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Investors Should Take Advantage of Tax Opportunities in 2020
The strangeness of 2020 and the pandemic reality we are all adjusting to does not confine itself to our day-to-day life choices. It’s a strange year as it relates to some retirement planning hallmark issues like taxes and your individual retirement accounts.
Given the high levels of market volatility, many investors will have the opportunity to reposition and rebalance their accounts and realize capital losses as they prepare for a post-pandemic economy.
Retirement accounts like IRAs, which usually force one to distribute the money as taxable income, have given Americans 72 and older a first-time opportunity to forego that distribution in 2020 and save the tax dollars. These two facts are a welcome reprieve for a portion of the baby-boomer generation vulnerable to the new coronavirus. There is certainly hope that 2021 is less eventful and brings positive change to the world. But for the time being, here are a couple of ways to turn the tables on 2020.
Reevaluate Your Investments
Based on the S&P 500, the market has recovered about 49% from its March lows. That said, many investors may still be sitting on substantial losses in individual positions.
The S&P 500 is positive about 3.7% year to date at the time of this writing, but there has been disparate performance among different sectors, allowing investors to sell positions at a loss and reallocate to sectors of the market that are well-positioned for a post-pandemic digital economy.
Many dividend-oriented investors have gravitated toward energy and financial companies over the past decade, as companies in these sectors have been reliable dividend payers for decades. But year to date, the S&P 500 financial sector is down 17.9%, and the S&P 500 energy sector is down a whopping 33%.
The pandemic has ravaged areas of the economy that were thought to be steady,reliable and impossible to do without. Take a look at Boeing (ticker: BA), for example.
Now is an opportunistic time to reevaluate your investment strategy as the world economy accelerates into an even more digitized future. In doing so, you will also get the benefit of taking tax losses on positions that have suffered year to date, and in some cases, have been in secular decline for much longer (e.g. energy).
Look at sectors and industries that did not just have resiliency during the pandemic, but have grown during the pandemic. Even within the energy sector, certain industries like renewable energy have fared quite well in some circumstances. The pandemic is not just a chance to reevaluate our life priorities, but also to ensure your portfolio is forward-looking.
Take Advantage of IRA Tax Perks
The Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act, was passed into law late in 2019, in what feels like ages and trillions of dollars ago. This landmark legislation changed the rules for required minimum distribution (RMDs) from age 70.5 to – wait for it – 72 for IRAs and other tax-deferred retirement accounts. Nevertheless, it defers money leaving your pocket and appearing in Uncle Sam’s coffers for a year and a half. The SECURE Act was quickly followed by the new coronavirus spreading across the world and bringing business and life to an abrupt halt.
The Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, is a $2.2 trillion economic stimulus bill that was passed amid an apex of financial panic and the health care system overload. It allows IRA owners to forgo RMDs in 2020. The waiver applies to IRAs, inherited IRAs as well as defined contribution plans such as 401(k)s. In addition, to the extent that an IRA owner has already taken their 2020 distribution, they can put that money back into the IRA account and avoid the associated tax – as long as it’s done by the Aug. 31 deadline.
There is another silver lining planning opportunity: This 2020 relief gives IRA owners who are accustomed to paying taxes on IRA distributions the opportunity to convert that same monetary amount to a Roth IRA.
Taxes will still be due, but now the RMD equivalent dollars will grow tax-free. Marginal tax rates are at their lowest since the Reagan-era tax cuts in the 1980s.
This year could prove to be a relatively advantageous year to pay taxes, given tax rates may increase significantly over the next decade. That’s especially true if 2020 ends in an administration change. In a worst-case scenario, you can tap the Roth IRA money during high tax years to manage the tax bill. In a best-case scenario, you can leave tax-free money to future generations. There are no RMD requirements for a Roth IRA, so the money can grow tax-free indefinitely until the nonspouse beneficiary inherits it, at which point RMDs would be required.
Take advantage. Over long periods of time, these types of incremental gains compound into significant wealth differences.
