February 6, 2023


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Retirees need to make these financial moves before Dec. 31

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Back in March, a couple who had recently sold their business called me to express concerns about their decision to sell and retire. With Covid-19 raging, the stock market quickly dropped in value and their retirement savings were in decline. They asked a straightforward question: Did they need to worry or worse, consider going back to work?

To address their concerns, we conducted a financial “stress test.”

It’s a simulation of scenarios to evaluate if their financial plan and investments could withstand the chaos in the stock market. Even though their investments had declined more than 10{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb}, the test assured them their portfolio was well positioned to withstand further volatility. With this information in hand, the couple quickly dropped any thought of returning to work.

While the impact of the coronavirus pandemic has stunned us all, it has also served as a needed wake-up call. For those on the cusp of retirement, the opportunity to re-evaluate their financial game plan is essential. In addition, new laws passed this year to help Americans endure Covid-19 can have favorable consequences for certain investors’ 2020 tax returns and their investments.

Here are three recommendations to consider during these remaining weeks of 2020.

Take the time to test to your retirement game plan. With Baby Boomers retiring for a variety of reasons, including early retirement due to job layoffs, now is a good time to examine your financial and retirement plan.

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Like the couple mentioned above, this assessment helps investors better understand how their portfolio and financial plan will respond to disruption in the economy. These tests simulate a wide range of financial outcomes.

And, if there is a problem, this analysis creates an opportunity to identify and address the issues early on. One common example is that retirement expenses start off higher than projected. Many investors incorrectly assume their lifestyle will slow down after retirement, but that’s often when the fun begins.

By running a recurring stress test, initial overspending can be analyzed and addressed before the problem compounds. And, for most investors, the stress test produces outcomes that are much better than the worst-case scenarios they have envisioned in their minds, providing peace and serenity at a critical time of transition.

It’s important to note that retirees may avoid paying some taxes in 2020. Because of changes to the rules surrounding distributions from 401(k) plans and other qualified retirement accounts, retirees have a unique opportunity to avoid certain income taxes for 2020.

The reason is largely tied to the amount a retiree is required to withdraw annually from these accounts, often referred to as a required minimum distribution. Here’s the background:

In late 2019, Congress passed the SECURE Act, which deferred the starting point for RMDs to the year an individual turns 72, rather than age 70½.

Then, in March 2020, the CARES Act was passed, which waives RMDs for all types of retirement plans — including inherited individual retirement accounts for calendar year 2020.

For investors required to make these withdrawals, these two changes can become a timely benefit. Instead of withdrawing money as an RMD where ordinary income taxes apply, many retirees can reduce their income by tens of thousands of dollars by instead drawing money from their non-retirement accounts.

For an investor taking a distribution of $100,000 annually from their IRA in the 22{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} federal tax bracket, income taxes could be reduced by up to $22,000 in 2020. This savings assumes these same funds could instead be withdrawn from non-retirement accounts.

Even if an investor has to pay capital gains to raise the funds for withdrawal, a tax tip is that capital gains rates will always be lower than the ordinary income tax rate. Thus, it is generally better from a tax perspective to take distributions from non-retirement accounts when possible.

As a result, many investors could have minimal to negative taxable income in 2020 due to the suspension of RMDs. If that’s the case, it creates a clear opportunity to convert taxable IRAs into a Roth IRA at below average tax rates.

The final weeks of 2020 are also a very good time to determine if it makes sense to convert a portion of your traditional IRA funds into a Roth IRA. Anyone can take advantage of this strategy, whether or not the laws on required withdrawals apply.

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I’m working with a couple in their early 60s who retired in mid-2019 to convert approximately $75,000 to $100,000 of their IRAs into a Roth. They’ve deferred taking Social Security benefits and are currently living off their personal investments and cash. Because their modest income applied against their standard deduction will result in almost no taxable income this year, a conversion should work for them.

My goal was to manage the conversion threshold to keep their ordinary income below the 12{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} federal income tax bracket for those married couples filing jointly. No matter the amount converted, the long-term benefits will be significant. After the $75,000 to $100,000 is converted to a Roth IRAs, these funds will no longer be subject to RMDs and will grow tax-free.

As we head into a potentially difficult winter, use this time wisely to look forward and be prepared. By making these moves now, retirees can look forward to a prosperous 2021. 

— By Brett Miller, partner and wealth advisor at Brightworth