Back in 2018, when the Tax Cuts and Jobs Act (TCJA) went into effect, did your financial adviser encourage the idea of changing how you save for retirement?
If you took action, you likely established a strategy to withdraw some or even all of the money from your tax-deferred retirement accounts in order to pay the taxes now at the historically low rates set by the TCJA. Moving those funds to a Roth IRA or some other after-tax instrument will likely save you much more in taxes later.
If you didn’t take action then, it may be even more beneficial now; a nudge from your adviser may turn into a shove this year. Why? Several reasons.
Most beneficial modifications to the individual income tax system will expire at the end of 2025, which means the window of opportunity is closing for those who are worried about potential future tax increases. In other words, there’s no guarantee that the current low tax rates will continue beyond 2025.
There’s now added incentive to move money into a lower tax environment, thanks to the effects that COVID-19 is having on the U.S. economy.
Prior to the pandemic, there was already great concern about the federal debt, which was $22.8 trillion at the end of 2019. But with coronavirus relief spending and stimulus programs continuing to swell, the national debt now tops $26.5 trillion and is expected to grow even higher.
Prior to the coronavirus, experts were already raising red flags about future funding problems for popular programs like Social Security, Medicare and Medicaid. The Social Security and Medicare Boards of Trustees made it clear that under currently scheduled benefits and financing, both funds will face shortfalls that could result in a future reduction in benefits — and that’s without taking the effects of the COVID-19 pandemic into account.
What will Uncle Sam do?
Now, I don’t own a crystal ball, but I don’t think I need to in order to predict that something has to give. There are far too few dollars coming in compared to the dollars projected to go out for nothing to change. And if the government goes looking for ways to shrink — or even sustain — the nation’s debt, there’s a good chance Uncle Sam could raise taxes or make cuts to some of the entitlement and benefit programs that assist retirees — or both.
In fact, we’ve already seen a precedent set with this year’s passing of the SECURE Act. Though the new law includes several changes that make it easier to save for retirement, it also eliminated the popular “stretch IRA” strategy, which gave non-spouse beneficiaries more time to empty and pay taxes on inherited IRAs. That provision is a sneaky tax generator, and we’ll very likely see more moves like this. Congress now has more reasons than ever to vote to increase the government’s share of your retirement savings now and far into the future.
What can you do?
If you want to be in charge of how much money you’ll have in retirement, a good bet is to get as much as possible into tax-free accounts now. So how will you do this?
If you’re still earning income, you can open a Roth IRA or participate in your employer’s Roth 401(k) to start making after-tax contributions. There are annual limits on how much you can contribute ($6,000, or $7,000 if you’re 50 or older for 2020), and if your income is over a designated threshold ($139,000 if you’re a single filer or $206,000 if you’re married filing jointly in 2020), you can’t contribute to a Roth IRA. The Roth 401(k) allows the same contributions as a traditional 401(k).
You can do a Roth conversion, however, regardless of income. You’ll have to pay taxes on the withdrawals you make from your tax-deferred retirement savings you are converting, but you can spread out the conversion process over several years, manage your tax bracket as you go and thereby reduce the annual tax bite. Or you can roll over all the money that’s already in your existing 401(k) or traditional IRA and pay the taxes you owe all at once.
The all-at-once choice might have seemed crazy in the past, but many savers will find the pandemic has made 2020 a fortuitous year to do a rollover and take advantage of a Roth’s tax-free growth. Some will land in a lower tax bracket this year because of a loss of income or because the COVID-19 stimulus package, as the CARES Act, allows retirees 72 and older to forgo taking their required minimum distributions.
There are other tools besides a Roth that can help you move away from the potential perils of tax-deferred savings. They include municipal bonds and/or a life insurance retirement plan (LIRP), which is a permanent life insurance plan that offers many of the tax-free traits of a Roth IRA with added legacy benefits through the death benefit. Some strategies can be more complicated than others, however, or are better suited to certain individuals or families, so it pays to think this through. Regardless of the direction you’d like to consider, it’s a good idea to talk with a professional who can analyze the pros and cons of all the options.
Sure, this will require some effort on your part to get it done, which is probably why it’s so easy to procrastinate. But if tax rates should skyrocket down the road, and your money is in a Roth, you won’t have anything to worry about because you’ll pay nothing on withdrawals from that account in retirement.
If you’re feeling stressed during these challenging times, and you’re looking for something you can control, this is it. You can take steps now to future-proof your retirement savings. Paying taxes is never fun, but paying less than you would have otherwise is a tax strategy you can get excited about.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
President & Founder, Elevated Retirement Group
Scott M. Dougan is the president and founder of Elevated Retirement Group . He is a Registered Financial Consultant, an Investment Adviser Representative and a licensed insurance agent.