4 Things Every Doctor Needs to Know About Their 401ks and 403bs during COVID-19
By Katherine Vessenes, JD, CFP®, Founder, MD Financial Advisors
Recent legislation had a big impact on IRAs and work retirement plans in light of COVID-19. Here are a few things you need to know to take advantage of these new rules:
1. Required Minimum Distributions (RMDs)
All RMDs are waived for 2020, including beneficiary IRAs. RMDs are when the IRS forces you to take a withdrawal from your accounts in retirement at older ages. This creates a special tax saving opportunity for certain clients. RMDs can never be converted to a Roth IRA. However, this year, since many of our doctor clients will not be taking RMDs, they might consider taking the same amount as a distribution and then converting it to a Roth IRA. This is a rare window of opportunity to get assets into the tax-free bucket and potentially pay less in taxes than previous years.
Take this example:
Drs. Joe and Jane Martin, retired, are both over the age of 72, the new age for RMDs. Joe has a $1,000,000 IRA and Jane has a $1,000,000 401k from her former employer. Normally, let’s say they would each have an RMD of around $50,000, which they would have to pay tax on and either use the funds for living expenses or invest them in their brokerage accounts, where they would be subject to capital gains taxes going forward. Let’s assume the tax would be an effective rate of 35% or $35,000 on $100,000 combined in RMDs.
In our hypothetical, Joe and Jane don’t need to spend the money so they take that $100,000 RMD and put it in a brokerage account and let them grow for 10 years. In 10 years, they sell the funds which grows to $300,000. At that time, they would have a tax bill of about 28.8% (Top capital gains rate plus ~5% state) on the gain of $200,000 which adds up to $57,600. Leaving them a total net after taxes of $242,400.
Contrast that to this year they are not required to take an RMD, but they might want to do Roth IRA conversions instead in the same amount. So, if Joe and Jane took the same $100,000 total and converted it to a Roth, the short-term taxes would be the same:
$100,000 x effective rate of 35% = $35,000
However, the long-term taxes would be quite different. Let’s assume they invested their $100,000 in Roth IRAs, and in 10 years, their Roth IRAs had grown to the same $300,000 as before. At that point in time, they could pull $300,000 out of their Roth IRAs with no taxes at all.
Total tax savings $57,600!
Lesson Learned: Now is the time to consider a Roth conversion.
2. Roth Conversions
Even if you are under the age of 72, and not required to do an RMD this year, you should consider doing a Roth Conversion. Our doctors are in a very unusual situation in 2020: they are likely in a lower tax bracket, since many of our doctors have taken huge pay cuts. In addition, tax rates in general are lower. When you accompany this with a down stock market you get an unprecedented opportunity to convert some, or all, of your IRA into a Roth at a dramatically reduced rate.
S&P 500 Year to Date
Assume 35% Effective Rate
$100,000 x 35% = $35,000 due
$91,318 x 35% = $31,961 due
Difference of $3,038
S&P 500 represented by iShares (IVV) E
iShares S&P 500 ETF (IVV) from 1/1/2020 to 5/20/2020
Personally, with unprecedented national debt, I anticipate much higher tax rates for our doctor clients in the near future. Let’s take advantage of this situation now, while you can, before Congress changes on retirement plans and taxes.
IRA expert, Ed Slott has said: “In particular, IRAs and 401ks are ‘sitting ducks’ for tax increases. It’s a low-hanging fruit [and] like a big, juicy steak to Congress…. We just wrote a $2 trillion check on a bank account that has no money in it. So, where is this going to come from and who’s going to pay the bill? Probably most of your clients that are stuck holding the bag with tax-deferred IRAs and 401ks.”
I totally agree with Ed Slott and am working with our clients to get as much moved over to the Roth accounts as possible. I think of it as pre-paying the taxes at a lower rate, or “tax insurance.”
Lesson Learned: IRAs, 401ks, and 403bs are “sitting ducks” to Congress. Take action now to avoid bigger taxes later.
3. Direct Roth IRA Contributions:
For our doctors making direct Roth IRA contributions for 2019, which includes most of our residents and fellows, you have some good news: the deadline has been extended until July 15th, 2020.
Most of our attending doctors make too much money to make a direct Roth Contribution, so we use the Back-door Roth technique for them whenever we can. Although it is too late to do a Back-door Roth for 2019, you should consider doing a Back-door Roth this year for 2020. This is a unique opportunity, since this money goes in after tax and many of our clients will be in a lower tax bracket this year due to pay cuts and furloughs. Also, the markets are down now, so it is a good time to invest when the market is “on sale.”
Lesson Learned: Get your Back-door Roth IRA in place as soon as possible.
4. Borrowing from your 401k or 403b
Before the CARES Act, 401k/403b loan limits were capped at 50% of the vested account balance, or $50,000, whichever comes first. Today you could borrow up to 100% of your 401k/403b, or $100,000. Just so you know, you are never able to “borrow” from an IRA.
Also, some plans do not allow borrowing at all, so you will need to check with your custodian to see if this is a good option for you. Finally, in order to qualify for these new loan limits, you need to have been negatively impacted by COVID-19. What “negatively impacted by COVID-19” actually means is subject to interpretation. It would definitely apply to doctors who fell ill due to COVID, were being forced into quarantine, or saw a reduction in their pay due to the virus.
Although borrowing from your retirement plan is usually the last option we suggest for cash-strapped doctors, it is something to consider if you are in a real pinch. Generally, borrowing from your Home Equity Line of Credit is a better choice, but this other method is something to consider if you are temporarily short on cash. Just remember, you will owe the money back to your plan, and most plans require the loan to be paid back in full should you leave current employer.
Lesson Learned: Look to borrowing from your work retirement plans only if absolutely necessary.
If you have questions on how to maximize your retirement accounts during COVID-19, please reach out. We are here to help!
Katherine Vessenes, JD, CFP®, is the founder and CEO of Minnesota-based MD Financial Advisors, who serve over 500 doctors from Hawaii to Cape Cod. An award-winning Financial Advisor, Attorney, Certified Financial Planner®, author and speaker, she is passionate about bringing ethical investment advice to physicians. She can be reached at Katherine@mdfinancialadvisors.com.