2021 Tax and Planning Update
2020 turned out to be a much better year in the financial markets than most anyone anticipated, with both stocks and bonds producing solid returns. While interest, dividends and capital appreciation are the obvious components of good returns, it’s also important to not give up too much to taxes. As a matter of course, we focus on tax loss harvesting and manageable portfolio turnover. Here are some additional considerations as you plan for the upcoming year:
RMDS ARE BACK
One of the pandemic relief tax changes for 2020 was the waiver of required minimum distributions (RMDs). If you took advantage of the waiver, you were able to avoid the associated income tax on distributions from your IRAs last year.
Those of RMD age in 2021 must now resume RMDs this year. RMDs were waived for inherited IRAs as well and will also resume in 2021. RMDs do not apply to Roth IRAs unless the Roth IRA was inherited from the original owner. In that case, distributions are required but are not subject to income taxation.
Contrary to speculation, the just enacted new stimulus bill does not extend the RMD waiver for 2021. We will continue to monitor any rule changes or waivers that could come up this year. In the meantime, we advise continuing or restarting distributions for 2021. RMDs can be taken at any time during the year, so it is okay to wait if you prefer to not take the money immediately.
AN RMD REFRESHER
An RMD is the minimum amount that an account holder must withdraw from a retirement account for any RMD year. More than the RMD amount can always be distributed, but a distribution of less than the required amount is subject to a penalty of 50% of the RMD shortfall.
For an IRA owner who is required to take RMDs for 2021, the IRA custodian will issue an RMD notice by January 31, 2021. The required distribution is based on the account value at the end of the previous year and the account holder’s age. For 2021, the required amount is based on the account value on December 31, 2020.
Most custodians (banks or brokerage firms) calculate the required distribution. Custodians, however, do not generally calculate required distributions for inherited IRAs (also known as beneficiary IRAs). We calculate RMDs for clients, including RMDs for inherited IRAs.
Even though IRA custodians calculate RMDs for non-beneficiary IRAs, we still review these calculations because custodians can make assumptions that could cause RMD calculations to be incorrect. For example, IRA custodians are not required to add outstanding rollovers to the fair market value when calculating RMDs, which would result in an RMD shortfall and a resulting penalty.
Also, in cases where the spouse is the sole primary beneficiary of the IRA and is more than 10 years younger than the IRA owner, the joint life expectancy table can be used, producing a lower RMD amount. Custodians often ignore that and use the uniform lifetime table, which results in a larger distribution.
RMDS NOW START AT AGE 72
The SECURE Act (Setting Every Community Up for Retirement Enhancement), passed in late 2019, increased the RMD beginning age for IRA owners from age 70½ to age 72. As a result, any IRA owner who reached age 70½ by December 31, 2019 – those born June 30, 1949, or earlier – must have begun RMDs for the year they reach age 70½ and continue for every year thereafter (except for 2020, when RMDs were waived). IRA owners who reach age 70½ after December 31, 2019, must now begin RMDs for the year they reach age 72.
NO “STRETCH” FOR INHERITED IRAS STARTING 2020
Previously, if someone inherited an IRA from a person other than their spouse, there were two basic options: Either the 5-year rule or the life-expectancy option. Both of these are still available for beneficiaries who inherited an IRA in 2019 or earlier.
Under the 5-year rule, distributions are optional until the end of the fifth year that follows the year the IRA owner died, at which time the entire account must be distributed. Under the life expectancy option, the beneficiary must take an RMD for every year that follows the year in which the IRA owner died (except for 2020).
For IRAs inherited in 2020 or after, the SECURE Act does away with the life expectancy option except for specific situations involving certain disabled or chronically ill persons or minors. For all other IRAs inherited starting in 2020, the entire account must be paid out by the end of 10 years.
CHARITABLE CONTRIBUTION DEDUCTIONS EXTENDED
There are several changes included in the new $900 billion stimulus bill. First, the above-the-line deduction for cash contributions to qualified charities has been extended through 2021 –but note, this is only available for those who do not itemize. In addition, in contrast to The CARES Act, a married couple filing jointly can deduct $600 (instead of the previous $300). This extension is for 2021 only.
Also extended through 2021 is the ability to deduct up to 100% of an individual’s adjusted gross income when making a cash contribution to a qualifying charity. This does not include donor-advised funds (see discussion below).
Other changes in the new stimulus bill include a permanent fix of the medical expense deduction at a level of greater than 7.5% of adjusted gross income, or AGI. Business meals, previously 50% deductible, are now 100%.
MORE PLANNING IDEAS
Qualified Charitable Distributions (QCD) from IRAs. An individual donor, age 70.5 or older, can donate up to $100,000 per year in QCDs. For married couples, each spouse can make QCDs up to the $100,000 limit for a potential total of $200,000. The $100,000 per person limit applies to the sum of all QCDs taken from all IRAs in a year. This rule, once expiring annually, is now considered permanent, to the extent any tax law can be. It can be a very useful tax planning tool for those of RMD age who also support qualified charities.
Donor Advised Funds. The Tax Cuts and Jobs Act of 2017 increased the standard deduction for individuals to $12,550 (2021) and $25,100 for couples filing jointly. For married taxpayers over age 65, the total 2021 deduction is $27,800. Combined with the $10,000 limit on state and local taxes, the impact of the larger standard deduction is that many taxpayers are unable to itemize and may lose some of the impact of charitable gifts. One way to improve the situation is to use QCDs from IRAs as discussed above. Another strategy is to open a donor-advised charitable fund and bunch contributions from two or more years into one, creating enough deductions to itemize. We assist clients with donor-advised funds and are happy to discuss the details and how an account might help in your planning.
A final word regarding capital gains: Due to pandemic related market volatility in March and April, we were able to harvest temporary tax losses that were used to offset capital gains incurred later in the year as stocks recovered and portfolio rebalancing was needed. The result was that taxable capital gains were on the low side for many clients in 2020, even in what ultimately turned out to be a very good year for returns. Going forward, we recommend keeping an eye on the realized gain report included in our quarterly report packages and on our client portal. We are also available to review the tax implications of your portfolio as the year progresses and are happy to work with you and your tax professional to optimize your tax situation.
As always, we are here to help. Please contact us with any questions or concerns about your particular situation.
Contact us at 865-584-1850 or info@proffittgoodson.com
Please see disclosures
