2020 was obviously a crazy year, for many reasons! And as with any tumultuous time, there are financial mistakes and also financial opportunities. We always try to use short-term opportunities to enhance your long-term financial planning.
There are still lessons from 2020 that we can continue to apply toward our finances and retirement today.
Now I'm going to cover some information from an article in Financial Advisor magazine called Oops! Mistakes Made in 2020.
I’m going to talk about 4 financial mistakes made in 2020 and 3 general financial mistakes that are not specific to 2020.
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Mistake #1: Not Taking an RMD
The CARES Act of 2020 waived the requirement for those over age 72 to take a Required Minimum Distribution from their retirement accounts during 2020.
By not taking an RMD, they would have less taxable income and, therefore, a lower tax bill.
But some retirees probably should have considered taking a distribution even though it wasn’t required.
For example, some retirees choose to pay much of their tax liability by having money withheld from their IRA distributions instead of paying quarterly estimated taxes throughout the year.
But if they didn’t take a distribution in 2020, those normal taxes weren’t withheld, and those retirees could face penalties for underpayment of the taxes they still owed during the year.
As another option, in lieu of skipping their RMD, those that are charitably inclined could have taken a Qualified Charitable Distribution from their IRA. Basically, if you do a QCD as your RMD, the money goes directly to a charity of your choice and that distribution never shows up as income on your tax return.
For more information on this and other ways to give charitably while saving taxes, check out this prior podcast episode.
Mistake #2: Not Making Student Loan Payments
Student loan interest was reduced to 0%, and monthly payments were deferred starting on March 13, 2020 and continuing through at least September 30, 2021.
This was likely a huge relief to those paying student loans who also lost jobs.
However, not continuing to make student loan payments may have been a mistake for people who weren’t affected by COVID job losses.
If you had been making payments all along, you would have a much lower student loan balance once interest begins to accrue again.
In this situation, there is still time to pay down student debt before interest begins to accrue on those balances.
Mistake #3: Unnecessary Tax Loss Harvesting
Tax loss harvesting can be used to offset long-term capital gains. I’m not going to go into the pros and cons of tax loss harvesting today, but it is a tool that is often used improperly.
For example, some people were using this strategy when they wouldn’t have even been required to pay capital gains taxes because their income was below the capital gains threshold.
In fact, you may even give yourself a higher tax bill in the future by resetting your tax basis to a lower amount.
Mistake #4: Confusion about Roth Conversions
We do a lot of Roth conversions at my firm. Roth conversions can be used to incur taxable retirement income now and pay the income taxes now so you don’t have to pay taxes later when you withdraw the funds in retirement.
Dropping into a lower tax bracket, such as from losing a job, could be a good time to consider a Roth conversion.
But with severance packages and unemployment benefits, people may not have dropped as much income as they thought.
High income earners may be tempted to convert money to a Roth IRA now with the likelihood of higher tax brackets in the future.
However, that might not be a wise thing to do now. Not only would they be increasing their income now while they are earning in the highest tax bracket, but they will likely not be in such a high tax bracket when they retire.
In this case, it might be better to start Roth conversions after retirement in what we call the "gap years" between when you retire and when you have to start taking RMDs. This is when we use a technique of filling lower tax brackets over several years.
Financial Mistakes that are Not Specific to 2020
There are also financial mistakes we can talk about that are not specific to 2020.
1. Ignoring taxes
Your taxable income can change in retirement depending on where you draw money from.
Changes to your income in retirement can affect how your Social Security is taxed. This is known as the Social Security tax torpedo.
Income is also a factor in how much you pay for Medicare Part B premiums. This is known as the IRMAA or income-related monthly adjustment amount.
Income can also affect how much of your long-term capital gains are taxed because those capital gains are stacked on top of other income.
A financial planner can help you identify and prepare for these things.
2. Obsessing over taxes
Some people hate taxes so much (let's be honest - nobody likes taxes!) they wouldn’t even think about paying more taxes now to do a Roth conversion, even when they are in a lower tax bracket.
We like to show people how it can make a huge difference to smooth out their tax liability to save 10 or 20% in lifetime tax liability. (10-20% of a few million dollars is obviously a lot of money!)
You can choose to defer as much tax as possible, but as your nest egg grows, so does its income potential and your lifetime tax liability.
But if you can convert some of that nest egg to a Roth IRA, that portion can grow tax free. This is especially true with the elimination of the stretch IRA. Now inherited IRA assets must be withdrawn within 10 years, often during high earning years for the beneficiary. This is something to consider with legacy planning.
3. Assuming good health
You may be active and feel great now, and I hope you continue to for a very long time, but long-term care is still something to think about.
It is common for one person in a couple to handle the household finances, but that doesn’t mean that person will always be able to manage the finances.
Make sure both spouses have relevant financial information in case one is no longer able to handle the household finances, so the other one isn’t left clueless. Also, having a trusted advisor in these situations can be invaluable.
It is also a good idea to assign someone you trust as a Power of Attorney (POA) to be in charge in the event that your mental health deteriorates.
I know no one likes to think about some of these things, but it is prudent and can often save your loved ones from problems and turmoil in the future.
It’s easier to make those plans now when you can still make your wishes known.
The tax code is complex!
But you can avoid most mistakes that often come with retirement by educating yourself and working with a financial planner who specializes in retirement income planning.