Episode 8: 2021 Is Over, But 2021 Tax Planning Isn’t

Benjamin Brandt:         Welcome back to The Retirement Tax Podcast. I’m your humble host as always, Benjamin Brandt, joined by the illustrious Steven Jarvis. Welcome Steven.

Steven Jarvis:     Ben, thanks for having me back on the show together. This is so much fun. It’s been a little while since we’ve recorded. Coming up on the holidays here and getting ready for the new year when this will actually release, so it’s good to be chatting again.

Benjamin Brandt:         So the question is just because 2021 is over, the tax planning season for 2021 still has a little bit of juice left in the squeeze.

Steven Jarvis:     Yeah. Yeah, we want to talk about that today, because a lot of people will say, “Oh, tax time is April or the tax deadline is April 15th.” Which this year it happens to be April 18th, but we’ll come back to that in a different episode. One of the things we want to accomplish today is really helping people understand that April 15th is not the only important date to keep in mind. Even though as this episode releases, the calendar year we’ve already turned over, there are still plenty of opportunities we can take advantage of.

Benjamin Brandt:         Right. So just because the calendar flipped over, there’s a lot of things that we’ve covered in previous episodes, that it’s actually December 31st at midnight, that’s the drop dead, we can’t do anything beyond. But now that we are in kind of an interesting time, in that the year is over, but tax filing deadline has not happened, there are some things that we can reach backwards into last year and still have some impact or have some influence on our tax consequence. So, let’s talk about what that looks like.

Steven Jarvis:     Yeah, this is really going to reinforce the importance of being intentional and being proactive, because the timing is really important. Then especially once the calendar year turns over, if we’re going to try to still take advantage of something for 2021, getting really clear on which tax year we’re reporting is really important as well.

                           But before we dive into the specific planning areas, just want to highlight real quick something that’s probably on a lot of people’s minds. As we record this episode, the Build Back Better bill that’s in Congress. Right now, it’s been passed by the House, it’s sitting in the Senate, and so I do get a lot of questions of, well, do I need to push pause on any of my tax planning, because we got to wait and see what happens there?

                           For me personally, Ben, I’d love to hear your approach with clients as well. I don’t ask people to gamble on what Congress is going to do, and so the things we’re going to talk about today, the deadlines for these tax plan opportunities, these aren’t things that Congress is talking about changing. Yes, there will be changes that come out of it when that eventually gets passed, but that doesn’t mean we should just sit back and wait on everything.

Benjamin Brandt:         Yeah, I mean, what we’re talking about with clients is based on some of the proposals with Build Back Better. There isn’t anything that’s going to radically change our plan. We’re looking at the next 30 years of retirement, we’re assessing what we think that tax bill might be, and we’re sanding off the rough edges of that tax bill. So, that big picture doesn’t change.

                           Now whether mega backdoor Roths are going to be a thing or not, or whether Roth conversions are going to be capped off at some point, that’s the nuance. That’s going to change things a little bit, but the big picture still isn’t going to change. We’ve got a really big tax bill facing us over the next 30 years of our retirement, and we’ve got to figure out a way to reduce that in areas.

                           So often with new legislation comes new things that we need to avoid, but oftentimes they bring in new opportunities that we can exploit as well. So any social security trick you’ve heard of over the last decade, that came as a loophole because of some other legislation opened this up. The Roth conversions, the Mulligan where you can re-characterize Roth conversions, all these things. Congress sets rules, which opens up loopholes, and then they pass new legislation to close loopholes. So, it’s this never ending process.

                           Which is great job security for Steven and I, also great content for Retirement Tax Podcast, but these are all things that we’re talking about with clients. So the big plan’s extremely unlikely not to change, but we’ll cover the nuance whenever that legislation when and if it passes, but we don’t want to spend a ton of mental calories planning or trying to make some big decision to avoid or to account for these things that we just don’t know yet.

Steven Jarvis:     Yeah, it’s a great point. I think the piece I’m most interested in with this one is that the backdoor Roth was actually created on accident by Congress, and so as they work to try to close that, I’m just curious to see what else they create by accident this time around. So, we’ll keep everyone posted.

Benjamin Brandt:         Absolutely.

Steven Jarvis:     On the topic of Roth, let’s go ahead and start there with what dates are important when we talk about Roth accounts. We have to get really clear on this one, because it makes a difference whether we’re talking about Roth conversions versus Roth contributions. We were talking before we hit record, it would’ve been nice if someone would’ve come up with much more distinct names for these things so they don’t all sound exactly the same.

                           But when we’re talking about Roth conversions, December 31st was the important date. So as we think about 2021, if we wanted to do Roth conversions, that opportunity has passed for 2021. We can start planning ahead for 2022, but conversions have to happen by the end of the calendar year by 1231.

Benjamin Brandt:         Right. So conversions, when that calendar flips over, we’re done. Contributions can really happen anytime, even beyond the year that we’re talking about. So you’re listening to this in 2022, if you’re going to make a Roth contribution, you can still reach backwards. In my mind, it’s sort of like the words push and pull. They mean opposite things, but they sound so similar. So contribution and conversion, we got to think of a different word for one of those that is adopted by the entire financial planning profession that we can use. So push and pull, too similar, conversion, contribution, way too similar.

Steven Jarvis:     Perfect. That can be one of our goals for 2022 is to come up with better names for these tax planning things that everyone talks about.

Benjamin Brandt:         Exactly.

Steven Jarvis:     So following this through on the contribution side, this great point that just because the calendar year has turned over, doesn’t mean we’ve missed our opportunity, but we still need to be intentional about this. So for Roth contributions, we have through the filing deadline, which this year is April 18th, that we can say, okay, we’re going to make a contribution and we want it to apply into the 2021 tax year.

                           We’ve got to make sure that we’re really particular when we make that contribution with our custodian, our account holder, that that gets classified in the right year, because between January 1st and the filing deadline, it technically could apply to either year. So we want to get real clear on that, that everything gets reported correctly, we don’t create issues for ourselves in the future.

Benjamin Brandt:         So Steven, when you say the deadline, is the deadline this year, April 18th, because that’s the actual deadline for IRA Roth, IRA and HSA, or is it because that’s the tax filing deadline? Let’s say I file my taxes on April 1st. Can I then still make an IRA or HSA contribution for the prior year two weeks after that, or is my personal deadline the day I file my income tax?

Steven Jarvis:     Oh, that’s a great clarification, Ben. Yeah, this has to be reported to the IRS. So as I talked about, April 18th, that happens to be the last day we can file before extending, but when you file your return for 2021, that’s basically you putting the bookend on the year and saying, “Okay, I’ve reported all of the activity and here’s what went on for the year.” So yes, we need to make this decision before we file our tax returns. So for those of you who are always really eager and excited to get your taxes done well in advance of that filing deadline, these decisions have to be made.

Benjamin Brandt:         Okay, what if I’m planning on filing an extension, then is it April 18th?

Steven Jarvis:     Oh, it’s a great question, and another area where the IRS isn’t really consistent, because for Roth contributions, as well as traditional IRA contributions, the IRS does not care if you extend or not, it’s still that initial filing deadline. There are some areas where the IRS will give you until the extended deadline if you extend, but this is not one of them.

                           So if you look at 2021 and you haven’t maxed out your Roth IRA contributions, you still have some of that limit left and you’d like to go ahead and make some contributions and apply them to 2021, you can go ahead and do that, but only through that initial filing deadline or when you file your return without any consideration of an extension.

Benjamin Brandt:         I see. Excellent.

Steven Jarvis:     Yeah, and that’s really great point, Ben.

Benjamin Brandt:         Okay, so the three main things we’re talking about today then are funding and IRA, funding a Roth IRA and funding an HSA. Of course, those would all appear in some form or another, either based on caps or phase-outs on income or actual deductibility of what you put into the accounts. Should we go through those and tell a bit about them?

Steven Jarvis:     Yeah, let’s do it. So Ben, I’ll kick this one back to you of how the conversation works with your clients, because really for listeners, okay, great, we’ve told them they’ve got this time period where they can make this decision, but what should they be looking for? How do we identify this opportunity for a specific person?

Benjamin Brandt:         Mm-hmm (affirmative). So with an IRA, we’re making a deductible contribution most of the time. So when we look at what your income is for 2021 and where you’d like it to be, funding an IRA gets us two things. One, we get some money that’s tax-preferred or tax-deferred for our retirement, but it also lets us have some influence on where we want our income to be. That’s the traditional deductible IRA contribution, not conversion.

                           Then we’ve got the Roth IRA. The Roth IRA also does the same thing as the IRA, in that we’re getting some tax-preferred, tax-deferred money for our retirement. That’s sort of step number one. We’re not getting a deduction on that in the same way that we would with the IRA, it’s the other side of the coin as the IRA. We’re not getting a deduction, but the benefit is that we get that growth, that we’ll get some tax-free income out of that at some point in the future as long as we follow some rules that I think we’ve discussed in the past.

                           So IRA is a deduction today, we pay taxes later. Roth is no deduction today, but tax-free income later. So picture a coin, two sides of a different coin. HSA is very like a retirement account, although it’s a savings plan specifically for paying for future health needs. Like many things in financial planning for planing the future, we get some tax benefit today. So, you do get a deduction on your HSA. It’s sort of like a Roth IRA for your health needs. So, you’ll get a deduction today.

                           If it’s a qualified distribution down the road and you invested those dollars and your $500 contribution became $600 and you spend that $600 on something health-related qualified distribution, that $600 is then a tax-free distribution, even though it’s $100 worth of growth. I think no matter how healthy you are, even if you’re running Spartan races like Steven, we are all going to need a hip replacement or some sort of thing later, no matter how healthy you are today, so it makes sense to use some of these tax-advantaged items.

Steven Jarvis:     Yeah, I’ve already told myself it’s going to be a knee replacement for me. My knees started hurting way sooner in life than I thought they would.

Benjamin Brandt:         Yes, I’m currently on a one month long CrossFit hiatus due to some back pain. Which if anybody knows anything about CrossFit, they’re not in the least bit surprised. So I’m saving up my HSA dollars, I’m waiting until they run a buy one, get one free on knee replacements and then I’ll cash in.

Steven Jarvis:     Perfect. Well, and if you don’t need both knees, maybe you and I can share that buy one, get one free.

Benjamin Brandt:         There you go, there you go.

Steven Jarvis:     Okay, coming back to the tax topics. So if you’re sitting there listening to this and saying, “Okay, great. I haven’t maxed out those opportunities yet. Okay, I’ve got this window.” So, you want to look at how much did you contribute in 2021, how much do you have left that you could contribute? Or if these are new topics to you that you haven’t considered, part of this might just be, okay, let’s start thinking about this for 2022 now and not wait until next year’s tax season.

                           We’re in this interesting couple of months here at the beginning of the year where we can really be proactively doing planning for both years. Again, we want to be intentional, we want to be proactive.

Benjamin Brandt:         Mm-hmm (affirmative). Yeah, I think it’s a good idea to think about what are we doing at the end of the year, what are we doing at the beginning of the year? So for our clients, they’re doing Roth conversions, almost to everyone doing Roth conversions at the end of the year, because that’s when we have the best idea of what our income is going to be. Then Roth contributions, either throughout the year or at the beginning of the year looking backwards.

                           Because other than the phase-outs and income caps on new Roth contributions, those can really be done anytime. Conversions, we’re trying to dial in our income, so we want that at the end of the year, or if there’s a really big market downturn, we want to do a partial Roth conversion. If we think there’s a really good chance we’ll do at the end of the year, let’s say $20,000, it would probably be a good idea to do $10,000 of that if we have a big downturn in the market to sort of proactively take advantage of the market going down.

                           I really only got one client that likes to do their entire Roth conversion at the beginning of the year, because he likes to do his own taxes and he likes to get absolutely everything done on one day. So, that includes the prior year and the year that we haven’t done yet. He likes to do it all at once and dial it into the dollar. So as an Excel nerd, I appreciate that, but I encourage people to do it at the end of the year, just because you have more known unknowns, I guess if that’s a thing. But yeah, to each their own.

Steven Jarvis:     Yeah, it does get a lot easier to take that year-to-date pay stub or your distribution statements, or whatever it might be, close to end of the year, or even as we get into to January and say, okay, where did I end up and is there some planning opportunities here?

Benjamin Brandt:         Right. If you do Roth conversion in January, and then your long lost uncle dies and leaves you an inheritance, well, now we’ve got more income than we thought, and we would’ve wished we would’ve waited. So again, another benefit of waiting is you don’t know what happened to you in the future, you only know looking backwards, so you just have so much more flexibility doing it late. But if you have a big surplus of income, most people aren’t going to complain too much.

Steven Jarvis:     Yeah, I always tell people that if they’re not happy paying the taxes on their income, they’re welcome to give their income to me. I’ll take the income and pay the taxes, and we’ll all be just fine.

Benjamin Brandt:         Absolutely, absolutely.

Steven Jarvis:     Ben, as you described that, it really highlights why you and I partnered up to do this. I mean, the tax elements are really important, but there’s these planning aspects as well that you can’t just focus on one area. We can’t only talk about taxes and assume that we’re covered, because there’s cash flow considerations, there’s other planning pieces of this that your traditional tax professional, even if you are working with someone else or doing it yourself might not be considering. So, that’s why it’s helpful to have these kind of broader discussions of what are the things we should be thinking about?

Benjamin Brandt:         It’s different for every person, right? I mean, we could have two different case studies with different goals and similar numbers, and we would advise somebody to do something different, because I guess that’s why they call it personal finance and not general finance.

Steven Jarvis:     Yeah, definitely. One deadline I do want to highlight, because we talked about it in a recent episode, is when it comes to charitable giving, this is another one that is a calendar year consideration. Even though we can in January make a Roth contribution and say, “Hey, this was applicable to 2021,” it doesn’t work with charitable giving. You can’t decide in January, “Hey, actually, I did want to give a little bit more to this local organization I care about. Can I back-date the check and call it 2021?” Nope, that’s a calendar year. Definitely build your plan for the current year. Please keep giving to those charities you care about, but that one is a calendar year.

Benjamin Brandt:         Yep. Yep, and I think that goes to one of your points from a previous week is that we’re giving, because we want to give first and then the tax impact second. So yeah, if the perfect charitable opportunity comes along on January 1st or January 2nd, “Yeah, gosh, I wish we would’ve got that in on last year, because that was an itemization year,” or whatever it was. But it’s important that you give to the charity because you care about the charity first and not taxes first.

Steven Jarvis:     Yeah. The other reminder I want to throw out with this conversation is that these things that we’re talking about that are calendar year cutoff, or if you’re listening to this episode a little bit later into the year and you’ve missed any of these cutoffs, just take that as an opportunity to start planning for 2022. Don’t tell yourself, oh, I’ll come back to this six months from now, eight months from now, put a plan in place. Even if you’re going to wait until late in the year to do the Roth conversion like Ben’s talking about, make sure you have a plan, make sure you have a reminder for yourself, whatever that looks like. But when these topics are top of mind and resonate with you, make sure you take action.

Benjamin Brandt:         Excellent. Should we move on to our listener question?

Steven Jarvis:     Let’s do it.

Benjamin Brandt:         We’ve got a listener from Pennsylvania who writes in, “I have most of my money in Roth accounts. I’ve done this because my pension and social security, both taxable, will keep me well until possibly my mid-70s.” She’s 57 now. “My question is, if I leave part of that Roth IRA to my children, do they have to pay taxes on it via some inheritance tax?”

                           Now, I’m not personally able to speak to Pennsylvania law. This is a global podcast, but most of our listeners I assume are in the United States, so we’re going to talk about federal law. But your Roth IRA, you have done your children a great service, in that you have paid the income tax for them. As long as you fall underneath federal estate tax laws, which could be potentially impacted by the pending legislation, so it’s generally the tens of millions of dollars, who knows what it’ll be by the time you hear this. But if you don’t fall under estate tax guidelines, yes, your children will be able to inherit that tax-free. However, due to the recent legislation and the death of the stretch IRA, they will have to take that money out within 10 years.

Steven Jarvis:     Yeah, this highlights one of the considerations that really should be informing your decision on whether to do Roth or traditional IRAs. A lot of times we only talk about the relative tax rate, but your end of life goals, your legacy goals play into that as well. So if you want to leave funds for your children, getting it into a Roth account is a great way to help them not have to take that tax burden on. But if your goal is to leave it all to charity, maybe it’s not worth taking the time to put it into Roth.

                           The one comment I’ll make on Pennsylvania, because the states do all get to make their own rules as well. Pennsylvania does have an inheritance tax which works a little bit differently than an estate tax as far as who’s responsible for it. We’re not going to dive deep on state details since we have listeners all over the country. Certainly something to look at, but in general, the states follow the same principles as the federal level, so Roth money is after tax money.

                           So it’s certainly something you want to look at specifically into the Pennsylvania details, but getting that money into Roth is typically going to set your children up so that they don’t have a tax burden they incur.

Benjamin Brandt:         Yes, and if you are potentially subject to the estate tax, if you’ve got illiquid properties or assets, a Roth IRA could inject some really valuable liquidity into that situation where they would have some tax-free money to pay the income tax or the estate tax on other things that aren’t the Roth that are generating some taxable income in the form of an inheritance.

                           Now, I think it’s important to point out. If I inherited my mom’s IRA, I wouldn’t be subject to the estate tax in particular, but I would be subject to income tax, because that money has not yet been taxed. So, there’s two different things. I think oftentimes, colloquially, we assume any taxes paid a death or an estate tax. That’s a totally separate net worth-based-tax if something has not been income taxed yet, like an IRA that’s deferred tax. It would be taxable to me if I inherit it. I’ve got to take the money out over ten years. As the money comes out, I pay taxes, so you could be subject to both depending on the size of your estate, I suppose. But in particular, in this instance, when we’re talking about Roth IRA, we’re talking about just that income tax. So, they are two separate things.

Steven Jarvis:     Yeah, that’s a great distinction, Ben, of the income tax versus the estate or inheritance tax, and you want to make sure that you’re considering both.

Benjamin Brandt:         And check locally, like Steven said. There are all kinds of different nuances with inheritance taxes and estate taxes. There’s the federal one, which we’re talking more federally here. Contact a local CPA to be sure. Contact a local advisor. These are just helpful hints and information—don’t take this as personalized financial advice. There could be a lot of nuance to your situation that I wouldn’t be comfortable answering unless I looked at your estate plan, unless I looked at your income taxes, so find somebody locally that’s answered this question hundreds of times for other Pennsylvania residents, and I would be much—that would be very valuable for your time and money to get a nuanced answer.

Steven Jarvis:     Yeah, that’s a great recommendation. Ben, any other parting words of wisdom on this topic?

Benjamin Brandt:         I could give you lots of parting words, but no guarantee that there’s any wisdom.

Steven Jarvis:     Perfect, well if we’re out of wisdom for the day, then for everyone listening, just remember to not let the tax man hit ya where the good Lord split ya.

Benjamin Brandt:         I love it. Everybody, have a great day.