Year-End Retirement Planning: CARES Act, Qualified Charitable Distributions, and More | Lord Abbett
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Retirement Perspectives

In our podcast, Brian Dobbis explains a few important strategies that you can take to optimize retirement savings and tax planning before year-end.

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Transcript

Recorded Nov. 9, 2020

Karyn McCormack: Welcome to Retirement Spotlight, Lord Abbett's podcast series. This is Karyn McCormack. This is our fourth at-home podcast edition recording via Zoom again today. So we finally made it. 2020 has been a grueling year but we're now in the home stretch.

As we reach the end of the year, a number of critical retirement account deadlines are fast approaching. So in order to take advantage of certain tax breaks and benefits, we want to remind everyone to review your year-end financial plan.

To help you with that, our retirement expert, Brian Dobbis, Lord Abbett's director of retirement solutions, has compiled a handy guide for year-end retirement planning. We call it our year-end checklist. Today, we're going to touch on a few of the important items on his list. And advisors are invited to Brian's webinar on December 10th. Let's get started. First, welcome, Brian.

Brian Dobbis: Thank you, Karyn. Thank you for having me back. I appreciate it.

Karyn McCormack: So earlier this year Congress, in response to the COVID-19 pandemic, passed the CARES Act. It's a $2 trillion stimulus bill which, among other items, included tax-favored provisions affecting retirement accounts. What can you tell our listeners about these retirement account provisions?

Brian Dobbis: Karyn, the CARES Act included a provision being referred to as the coronavirus-related distributions or by its acronym, CRD. And this provision has proved to be notable within the CARES Act. Why? Because CRDs are tax-advantaged distributions of up to $100,000 made from IRAs, employer-sponsored plan, such as a 401(k) or a 403B, or a combination of employer plan and IRAs, which are made by a qualified individual.

Furthermore, a qualified individual can take a coronavirus-related distribution-- anytime between January 1st through December 30th, not December 31st. Therefore, if you previously took a CRD throughout the year or are planning to take one on or before December 30th, it's critical the distribution is reported correctly.

Furthermore, the tax treatment of a CRD is an individual taxpayer issue, not a plan or IRA provider issue. So what does that mean? CRDs are reported as part of an individual's tax return. So it doesn't matter how the plan or the IRA provider reports to the IRS the distribution.

It is the in the end user, the share owner, the plan participant. It is their responsibility to make this determination-- along with their accountant to ensure that they receive all the tax breaks. And some of those tax breaks, Karyn, I think are important to reiterate to our listeners.

First and foremost, if you took coronavirus-related distribution, there is no 10% early distribution penalty. Secondly, the income associated with the distribution is taxable. However, Karyn, it can either all be reported on an individual's 2020 return or it can be split ratably among the next three tax years, 2020 through 2022.

However, once a qualified individual files his or her 2020 taxes reflecting one of the two methods I just mentioned, it cannot be changed at a later date. So for example, if I took a CRD valued at, say, $60,000, I can either report the full $60,000 on my 2020 return or I can split it ratably over the next three tax years, 2020 through 2022.

Karyn McCormack: Good to know, Brian. And speaking of the different type of payout here, the CARES Act also waived 2020 required minimum distributions. What do our listeners need to know about this?

Brian Dobbis: Oh, one annual deadline that our listeners do not have to be concerned with this year is taking your required minimum distribution by year-end. As you said, Karyn-- the CARES Act waived 2020 required minimum distributions for all retirement accounts except for defined benefit plans and nongovernmental 457 plans.

However, if you took an RMD anyway, it generally must be included in your 2020 taxable income. And in my opinion, the big takeaway regarding the waiver of RMDs is if a 2020 RMD was previously taken, the funds could be repaid, i.e. rolled over, thus avoiding taxation if you are otherwise eligible for a rollover.

So what does "otherwise eligible" mean? This means any repayment must be done within a 60-day period and is subject to a once-per-year IRA-to-IRA rollover rule. So this occurs, this being a rollover or return of RMDs, this may occur in a situation where you don't need to income that the RMD produces.

Remember, the RMD-- everyone has to take one-- whether they want to or not in a normal year. This year, if you don't need the income, you don't need to take it. However, what I've seen in my experience, Karyn-- some individuals have taken RMDs, not realized that there was a waiver. So there is an option to return to money under certain circumstances thus avoiding taxable income.

Karyn McCormack: Now, Brian, did the CARES Act also waive 2020 RMDs for nonspouse beneficiaries?

Brian Dobbis: Terrific question. The answer is yes. The waiver also applies to inherited IRAs, including inherited Roth IRAs and employer plans such as 401(k) beneficiaries. However, unlike lifetime required minimum distributions, nonspouse beneficiaries cannot repay, i.e. roll over, previously received required minimum distributions.

Therefore, as of this recording, if a beneficiary of an inherited IRA has yet to take their 2020 RMD-- they can request these funds to remain in the plan-- thus avoiding taxation. On the flip side, Karyn, if you're a beneficiary and you already took a 2020 distribution that you originally thought was an RMD but, due to the CARES Act has now been waived, unfortunately those funds cannot be returned.

Karyn McCormack: So one more RMD question, Brian. Does a 2020 RMD impact 2021 RMDs?

Brian Dobbis: Not at all, Karyn. The short answer is no. Your 2020 required minimum distribution will follow the rules-- as determined in prior years. For example, your 2021 required minimum distribution will be based on your prior year, your December 30th-- December 31st account value divided by your life expectancy.

Karyn McCormack: Okay. What do we need to know about qualified charitable distributions from IRAs this year? If the CARES Act waived RMDs, are QCD still permitted?

Brian Dobbis: Qualified charitable distributions, otherwise known as QCDs, are a tax-free direct transfer of IRA funds up to $100,000 annual paid to certain qualified charities. QCDs, Karyn, can be made from traditional IRAs, Roth IRAs, and inactive SEP and SIMPLEs held by account owners or beneficiaries who are at least 70.5 or older.

However, and very important to our listeners, qualified charitable distributions are not eligible from employer plans such as a 401(k). As stated, QCDs can be counted towards satisfying your annual required minimum distribution if certain rules are satisfied.

QCDs can still be done in 2020 even though there are no RMDs to offset. However, QCDs would still be nontaxable but would not save money by reducing otherwise taxable income from your from your RMD, Karyn. Instead, all your QCD would do in 2020 is reduce your IRA balance and then reduce future RMDs.

Therefore, if you're still considering doing a QCD for 2020, I would suggest maybe pushing it off to 2021 when RMDs will start up again. Therefore, you can reduce your 2021 RMD. For our listeners, this is a conversation to have with your financial team.

Karyn McCormack: Yeah, that's a good strategy to have for next year. So you also said, Brian, that QCDs are available at age 70.5. Would the SECURE Act increase the RMD age to 72?

Brian Dobbis: Great catch, Karyn, and a great question. Something-- a question I've been getting a lot of concerns about. The SECURE Act did increase the required minimum distribution age until 72 effective for 2020. However, as we discussed earlier, 2020 required minimum distributions were waived as part of the CARES Act and to help offset the financial duress due to the COVID pandemic.

The SECURE Act, however, did not change the age at which an otherwise eligible individual can still do a QCD. Therefore, Karyn, QCD eligibility remains at 70.5 even though the RMD age has increased to 72. QCDs prior to the start of RMDs would function like a QCD this year when there are no RMDs meaning you're simply taking pretax retirement dollars and donating it to a charity without the ability to offset future minimum distributions.

Further, Karyn-- another one of these nuances that is so crucial for our listeners. For those who did make a QCD this year in 2020, be aware that although the amount of funds of the distribution will still be reported on IRS Form 1099-R, which reports retirement distributions, there is no code or specific reporting function to report a QCD.

As such, QCDs can easily be missed on a tax return. Therefore, if you did a QCD, I would urge our listeners to have a conversation with their CPA and their financial team to ensure that the QCD is reported properly on your tax return and, thus, not inadvertently added to your taxable income.

And Karyn, one last thing I thought I would mention regarding QCDs-- one nuance that is commonly overlooked. Since an annual QCD must be received by the charity by December 31st, I would suggest not waiting until the end of the year. It's not processing the QCD, Karyn. The charity must actually receive the QCD by the end of the year to qualify for 2020.

Karyn McCormack: Thanks, Brian. One more strategy that we should talk about is if you own company stock in your 401(k). This strategy is called the net unrealized appreciation strategy. Can you tell our listeners who might want to use that strategy in their year-end planning?

Brian Dobbis: Yeah, this is an oft-overlooked significant tax strategy. Net unrealized appreciation, known as NUA-- is a tremendous tax-planning strategy if you hold highly appreciated company stock in your 401(k) plan. The NUA strategy allows an individual to pay ordinary income tax on the cost of the basis when distributed as opposed to the value of the stock at favorable, long-term capital gains rate even if the stock is subsequently sold within a year.

So Karyn, to give our listeners an idea of how this works, so they can let this marinate. For example, if I hold company stock in my 401(k) plan and let's say it's valued at $100,000 but my basis, the amount that it cost to purchase the stock, is only $10,000. So my holding has appreciated $90,000.

Using the NUA strategy, I would pay $10,000 in taxable income in 2020 that's taxed at ordinary income tax rate, but the appreciation, i.e. the NUA, isn't taxed until the shares are sold. Even then, at favorable, long-term capital gains rates, which are less taxation than ordinary income tax rate.

The long-term capital gains rate is 20%. The top income tax rate in 2020 is 37%. However, Karyn, why do we have this at the year-end checklist? NUA treatment requires a taxpayer to satisfy several rules. And one rule, or one requirement, is that all retirement plan funds must be distributed by the end of the year.

In other words, if plan funds, such as mutual funds, remain in the plan and all you've liquidated is the company stock, the lump sum distribution requirement will not be satisfied and you will not be eligible for NUA. And finally-- it's crucial to be aware NUA requires the stock to be transferred to a taxable account, not an IRA rollover.

Moving the stock to an IRA rollover invalidates the NUA treatment. So again, for our listeners, I would urge our listeners to have a conversation with their financial team-- their financial advisor, their CPA, to ensure that if they want to use, or are looking to use, or are using NUA that they fulfill all the requirements.

Karyn McCormack: Brian, thanks for explaining that. Are there any other additional items we should keep in mind as we wind down the year?

Brian Dobbis: Yeah, Karyn. I would suggest, in my experience, I've found these are three items—that should definitely be looked at and discussed before year-end. One is for those individuals who have made tax nondeductible, traditional IRA contributions, or took a distribution from their traditional IRA that included basis, including any of our listeners who have done a backdoor Roth, it is imperative that you, or most likely your tax professional, files IRS Form 8606 called Nondeductible IRA.

This form is filed generally with your tax return. If you don't file this very crucial form, your distributions from your IRA could potentially be taxed multiple times. The second item, Karyn, is make sure you're contributing the maximum to all your tax-advantaged accounts.

This would include IRAs, SEP IRAs, SIMPLE IRAs, 401(k), your 529 education accounts-- 529 ABLE accounts, which are tax-advantaged accounts-- for folks who have certain disabilities, and of course health savings accounts.

Although some of these accounts can be funded as late as next April 15th, start preparing now. And the third item, Karyn, for our listeners is review and update, if needed, all your beneficiary paperwork for all your tax-advantaged accounts across the board. IRA, 401(k)s, and even health savings accounts. Yes, ladies and gentlemen, HSAs require a beneficiary form. And remember, your beneficiary forms will determine who inherits your retirement account as opposed to your will.

Karyn McCormack: Brian, all good advice. Thank you so much for being with us today.

Brian Dobbis: Thank you for having me, Karyn.

Karyn McCormack: Our full article, Year-End Retirement Checklist, can be found on our website, lordabbett.com/retirementperspectives. Advisors, you can also attend our webinar with Brian on December 10th at 1:00 P.M. Our full article, Year-End Retirement Checklist, can be found on our website, lordabbett.com/retirementperspectives.

Brian also has a number of articles covering retirement provisions in the CARES Act. Advisors, you can also attend our webinar on December 10th at 1:00 PM Eastern with Brian. You can find the registration link at lordabbett.com.

Advisors, if you have additional questions, please contact your Lord Abbett representative at 888-522-2388.

Thanks for listening to our at-home addition of Retirement Spotlight. We hope you're all staying safe and healthy as this year comes to a close. Ta-ta for now.



DISCLOSURES

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

A Qualified Charitable Distribution, or QCD, allows individuals who are 70.5 years old or older to donate up to $100,000 annually to one or more charities directly from a taxable IRA instead of taking the required minimum distribution.

Net Unrealized Appreciation, or NUA, of employer stock held in an employer-sponsored retirement plan permits gains that occurred inside the plan to be taxed outside the plan, for instance a brokerage account, at preferential long-term capital gains rates.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

Required minimum distribution (RMD) is the minimum amount you must withdraw from your account each year. You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

This broadcast is the copyright © 2020 of Lord, Abbett & Co. LLC. All Rights Reserved. This recording may not be reproduced in whole or in part or any form without the permission of Lord Abbett. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.

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