The stock market reached all-time highs in 2023, with year-end balances in individual retirement accounts and 401(k)s hitting the highest ever for many. That’s great news, of course, but it also opens up some IRA tax-planning moves that advisors should make clients aware of right away.
The record year-end stock values will mean larger required minimum distributions, because the RMDs will be based on the December 31, 2023, account values, even if those values decline later. This means higher taxes, and clients should be prepared for that.
This also goes for beneficiaries who are subject to RMDs. Estimated taxes for 2024 may need to be adjusted. Tax preparers should let clients know that next year’s tax bills could be higher due to larger RMDs, and make sure they understand the ripple effect those RMDs can have through stealth taxes (additional taxes and related costs due to increased income).
While larger RMDs can mean higher tax bills, this may be a blessing in disguise because we still have historically low tax rates for two more years (2024 and 2025), before rates are scheduled to increase in 2026. The higher RMDs force more IRA funds out, and that’s good if they can be withdrawn at lower rates compared to what rates might be in the future.
Larger IRA balances may be a sign that too much is building up in tax-deferred accounts, increasing the eventual tax debt that will be owed to Uncle Sam. Higher balances, subject to higher rates, will leave clients and their beneficiaries with less later. Roth conversions can be especially effective right now not only to take advantage of current lower tax rates but also to reduce these growing taxable IRA balances. (Of course, Roth conversions should ideally be done before RMDs begin since RMDs cannot be converted.)
Under the post-SECURE Act rules, most beneficiaries who inherit an IRA will no longer qualify for the stretch IRA, and instead will have to pay all the tax due by the end of the 10th year after death, under the 10-year rule.
Converting now to a Roth will relieve the beneficiaries of that tax bill. In addition, Roth IRA beneficiaries, while still subject to the 10-year rule, are not required to take annual RMDs during the 10 years. This allows all the accumulation by the end of the 10th year to be withdrawn income-tax-free. That can mean big tax savings for beneficiaries who may be in their own highest earnings years.
In addition, a beneficiary can’t convert an inherited IRA to an inherited Roth IRA, so inheriting a Roth IRA can lower the overall estate and income tax bills for both the clients and their beneficiaries. (Under a quirk in the tax code, an inherited 401(k) can be converted to an inherited Roth IRA.)
Larger market values also mean larger estates for those invested in the market both inside and outside of their IRAs. Paying the income tax now on a Roth conversion can reduce estate values by the amount of tax paid. While the 2024 federal estate tax exemption has increased to a staggering $13.61 million per person (or $27.22 million per couple), many clients are subject to state estate taxes where the exemptions may be much lower, exposing these growing estates to unexpected state estate taxes.
For those clients who are already charitably inclined, seeing larger year-end IRA balances might encourage them to give more. Qualified charitable distributions are the perfect vehicle for those who qualify. QCDs are available only to IRA owners and IRA beneficiaries who are at least 70½ years old. Thanks to SECURE 2.0, the annual $100,000 limit has been increased slightly for 2024 to $105,000, as a result of inflation indexing.
QCDs must be done as direct transfers from the IRA to a qualifying charity. IRAs are the best assets to give to charity since they are loaded with taxes. Since QCDs can be done at age 70½, there is a slight gap before RMDs begin at age 73. During this pre-RMD period, QCDs can reduce IRA balances at zero tax cost. That can lower future RMD income, saving taxes when rates might be higher.
Most people no longer receive tax benefits for the charitable gifts they make since, according to the IRS, around 90 percent of taxpayers take the standard deduction. QCDs can replace that lost tax benefit, not in the form of a deduction but as an exclusion from income. An exclusion from income is better than a tax deduction because an exclusion lowers adjusted gross income, which in turn can maximize other tax benefits, credits, and deductions. It can also reduce Medicare IRMAA charges.
The strategy for using QCDs is best accomplished by doing them early in the year (for those subject to RMDs). While most people think of giving in December, for QCDs, January is the new December.
Doing the QCD first, before any RMD is taken, allows the QCD to satisfy the RMD, up to the QCD amount (which can’t exceed the $105,000 annual limit). If the RMD is taken first (before the QCD), a QCD done later cannot offset that RMD income.
The market is up, and IRA tax-planning antennas should be up as well to take advantage of opportunities to save future taxes now.
For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com.
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