As I notice that two of my clients turn 70 today, I am reminded of two planning opportunities that are worth mentioning. Each became more useful after the new tax bill went into effect on January 1st of this year. With strategies that aren’t particularly new, two changes in the tax code: the increase of the standard deduction, and the lowering of overall rates have opened new windows of opportunity
income was the 25% bracket and above that was 28%. A Roth conversion is most beneficial when you can convert traditional IRA assets at a lower tax rate than they would later be drawn as a Required Minimum Distribution (RMD).
What do the new tax brackets look like in comparison? It is a little confusing to look at, but for a married couple filing jointly the bracket shift is dramatic. Below is a table of the amount of money that found new brackets within the new law.
Amount of Money that is Taxed at a Lower Rate in the New Law
If you had no other income, converting as much as $ 170,000 of IRA to Roth is $7,000 less expensive than it was in 2010. It is a bit involved to test whether this is a good idea for you. We must look at your current tax bracket, IRA balances, and age to develop some assumptions about what taxes you will pay in the future after the RMD kicks in. My recent experience has shown a great deal of opportunity though.
For taxpayers that are under 70 ½, who make too much money to contribute to a Roth (phase-out begins at $189,000), there is also a strategy known as the backdoor Roth. The backdoor Roth requires two steps. The first is to make a traditional IRA contribution. Depending on your income and if you have an employer-sponsored plan available this contribution might not be tax deductible. Also, if your spouse doesn’t have employment income, but you have enough to support both contributions, you may “double up” and create a second spousal IRA. Once the IRA/s are established, you may do a Roth conversion of the traditional IRA account/s. Of course, any pre-tax money in the IRA will be taxable with the conversion.
To be fair, the second opportunity may be more of a workaround than opportunity because of the new tax law. There have been big changes to who will want to “itemize” on schedule A versus take the standard deduction. The two biggest changes are that the standard deduction is much higher now than last year. It nearly doubled for a couple filing jointly to $24,000. Along with this change is a controversial $10,000 cap on “SALT” (State And Local Tax) deductions on your schedule A. Prior to these changes more than 30 percent of taxpayers could itemize each year, and it is estimated that this number will fall below 10 percent under the new law.
And, what does that mean to me? For taxpayers over 70 ½, that were in the original 70% of people filing non-itemized returns, or have found themselves in the new larger group that can’t itemize because of the new tax law, there is a Qualified Charitable Distribution (QCD). Beginning in August of 2006, the QCD was introduced for one year. Subsequently, it lapsed, was reinstated retroactively, was then extended through four different tax acts, but considered “touch-and-go” until it was made permanent in December of 2015.
A QCD is a distribution directly from your IRA to a “qualified charity”. The best part is that the distribution is not taxed, but it counts towards your RMD. While it has been discussed, the QCD cannot fund a Donor Advised Fund, private foundation, or split-interest trust. Currently, the QCD can only fund a “public charity” (as described in IRC Section 170(b)(1)(A)). The last limitation is that the QCD cannot exceed $100,000.
If you find this intriguing, you may want to take my Retirement Optimization Quiz. During this short quiz, you will be asked questions about your retirement, and based on those answers offered planning opportunities. It is quick and easy but has several actionable financial planning strategies to offer based on your personal situation.