Accelerating withdrawals for a tax break
Q: Is it better to take more than the required distribution from an IRA and reinvest it in a taxable account where the investments are taxed at the lower capital gains rate when sold? Is this a good way to reduce taxes in retirement?
A: You’re on to something. If you accelerate those withdrawals and reinvest the money in a taxable account, you’ll pay taxes on that distribution now, but any future appreciation for the reinvested shares won’t be taxed until you sell them from your taxable account.
When you do, you would get the benefit of the lower capital gains rate (0%, 15% or 20% depending on income) for shares that have been held a year or more versus the federal tax rate of 10% to 37% that you pay for IRA distributions.
If your heirs inherit the shares, it’s another win because under current law, their basis would be the value of the shares on the date of your death. Any
appreciation between the date you reinvested the shares and your death would be tax-free.
There are two caveats to your strategy. First, how the money is reinvested in the taxable account matters. “The strategy makes more sense for growth assets that don’t generate any income,” says David Levi, a certified public accountant and senior managing director at CBIZ MHM in Minneapolis.
Bonds or dividend stocks are better off kept in the IRA because, in a taxable account, you’ll owe taxes for any dividends or interest earned whether you sell the investment or not. The second caveat, he says, is all this is based on current tax law, and that can change. “In a lot of ways, this is not terribly different to the analysis of the Roth conversion,” Levi says. That decision also hinges on whether you believe your own circumstances or rising taxes in general will mean you’ll pay more later on. If so, then your strategy makes sense.
Q: I understand that longer tax forms for Schedules 1, 2 and 3 are coming. Why and how will they be different?
A: The Form 1040 for 2021 will look very much like that for the 2020 tax year. There are only minor changes to the two-page form, based on a draft. But Schedules 1, 2 and 3 are much longer because they will list specifics for other types of income, adjustments, credits and so on. For example, the 2020 Schedule 1 asked for other income as a general category on line 8. The draft 2021 Schedule 1 separates line 8 into 17 income types, such as cancellation of debt and stock options. The formerly one-page Schedules 1, 2 and 3 will now each be two pages in length.