Monthly Archives: October 2020

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How to make a ROTH Conversion Tax-Free in 2020

Many people know the benefits if they convert their Traditional IRA to a ROTH IRA but are still reluctant to do it because doing so would be a taxable event. There is an opportunity right now to do it tax-free. But you need to hurry.

First let’s review some of reasons to convert a Traditional IRA to a ROTH IRA:

  • Paying taxes at lower rates after retirement
  • NO required minimum distributions from ROTH
  • Lower taxes on Social Security during retirement
  • Lower Medicare premiums throughout retirement
  • Lower tax rates for married couples vs. single
  • Eliminates future tax rate uncertainty
  • Lower Medicare surtax on retirement income
  • Tax free distributions for beneficiaries
  • Estate planning considerations

So how can I have my cake (the ROTH Benefits) and eat it too (avoid the taxes on conversion)? You will need to hurry.

Recall that the CARES Act enacted on March 27, 2020, changed the limitations that are usually placed on charitable gifts. Ordinarily, cash contributions are limited to 60% of your adjusted gross income in the year the gift is made. Recognizing that charities are also hurting from the impact of the virus, Congress modified the limits for 2020. This year, and this year only, the deductible limit is 100% of adjusted gross income.

So the solution can be as simple as converting a portion (or all of) your Traditional IRA to a ROTH IRA and making a qualifying charitable contribution of the same amount. The contribution should not come from your IRA. It will come from your other accounts. To qualify for the higher limit, the gift must be a cash contribution directly to the charity. That is, it cannot be appreciated assets or made to start or maintain a donor advised fund. But you need to hurry and get both done in 2020.

I am making the assumption you itemize deductions on Schedule A of your tax return. Your charitable giving added to your other itemized deductions (medical and dental expenses, taxes you pay, interest you pay, casualty and theft losses, and other itemized deductions) must exceed the standard deduction allowed for your filing status. The standard deduction was increased by the Jobs Act in 2017.

Your financial advisor should be able to prove the benefit of this strategy by modeling various scenarios. We typically model this in two ways:

  • conversion vs. no conversion (status quo) this year
  • conversion with charitable contribution this year vs. next year

As with any significant tax maneuver, you should consult with your own tax advisor / preparer before making either of these moves.

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Need a reason to prepare the FAFSA? Here are 4.

Many have asked whether, given their family’s level of assets and / or income, they should go to the trouble of filling out the Free Application for Federal Student Aid (FAFSA). If you are a high school or college student (or the parent of one) that plans to attend college in the fall of 2021, the short answer is an unqualified “YES, do it now.” I believe that every student’s family should complete the FAFSA. Completing the FAFSA is a family affair–it involves the collection of data on the student as well as the parents or guardian.

Colleges and universities are run like businesses these days. They are competing for certain students and the admissions departments are busy evaluating students to see who gets in and who doesn’t. They use terms like “holistic” or “comprehensive” to describe the selection process. That means that a certain GPA or involvement in extracurricular activities are not the sole minimum requirements. They consider the whole package, including the family’s ability to pay for the education. The FAFSA shows the college your ability to pay.

Even if you think student loans are the work of the devil and you would not, at this moment, ever think of borrowing for college, submit the FAFSA anyway. FAFSA is also used for other forms of financial aid. The U.S. Department of Education awards $120 billion a year in grants, work-study programs and loans.

Here are some other reasons why you should complete the FAFSA:

When the FAFSA is completed, the Expected Family Contribution (EFC) is generated. Colleges determine financial need by subtracting your EFC from the Cost of Attendance (COA) at their school. Bear in mind, that the EFC is an estimate of your family’s ability to pay. Your ability to pay may actually increase or decrease before the child enters school next year. Life sometimes throws curve balls at the best laid plans. Schools can use professional judgement in their awards. When that happens, the first thing a school is likely to ask for is the FAFSA.

The chief reason for completing the FAFSA is to become eligible for Direct Federal Loans. High-income families will not likely qualify for Direct Federal Subsidized Loans, but by completing the FAFSA, they will become eligible for Direct Unsubsidized Federal Loans. The interest rate for undergrads is low enough to consider this source of capital.

Completing the FAFSA, along with the college application, puts the ball in the court of the admissions office. They don’t have to wait until after the FAFSA deadline (which can vary by state and school) to provide a financial aid award letter. The sooner you get the award letter, the sooner you know the net cost of college, and the sooner you can begin the award letter appeal process if the letter is unfavorable. We will deal with appealing award letters in a later blog post.

Because the Direct Federal Loan has an annual and a lifetime limit, it has become very important to project the entire cost of college from matriculation to graduation. Cash flow planning and debt structuring become crucial parts of a family’s financial plan when their student is headed off to college. Direct Federal Loans for undergrads are usually cheaper than the Federal Grad Plus loans. Therefore, sometimes it makes sense to borrow for undergrad education and save resources for graduate or professional school. A plan for repayment should also be developed before the money is borrowed. Because paying for college is likely to be the second largest expense for a family a complete college financial planning package should include a plan to reduce the cost of college, college cost comparisons, debt analysis, student loan repayment, and public loan forgiveness planning.

Federal funds are limited, and many states award their grants on a first-come, first-serve basis. So do it NOW.

Here is what you will need:

  • Social Security numbers for student and parents if student is a dependent
  • Driver’s license number if you have one
  • Tax returns including forms W2 for student and parents if student is dependent
  • Any records of untaxed income.
  • Asset records for cash, checking accounts, investments, real estate, business and farm interests.

Let us show you how to reduce the cost of college. For a free resource called 4 Keys to Cutting College Costs, click here.

Updated October 1, 2020