Do you find that your required minimum distributions (RMDs) from qualified plans and IRAs are providing unneeded income and a high tax bill? Or, are you afraid that the government’s RMD requirements will leave too little in your retirement plan for your later years? If you answered yes to either of these, good news! You can now use a qualified longevity annuity contract (QLAC) to reduce your RMDs and extend the life of your retirement distributions.
The government allows individuals to purchase QLACs with their retirement funds, thus reducing the value of those funds (subject to the RMD rules) and in turn reducing the funds’ annual RMDs.
A QLAC is a deferred-income annuity that begins at an advanced age and that meets the stringent limitations included in the tax regulations. One benefit of a retirement-planning strategy involving QLACs is that they provide a form of longevity insurance, allowing taxpayers to use part of their retirement savings to buy an annuity that helps protect them from outliving their assets.
The tax-planning benefits of QLACs are twofold:
- Because the QLAC is purchased using funds from a qualified retirement plan or IRA, that plan’s year-end balance (value) is lowered. This causes the RMDs for future years to be less than they otherwise would be, as the RMD is determined by dividing the account balance (from 12/31 of the prior year) by an annuity factor that is based on the retiree’s age.
Example: Jack is age 74, and the annuity table lists his remaining distribution period as 23.8 years. The balance of his IRA account on 12/31/2016 is $400,000. Thus, his RMD for 2017 would be $16,807 ($400,000 / 23.8). However, if Jack had purchased a $100,000 QLAC with his IRA funds during 2016, his balance would have been $300,000, and his 2017 RMD would be $12,605 ($300,000 / 23.8). By purchasing the $100,000 QLAC, Jack would have reduced his RMD for 2016 by $4,202 ($16,807 – $12,605). This reduction would continue for all future years. Later, the $100,000 QLAC would provide retirement benefits, likely beginning when Jack reaches age 85.
(2) Tax on the annuity will be deferred until payments commence under the annuity contract.
A deferred-income annuity must meet a number of requirements to be treated as a QLAC, including the following:
Limitation on premiums – When buying a QLAC, a taxpayer can use up to the lesser of $125,000 or 25% of his or her total non-Roth IRA balances. The dollar limitation applies to the sum of the premiums paid on all QLAC contracts.
When distributions must commence – Distributions under a QLAC must commence by a specified annuity starting date, which is no later than the first day of the month after the taxpayer’s 85th birthday.
For additional details about how QLACs might fit into your retirement strategy, please give Dagley & Co. a call.
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Last week, on March 6th, the House Republicans unveiled their draft legislation that would repeal and replace the Affordable Care Act (ACA). This plan would ultimately continue the ACA’s premium tax credit through 2019 and then replace it in 2020. Then, a new credit for individuals without government insurance and those who are not offered insurance by their employer will be available.
Additional details are provided below. Dagley & Co. wants you to keep in mind that the legislation is only a draft legislation and is subject to changes.
Repeal of the Individual Mandate
Background: Under the ACA, individuals are generally required to have ACA-compliant health insurance or face a “shared responsibility payment” (penalty for not being insured). For 2016, the annual penalty was $695 per uninsured individual ($347.50 per child), with a maximum penalty of $2,085 per family.
GOP Legislation: Under the new legislation, this penalty would be repealed after 2015.
Repeal of the Employer Mandate
Background: Under the ACA, large employers, generally those with 50 or more equivalent full-time employees, were subject to penalties that could reach thousands of dollars per employee for not offering their full-time employees affordable health insurance. These employers were also subject to some very complicated reporting requirements.
GOP Legislation: Under the new legislation, this penalty would be repealed after 2015.
Recapture and Repeal of the Premium Tax Credit
Background: The premium tax credit (PTC) is a health insurance subsidy for lower-income individuals, and it is based on their household income for the year. Since the household income can only be estimated at the beginning of the year, the insurance subsidy, known as the advance premium tax credit (APTC), must also be estimated at the beginning of the year. Then, when the tax return for the year is prepared, the difference between the estimated amount of the subsidy (APTC) and the actual subsidy allowed (PTC) is determined based on the actual household income for the year. If the subsidy paid was less than what the individual was entitled to, the excess is credited to the individual’s tax return. If the subsidy paid was more than what the individual was entitled to, the difference is repaid on the tax return. However, for lower-income taxpayers there is a cap on the amount that needs to repaid, and this is also based on household income.
GOP Legislation: For tax years 2018 and 2019, the GOP legislation would require the repayment of the entire difference regardless of income. In addition, the PTC would be repealed after 2019.
Background: The current law does not allow the PTC to be used for the purchase of catastrophic health insurance.
GOP Legislation: The new legislation would allow premium tax credits to be used for the purchase of qualified “catastrophic-only” health plans and certain qualified plans not offered through an Exchange.
Refundable Tax Credit for Health Insurance
Beginning in 2020, as a replacement for the current ACA insurance subsidies (PTC), the GOP Legislation would create a universal refundable tax credit for the purchase of state-approved major medical health insurance and un-subsidized COBRA coverage. Generally eligible individuals are those who do not have access to government health insurance programs or an offer of insurance from any employer.
The credit is determined monthly and ranges from $2,000 for those under age 30 to $4,000 for those over 60. The credit is additive for a family and capped at $14,000. The credit phases out for individuals who make more than $75,000 and for couples who file jointly and make more than $150,000.
Health Savings Accounts
Background: Individuals covered by high-deductible health plans can generally make tax-deductible contributions to a health savings account (HSA). Currently (2017), the maximum that can be contributed is $3,400 for self-only coverage and $6,750 for family coverage. Distributions from an HSA to pay qualified medical expenses are tax-free. However, non-qualified distributions are taxable and generally subject to a 20% penalty.
GOP Legislation: Beginning in 2018, the HSA contribution limit would be increased to at least $6,550 for those with self-only coverage and to $13,100 for those with family coverage. In addition, the new legislation would do the following:
- Allow both spouses to make catch-up contributions (applies to those age 55 through 64) beginning in 2018.
- Allow medical expenses to be reimbursed if they were incurred 60 days prior to the establishment of the HSA (whereas currently only expenses incurred after the HSA is established qualify).
- Lower the penalty for non-qualified distributions from the current 20% to 10% (the amount of the penalty prior to 2011).
Medical Deduction Income Limitation
Background: As part of the ACA, the income threshold for itemizing and deducting medical expenses was increased from 7.5% to 10% of the taxpayer’s AGI.
GOP Legislation: Under the new legislation, the threshold would be returned to 7.5% beginning in 2018 (2017 for taxpayers age 65 or older).
Repeal of Net Investment Income Tax
Background: The ACA imposed a 3.8% surtax on net investment income for higher-income taxpayers, generally single individuals with incomes above $200,000 and $250,000 for married taxpayers filing jointly.
GOP Legislation: The new legislation would repeal this tax after 2017.
Repeal on FSA Contribution Limits
Background: Flexible spending accounts (FSAs) generally allow employees to designate pre-tax funds that can be deposited in the employer’s FSA, which the employee can then use to pay for medical and other qualified expenses. Effective beginning in 2013, annual contributions to health FSAs (also referred to as cafeteria plans) were limited to an inflation-adjusted $2,500. For 2017, the inflation limitation is $2,550.
GOP Legislation: The new legislation would remove the health FSA contribution limit, effective starting in 2017.
Repeal of Increased Medicare Tax
Background: Beginning in 2013, the ACA imposed an additional Medicare Hospital Insurance (HI) surtax of 0.9% on individuals with wage or self-employed income in excess of $200,000 or $250,000 for married couples filing jointly.
GOP Legislation: The new legislation would repeal this surtax beginning in 2018.
- Preexisting Conditions – Prohibits health insurers from denying coverage or charging more for preexisting conditions. However, to discourage people from waiting to buy health insurance until they are sick, individuals will need to maintain “continuous” coverage. Those who go uninsured for longer than a set period will be subject to 30% higher premiums as a penalty.
- Children Under Age 26 – Allows children under age 26 to remain on their parents’ health plan until they are 26.
- Small Business Health Insurance Tax Credit – Repealed after 2019
- Medical Device Tax – Repealed after 2017
- Tanning Tax – Repealed after 2018
- Over-the-Counter Medication Tax – Repealed after 2017
This is a proposed law change, and it may not ultimately turn out as described here. If you have any questions, please give Dagley & Co. a call.
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Tax fraud is currently a huge issue which has cost the government billions of tax dollars. New laws are taking effect that clamp down on individuals who have fraudulently claimed the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) or the Earned Income Tax Credit (EITC). Details on these credits are as follows:
- The AOTC is the college tuition credit for low-income families that provides a credit for each eligible student equal to 100% of the first $2,000 and 25% of the next $2,000 spent on college tuition and related expenses; the maximum credit is $2,500, of which 40% is refundable. The credit is phased out depending on income.
- The CTC is a tax credit of $1,000 for each of the taxpayer’s qualifying dependent children. A portion of the credit that is not used to offset the taxpayer’s tax liability can be refundable; the refund is based in part on the number children in the family and in part on the taxpayer’s earned income. This credit may also be phased out for higher-income taxpayers.
- The EITC is a refundable credit awarded to low-income taxpayers who work. The credit is based on the amount of the taxpayer’s income that comes from working as well as on total income and on number of children. In 2016, this credit can be worth as much as $6,269.
We have your rundown of some of the new provisions that the government has put in place to defend against fraud:
Retroactive Claims – Individuals are now prevented from retroactively claiming the AOTC, CTC or EITC if the individual, dependent child or student for whom the credit is claimed does not have a taxpayer identification number (TIN). In other words, the TIN must be issued prior to the due date for filing the original return in the tax year for which the credit is claimed; the IRS will deny the credit if the TIN is not issued on time. In most cases, the TIN is a Social Security number.
Disallowance Periods – When a taxpayer improperly claims the AOTC, CTC or EITC (either fraudulently or recklessly), he or she will be barred from claiming that credit for a period of time. The disallowance periods are 10 years for fraud and 2 years for reckless or intentional disregard of rules and regulations.
Preparer Due Diligence Requirements – In the past, paid tax preparers have always abided by a set of due-diligence guidelines for EITC qualification before including that credit on any return that they prepared. These due-diligence requirements have been expanded to include the CTC and the AOTC. This adds additional work for paid preparers and increases their liability for errors, as each disallowed credit could be subject to a $510 preparer penalty.
1098-T Required to Claim Education Credits – Education credits can no longer be claimed unless the taxpayer includes the employer identification number of the educational institution to which the tuition was paid. This number, as well as the other information needed to determine the credit, can be found on the Form 1098-T (Tuition Statement) issued by the educational institution. The new rules require that the taxpayer (or the dependent who is a student) receive a 1098-T form to claim the credit, although some exceptions are provided.
Refunds that Include the EITC or CTC Will Be Purposely Delayed – Refunds from returns that include an EITC or a refundable CTC will not be issued prior to February 15th, which gives the IRS additional time to verify the validity of the credit claims and to match them against the taxpayers’ income amounts and the informational returns that are filed with the IRS to verify tuition.
If you have questions related to any of the foregoing safeguards, the delayed refunds or the credits themselves, please give Dagley & Co. a call.
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Did you know the government has a “pay-as-you-go” system and wants its tax revenue up front? If your pre-paid amount is not enough, you may become liable for non-deductible interest penalties. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. The primary among these include: payroll withholding for employees; pension withholding for retirees; and estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
Determining how much tax to pre-pay through withholding and estimated tax payments has always been difficult, and thanks to Congress’ constant tinkering with the tax laws, ensuring there are no underpayment penalties or tax surprises when the tax return is prepared next year can be challenging.
When a taxpayer fails to prepay a safe harbor (minimum) amount, he or she can be subject to the underpayment of estimated tax penalty. This penalty is the short-term federal rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis. So, even if you pre-pay the correct amount for the year, if the amounts are not paid evenly, you could be subject to a penalty. Interestingly enough, withholding amounts are treated as paid ratably throughout the year, so taxpayers who are underpaid in the earlier part of the year can compensate by bumping up their withholding in the later part of the year.
Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (referred to as the de minimis amount), no penalty is assessed. In addition, the law provides “safe harbor” prepayments –meaning if you meet the parameters set by law, you won’t be penalized, even if your underpayment is more than $1,000. There are two safe harbors. The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty. The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for a higher income taxpayer who has AGI exceeding $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.
Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. As 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can’t avoid the penalty under this exception.
However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. As you prepaid $5,600, which is greater than 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.
If your state has a state tax, the state’s de minimis amount and safe-harbor percentage and amount may be different.
This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, or when a taxpayer retires. If you need to make estimated tax installments for 2016, please note that the first payment for 2016 is due April 18, 2016.
If you have questions regarding your pre-payments or would like to review and adjust your W-4 payroll withholding, W-4P pension withholding, and estimated tax payments to provide the desired tax result for 2016, please give Dagley & Co. a call.
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