Roth IRA accounts are well known for providing tax-free growth and retirement income within specific parameters. The catch is that contributions must be made with earned income that has been taxed already. In other words, Roth accounts aren’t exactly tax-free, they are merely taxed differently.
On the other hand, Traditional IRA retirement accounts are funded with pretax dollars, thereby reducing taxable income in the year of contribution. Then, distributions from Traditional IRA retirement accounts are taxed as income.
The Roth IRA is not tax-free, it is merely taxed differently
However, the tax benefit remains the most prominent factor in the Roth vs. Traditional IRA decision. To make the decision that helps you pay fewer lifetime taxes requires an analysis of current vs. future taxes. That will usually require you to enlist professional help. After all, you would not want to choose to contribute to a Roth to pay fewer taxes and end up paying more taxes instead!
As everyone’s circumstances will be different, it would be beneficial to check with a Certified Financial Planner® or a tax professional to plan a strategy that will minimize lifetime taxes, taking into account future income and projected taxes.
Check out our other posts on Retirement Accounts issues:
The SECURE Act makes several changes to the Internal Revenue Code (IRC) as well as the Employee Retirement Income Security Act (ERISA) that are intended to expand retirement plan coverage for workers and increase savings opportunities. The SECURE Act also radically changes several techniques used for retirement and tax planning.
Some of the key provisions affecting employer retirement plans, individual retirement accounts (IRAs), and Section 529 Plans included in the SECURE Act are as follows.
This RMD provision is part of the good news in the SECURE Act. It will allow retirees more time to reach their retirement income goals. For many, it will enable better lifetime tax planning as well.
End of the “Stretch” IRA
Prior to the SECURE Act, the distributions on an inherited IRA could be “stretched” over the expected lifetime of the inheritor. That was a staple tool of estate and tax planning.
No more. With a few exceptions, such as for the spouse, the “stretch” is now effectively crunched into ten years. Accounts inherited as of 12/31/2019 are now expected to be distributed over ten years, without a specific annual requirement.
The new law allows a penalty-free distribution of up to $5,000 from an IRA or employer plan for a “Qualified Birth or Adoption Distribution.” For a qualified distribution, the owner of the account must take the distribution for a one-year period starting on (1) the date of birth of the child or (2) the date when the adoption becomes final (individual must be under age 18). The law permits the IRA owner who took the distribution to pay it back to the plan or IRA at a later date. However, these distributions remain subject to income taxes.
Generally speaking, we at Insight Financial Strategists think that people in this situation should avoid availing themselves of this new wrinkle in the law. In our experience, a distribution from retirement accounts before retirement can have profound impacts on retirement income security.
It may sound off-topic, but it is not. The SECURE Act also addresses 529 plans. For students and their parents, the SECURE ACT allows tax-free 529 plans to pay for apprenticeship programs if they are registered and certified by the Department of Labor.
This provision will be helpful for those people who have children headed to vocational track programs.
Given how students and parents scramble to meet the challenge of the cost of higher education, I do not forecast that most 529 plans have much left over to pay off loans!
Business Retirement Plans
(Part-Time) Employee Eligibility for 401(k) Plans – In most 401(k) plans, participation by part-time employees is limited. The SECURE Act enables long-time part-time workers to participate in 401(k) plans if they have worked for at least 500 hours in each of three consecutive 12-month periods. Long-term part-time employees who become eligible under this provision may still be excluded from eligibility for contributions by employers.
Delayed Adoption of Employer Funded Qualified Retirement Plan– Beginning in 2020, a new plan would be treated as effective for the prior tax year if it is established later than the due date of the previous year’s tax return. Notably, this provision would only apply to plans that are entirely employer-funded (i.e., profit-sharing, pension, and stock bonus plans).
403(b) Custodial Accounts under Terminated Plans are allowed to be Distributed in Kind – Subject to US Treasury Department guidance, the SECURE Act allows an individual 403(b) custodial account in a terminating plan to be distributed “in-kind” to the participant. The account distributed in this way would retain its tax-deferred status as a 403(b).
Establish Open Multiple Employer Plans (MEPs) – Employers may now join together to create an “open” MEPs, referred to in the legislation as “Pooled Plans.” This will allow small employers to join together and share the costs of retirement planning for their employees, such as through a local Chamber of Commerce or other organization, to start a retirement plan for their employees.
Increased Tax Credits – The tax credit for small employers who start a new retirement planwill increase from $500 to $5,000. In addition, small employers that add automatic enrollment to their plans also may qualify for an additional $500 annual tax credit for up to three years.
There are many more provisions in the SECURE Act. While some of them are useful for taxpayers, it is worth noting the observation by Ed Slott, a tax expert and sometimes wag: “whatever Congress names a tax law, it does the opposite .” This is worth keeping in mind as you mull the implications of this law. With the SECURE Act now the law, it may be time to check in with your fiduciary financial planner and revise your retirement income and estate plans.
A key item of the TCJA is that it increased the standard deduction, reducing the impact of the elimination of State and Local Taxes (SALT) under $10,000 and the elimination of personal deductions. As a result, about 84% of taxpayers claim the standard deduction and do not itemize. By comparison, about 56% of taxpayers itemized before the enactment of the TCJA. The vast majority of taxpayers are no longer subject to the Alternative Minimum Tax (AMT), since two of its key drivers, the deductibility of state and local taxes and personal deductions, are no longer a practical issue for most people. And in 2018, only 1,700 estates were subject to the federal estate and gift tax. So for most people, the TCJA has made taxes simpler to deal with. What’s there not to like about a simpler tax return ?
Source: Congressional Budget Office
Impact of the TCJA on the Federal Deficit
As predicted, the TCJA worsened the federal deficit bringing it to nearly a trillion dollars in fiscal year 2019. That was in spite of an increase in tax revenue due to the continuing improvement in the economic climate. Of course, the federal deficit continues to be driven by federal spending on the sacred cows of modern US politics: Defense, Social Security, and Medicare. Interest on the federal debt is also a major budget item that needs to be paid. While our continuing regime of low interest rates is helping control the interest on the debt, it is clear that the future may change that.
What will happen to tax rates?
Tax rates are lower now than they have been since the 1970s and 80s. Hence, industry insiders tend to think that tax rates have nowhere to go but up. That is also what’s is predicted by the TCJA, which is largely designed to sunset in 2025. Should the American people turn on Republicans at the 2020 election, it’s possible that the TCJA will see a premature end. However, it seems that the possibility that the American people might elect a progressive in 2020 is largely discounted when it comes to tax rate forecasting: most people assume that tax rates will increase.
Political forecasting aside, there are still things that we can do to lower our taxes . It should be noted that many of the techniques in this article are not limited to the year-end. Furthermore, we all have different situations that may or may not be appropriate for these techniques.
Tax Loss Harvesting
Even though we have had a pretty good year overall, many of us may still have positions in which we have paper losses. Tax-loss harvesting consists of selling these positions to realize the losses. This becomes valuable when you sell the equivalent amount of shares in which you have gains. So if you sell some shares with $10,000 in losses, and some with $10,000 in gains, you have effectively canceled out the taxes on the gains.
You then have to reinvest the shares sold into another investment. Be careful not to buy back the exact same shares that you sold. That would disallow the tax loss harvesting!
At the same time, it makes sense to review your portfolio and see if there are other changes that you would like to make. We are not fans of frequent changes for its own sake. However, periodically our needs change, the markets change, and we need to adapt.
Income Tax Planning
While tax loss harvesting is mostly about managing Capital Gains taxes, it is also important to keep an eye on income tax planning . This is a good time of year to estimate your income and your taxes for the year. When comparing your estimated Adjusted Gross Income with the tax tables, you will see if you might be creeping up into the next tax bracket. For instance, if you are single and your estimated AGI is $169,501 (and you have no other complexity), you are right at the 32% tax bracket (after you remove the $12,000 standard deduction). In this example, that means that for every dollar above that amount you would owe 32 cents in federal income tax, and a little bit more for state income tax, if that applies to you.
If your income is from a business, you may possibly defer some of that income to next year. If your income comes from wages, another way to manage this is to plan an additional contribution to a retirement account. In the best of cases your $1,000 contribution would reduce your taxes by $320, and a little bit more for state taxes.
In some cases, you might have a significant dip in income. Perhaps if you have a business, you reported some large purchases, or you booked a loss or just had a bad year for income. It may make sense at this point to take advantage of your temporarily low tax rate to do a Roth conversion. Check with your wealth manager or tax preparer.
One way around that situation is to bundle or lump charitable gifts. Instead of giving every year, you can give 2, 3 or more years worth of donations at one time. That would allow your charity to receive the contribution, and, potentially, for you to take a tax deduction.
Pushing the bundling concept further, you could give even more to a Donor Advised Fund (DAF). With that option, you could take a tax deduction, and give every year from the DAF. That allows you to control your donations, reduce your income in the year that you donate, and potentially reduce income taxes and Medicare premiums. Consult your wealth strategist to ensure that taxes, income, and donations are optimized.
First, it is important to review Required Minimum Distribution (RMDs). Anyone who is 70 ½ years of age or older is subject to RMDs. Please make sure to connect with your financial advisor to make sure that the RMD is properly withdrawn before the year-end.
The RMD is a perennial subject of irritation for people . Obviously, if your retirement income plan includes the use of RMDs, it’s not so much of an issue. However, if it is not required, it can be irritating. That is because RMD distributions are subject to income taxes that may even push you into the next tax bracket or increase your Medicare premium. There are, however, some ways that you can deal with that.
For instance, if you take a Qualified Charitable Distribution (QCD) from your IRA and have the distribution given directly to a charity, the distribution will not be income to you. Hence you won’t pay income taxes on that distribution, and it will not be counted toward the income used to calculate your Medicare premium. However, it will fulfill your RMD, thus taking care of that pesky issue.
Generally, we advocate planning for lifetime taxes rather than for any one given year. Lifetime financial planning has the potential to result in even more benefits. It should be noted that many of the possibilities outlined in this article can be used throughout the year, not just at year-end. We encourage you to have that conversation with your wealth management team to plan for the long term!
It is health insurance plan signup season . Whether you subscribe to your employer’s health care insurance plan or you buy your own directly, it is the time of the year when you have to sign up all over again. Unless you have specific circumstances such as a change of employer, a divorce, or new baby, this is the one time in the year when you get to change your health care insurance plan.
If you have been keeping abreast of the popular financial media, you may have come across the Health Savings Account (HSA). According to AHIP (America’s Health Insurance Plans), 22 million people had HSA accounts in 2018. Financial Planners love HSA. It is potentially the most tax advantageous vehicle that exists. Contributions to HSAs are pre-tax, the money is invested tax-free, and distributions are tax-free if used for health purposes. Triple tax-free. HSAs are even better than Roth retirement accounts !
The reality is that we all have health care expenses, and they can be substantial . Having the ability to pay with tax-free money is a critical advantage. If you have to pay a $100 hospital invoice, you might have to earn $150 or more first, pay Federal income taxes, Social security taxes, state income taxes, before you can have $100 to pay your bill. With an HSA, there is no income tax, you pay with $100 of your earnings.
A Health Savings Account is effectively an alternative to the Flexible Spending Account (FSA) , the more traditional way to pay for health care expenses that are not covered by insurance. The FSA allows employees to save pre-tax from earnings, and then to spend it on health care expenses without paying taxes on the earnings. Money in FSAs, however, is not invested, and it must be spent by year-end or be forfeited. It has to be spent, or it will be lost. HSA funds, on the other hand, can be invested, and funds from HSA accounts can be carried over into the future. Thus, HSAs can be spent in a way that is similar to other retirement savings accounts such as the IRA or the Roth IRA.
Contributions are pre-tax
Funds are invested tax-free
Distributions are tax-free (1)
Distributions can be taken in the future
If used as intended for retirement, education or health expenses respectively
What’s in it for the employer?
In order to contribute to an HSA, you must have chosen a High Deductible Health Plan with your employer.
According to the IRS, for 2019, a high deductible is defined as $1,350 ($1,400 in 2020) for an individual or $2,700 for a family ($2,800 in 2020.) On top of this high deductible, annual out of pocket expenses (including deductibles, copayments, and coinsurance) cannot exceed $6,750 for an individual or $13,500 for a family. Those numbers increase in 2020 to $6,900 for an individual and $13,800 for a family.
For employers, offering high deductible health insurance plans is more cost effective than other plans. Therefore, they will prefer that their employees sign up for high deductible plans. Many employers will contribute directly to HSA accounts to encourage their workforce to choose a high deductible health insurance plan.
Theoretically, if employees have to pay out of pocket or out of their HSA for their health care expenses, they will be more careful about their choices. While the funds in the HSA remain available to be used for health care expenses immediately if needed, the designers of the HSA believe that the ability to carry over HSA balances to future years will motivate employees to be better health care shoppers when choosing treatments or, indeed, when choosing to be treated in the first place. The net result is that high deductible health plans help employers contain health care expenses, and shift the burden on their employees.
And how do you maximize the value of the HSA? By contributing to the maximum, and investing it. A dollar contributed may be worth many times its value in the future when invested.
The Internal Revenue Service allows individuals in 2020 to contribute up to $3,550 to their HSAs. Families may contribute up to $7,100. Both individuals and families can benefit from a catch-up provision of $1,100 if they are over 55.
If you are choosing the high deductible plan to save money, but you are not able to contribute to your HSA, you are putting yourself at risk if you have an unforeseen health event. Not having enough saved to cover the cost of the health care you need means that you may have to go into debt until you have met your plan’s deductible.
So, if you have a tight budget, please think twice before trying to save money with a high deductible plan. It may just backfire on you.
A question that is often minimized at enrollment time is what happens to the HSA if you have miscalculated, and you happen to have a significant health care expense in the year that you are contributing?
First, if it is a major event, you may consider using funds in your HSA account. However the health care insurance will eventually kick in and cover most of the cost. So as a subscriber to a high deductible plan, you are still protected from the catastrophic consequences of an unexpected health issue. While you may not harvest all the benefits of the HSA, and you will likely lose the cost savings of choosing a high deductible plan, you are protected from financial disaster.
What if it is not a reallymajor event, just a somewhat major event like, say, a trip to the emergency room for a temporary issue that you will easily recover from?
In that case, you also have the option to use your funds in the HSA to pay for those expenses. Your contributions will have been pre-tax as with an FSA. You will not have enjoyed much investment growth. Your distribution will still be tax-free. You are giving up the future benefits of the HSA, but you are dealing with your more immediate issues. Basically, your HSA will have functioned like an FSA. You will also lose the savings benefits of choosing a lower cost high deductible plan over a higher cost low deductible plan.
What if instead, you decide to pay for your trip to the emergency room out of pocket with post-tax savings and save your HSA for the future, as your wealth manager told you that you should? The real cost of your $5,000 trip depends on your income and tax bracket. If you happen to be in the 32% Federal tax bracket and you live in Massachusetts, the cost of the $5,000 emergency room trip will be around 58% higher.
HSAs provide some tremendous benefits that should be considered by everyone who is looking to enhance their health care and their retirement situation. However, the decision to choose a Health Savings Account should be based on more than just taxes and the cost of your health care insurance. It is important to consider the very real costs of unforeseen events and to be realistic about your health insurance needs.
For those filing as single with income below $25,000, or married filing jointly with income below $32,000, social security income is income tax-free. However, single filer retirees with income up to $34,000 or $44,000 for married filing jointly will find that 50% of their social security becomes taxable. When income increases over $34,000, or $44,000 for married filing jointly then 85% becomes taxable.
Retirement accounts such as 401(k), 403(b), and IRAs are an important source of income for retirees. Income from these accounts is taxed as ordinary income, as if it was being earned in a job, with tax rates ranging from 10% to 37% at the federal level. That is because the initial contribution to those accounts helped to reduce taxable income at the time. That means that the money in these retirement accounts was never taxed.
To complicate the matter, distributions from some accounts may be exempt from State taxes. For instance, 403(b) accounts earned in New Jersey are exempt from New Jersey State income taxes at distribution. Similarly, IRA distributions from accounts that were established by Massachusetts taxpayers are exempt from State income taxes. These peculiarities vary from State to State. It’s important to verify how they may apply in your State rather than making an assumption.
Many retirees still receive pension income. Some of the more common ones include state, federal and military pensions. Although private pensions have been in decline for several decades now, there continue to be many people who receive payments from these pensions.
Income from Roth accounts is not taxed in retirement. That is because the initial contribution came from after-tax money. In other words, the income used to make the contribution was taxed on the full amount before the contribution was made. I like to say that “Roth accounts are not tax-free, they are just taxed differently“.
A key benefit of Roth accounts is that their distributions do not count toward high-income surcharges for Medicare Part B and Part D premiums.
Income received from municipal bonds is federal tax-free. Like a Roth contribution, an investment in municipal bonds is made with after-tax money. If you own municipal bonds from the state of your residence, the interest is also state tax-free. However, if you own municipal bonds from states other than your residence, their interest is usually taxable at the state level.
People also wonder what happens when they sell their municipal bonds. When that happens, the price of the bond can be higher or lower than the face value, known as a premium or a discount. When the price is at a premium, the difference between the premium and the face value can be taxed. That can often be an impediment to a sale as people don’t want to be taxed.
When held for one year or longer, investments outside of retirement accounts are subject to long term capital gains taxes. They can range from 0% to 23.8%, including potential Medicare surcharges. In 2019, for a married couple filing jointly with taxable income up to $78,750, long term capital gains are taxed at 0% federally ($39,375 for people filing as single).
Therefore investments can potentially be taxed less than other sources of income such as retirement accounts. Balancing distributions from investments in conjunction with Traditional retirement and Roth accounts can be a valuable tax optimization tool.
Any income from annuities held inside qualified retirement accounts such as an IRA will be taxable as ordinary income in its entirety.
Income from annuities that are not held in qualified retirement accounts is partially taxable as ordinary income. The amount of the distribution that represents your original investment is considered tax-free.
Therefore, the taxation of annuity income falls somewhat below that the taxation of income from retirement accounts.
Loans from the cash value of an insurance policy are considered tax free. That is because, as any loans, they are not considered income. That is a critical point made at the time that an insurance sale occurs. It should be noted, however, that life insurance is an instance when the tax issues are so prevalent in the discussion that they obscure the other costs of cash value life insurance. The loan from the policy is tax-free, but that in an of itself does not necessarily make life insurance cost-effective or appropriate for your needs.
Income earned in retirement is taxed as any other earned income before retirement. Some retirees continue to earn work income, from part-time jobs or from consulting gigs for example. That income is taxed as earned income as if they were not retired, including Social Security and Medicare. Unfortunately, there is no tax break for working in retirement!
The reality for most of us is that we will owe taxes in retirement. The multiplication of tax situations can make planning difficult for a retiree.
The challenge is to plan our income situation strategically, manipulate it if you will, in order to minimize lifetime taxes.
Fortunately, wealth planning done properly is a very feasible endeavor that may help you keep more of what you earned in your pockets!
On April 4th, it was announced that McKenzie Bezos would be receiving 36 billion dollars worth of assets from her divorce from Jeff.
First of all, congratulations to Jeff and McKenzie for keeping this divorce process short, out of the media as much as possible, and out of the courts. We are not going to know the details of the Bezos’ agreement. However, some information has been disclosed in the press.
As reported by CNN, McKenzie is keeping 4% of their Amazon stock, worth approximately 36 billion dollars. Jeff retains voting power for her shares as well as ownership of the Washington Post and Blue Origin, their space exploration venture. According to The Economist, this makes the Bezos divorce the most expensive in history by a long shot.
Unsurprisingly, McKenzie’s wealth is concentrated in AMZN stock. That has worked out well for the Bezos’ for the past several years. It is likely to continue to be a great source of wealth for both of them in the future. As it stands, McKenzie is now the third richest woman in the world. Who knows, if she holds onto AMZN stock, she could become the richest woman in the world one day! McKenzie’s concerns with budgeting, taxes, and wealth strategy will soon be in a class of their own.
There are, however, some lingering considerations for McKenzie, particularly when it comes to capital gains taxes, portfolio management, philanthropy and wealth transfer.
A benefit of keeping the stock until her death is that her estate will benefit from a step up in cost basis. This would mean that the IRS would consider the cost of the stock to be equal to the value at her death. This favorable tax treatment would wipe out her capital gains tax liability.
Nevertheless, the standard advice that wealth strategists give clients with ordinary wealth applies to Ms. Bezos as well: it would be in McKenzie’s best financial interest to diversify her holdings. Diversifying would help her reduce the risk of having her wealth concentrated into a single stock. It is a problem that McKenzie (and Jeff) share with many employees of technology and biotech startups.
An advantage of having more money than you need is that you have the option to use the excess to have a measurable impact on the world through philanthropy. In 2018, Jeff and McKenzie created a $2B fund, the Bezos Day One Fund, to help fight homelessness. Given that the home page of the fund now only features Jeff’s signature, this may mean that Jeff is keeping this also. McKenzie will likely organize her own charity. What will her cause be?
McKenzie’s net worth is far in excess of the current limits of federal and state estate taxes. Unless she previously planned for it during her marriage, she will have to revise her estate plan. Even though she would benefit from a step up in basis on her AMZN stock if she chooses not to diversify, she would still be subject to estate taxes, potentially in the billions of dollars.
Of course, no matter how much estate tax McKenzie ends up paying, it is likely that she will have plenty to leave to her heirs.
1) Harvest your Tax Losses in Your Taxable Accounts
As of[ October 26, the Dow Jones is up 1.65%, and the S&P500 is up just 0.98% ]for the year. Unfortunately, many stocks and mutual funds are down for the year. Therefore you are likely to have a number of items in your portfolio that show up in red when you check the “unrealized gains and losses” column on your brokerage statement.
However, you can also offset your losses against gains. For example, if you were to sell some losers and hypothetically accumulate $10,000 in losses, you could then also sell some winners. If the gains in your winners add to $10,000, you have offset your gains with losses, and you will not owe capital gain taxes on that joint trade!
This could be a great tool to help you rebalance your portfolio with a low tax impact. Beware though that you have to wait 30 days before buying back the positions that you have sold to stay clear of the wash sale rule.
2) Reassess your Investment Planning
Tax loss harvesting is a great tactic to use for short-term advantage. As an important side benefit, it allows you to focus on more fundamental issues. Why did you buy these securities that you just sold? Presumably, they played an important role in your investing strategy. And now that you have accumulated cash, it’s important to re-invest mindfully.
You may be tempted to stay on the sideline for a while and see how the market shakes out. Although we may have been spoiled into complacency after the Great Recession, the last month has reminded us that volatility happens.
Take the opportunity to review your goals, ensure that your portfolio risk matches your goals and that your asset allocation matches your risk target..
3) Check on your Retirement Planning
It is not too late to top out your retirement account! In 2018, you may contribute a maximum of $18,500 from your salary, including employer match to a 401(k), TSP, 403(b), or 457 retirement plan, subject to the terms of your plan. Those who are age 50 or over may contribute an additional $6,000 for the year.
If you have contributed less than the limit to your plan, there may still be time! You have until December 31 to maximize contributions for 2018, reduce your 2018 taxable income (if you contribute to a Traditional plan), and give a boost to your retirement planning.
Alternatively to deferring a portion of your salary to your employer’s Traditional plan on a pre-tax basis, you may be able to contribute to a Roth account if that is a plan option for your employer. As with a Roth IRA, contributions to the Roth 401(k) are made after tax, while distributions in retirement are tax-free.
Many employers have added the Roth feature to their employee retirement plans. If yours has not, have a chat with your HR department!
Although the media has popularized the Roth account as tax-free, bear in mind that it is not. Roth accounts are merely taxed differently . Check in with your Certified Financial Planner practitioner to determine whether electing to defer a portion of your salary to on a pre-tax basis or to a Roth account on a post-tax basis would suit your situation better.
It is health insurance re-enrollment season! The annual ritual of picking a health insurance plan is on to us. This could be one of your more significant financial decisions for the short term. Not only is health insurance expensive, it is only getting more so.
First, you need to decide whether to subscribe to a traditional plan that has a “low” deductible or to a high deductible option. The tradeoff is that the high deductible option has a less expensive premium. However, should you have a lot of health issues you might end up spending more. High deductible plans are paired with Health Savings Accounts (HSA).
The HSA is a unique instrument. It allows you to save money pre-tax and to pay for qualified healthcare expenses tax-free. Unlike Flexible Spending Accounts (FSAs), balances in HSAs may be carried over to future years and invested to allow for potential earnings growth. This last feature is really exciting to wealth managers: in the right situation clients could end up saving a lot of money.
If you pick a high deductible plan, make sure to fund your HSA to the maximum. Employers will often contribute also to encourage you to choose that option. If you select a low deductible plan, make sure to put the appropriate amount in your Flexible Spending Account. FSAs are used to pay for medical expenses on a pretax basis. Unlike with an HSA, you cannot rollover unspent amounts to future years.
6) If you are past 70, plan your RMDs
If you are past 70, make sure that you take your Required Minimum Distributions (RMDs) each year. The 50% penalty for not taking the RMD is steep. You must withdraw your first minimum distribution by April 1 of the year following the year in which you turn 70 ½, and then by December 31 for each year after.
Perhaps you don’t need the RMD? You may want to redirect the money to another cause. For instance, you may want to fund a grandchild’s 529 educational account. 529 accounts are tax-advantaged accounts for education. Although contributions are post-tax, growth and distributions are tax-free if they are used for educational purposes.
Or, you may want to plan for a Qualified Charitable Distribution from the IRA and take a tax deduction. The distribution must be directly from the IRA to the charity. It is excluded from taxable income and can count towards your RMD under certain conditions.
7) Plan your charitable donations
Speaking of charitable donations, they can also be used to reduce taxable income and provide financial planning benefits. However, as a result of the Tax Cut and Jobs Act of 2017 (TCJA), it may be more complicated than in previous years. One significant difference of the TCJA is that standard deductions went up to $12,000 for individuals and $24,000 for married filing jointly. Practically what that means is that you need to accumulate $12,000 or $24,000 of deductible items before you can feel the tax savings benefit.
In other words, if a married couple filing jointly has $8,000 in real estate taxes and $5,000 of state income taxes for a total of $13,000 of deductions, they are better off taking the standard $24,000 deduction. They would have to donate $7,000 before they could start to feel the tax benefit of their donation. One way to deal with that is to bundle your gifts in a given year instead of spreading them over many years.
For instance, if you plan to give in 2018 and also in 2019, consider bundling your donations and giving just in 2019. In this way, you are more likely to be able to exceed the standard deduction limit.
If your thinking wheels are running after reading this article, you may want to check in with your wealth manager or financial planner: there may be other things that you could or should do before the end of the year!
Note: The information herein is general and educational in nature and should not be construed as legal, tax, or investment advice. We make no representation as to the accuracy or completeness of the information presented. To determine investments that may be appropriate for you, consult with your financial planner before investing. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions.We make no representation as to the completeness or accuracy of information provided at the websites linked in this newsletter. When you access one of these websites, you assume total responsibility and risk for your use of the websites to which you are linking. We are not liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, websites, information, and programs made available through this website.
Financial Planner or Estate Planner: Which Do You Need?
Financial Planners and Estate Planners are two different professions that are often confused. There is some overlap between professionals in these fields, but their roles are rather distinct. When you are striving to make a long-term plan for a strong financial future, both financial planners and estate planners play a crucial role.
In fact, when you consider some of the most recent personal finance statistics, it becomes very clear that many Americans could really benefit from retaining the services of both a financial planner AND an estate planner. For instance, 33% of Americans have no money saved for retirement, 60% lack any form of an estate plan, and only 46% have money saved for emergencies. Better planning starts with understanding what both types of planners do.
What is a Financial Planner?
A financial planner is a professional who offers a wide range of services that can assist both individuals and businesses to accomplish their long-term financial goals and accumulate wealth. They fall into two categories:
Registered Investment Advisor
Certified Financial Planner
Certified Financial Planners (CFP) are required to comply with the Certified Financial Planner Board of Standards, which means they have a basic level of expertise backed by a larger organization. Ethically they have to work in your best interest.
Services provided by both financial advisors and CFPs include:
While you might believe only wealthy individuals need to work with an estate planner, you should consider the fact that everything you have accumulated in your life comprises your estate. Accumulated assets such as vehicles, furniture, bank accounts, life insurance, your home, and other personal possessions are all included in your estate.
When you work with both a financial planner and an estate planner, they will keep you accountable by periodically reviewing your documentation and beneficiaries and making sure everything is updated and reviewed as necessary. By taking the time to work with both these professionals, no important decisions will be overlooked, and you will take control of your financial future.
Note: This article was authored by Kristin Dzialo, a partner at Eckert Byrne LLC, a Cambridge, MA law firm that provides tailored estate planning. Eckert Byrne LLC and Insight Financial Strategists LLC are separate and unaffiliated companies. This article is provided for educational and informational purposes only. While Insight Financial Strategists LLC believes the sources to be reliable, it makes no representations or warranties as to this or other third party content it makes available on its website and/or newsletter, nor does it explicitly or implicitly endorse or approve the information provided.
If you are self-employed, one of your many tasks is to plan for your own retirement. While most Americans can rely on their employer’s 401(k) for retirement savings, this is not the case for self-employed people.
In some respects, that is an advantage: most employees barely pay any attention to their 401(k). It is an opportunity for the self-employed to make the best choices possible for their business and personal situation.
The most obvious benefit of saving for retirement is that you will have to retire anyway, one day, and you will need a source of income then. With a retirement account, most people appreciate that it is specifically meant to save for retirement. People also appreciate the tax benefits of the SEP IRA and Solo 401(k).
The more immediate benefit is that retirement savings in tax-deferred accounts help reduce current taxes, possibly one of the greatest source of costs for small businesses. Of course, the tax saved with your contribution will have to be paid eventually when you take retirement distributions from the SEP-IRA.
When it comes to tax-deferred retirement savings vehicles for the self-employed and owner and spouse businesses, two of them stand out due to their high contribution limits and flexible annual contributions: the SEP IRA and the Solo 401(k). These two vehicles provide a combination of convenience, flexibility, and efficiency for the task.
The SEP IRA is better known by its initials than its full name (Simplified Employee Plan IRA). For 2018 the SEP IRA contribution limits are the lesser of 25% of compensation up to $275,000, or $55,000 whichever is less. You may note that this is significantly higher than the limit for most 401(k)s plans, except those that have a profit sharing option. SEP IRA rules generally allow contributions to be deductible from the business’ income, subject to certain SEP IRA IRS rules.
One of the wrinkles of SEP IRA eligibility is that it applies to employees: you have to make a contribution of the same percentage of compensation as you are contributing for yourself. So if you have employees, another plan such as a Solo 401(k) might be a better choice.
And for fans of the Roth option, unfortunately, the SEP IRA doesn’t have one. When comparing the SEP IRA vs Roth IRA, the two clearly address different needs.
The Solo 401(k) also known as the individual 401(k) brings large company features to the self-employed. It generally makes sense for businesses with no common law employees. One of the Solo 401k benefits is that just owners and their spouses, if involved in the business, are eligible. Employees are not. So, if you are interested in just your own retirement plan (and your spouse’s), a Solo 401(k) may work better for you than a SEP IRA. If your business expands to include employees and you want to offer an employer-sponsored retirement plan as a benefit to them, then you should consider a traditional company 401(k) option.
The Traditional Solo 401k rules work in the same way as the SEP IRA: it defers income taxes to retirement. It makes sense if you believe that you will be in an equal or lower tax bracket in retirement. Those who think that they may be in a higher tax bracket in retirement should consider a Roth option for their Solo 401(k): it will allow you to contribute now on an after-tax basis, and you will benefit from tax-free distributions from the account after retirement. A Roth 401k calculator may be required to compare the benefits. Again, the Roth option is not available in SEP accounts.
Solo 401k contribution limits permit you to contribute the same amount as you might in its corporate cousins: up to 100% of compensation, up to $18,500 a year when you are younger than 50 years old, with an additional $6,000 annual catch-up contribution for those over 50 years of age.
In addition, profit sharing can be contributed to the Solo 401(k). The Solo 401k limits for contributions are up to 25% of compensation (based on maximum compensation of $275,000) for a maximum from all contributions of $55,000 for those under 50 years of age and $61,000 for those over 50 years of age.
Another difference with the SEP IRA is that the Solo 401(k) can be set up to allow loans. In that way, you are able to access your savings if needed without suffering a tax penalty.
So Which Plan Is Best for You?
The SEP IRA is simpler to set up and administer. However, the Solo 401(k) provides more flexibility, especially for contribution amounts. Given that the amount saved is one of the key factors for retirement success, that should be a consideration.
Comparing the Solo 401k with the traditional employer 401k, you may no longer have to ask how to open a Roth 401k. You will have control of that. On the other hand you will be entirely responsible for figuring out your Roth 401k employer match.
As could be expected, administration of the Solo 401(k) is slightly more onerous than that of the SEP IRA.
Solo 401(k) and SEP IRA
A Last Word
If you don’t have a plan get one. It is easy. It reduces current taxes. And it will help you plan for a successful retirement. The SEP IRA and the Solo 401(k) were designed specifically for small businesses and the self-employed. Although we have reviewed some of the features of the plan here, there are more details that you should be aware of. Beware of the complexities!
In general, when IRA aggregation is permissible for distribution purposes, all the Traditional IRAs, SEP IRAs, and SIMPLE IRAs of an individual are treated as one traditional IRA. Similarly, all of an individual’s Roth IRAs are treated as a single Roth IRA.
IRA Aggregation does not apply to the return of excess IRA contributions
The IRA contribution limit for individuals is based on earned income. Individuals under 50 years of age can contribute up to $5,500 a year of earned income. Those older than 50 years of age are allowed an additional catch up contribution of $1,000. The contribution limit is a joint limit that applies to the combination of Traditional and Roth IRAs.
When the IRA contribution happens to be in excess of the $5,500 or the $6,500 limit (for people over 50), the excess contributions, including net attributable income (NIA), ie the growth generated by the excess contribution, must be returned before the IRA owner’s tax filing due date, or extended tax filing due date. Those who file their returns before the due date receive an automatic six-month extension to correct the excess contributions.
Mandatory aggregation applies to the application of bases for Traditional IRAs
Contributions to Traditional IRAs are usually pre-tax. Thus, distributions from IRAs are taxable as income. In addition, distributions prior to 59.5 years of age are also subject to a 10% penalty.
After-tax contributions to an IRA, but not the earnings thereof, may be distributed prior to 59 ½ years of age without the customary 10% penalty. Distributions from an IRA that contains after-tax contributions are usually prorated to include a proportionate amount of after-tax basis (amount contributed) and pre-tax balance (pro rata rule).
Suppose that Janice has contributed $700 to a non-deductible Traditional IRA, and it has grown to $1,400. If Janice takes a distribution of $500, one half of the distribution is returnable on a non-taxable basis, and the other half is taxable and subject to the 10% penalty if Janice happens to be under 59½ years of age. You can see why Janice would want to keep accurate records of her transaction in order to document the taxable and non-taxable portions of her IRA.
Limited aggregation applies for inherited Traditional IRAs
In practice, it means that if Johnny inherited two IRAs from his Mom and another from his Dad, Johnny must take the Required Minimum Distributions for his Mom’s two IRAs separately from his Dad’s, and also separately from his own IRAs.
Furthermore, IRAs inherited from different people must also be kept separate from one another. They can only be aggregated if they are inherited from the same person. In addition, inheriting an IRA with basis must be reported to the IRS for each person.
Mandatory aggregation applies to qualified Roth IRA distributions
Qualified distributions from Roth IRAs are tax-free. In addition, the 10% early distribution penalty does not apply to qualified distributions from Roth IRAs.
Roth IRA distributions are qualified if:
– they are taken at least five years after the individual’s first Roth IRA is funded;
– no more than $10,000 is taken for a qualified first time home purchase;
– the IRA owner is disabled at the time of distribution;
– the distribution is made from an inherited Roth IRA; or
– the IRA owner is 59½ or older at the time of the distribution.
If Dawn has two Roth IRAs, she must consider both of them when she takes a distribution. For instance, if Dawn takes a distribution for a first time home purchase, she can only take a total $10,000 from her two Roth IRAs
Optional aggregation applies to required minimum distributions
The RMD for each IRA must be calculated separately; however, the owner can choose whether to take the aggregate distribution from one or more of his Traditional, SEP or SIMPLE IRAs.
So, if Mike has a Traditional, a SIMPLE and a SEP IRA, he would calculate the RMD for each of the accounts separately. He could then take the RMD from one, two or three accounts in the proportions that make sense for him.
As a reminder, Roth IRA owners are not subject to RMDs.
Limited aggregation applies to Inherited IRAs
Beneficiaries must take RMDs from the Traditional and Roth IRAs that they inherit with the exception of spouse beneficiaries that elect to treat an inherited IRA as their own.
With this latter exception, RMD rules apply as if the spouse was the original owner of the IRA.
When a beneficiary inherits multiple Traditional IRAs from one person, he or she can choose to aggregate the RMD for those inherited IRAs and take it from one or more of the inherited Traditional IRAs. The same aggregation rule applies to Roth IRAs that are inherited from the same person.
Suppose again that Johnny has inherited two IRAs from his Mom and one from his Dad. Johnny can calculate the RMDs for the two IRAs inherited from his Mom, and take it from just one. Johnny must calculate the RMD from the IRA inherited from his Dad separately, and take it from that IRA.
If in addition, Johnny has inherited an IRA from his wife, he may aggregate that IRA with his own.
If an IRA distribution is rolled over to the same type of IRA from which the distribution was made within 60 days, that distribution is excluded from income.
Such a rollover can be done only once during a 12-month period.
In this kind of situation, all IRAs regardless of types (Roth and non-Roth) must be aggregated. For instance, if an individual rolls over a Traditional IRA to another Traditional IRA, no other IRA to IRA (Roth or non-Roth) rollover is permitted for the next 12 months.
Conclusion: What you should keep in mind
These are some of the more common IRA aggregation rules. There are others including rules for substantially equal periodic payments programs (an exception to the 10% early distribution penalty), and those that apply to Roth IRAs when the owner is not eligible for a qualified distribution.
Lastly, many of the potential problems that people may face with IRA aggregation can be avoided with proper documentation. Recordkeeping is essential. Individuals can do it themselves or they can rely on their Wealth Managers. In the case where you have to change financial professionals, make sure that you have documented the history of your IRAs.