Many federal employees and retirees are still recuperating from this past tax filing season.
Tax year 2018 was the first year in which federal income tax returns were prepared and filed under the Tax Cuts and Jobs Act (TCJA) of 2017. TCJA’s passage resulted in several tax law changes affecting both employees and annuitants. It is quite likely therefore that IRA and retirement planning for 2019 may have been neglected in the aftermath of the 2018 tax return filing season.
This column makes some suggestions for IRA and retirement planning for 2019 and beyond.
5 Retirement Planning Moves
There are four recommended IRA and retirement planning moves that are presented, two of which are for employees and the other two are for annuitants. A last suggestion for IRA planning is for all IRA owners, no matter their age or employment status.
1. Convert traditional IRAs to Roth IRAs
Under the TCJA of 2017, marginal tax rates were reduced an average two to three percent. The rates will remain at these lower levels until 2026 at which time marginal tax rates will revert back to what they were in 2017, inflation adjusted.
This means that by converting a traditional IRA to a Roth IRA during 2019, the traditional IRA owner may pay a lower overall tax compared to what were to happen if no Roth IRA conversion was performed and the traditional IRA funds were withdrawn after 2025. The IRA owner would pay the tax on the traditional IRA withdrawals after the marginal tax rates reverted back to what they were in 2017, inflation adjusted. Also, once a traditional IRA owner reaches age 70, the owner must take a required minimum distribution (RMD) from the IRA each year. Roth IRAs on the other hand are not subject to RMDs.
Those traditional IRA owners who intend to convert their traditional IRAs to Roth IRAs during 2019 should make sure that as a result of the Roth IRA conversion, that they are not pushed into a higher marginal tax bracket. They should work with an experienced tax professional who can inform the IRA owner how much of the traditional IRA can be safely converted without pushing the IRA owner into a higher marginal tax bracket for 2019.
2. Make Roth IRA contributions
Those employees who file as single and whose adjusted gross income is expected to be lower than $122,000 should make every effort to contribute to a Roth IRA.
Maximum contribution during 2019 is $6,000 for individuals younger than 50 and $7,000 for individuals over age 49 during 2019. Employees who are married and filing jointly and whose adjusted gross income during 2019 is below $193,000 should contribute the maximum possible to a Roth IRA. Employees who are able to contribute to a Roth IRA should ideally be contributing the maximum possible to the traditional TSP.
In so doing, these employees are performing “tax diversification”; in particular, getting tax savings during 2019 when contributing to the traditional TSP while getting the benefit of “tax-free” income in the future (at which time marginal tax rates should be higher) when withdrawals are made from the Roth IRA.
3. Annuitants, especially those getting closer to age 70, with traditional IRAs should consider rolling their traditional IRAs into their traditional TSP account
In so doing, they can avoid having to take a separate RMD from their traditional IRAs and make their life “simpler”.
4. Annuitants over age 70.5 with traditional IRAs should consider qualified charitable distributions (QCDs).
Due to recent tax law changes, more individuals should be performing QCDs during 2019. QCDs are a tax-efficient and easy way to make charitable contributions, but only for traditional IRA owners age 70.5 and older. The rather large tax benefit associated with a QCD is that rather than including the traditional IRA RMD in income and taking an itemized deduction, a QCD is a charitable gift made by a direct transfer from the traditional IRA to a charity.
The transfer counts towards any RMD not yet taken and is excluded from income. While there is no tax deduction for the charitable donation, the QCD is in fact “deducted” by excluding it from the traditional IRA owner’s income for the year the QCD is made.
QCDs must be made from traditional IRAs and not from the TSP. Since a TSP participant is allowed to directly transfer a part or all of his or her traditional TSP to a traditional IRA, a TSP participant over age 70.5 and retired may want to consider directly transferring during 2019 a part of his or her traditional TSP account to a traditional IRA.
While this direct transfer will not affect the TSP RMD for 2019, for 2020 and beyond the direct transfer should result in a smaller TSP RMD because the traditional TSP account balance would be less as of Dec. 31, 2019. In the meantime, the TSP participant can fulfill the traditional IRA RMD in future years by performing QCDs.
5. All IRA owners should track and keep a record of their IRA contributions through the years, including types of IRAs, amounts contributed, years contributed, and “cost basis”.
Many IRA owners make contributions to their IRAs when they were young, early in their working careers and have continued making contributions to IRAs during most of their mid-career working years. By the time they reached their mid-to-late 50’s, they tended to cease contributing to their IRAs. They have not kept a complete inventory of the type of IRAs (traditional or Roth) to which they have contributed through the years. With respect to traditional IRAs, they have no record of whether the contributions made through the years were tax deductible (“deductible” IRA) or non-tax deductible (“nondeductible” IRA).
In the case of nondeductible traditional IRAs, they did not file IRS Form 8606 (Nondeductible IRAs) during the years they contributed to a nondeductible traditional IRA, in order to keep a “cost basis” of contributions made to the nondeductible IRA. By filing Form 8606 in each year that the traditional IRA owner made nondeductible contributions, the IRA owner will only have to pay federal and state income taxes on the accrued earnings that have been withdrawn and not the contributions. It is not too late for traditional IRA owners to file Form 8606 if they have not done so. Also, Roth IRA withdrawals are not taxed assuming that the withdrawal is a “qualified” distribution. A “qualified” Roth IRA withdrawal means that the Roth IRA owner is at least age 59.5 and it has been at least five years since January 1 of the year the Roth IRA owner made his or her very first Roth IRA contribution.
It is important that employees and annuitants do an inventory and make a spreadsheet of their IRA contributions, conversions, and rollovers through the years before they start withdrawing from their IRAs. In so doing, they will make it easier to determine the federal and state income tax consequences (if any) of these withdrawals.