5 IRA Plan­ning Strate­gies

Given the new rules, now is the time to make sure clients are mak­ing the right de­ci­sions for next year’s tax sea­son.

Financial Planning - - CONTENTS - BY ED SLOTT

How to help clients face the 2018 tax sea­son.

Ad­vi­sor in­vest­ment fees are no longer de­ductible as an item­ized de­duc­tion. Let clients know this now and dis­cuss al­ter­na­tives.

Here’s what will hap­pen next year at tax time: Your client’s ac­coun­tant will tell your client about all the tax plan­ning that could have been done last year. But by then, it will be too late. That’s be­cause, un­for­tu­nately, many tax pre­par­ers are his­tory teach­ers. They tell you what al­ready hap­pened. No­body wants to hear woulda, coulda, shoulda. How about chang­ing this an­nual an­noy­ing sce­nario? With all the new tax law changes, ev­ery ad­vi­sor should alert clients about what can be done now to help them avoid tax­pay­ers’ re­morse next year. Con­sider these five ideas to stay ahead of the game. 1. Roth con­ver­sions. The Tax Cuts and Jobs Act elim­i­nated the abil­ity to re­verse or rechar­ac­ter­ize a Roth con­ver­sion. The new rule ap­plies to con­ver­sions done in 2018 and later years. In past years, if a Roth IRA con­ver­sion re­sulted in an un­ex­pect­edly high in­come-tax bill, or if the client sim­ply changed his or her mind, the con­ver­sion could be re­versed by rechar­ac­ter­iz­ing the Roth IRA funds back to a tra­di­tional IRA. How­ever, start­ing in 2018, this op­tion no longer ex­ists. But there’s still a short­term rechar­ac­ter­i­za­tion plan­ning op­por­tu­nity, if you act now. The IRS has said that 2017 Roth con­ver­sions can still be un­done up to Oct. 15, 2018. How­ever, each client needs to con­sider this op­tion in­di­vid­u­ally. All else be­ing equal, a tax ar­bi­trage strat­egy can work for your clients, where you re­verse last year’s Roth con­ver­sion and re­move the tax bill at last year’s higher rates, then re­place it with a Roth con­ver­sion this year at lower tax rates. That’s OK if in­come is roughly the same each year. But you’ll need to look fur­ther, for ex­am­ple, to see what 2017’s tax bracket ac­tu­ally was, and how it will com­pare with his year’s lower and more ex­panded tax brack­ets. You’ll also have to see how well the 2017 con­verted funds per­formed. For in­stance, if they are up sub­stan­tially, those are tax-free gains and, in that case, the con­ver­sion most likely should not be un­done. Why move tax-free gains back to a tax­able IRA? Also, com­pare the 2017

tax re­turn with a pro­jected 2018 tax re­turn to see if there are any spikes or in­come aber­ra­tions to plan around. For ex­am­ple, if 2017 in­cluded a large busi­ness loss that would have made last year’s Roth con­ver­sion less costly, that con­ver­sion is worth keep­ing. But maybe 2018 will have large de­duc­tions or losses that would make a 2018 con­ver­sion more tax ef­fi­cient, as op­posed to the 2017 con­ver­sion. This re­verse-and-re­place strat­egy is a one-time op­por­tu­nity that ends on the Oc­to­ber dead­line. Af­ter that, any new Roth con­ver­sion is per­ma­nent. That cer­tainly doesn’t mean con­ver­sions should be avoided. The long-term tax-free ben­e­fits, af­ter all, are too good to pass up. It just means clients need more plan­ning ad­vice when con­sid­er­ing Roth con­ver­sions in the fu­ture. Here are three more tax-plan­ning ideas to bet­ter project the tax bill for con­vert­ing an IRA to a Roth IRA: Make the con­ver­sion late in the year when tax re­sults for the full year can be more ac­cu­rately es­ti­mated, es­pe­cially given mar­ket volatil­ity. There’s an ex­cep­tion to that ad­vice. If the mar­ket takes a big dip ear­lier in the year, con­sider con­vert­ing while stock prices are low. Your client may also want to con­sider mak­ing only a par­tial con­ver­sion to min­i­mize the tax costs. A se­ries of an­nual par­tial con­ver­sions may con­vert even a large IRA without push­ing in­come into higher brack­ets. Have the new tax brack­ets avail­able to bet­ter project next year’s tax bill. 2. Plan a qual­i­fied char­i­ta­ble dis­tri­bu­tion. This is one of those strate­gies the client will hear about only next year, when it’s too late to take ad­van­tage of a QCD for this year. As a re­sult of the new tax law, more clients will be tak­ing a stan­dard de­duc­tion and their char­i­ta­ble gifts will no longer be de­ductible. But the QCD gives the client a dou­ble ad­van­tage. They can take the stan­dard de­duc­tion and ef­fec­tively add a char­i­ta­ble de­duc­tion on top of that, by hav­ing those gifts ex­cluded from in­come. The only neg­a­tive is that the pro­vi­sion isn’t avail­able to more tax­pay­ers. It ap­plies only to pre­tax funds in IRAS, not com­pany plans, and clients must be at least age 70½ at the time of the QCD. A QCD may be as large as $100,000 per per­son (not per IRA) and can be used to sat­isfy a client’s RMD re­quire­ments. QCD rules pro­hibit us­ing donor-ad­vised funds or pri­vate foun­da­tions. Be­cause a QCD is not in­cluded in in­come as a dis­tri­bu­tion, tax-wise, this is bet­ter than tak­ing a tax­able IRA dis­tri­bu­tion and try­ing to off­set it with a char­i­ta­ble con­tri­bu­tion de­duc­tion. The QCD does not in­crease ad­justed gross in­come as a tax­able IRA dis­tri­bu­tion does. Higher AGI can be costly in sev­eral ways, for in­stance by in­creas­ing in­come tax on So­cial Se­cu­rity ben­e­fits and boost­ing Medi­care pre­mi­ums. When a client is near­ing age 70½, it may make sense to de­lay mak­ing char­i­ta­ble con­tri­bu­tions un­til the client be­comes el­i­gi­ble to make use of QCDS. The tax sav­ings can be sig­nif­i­cant. Say a client will be in the new 24% tax bracket for 2018 and makes a $10,000 gift us­ing the QCD. If the RMD hap­pens also to be $10,000, then none of that RMD is in­cluded in in­come. If the client is tak­ing the stan­dard de­duc­tion where no char­i­ta­ble con­tri­bu­tions are de­ductible, this $10,000 QCD pro­vides an ef­fec­tive tax de­duc­tion and will re­duce the 2018 tax bill by $2,400 ($10,000 lower tax­able in­come x 24% tax rate = $2,400 tax sav­ings) com­pared with giv­ing the old way — without the QCD. The sav­ings are high­est when the client takes the stan­dard de­duc­tion, but due to the lower AGI lim­its, there are still tax sav­ings for clients who item­ize. 3. IRA fees no longer de­ductible. Ad­vi­sor in­vest­ment fees are no longer de­ductible as an item­ized de­duc­tion. Let clients know this now and pro­vide some al­ter­na­tives, rather than have their CPA tell them next year at tax time. The bot­tom-line strat­egy here is to pay IRA fees from the IRA. This will pro­vide an ef­fec­tive tax de­duc­tion, as the fees are paid from pre­tax funds. But never do this from the Roth IRA, as those are af­ter-tax funds. In that case, pay the Roth fees from other tax­able funds, even if there is no tax de­duc­tion avail­able. Roth fees can­not be paid from the tra­di­tional IRA.

When a client is near­ing age 70½, it may make sense to de­lay mak­ing char­i­ta­ble con­tri­bu­tions un­til the client can use a QCD.

4. An­tic­i­pate taxes from the pro rata rule. The IRS ag­gre­gates all tra­di­tional IRAS, in­clud­ing SEP and Sim­ple IRAS, as one when de­ter­min­ing the tax due on dis­tri­bu­tions. This can re­sult in a sur­prise tax bill if clients are un­pre­pared, so re­view this is­sue with clients now, be­fore do­ing any Roth con­ver­sions or tak­ing other IRA dis­tri­bu­tions. As an ex­am­ple, to make a back-door Roth IRA con­tri­bu­tion, Jack makes a $5,000 nond­e­ductible con­tri­bu­tion to a new tra­di­tional IRA and promptly con­verts it to a Roth IRA. All the funds in this tra­di­tional IRA are af­ter taxes, so he ex­pects no tax­able in­come to re­sult. This would be true if Jack owned only that tra­di­tional IRA. But Jack also owns an­other IRA hold­ing $120,000, con­sist­ing en­tirely of pre­tax con­tri­bu­tions and earn­ings. The IRS will ag­gre­gate the two IRAS and treat them as one with a bal­ance of $125,000. Of that, $5,000, or 4%, con­sists of af­ter-tax funds. Thus, Jack’s $5,000 Roth IRA con­ver­sion will pro­duce $4,800 of tax­able in­come. The con­verted funds are 96% tax­able and 4% tax free, as will be any dis­tri­bu­tion from ei­ther IRA. Be­fore mak­ing any Roth IRA con­ver­sion or IRA dis­tri­bu­tion, check the im­pact of the pro rata rule to avoid giv­ing the client an in­cor­rect es­ti­mate of the tax bill. This mis­take can­not be un­done be­cause Roth rechar­ac­ter­i­za­tions are no longer avail­able. 5. Plan for RMDS. Check clients’ RMD obli­ga­tions and be sure they are met. Re­mem­ber, there’s a whop­ping 50% penalty for miss­ing one. If a client has mul­ti­ple tra­di­tional IRAS, un­der the ag­gre­ga­tion rules, the year’s en­tire RMD can be taken from any one of those ac­counts. This can be a way to ad­just the amounts left to dif­fer­ent ben­e­fi­cia­ries or if the IRAS in­vest in dif­fer­ent kinds of as­sets, to liq­ui­date par­tic­u­lar as­sets first. For a client who reaches age 70½ dur­ing 2018, the first RMD must be taken by April 1, 2019. For oth­ers, RMDS must be taken by year-end. If in­come will be con­sid­er­ably lower in 2018 than in 2019, it might pay to look at tak­ing all or part of the first RMD in 2018. Re­mem­ber, clients who in­herit Roth IRAS as non-spouse ben­e­fi­cia­ries are also sub­ject to RMDS. In con­clu­sion: Now is the time to help your clients plan their 2018 Ira–re­lated tax moves and end the woulda, coulda, shoulda cy­cle.

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