Category

Tax Planning

RMDs Not Required in 2020 = Good News for Seniors

By Retirement, Social Security, Tax Planning, Widows and Money

The Coronavirus Aid, Relief & Stimulus Act waives required minimum distributions (“RMDs”) from IRAs in 2020. It’s a one-time waiver that could substantially lower taxable income for those seniors fortunate enough to not need any/all of their RMD to support their annual income needs.

Let me explain.

The money you contributed to your Traditional IRA or Rollover IRA – created when you rolled funds from a 401(k) or other retirement plan from an old employer into an IRA – had not yet been taxed. In the years since, it’s grown tax-free. The IRS is going to require that you take a certain percentage out, every year after you turn 72[1], and pay income tax on that distribution. Simply put, after all of these years of tax-free growth, the IRS wants to collect its pound of flesh (aka tax). In the year you turn 72 this distribution must total 3.91% of the value of your IRA on December 31st of the year prior. From 73 on, the percent that you are required to take rises – to 4.37% at 75, 5.35% at 80, 6.76% at 85 and so on. These distributions are called RMDs. And if you fail to take them on time the penalty is severe – the IRS demands you pay them 50% of the RMD amount you should have taken. Ouch.

Some seniors are fortunate enough to be able to live off of their Social Security and other sources of income in retirement – for example, pensions, private annuities, and taxable savings. Some others need only take a distribution from their IRAs that is smaller than their RMD. For these fortunate seniors, a one-year holiday from RMDs means that their taxable income in 2020 could be substantially lower.

This opens up lots of opportunities, tax-wise and portfolio-diversification-wise. For those who have taxable brokerage accounts with substantial long-term capital gains but in dire need of change – like dumping legacy stock, mutual fund or bond holdings in favor of a shift to a lower-cost, better-diversified mix of Exchange Traded Funds (ETFs) – the waiver of RMDs coupled with the fall of stock market values represent a unique opportunity in 2020 to reconfigure smarter portfolios for the future.

Now is a good time to reach out to a Certified Financial Planner. Take advantage of the fact that s/he is a fiduciary who must put your interests first. You may discover that your current Financial Advisor isn’t actually earning the fees you’ve been paying.

[1] The SECURE Act, signed in December 2019, raised the starting age for RMDs from 701/2 to 72 for those who had not yet turned 701/2 by December 31, 2019.

The tax code has changed. Should your investment strategy?

By Investing, Tax Planning

Republicans enacted dramatic changes to the federal tax code in late 2017. Income tax brackets were lowered, and the personal exemption and deductibility of interest on home equity lines of credit were eliminated. The standard deduction was doubled and limits were placed on the deductibility of taxes paid in income and property taxes to the states. The impact on your taxable income will depend on your specific circumstances and your tax professional may recommend certain strategies to reduce your tax bill going forward.

Given all of that, should you also make changes to how you’re investing your savings?

The short and sweet answer is “No!” Why? Because the surest way to grow your savings and retire with more is to

  • Build a globally-diversified portfolio of stocks, bonds, real estate and commodities using low-cost ETF’s;
  • Rebalance periodically;
  • Ignore the hype and resist the urge to follow the herd into this “winning” company or sector based on some piece of news.

Why? Because trying to “time the market” and pick the “winners” and “losers” has proven time and time again to deliver inferior returns.

So when should you revisit your investment strategy? When something changes in your personal life that affects your savings goals, time horizon and/or risk tolerance.

Why are ETFs better than mutual funds?

By Investing, Tax Planning

An extremely brief history of mutual funds.

It used to be that individual investors could only buy shares in a company in “round lots” of 100 shares. If a stock was trading for $20, an individual would have to have $2,000 to invest in that company. Ordinary investors with only $10-15,000 to invest thus found it difficult to build a diversified portfolio.

Someone saw an opportunity to create a fund that would pool money from lots of individual investors so that the fund could build a well-diversified portfolio. Thus, mutual funds were born. Their growth and impact on investing was nothing short of revolutionary. It was a giant step in democratizing investing for the average person.

Exchange Traded Funds – ETF’s – are like Mutual Funds 2.0.

ETF’s and mutual funds are similar in that both bundle together hundreds or thousands of securities to offer investors diversified portfolios. They differ in several substantial respects, however.

First, as their name reveals, ETF’s trade throughout the trading day, allowing investors to buy and sell at any point in time – just like shares in Exxon Mobil or Apple. Shares in mutual funds can only be purchased or redeemed after trading has closed for the day and the Net Asset Value of each share has been calculated.

Second, ETF’s have lower operating expenses and thus charge significantly lower fees to investors. The average expense ratio for a stock mutual fund is 0.82% while the expense ratio for a stock ETF averages 0.09%. The mutual fund is nine times more expensive!

Third, many mutual funds have sales loads. ETF’s have none. Sales loads – sometimes as high as 5.75% at the purchase of a mutual fund and 0.25% each year thereafter – come out of an investor’s pocket and go straight to the investment adviser who sold them.

Fourth, mutual funds come with minimum amounts that an individual must invest. ETF’s have no investment minimums.

Lastly, ETF’s are significantly more tax-efficient. This is because when they buy or sell shares they are deemed to be “in kind” transactions that do not trigger a taxable event. When mutual fund managers trade shares in their portfolios, they trigger capital gains and losses for every one of their shareholders.

For all of these reasons, ETF’s are a smarter option for today’s investors. After all, it’s not about what you make, it’s about what you keep.