Losses to roll
This first piece of strategy isn't necessarily new. Taxpayers have been able to offset capital gains with capital losses for some time now. The difference is in how many people will be able to employ the strategy this year and in the next few years. Advisors and clients need to be diligent in keeping track of client losses because Uncle Sam probably isn't going to send out a reminder letter.
"It's important now more than ever," Reed says. "If a client has some losses, it's critical to see where they are before year-end, to offset any gains."
And remember, it's not just the stock market that suffered over the last year. With unemployment at generation-high levels, consumers have tightened up their spending habits, and that is hurting small businesses, which baby boomers own in droves. That, points out CFP Shabri Moore, owner of Frederick, Md.-based Moore Wealth Inc. (moorewealthinc.com), means many boomers will have operating losses to use against this year's gains and possibly to roll forward for some time.
Something else advisors wanted to talk about that could benefit boomers' tax liability this year is the fact the required minimum distribution from IRAs has been suspended for 2009 only.
"That's great for those who don't need to take it," says Howard.
Now, by definition, there are no boomers who have reached the age threshold for the RMD--no matter how many years Woodstock and raising Generation X aged anyone, no boomer is 70 1/2 years old yet. But, and this could affect millions of them, many boomers have inherited IRAs that require the RMD each year, even though the inherited IRA holder may be working and not need the withdrawal. For 2009 at least, that requirement is lifted, which, as Reed points out, helps the current tax liability and re-accumulation.
"By the government not requiring the RMD," Reed says, "2009 returns are going to be alleviated from having to record a forced distribution. Not forcing the RMD lightens the tax bill, and it helps with trying to rebuild the portfolio."
Reed goes on to point out that any boomers drawing Social Security may see the tax liability on those funds decrease or disappear for a year due to the relaxed RMD rules for 2009.
The RMD exception for 2009 is a rare gift at just the right time, but it is one that doesn't come around very often and shouldn't be expected to be given again. If it is, great, but it shouldn't be counted on. In fact, there's not much that can be predicted when it comes to taxes, except that they'll probably go up--maybe. The uncertainty surrounding taxes and the future is the reason Moore practices the same principle with taxes that most people practice with investments--diversification. She says it's the driver and "is most important from a taxable standpoint."
She looks at it like this. There are three categories of taxable investments, and boomers should be diversified between all three: taxable investments, tax-deferred investments and tax-advantaged investments. Taxable investments are going to be taxed every year, but they provide the easy access that taxpayers need, and they are taxed at current rates. Tax-deferred investments like 401(k)s and IRAs are going to move the tax liability down the line and build up a boomer's portfolio over the long haul.
"They can lead to more taxes down the line," depending on one's tax bracket, Moore says, "but there's no way of telling what taxes are going to be."
Tax-advantaged investments that grow tax-free because they use after-tax dollars--Roth IRAs and Roth 401(k)s, for example--are the third category of taxable investments. These are ideal from an accumulation standpoint because whatever the accounts have grown to at retirement time is there for the boomer. As Moore says, "We don't care what tax rates are with this one." There is the chance that the client will have paid more in taxes on the money he used to seed these accounts than he would have when he withdrew the money in retirement, but that is what the tax-deferred accounts are for: Those funds will be taxed at a lower rate upon withdrawal than they would have been previously.
It's tax diversification, and in the face of uncertainty over future tax rates, it's a strategy that will sustain many boomers' retirement hopes and dreams.
In all the hustle and bustle to get ready for 2009 taxes, it's worth noting one important caveat for 2010: the lifting of the income limit for conversions to Roth IRAs. On Jan. 1, 2010, boomers showing more than $100,000 in adjusted gross income will be eligible to convert traditional IRAs to Roth IRAs--to move some of their tax-deferred assets to a tax-advantaged account. Advisors see this as a potential boon to many boomers because of the beating their assets have taken in the last year or so.
"It is important right now because portfolios are down," Moore says. "They can convert a diminished IRA and pay less in taxes. It's a great strategy for boomers."
The conversion will be counted as ordinary income, but the taxes on that income can be spread over two years for conversions made in 2010 only, and if an IRA has taken a 30 percent hit, that's 30 percent less income to report during the conversion.
"[Boomers] will have to look hard at whether they want to convert," Reed says. "They'll have to pay income tax, but because portfolios are down, it may be a good time to bite the bullet and convert."
Moore cautions that boomers who make the conversion need to have the cash to pay the income tax because if the funds are taken from the IRA being converted, there will be a penalty involved.
Tax planning is always an important component to any financial plan, and it is something advisors and clients should always talk about. Recent economic events, however, have made this year unique for many taxpayers, especially those who have never suffered the effects of a downturn like this one. Capital losses are more important than ever--and keeping track of them needs to be a priority. The RMD exception for 2009 is a re-accumulation and tax-relief gift from Congress. Tax diversification is something that should receive a renewed focus as boomers look for ways to get back to where they need to be for retirement. Even with all this, boomers and their advisors will have to take a hard look at retirement goals and make the necessary adjustments so retirement is less taxing than the working years.
Losing it all to taxes
Losses to roll