Nov 4, 2021 4 min read

Time is getting short to complete 2021 tax planning.

Many people complain about their income tax due, yet take little or no action to try and reduce that amount. A better way is to be proactive and take action.

When we discuss tax planning, it is from a longer-range perspective than just this tax year. Some actions you take this year, such as a Roth conversion, could increase this year’s bill, but provide large future savings.

Most possible actions must be completed before Dec. 31, so that leaves about eight weeks to get everything done. Many custodians and other financial institutions run on skeleton crews during the holiday and there may be mail delays so those facts must be factored in when determining a time schedule.

Let’s talk about possible Roth conversions first. A Roth is much like the old Fram oil filter commercial: “You can pay me now or pay me later.” In the commercial, the reference was keeping your engine oil clean or you may have to replace the car engine.

When doing a Roth conversion, you decide to pay the income tax that you deferred when making an IRA contribution, now instead of later. There are several reasons you may decide to do this.

First you think tax rates are going up in the future. Why not pay when they are lower? Maybe you want the future growth in this Roth to be tax free instead of tax deferred, or maybe you have a large amount of qualified money in a 401k and you are delaying taking Social Security to manage your tax exposure.

You may have a year with less income than normal or have room to bump the bracket. Converting some qualified money now instead of later could make a big difference after the death of the first spouse. At that time, you get half the free money from personal exemptions and the tax brackets are approximately half the size. This can make a huge difference in taxes.

Doing a conversion could help reduce your taxable estate upon death. If your children or other beneficiaries are in their peak earning years, doing a conversion may let you pay the tax at a lower rate they would have to do.

Some of the tax changes being discussed in Washington, D.C., right now could cut in half the amount of estate you can pass on to heirs without incurring federal estate tax. This lower limit would affect many more families. There is also discussion about possibly phasing out Roth conversion for some tax payers and ending such strategies such as a back door Roth. While these changes have not yet been signed into law, they are being discussed.

One important thing that many people do not realize is that an inherited IRA that goes to your children cannot be converted into a Roth by them. It must stay as qualified money until they pay taxes on it. Because of the Secure Act which became law on Jan. 1, 2020, they must liquidate your inherited IRA by the end of the 10th year after your death. This rule does not apply to your spouse and a few other limited groups. This could force distribution on beneficiaries during peak income earning years.

We will look at additional tax planning opportunities in a future column. Be proactive and keep lifetime tax bills as low as legally possible. Do not miss the opportunity to do something before Dec. 31.

Your Financial Future is written by certified financial planner Gary W. Boatman, MBA and CFP, who also wrote the book, “Your Financial Compass: Safe Passage Through The Turbulent Waters of Taxes, Income Planning and Market Volatility.” If there is an area that you would like to see discussed in the column, send your suggestions to gary@BoatmanWealthManagement.com.