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Time Is Running Out to Minimize Future Taxes. Here’s How to Do It.


Americans worried about financial stress from the pandemic have until year’s end to take advantage of tax-friendly provisions in the Cares Act, moves that require some planning to avoid draining retirement funds or unleashing a hefty tax bill in the future.

The Cares Act allows people of any age who have been affected by the pandemic to remove as much as $100,000 from individual retirement accounts and 401(k)s without the usual tax penalties. And it gives those people the chance to put the money back into the plans and avoid taxes if they can return the cash over the next couple of years. It also frees retirees from taking money out of IRAs and 401(k)s this year if they don’t want to pay taxes on distributions, or if they need time to recover from investment losses.

Here are some details and planning tips:

On Skipping RMDs

After the Cares Act passed in the spring, retirement savers who were older than 70½ when the year began had three options for their required minimum distributions: skip their RMD this year; receive their distribution and pay the tax on that income; or take the distribution, pay the taxes on the income, and convert the sum into a Roth IRA.

For those who didn’t want or need this year’s RMD and forgot to tell their banks and brokers to cancel distributions that were already scheduled to happen automatically near year-end, distribution checks and deposits are arriving as unwelcome tax burdens.

If you are among them, and especially if you are expecting a high-income and high-tax year for 2020, there is a solution: Under tax rules, people have 60 days to return a distribution to their IRA and, in effect, undo it, says Ed Slott, a certified public accountant and retirement expert in Rockville Centre, N.Y. Doing that will remove the need to pay the related taxes.

Those who haven’t yet received a distribution scheduled for late December could still contact their bank or broker and stop it and the 2020 accompanying tax. This includes people of any age with inherited IRAs. Yet people with inherited IRAs are out of luck if they have already received a distribution; once it’s issued, there is no going back, Slott says.

But because taxes eventually come due for RMDs, many financial advisors say the best solution for those who have the financial wherewithal this year—and don’t need the RMDs for living expenses—is often to take them anyway and convert the distributions into Roth IRAs. Under this move, an investor would pay taxes on the RMD this year in a trade-off for tax-free growth under a Roth IRA.

On Tapping Retirement Funds

Financial planners typically tell people to dip into retirement savings only as a last resort so a temporary cash crunch when young doesn’t harm long-term retirement savings. But with the Cares Act benefits running out this month, now could be the time for those expecting serious pandemic pressure into next year to consider taking a withdrawal, says Jeffrey Levine, director of advanced planning for Buckingham Strategic Wealth.

The Cares Act gives people an opportunity during the rest of this year to take up to $100,000 out of retirement accounts to help get them through tough times if they or a family member has had Covid-19 this year, or their household has suffered a job loss or business distress.

The benefit of the provision is that people younger than 59½ can get their hands on their retirement savings in workplace plans like 401(k)s or IRAs, without facing the usual 10% penalty that is designed to discourage early withdrawals. And instead of having to pay the tax on the full sum they withdraw this year, people can spread out the tax payments over three years, culminating with the tax return filed in 2023 for the 2022 tax year.

What’s more, people taking advantage of this provision can escape some or all of the income taxes if they replenish the money in the retirement plan over the three years and then amend their tax returns accordingly. (Be warned, though: Some 401(k) plans don’t allow distributions to be returned, so tapping an IRA may work more smoothly.)

The bottom line for taxpayers, says Randy Gardner, a Las Vegas CPA and director of education for Garrett Planning Network, is to use the same rigor in Cares Act planning as is typical in year-end tax planning: Adjust tax obligations so they are reduced as much as possible and handled at the most opportune time.

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