Jul 17, 2020 3 min read

This week, we will continue to discuss the importance of proactive tax planning for 2020.

Taxes are currently on sale. It may not seem like that if you had just sent in a big check with your tax return. The TCJA, or Trump tax cuts, are due to expire on Jan. 1, 2026. At that time, we will revert to the old, higher tax rates.

In light of all of the government stimulus spending, rates may need to go much higher.

While we were working, there was a common myth that taxes would be lower when we retired. It seemed to make sense to defer taxes on working income and not pay taxes until we retired.

Unfortunately, taxes most likely will not be lower in retirement. This is not just because rates will be higher, but many of us saved in the wrong tax funnels.

Many people have the largest part of their savings in qualified accounts, such as IRAs and 401(k)s. This money is taxed at the highest ordinary rate. It also can create a tax torpedo and make more of your Social Security payments taxable. It must be withdrawn and taxes paid starting at 72, whether you need the income or not.

The SECURE Act also eliminated the possibility of stretching this income to your children and grandchildren. It must be distributed to most non-spouses over a 10-year period. This may be during your children’s highest income years.

One thing that might make sense now is doing a Roth conversion. This is when we take money that is tax-deferred in a qualified account and pay the taxes on those funds. If it is rolled into a Roth, the earnings grow tax-free if you follow two rules: you must be over 59½ and must have owned a Roth for at least five years.

You can always take out your contributions tax-free. The conversion will grow faster if you use funds from another account to pay the taxes.

You can decide whether to do a Roth conversion by answering one simple question. You have two different IRAs with $100,000 in each. One you pay the taxes and convert to a Roth. The other you leave as an IRA. For the next 10 years, they both grow 6%, and at the end of 10 years; you pay the tax on the IRA.

Which is worth more?

There would be the same amount in both. So why would you do the conversion? If you think tax rates will rise, the Roth will do better. It is hard to believe they will not go up, considering the size of the deficit.

If you leave a balance in a Roth to a non-spousal beneficiary, that person still would have to take all of the money out by the end of year 10. The good news is this money is not taxable. It may make sense to wait until the end of the 10th year and take it all out instead of some each year, because you would be enjoying tax-free growth.

Tax planning can have a major impact on your finances. Remember, it is not just what you earn that is important, but what you get to keep.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.