The tax landscape is likely to change over the near-term, and the changes may be substantial. While a majority of tax law changes are not necessarily intended to directly impact IRAs, many indirect impacts could be significant.

(This article was written prior to the Senate tax bill vote last night.)

As we are in the prediction season for 2018, and the US political calendar ticks down with tax reform debate still in the air, this publication carries a commentary here from Manning & Napier, a Rochester, NY-headquartered firm founded in 1970. The authors are Dana F Vosburgh, CFP®, director, family wealth management, and Ethan McKenney, MBA, CFP®, senior wealth management consultant. The editors are pleased to share guest contributors’ views on the news service. As ever, the editors don’t necessarily endorse all views from outside writers and invite readers to respond. They can email tom.burroughes@wealthbriefing.com

As we are nearing the end of the year, it is becoming more likely that our tax system will be reformed in the near future. While a final plan is not yet set, several themes in the House and Senate tax bills exist. For example, both plans are focused on simplifying the tax code and reducing taxes paid overall. Moreover, many of these changes may impact how investors utilize Traditional IRAs as a part of their overall financial plan.  

While Traditional IRAs are often seen as a “set it and forget it” type of account, there are planning strategies to consider, whether or not the tax laws change. Below are four different strategies for investors and retirees that are looking to optimize their IRA accounts and savings, and some insight as to how some of the tax law proposals may impact these strategies.

Small Roth IRA conversions

For those in early stages of retirement (ages 60-70), and especially those who are not yet taking Required Minimum Distributions (RMDs), you may want to consider making small Roth IRA conversions. The idea is that you may have a range of years when you are in a lower income tax bracket in these early stages of retirement. This may be a good time to make a conversion (and pay less tax) while also reducing the future RMDs from the traditional IRA account.

- Under current law, you can choose to “undo” a Roth IRA conversion by completing a “Roth IRA Recharacterization.” However, under both of the proposals of the House and the Senate, these recharacterizations would no longer be allowed. 

- The new tax law is set to double the itemized deduction. This means that people that do not typically itemize deductions today may have the ability to convert slightly more to a Roth IRA in the future if they are in the commonly “lower income” years in their 60s. 

Consolidating multiple IRAs in retirement

If you find yourself in your 70s and juggling several IRAs, you’re probably up to your neck in administrative hassles. For this reason alone, you should consider consolidating your IRAs to reduce the irritation. Furthermore, your separate IRAs might have different investment objectives, and may even be at odds with each other. Having multiple IRAs often leads to painstaking confusion and even costly mistakes in terms of when and how RMDs are taken from accounts.

- The new tax law leaves a significant penalty intact, the penalty on Required Minimum Distributions that are not taken during the year. Under current law (and both proposals), any amount of a RMD that is not taken is subject to a 50 per cent penalty in addition to the income tax liability. 

Stretch IRAs & Trusteed IRAs

Under current law (and both the House and Senate’s proposed laws), non-spouse beneficiaries that inherit IRAs have the ability to stretch RMDs over their actuarial life expectancy. Changes to this law were discussed by prior administrations although no changes were made. With the ability to stretch distributions over the life expectancy of the beneficiary, there are benefits to naming younger relatives as beneficiaries.   

The Trusteed IRA is an IRS-approved vehicle with a “trust wrapper” around it. This means individuals can use a trust account to control how their beneficiaries will receive distributions from the Trusteed IRA after passing away, while also benefiting from expert support from a corporate trustee. When the concepts of a Stretch IRA and Trusteed IRA are combined, a wealthy retiree may be able to pass a larger IRA to a grandchild with significant tax-deferral benefits while maintaining the control that is included with a trust. 

- Ensuring IRA assets maintain its tax-deferred status for as long as possible is important because the proposed tax amendments may increase the taxes in your non-IRA accounts. Specifically, some of the taxation of non-IRAs may change under new tax laws.  For example, under the Senate’s tax bill, investors will no longer be able to select individual tax lots when securities are sold. Instead, they could be required to use the FIFO approach (first-in-first-out), which may lead to more taxes paid.

- In addition, while the current versions of the Senate and House tax bills continue to have a step up in cost basis of assets at death, some prior proposals did not. Thus, if a tax law is passed that does not provide a step up in cost basis, this could make IRAs that much more valuable. 

$100,000 charitable IRA rollover

For retirees who are charitably inclined and with extra money to spend, you may wish to consider what is known as an IRA Charitable Rollover. Here, you can donate up to $100,000 of your IRA to an eligible charity per year without it being recognized as income, and yet the distribution can qualify as all or a portion of the RMDs for the year.

- Under current law, individuals can give money to charity out of their IRA (and have it count against the RMD or they can give directly out of other non-IRA investments and take a charitable deduction. Neither of these laws is changing. However, since it appears that any new tax laws will include a much higher standard deduction, it may be less likely that the charitable deductions are used because these are itemized deductions. Thus, charitable IRA rollover contributions may become more useful to reduce income taxes while benefitting a charity.

The tax landscape is likely to change over the near-term, and the changes may be substantial. While a majority of tax law changes are not necessarily intended to directly impact IRAs, many indirect impacts could be significant. Thus, it is important to understand what planning opportunities exist today and what may change going forward.

About the authors:

Dana F. Vosburgh

As the Director of family wealth management at Manning & Napier, he is responsible for the delivery and management of the firm’s comprehensive planning service designed to assist clients with their overall financial picture. This includes providing guidance and recommendations in areas such as retirement planning, investments, estate and tax planning, insurance, and more. Dana Vosburgh has been with Manning & Napier for over 15 years. He earned his BS in Business Administration from Mansfield University. He is a CERTIFIED FINANCIAL PLANNER™ professional, and holds Series 6 and 63 licenses.

Ethan McKenney

As senior wealth management consultant, his primary responsibilities are to provide comprehensive financial planning and wealth management services to high-net-worth clients through the creation of written wealth management plans dealing with financial, retirement, estate, and tax planning; conducting client meetings and annual reviews; ongoing plan monitoring; and coordinating aspects of the plan with a client’s outside advisors. McKenney has been with Manning & Napier for over 10 years. He earned his BA in Statistics and BS in Applied Mathematics from the University of Rochester, as well as a Master’s in Business Administration from the Simon School of Business in Rochester, NY. He is a CERTIFIED FINANCIAL PLANNER™ professional, and holds Series 6 and 63 licenses.

Disclaimer:

Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.