By Josh Morris, CPA/PFS, CFP®
The end of the year represents the perfect opportunity to reflect on the last twelve months and to review your overall personal financial situation. 2019 may have been a great year, or perhaps you didn’t accomplish as much as you would have liked. In either case, 2020 can be a fresh start, allowing you an opportunity to become more intentional about accomplishing your goals.
These final weeks of 2019 have introduced some new planning items in 2020 with the introduction of the SECURE Act, which will affect everyone either now or in the future. We have summarized some of the key points from this legislation below, along with the top 3 items for each financial planning area to help make 2020 the best year ever!
The SECURE Act
The entire bill can be found here, but a summary of key areas that may affect you are listed below.
- The ‘Stretch provision’ for non-spouse beneficiaries of IRAs is being eliminated. This provision previously allowed for distributions from IRAs to be made over the beneficiary’s life expectancy, which won’t be available to those that pass away in 2020 or later. Instead, the new standard distribution requirement will be the ‘10-Year Rule,’ in which the entire balance must be distributed by the 10th year after death (with no required distributions during the 10-year period). Spouses, minor children, and other “Eligible Designated Beneficiaries” are not subject to the 10-Year Rule, but this change presents planning challenges for trust beneficiaries and large IRA accounts since the limited distribution period and compressed tax brackets of trusts can cause much more of the account to be subject to income taxes.
- The Required Minimum Distribution (RMD) beginning age increased from 70 ½ to 72. This new beginning age applies to those turning 70 ½ in 2020. Therefore, if you already turned 70 ½ in 2019 or earlier, you will still be subject to RMDs going forward. Also, unrelated to the SECURE Act, the IRS is updating their life expectancy tables for calculating RMDs beginning in 2021.
- You can now contribute to an IRA after age 70 ½. Previously, you could not do so even if you had earned income since RMDs began at 70 ½. You must have earned income to make these contributions.
- You can still make Qualified Charitable Distributions (QCDs) beginning at age 70 ½. Even though the beginning age for RMDs has increased to 72, QCDs up to $100,000 per year can be made beginning at age 70 ½. Making QCDs can help lower your income taxes since those distributions are excluded from income, which reduce your AGI and potentially also reduce Medicare premiums and the taxation of Social Security benefits.
- 529 plans can be used to pay for homeschooling, apprenticeship programs, and student loans. Retroactive to the beginning of 2019, Apprenticeship Programs registered and certified with the Department of Labor and homeschooling will now be eligible for tax-free distributions from 529 plans to cover fees, books, supplies, and required equipment. Also, up to a lifetime maximum amount of $10,000 from a 529 plan may be used to pay interest and/or principal of qualified education loans.
- The ‘Kiddie Tax’ reverts to pre-TCJA laws. The Tax Costs and Jobs Act (TCJA) made the unearned income of certain children taxable at trust rates rather than at the parents’ marginal tax rate. The SECURE Act eliminated this provision and made the income taxable at the parents’ marginal tax rate once again (and allowing taxpayers to use either method in 2019 or 2018, if you decide to amend).
Cash Flow Planning
- Review your 2019 spending and create a spending plan for next year. Most of the time, we don’t realize how much we may spend in various categories and can be surprised how small purchases over time can add up. Understanding your cash flow is an important aspect of determining if you have sufficient assets in retirement to meet your goals.
- Contribute the maximum amount to qualified plans. Each year the IRS can adjust the maximum amounts that can be contributed to certain account types. For 2020, the maximum amounts are as follows, and you may need to make adjustments with your employer or automatic investments to ensure you are fully funding them.
- 401(k)/403(b)/457 – $19,500 ($26,000 if 50 or over due to catch-up contributions)
- SEP IRA – $57,000 ($63,500 if 50 or over)
- SIMPLE IRA – $13,500 ($16,500 if 50 or over)
- IRA – $6,000 ($7,000 if 50 or over)
- HSA – $3,550 single / $7,100 family (plus $1,000 catch-up for each individual age 55 or over who is covered by an HSA-eligible medical plan)
- Set your investing on autopilot. Just like your 401(k) contributions are withheld from each paycheck, you should set up automatic contributions to your IRAs and other investments to ensure they are funded before the income is spent. Fully funding your 401(k) plans may not be enough to meet your retirement goals, and you should at least be saving 20% of your gross income while working. Finally, setting up these automatic investments also allows for dollar-cost averaging, ensuring that you buy more shares at lower prices and less shares at higher prices.
- Be sure that your estate planning documents are up to date. These documents include not just your will, but also your power of attorney, health care documents, and any trust agreements. Keep in mind that if you moved to a new state, you will likely need to update your estate planning documents as well.
- Update your beneficiaries to coincide with your estate plan. Since life insurance and retirement plan beneficiaries override what is stated in your will and other estate planning documents, it is important to review them to make sure they are consistent. Also, given the 10-Year Rule change by the SECURE Act, it is important to review any trust language if a trust is named as beneficiary to an IRA.
- Prepare a flowchart of your current estate plan to visualize what would happen to each of your assets and how the current estate tax law will impact you. If you might be subject to the estate tax, consider annual gifting of up to $15k, paying medical expenses and/or tuition directly on behalf of family, and charitable giving. Don’t forget to consider the impact of any state estate taxes, which could differ from the Federal estate tax exemptions.
- Obtain an umbrella liability insurance policy. This policy provides additional liability protection above your homeowner’s and automobile insurance. Working with an independent agent that can shop many different carriers helps ensure you aren’t paying too much for your coverage. Also, the independent agent will be able to review the policies to see if any gaps in coverage exist.
- Review your life insurance coverage. We typically recommend obtaining 10- to 20-year level term life insurance rather than obtaining permanent or cash value life insurance. Term insurance premiums are on average 10x less expensive for similar coverage amounts, which allows you to invest more to meet your retirement goals.
- Review your disability coverage. Many employers offer long-term disability coverage, but you many want to consider a membership organization if you don’t have access to employer coverage as they sometimes have cost-effective coverage. Also, you may want to consider paying the disability premiums rather than your employer, if offered, as doing so will mean any benefits received would be considered free from income tax. Finally, another point to consider is whether the policy is considered “own occupation,” which means that disability benefits are paid if you can’t perform your current, specific role rather than any occupation.
- Fund a 529 plan to pay for education costs. Given the improved flexibility provided by the Tax Cuts and Jobs Act (TCJA) and the SECURE Act, funding a 529 should be the first priority for education costs. 529 plans don’t offer any federal income tax deductions, but if your state has an income tax, there may be benefits to funding your state 529 plans. Any contributions made to the 529 grow tax-deferred, and distributions are free from income tax when used for qualified education expenses.
- Determine where you would like children to attend. College choice is the number one driver of the cost of attendance. All too often the deciding factor for college selection is the athletics, the campus atmosphere, or the prestige associated with it rather than if the school is best suited for the future student’s educational goals. Deciding on how much you are willing to contribute to their education (and speaking candidly with your children about it) will help establish boundaries, reduce the burden of student loan debt, and increase the likelihood of success for your own retirement goals.
- Encourage students to increase ACT/SAT scores and apply for scholarships. Investing in test preparation materials and courses to improve the scores for the ACT/SAT is a good value when you consider the merit financial aid that is given to students with high scores. Also, in their junior and senior years, they should be engaging in various organizations to make them more well-rounded and begin applying for various scholarships to reduce the financial cost of education.
Income Tax Planning
- Work with a CPA to prepare your taxes each year. Unless your return is relatively straightforward with a W-2 and taking the standard deduction, we encourage everyone to work with a CPA to prepare their taxes. Since they see hundreds of client returns a year and know most of the rules without having to look them up, they will typically be able to prepare it faster, more accurately, and could even find some additional deductions or credits that you may have missed. Also, you probably don’t enjoy doing them yourself, so it should be something that you consider outsourcing to free up that time.
- Implement tax reduction strategies such as maximizing your retirement plan contributions or tax loss harvesting in taxable accounts. Some strategies involving charity include donating appreciated stock, taking Qualified Charitable Distributions from your IRA if you are over 70 ½, and bunching charitable contributions every other year to take advantage of larger itemized deductions one year and the standard deduction the next year. Investing in tax-efficient investments such as ETFs rather than mutual funds can also help reduce taxes since mutual funds typically issue capital gain distributions in December each year whereas ETFs typically do not.
- Prepare multi-year tax projections to see if you can benefit from other tax planning strategies. Sometimes your income may vary from year to year, particularly as you enter retirement or if you plan to start a business. Preparing multi-year tax projections can help in seeing the difference a Roth conversion would make during a year of low income compared to taking them out as RMDs in retirement. Also these tax projections can help ensure that you not only have the proper amount of income tax withheld each year so that you don’t owe a penalty for underpayment, but also to ensure that you don’t give an interest-free loan to the government if you receive a refund.
- Focus on what you can control, not on what you can’t. Two of the largest drags on investment performance are taxes and investments costs. One of the distinct advantages of most ETFs is that they are relatively low-cost since they track an index, whereas actively managed mutual funds employ analysts who attempt to predict how the securities inside the mutual fund will perform. This typically increases the overall expense ratio as well as the tax drag due to buying and selling positions within the mutual fund.
- Resist financial media ‘noise’ and invest for the long-term. As everyone who experienced the Great Recession knows, the market in the short-term can be unpredictable. There have been countless studies performed to show that time in the market matters more than timing the market, and a case study for that is 2008 since you had to not only know when to get out but also when to get back in. To date, 2019 has been a good year for every asset class in the stock and bond market even though there were periods of uncertainty. While it is unknown what 2020 will bring, investing in a well-diversified, low-cost portfolio each month will result in a portfolio that increases over time despite what the market may do each year.
- Bear markets will happen, and you should love them while you are investing. While it may feel painful at the time to see your portfolio drop during a bear market, it is often one of the best things that can happen assuming you are still able to contribute to the portfolio. As long as you are in a well-diversified portfolio, there is virtually no risk that your portfolio will drop to zero as it can with a single stock. Therefore, if you are still contributing to your investments, you are buying more shares at lower prices. Since all bear markets are temporary in nature, when the market returns to its pre-recession level, you will actually in most cases be better off than if the market had continued to rise steadily over time since you would have bought many more shares at those lower prices.
The decisions you make each year with your personal finances will have a lasting impact, and we hope these items have begun to generate some insight to areas of your personal finances that need attention. We are honored to be your trusted adviser and partner, and please contact us when you are ready to talk through any of these or any other items to help you with your 2020 vision!
Josh Morris serves as a financial planner with Strategic Financial Planning, Inc., an independent, fee-only financial advisory firm. With over 10 years of industry experience, Josh is passionate about developing relationships with clients, learning about their dreams, and helping them reach their goals. Josh graduated summa cum laude from Oklahoma Christian University with a Bachelor of Business Administration in Accounting and started his career at Ernst & Young LLP, where he focused his efforts on high-net-worth individuals and their closely-held businesses before transitioning to wealth management. Josh is a CERTIFIED FINANCIAL PLANNER™ Professional, a Texas CPA, and holds the Personal Financial Specialist (PFS) designation from the AICPA. Josh is also a member of the Texas Society of CPAs and has been recognized as a Five Star Wealth Manager. To learn more about Josh, connect with him on LinkedIn.