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End-of-Year Planning Becomes Urgent

Last month I advised to be on your financial toes and to pay attention to what is happening around you as well as to the changes that have occurred in your own family this year. We have a checklist for 2021 end-of-year planning that I will be happy to send you. Simply ask. My email is at the bottom of this article.

Keeping up with what is going on in Congress is an occupational hazard for a forward-looking financial planner. I have never been a big fan of speculating or implementing strategy on laws that have only been proposed, but not yet enacted, by Congress. Many bills get changed just before passage, rendering moot some of the best plans constructed while Congress was still deliberating. I usually don’t expend the time and energy on such planning. This year is different. If the House Ways and Means version is passed by the full Congress very late in the year and becomes law on January 1, 2022, there will be no time to plan for and implement tax saving strategies. Unfortunately, we must plan now.

Some will dismiss the new law because they think it only applies to those with very large retirement accounts. Don’t fall for that. You certainly will be impacted if your retirement accounts are over $10 million and your income is over $400,000, but you may also be affected if you 1) have basis in your IRA (i.e. those that have made non-deductible contributions in the past), 2) are converting funds to a Roth, 3) are doing back door Roth contributions, 4) have made accredited investments in IRAs, or 5) own over 10% in an entity owned in your retirement plan.

If Congress is to get its $3.5 trillion to spend, they must find a way to pay for it. Raising taxes, particularly on those with income over $400,000, will be in the cards. (Remember President Biden’s campaign promise that he would not raise taxes on anyone with income under $400,000.) If your income is above that threshold, you should certainly project 2021 and 2022 taxes now and determine your tax saving strategy.

Earning less money is not a tax saving strategy I recommend. However, there is going to be a lot of emphasis placed on developing plans to reduce taxable income to below the $400,000 ($450,000 for married filing jointly) threshold. One of the most popular ways of doing that is through charitable contributions, either outright contributions (which are still 100% deductible this year) or via Qualified Charitable Distributions (QCD) from a retirement plan. Tax-free bonds could become much more popular to keep taxable income below the threshold.

Roth Conversions

A popular strategy for future tax savings has been Roth conversions. Recall that Roth contributions are taxable only in certain cases. Before 2010, those with income over $100,000 were prohibited from making Roth conversions. Currently, higher income limitations remain for Roth contributions, but many people who have higher incomes have gotten around that rule by doing what has been called the “backdoor” Roth conversion. To refresh your memory, a “backdoor” conversion happens when you make a non-deductible contribution to a Traditional IRA and then soon thereafter convert it to a Roth and only pay taxes on the growth. Under the new rules, starting in 2022 the “Backdoor Roth IRA” and “Mega-Backdoor Roth IRA” will be prohibited.

New RMD Rules

The bill introduces new Required Minimum Distributions (RMD) for MEGA retirement accounts. If your total retirement account balances (including all IRAs and employer sponsored plans) exceed $10 million at year end, you will be hit with a new RMD. The RMD is 50% of the amount over $10 million or 100% of the amount over $20 million in a Roth. You read that correctly. If your retirement account balances are $12 million on December 31, 2021, you will be required to take a taxable distribution of $1 million in 2022.

However, the RMD does not apply if your income is below the $400,000 ($450,000) thresholds. The strategy to deal with this will be to reduce your taxable income through charitable giving, oil & gas investments, life insurance, or large defined benefit plan contributions. Incidentally, the $10 million threshold applies separately to spouses, making filing separately a consideration for families with a non-working spouse who happens to have a MEGA IRA.

The Five-year Clock

Typically, most advisors recommend that distributions from Roth accounts will be the last money you take out of your retirement accounts. Current law states that if you take distributions within 5 years of starting a Roth, you may suffer adverse tax consequences depending on your age. If you do not currently have a Roth IRA, and all your retirement accounts are in a Traditional IRA and/or a retirement plan where you work, we believe you should start a Roth IRA, and do it NOW. Do it even with a small amount of money, such as $1,000. The goal is to start the 5-year clock running to avoid taxes and potential penalties on a future distribution should you need the funds later.

If you take nothing else from this article, just know that the legislation working its way through Congress at the time of my writing will have far reaching impact that can affect us all for years to come. Plan now for its consequences should it come to pass.

Scott Neal is the president of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm with offices in Lexington and Louisville. He would love to hear from you at or 1-800-344-9098.