many have come to expect from traditional financial advisors. When he’s not working, Ember enjoys sharing life with his high school sweetheart, Donna. You can also find him cooking, reading, traveling, hiking, playing chess, and spending time with his two teenage daughters, Lucie and Truly. To learn more about Ember, connect with him on LinkedIn.
SOURCES:
1 – https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020
https://www.irs.gov/pub/irs-prior/i1040tt–2017.pdf
2 – https://www.irs.gov/pub/irs-pdf/p590b.pdf
3 – https://www.irs.gov/publications/p502
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