Before you start tapping into your retirement savings, you may want to read this first:
If you are under age 59½ and plan to withdraw money from a qualified retirement account, you will likely pay both income tax and a 10% early-distribution tax on any previously un-taxed money that you take out. Withdrawals you make from a SIMPLE IRA before age 59½ and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited. These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
The following exceptions may help you avoid the penalty:
- Withdrawals from any retirement plan to pay medical expenses—Amounts withdrawn to pay unreimbursed medical expenses are exempt from penalty if they would be deductible on Schedule A during the year and if they exceed 10% of your adjusted gross income. This is true even if you do not
- IRA withdrawals annuitized over your lifetime—To qualify, the withdrawals must continue unchanged for a minimum of 5 years, including after you reach age 59½.
- Employer retirement plan withdrawals—To qualify, you must be separated from service and be age 55 or older in that year (the lower limit is age 50 for qualified public-service employees such as police officers and firefighters) or elect to receive the money in substantially equal periodic payments after your separation from service.
- Withdrawals from any retirement plan as a result of a disability—You are considered disabled if you can furnish proof that you cannot perform any substantial gainful activities because of a physical or mental condition. A physician must certify your condition.
- IRA withdrawals by unemployed individuals to pay medical insurance premiums—The amount that is exempt from penalty cannot be more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You also must have received unemployment compensation for at least 12 weeks during the year.
- IRA withdrawals to pay higher education expenses—Withdrawals made during the year for qualified higher education expenses for yourself, your spouse, or your children or grandchildren are exempt from the early-withdrawal penalty.
- IRA withdrawals to buy, build, or rebuild a first home—Generally, you are considered a first-time homebuyer for this exception if you had no present interest in a main home during the 2-year period leading up to the date the home was acquired, and the distribution must be used to buy, build, or rebuild that home. If you are married, your spouse must also meet this no-ownership requirement. This exception applies only to the first $10,000 of withdrawals used for this purpose. If married, you and your spouse can each withdraw up to $10,000 penalty-free from your respective IRA accounts.
You should be aware that the information provided above is an overview of the penalty exceptions and that conditions other than those listed above may need to be met before qualifying for a particular exception. You are encouraged to contact this office before tapping your retirement funds for uses other than retirement. Distributions are most often subject to both normal taxes and other penalties, which can take a significant bite out of the distribution. However, with carefully planned distributions, both the taxes and the penalties can be minimized. Please call Dagley & Co. for assistance.
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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Miss a 60-day rollover? According to the IRA, the acceptable reasons for missing include: An error was committed by the financial institution, the distribution check was misplaced and never cashed, the distribution was mistakenly deposited into an account that the taxpayer thought was an eligible retirement plan, the taxpayer’s principal residence was severely damaged, a member of the taxpayer’s family died, the taxpayer or a member of the taxpayer’s family was seriously ill, the taxpayer was incarcerated, restrictions were imposed by a foreign country, a postal error occurred, or the distribution was made on account of an IRS levy, and the proceeds of the levy have been returned to the taxpayer. If you, or someone you know, fall into any of these situations, as a taxpayer, you can take a distribution from an IRA or other qualified retirement plan and if they roll it over within 60 days they can avoid taxation on the distributed amount.
Financial Institution Error – Where the failure to meet the deadline is due to financial institution error, the IRS provides an automatic waiver.
Private Letter Ruling (PLR) – Where automatic waiver does not apply, and the taxpayer feels there is a legitimate reason for missing the 60-day rollover requirement, the taxpayer can request relief though a PLR where the IRS reviews the reason for missing the 60-day rollover period and either allows or denies relief from the 60-day requirement. However, the IRS will charge the taxpayer requesting the PLR a user fee of $10,000, which negates the purpose of a PLR except in cases of very large rollover amounts.
New Self-Certification Procedure – The IRS recently announced a new certification procedure that allows a taxpayer who misses the 60-day time limit for properly rolling the amount into another retirement plan or IRA to make a written certification to a plan administrator or an IRA trustee that a contribution satisfies one of the acceptable reasons, and therefore is eligible for a waiver of the 60-day rule.
Please remember: This provision does not apply to required minimum distributions for taxpayers who are 70.5 years of age and over.). Also, taxpayers are limited to one IRA-to-IRA rollover per year.
The rollover must be completed as soon as practicable after the reason(s) listed above no longer prevent the taxpayer from making the contribution. This requirement is deemed to be satisfied if the contribution is made within 30 days after the reason(s) no longer prevent the taxpayer from making the contribution.
This procedure does not apply where the IRS previously denied a waiver request for the same missed rollover.
The IRS provides a model letter that can be used to make the self-certification. Please call Dagley & Co. if you need a copy of the letter, have questions, or need assistance related to a missed 60-day rollover.
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Are you a baby boomer? If so, have you been stashing away tax-deferred retirement savings? If so, take note… It is getting close to the time to start withdrawing funds from those accounts and, of course, paying taxes on those withdrawals. (This includes distributions from traditional IRAs and 401(k)s)
The same Internal Revenue Code that allowed you to save tax dollars when you contributed to those tax-deferred retirement plans also generally requires you to begin withdrawals on the year you reach age 70½. These distributions are called required minimum distributions (RMDs) and are based on annuity tables. Generally, most individuals will utilize the single life table, but the joint life annuity tables are used if the individual’s spouse is more than 10 years younger.
Keep in mind that you can always take as much as you wish from your tax-deferred retirement accounts, but you must take the RMD amount each year, beginning with the year you turn age 70½, or you will be subject to a very severe penalty, which we will discuss later. One exception is that you can delay the payout for the year you become 70½ until no later than April 1 of the following year. However, since you will also need to make an RMD for that following year, you will end up with two years’ worth of distributions being taxed in one year if you use the delayed distribution option.
The following is an abbreviated single life table. The actual table goes to age 111.
Age 70 71 72 73 74 75 Distribution Period (Years) 27.4 26.5 25.6 24.7 23.8 22.9
Required Minimum Distribution – To determine an RMD, first determine the distribution period (life expectancy) based on your current age. So, for the year you turn 70½, the distribution period would be 27.4 years. Next, determine the retirement account’s balance on December 31 of the prior year. The account balance divided by the distribution period equals the RMD. For example, say you will turn age 70½ in 2016 and your tax-deferred retirement account had a balance of $500,000 on December 31, 2015. Your 2016 RMD would be $18,248 ($500,000/27.4).
Failure to Take an RMD Penalty – When the full amount of an RMD is not taken, the penalty is 50% of the amount you didn’t withdraw. Luckily, the IRS is very lenient on this penalty and will generally waive it when an under-distribution is inadvertent or due to ignorance of the law, provided that the RMD amounts are made up as soon as possible once the error is discovered. Avoid RMD problems by having your account custodian or trustee determine the RMD annually and then transfer the distribution directly to your checking, savings or non-retirement plan brokerage account.
Multiple Retirement Accounts – When you have multiple accounts, the question often is, “Which account should I take the RMD from?” All traditional IRAs are treated as one for distribution purposes. So, you can take the RMD for the IRA accounts from any combination of the accounts that you choose. However, that may cause a problem with a trustee of the IRA account(s) from which you didn’t take a distribution, who may think you didn’t take your RMD for the year. So, it is less problematic to take a distribution from each account.
You may wish to simplify the RMD distributions by transferring all of your traditional IRAs into one account, if you have several traditional IRAs. This is best done by having the trustees make direct transfers to the target IRA, rather than you receiving the distributions and then rolling over the funds, since you are only allowed one IRA rollover each twelve months (trustee-to-trustee transfers don’t count as rollovers). Note that spouses must maintain their accounts separately and cannot combine their accounts with yours when figuring RMDs.
If you have a 401(k) account, the RMD for it must be figured separately from any IRA accounts you also have. And, if you have multiple 401(k)s, each 401(k) account’s RMD is figured separately from those of your other 401(k) plans.
Non-Taxable Amounts – If your tax deduction for the contribution was limited when you made your traditional IRA contribution because you were a high-income taxpayer, you would have created a non-taxable basis in your IRA. If this is true, then that non-taxable basis is recovered tax-free in proportion to your distribution.
Roth Conversions – The ability of individuals to convert amounts of their traditional IRAs to Roth IRAs gives rise to some possible tax-saving moves in the years leading up to the RMD age. Things to consider are:
- Is you tax bracket lower now than it will be after retirement? If so, you might consider converting some portion of your traditional IRA to a Roth IRA now. You will pay tax on the traditional IRA distribution in the year of the conversion, but when you withdraw it from the Roth IRA, it will be tax-free.
- If you have a low-income year for some reason, and if you are age 59½ or older, it might be appropriate to take a distribution in that year and pay little or no tax. You won’t get a credit against a future RMD by doing so but you will be lowering the balance in the account for the eventual calculation of RMDs.
The following strategies require careful planning:
Effect on Taxable Income Once RMDs Start – Your taxable income may be increased by more than just the amount of the RMD. Adding your RMD to your income that is already taxed will increase your adjusted gross income (AGI); as a result, the amount of your Social Security benefits that is taxed may also increase. In addition, since the AGI is the amount on which the phaseout or reduction of many tax deductions is based, you may also find that you are getting less tax benefit from such items as medical expenses, charitable contributions, and investment-related expenses – all of which means your tax bill will go up by more than it otherwise would by just adding the RMD to your income.
Plan for Additional Withholding or Estimated Tax – Once you start taking distributions from your IRA or 401(k), and to avoid a potential underpayment of tax penalty, you will likely need to increase your tax prepayments, either by having federal (and possibly state) income taxes withheld from the distributions or by making quarterly estimated tax payments. If you already make estimated tax payments, you may need to increase the installment amounts.
If You Don’t Need the RMD – If you simply don’t need the retirement distribution, after reaching age 70½, you can donate up to $100,000 of IRA funds per year to a qualified charity without having to include the distribution in your income, and it will still count towards your RMD. If you are married and your spouse has an IRA and is also 70½ or older, he or she may also make a charitable IRA distribution of up to $100,000. So, if you are someone who gives substantial amounts to charity each year, this is a distribution strategy you may want to consider after reaching RMD age. CAUTION: To qualify under this provision, the funds must be directly transferred from the IRA account to the charity.
RMD issues can be quite complicated. We believe it is highly suggested that you consult Dagley & Co. for pre-RMD planning, determining the correct RMD amounts, and analyzing your withholding and/or estimated tax obligations. Give us a call at (202) 417-6640.
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Are you a sole proprietor with no full-time employees other than yourself and/or your spouse? Also, are you are seeking to maximize your retirement plan contributions? If so, a Solo 401(k) may be right for you. The key benefits of a Solo 401(k) plan are as follows:
- Manage your own account directly without any brokers, banks, or trust companies as middlemen.
- Generally contribute larger amounts, approximately equal to the 401(k) and profit-sharing amounts combined.
- Legally avoid the unrelated business income tax (UBIT) that would apply to certain self-directed IRA transactions.
- Make Roth contributions to the 401(k) element (not the profit-sharing part) of the plan, regardless of the AGI limitations that apply to regular Roth contributions.
- Transfer existing retirement funds into the Solo 401(k).
- Direct your investments with absolutely no restrictions on investment choices (including real estate, private companies, foreign assets, precious metals, etc.).
Solo 401(k) Contributions – The maximum annual contribution to a Solo 401(k) for 2016 is $53,000 but not exceeding 100% of compensation. The Solo 401(k) contribution consists of two parts: (1) a profit-sharing contribution of up to 20% of net self-employment income for unincorporated businesses or 25% of W-2 income for incorporated businesses and (2) a salary-deferral contribution (same as the 401(k)) of as much as 100% of the first $18,000 ($24,000 if age 50 or over) of the remaining compensation after the profit-sharing contribution, as a tax-deductible contribution.
Given sufficient income, a self-employed individual and spouse (assuming the spouse is employed in the same business) may contribute, for 2016, up to $106,000 combined. Because of the way the contribution is calculated, a larger contribution can usually be made into a Solo 401(k) than to a Keogh or SEP IRA at the same income level.
Discretionary Funding –The funding of the Solo 401(k) plan is completely discretionary and flexible every year. Funding can be increased, decreased, or skipped entirely, if necessary.
Where Deducted – If your business is organized as a Subchapter S or C corporation, or LLC electing to be taxed as a corporation, then you are an employee of the business, so the salary-deferral contribution reduces your personal W-2 earnings and the profit-sharing contribution is deducted as a business expense.
For a sole proprietorship, a partnership, or an LLC taxed as a sole proprietorship, the owner’s salary-deferral and profit-sharing contributions are deductible only from personal income (i.e., on page 1 of Form 1040, as an adjustment to gross income), and not as an expense of the business.
Deadlines – The deadline for establishing a Solo 401(k) is December 31st for an individual or the fiscal year end for corporations. For unincorporated businesses, the deadline for making the contributions is the regular April income tax filing due date plus extensions. For incorporated businesses, the deadline is 15 days after the close of the fiscal year.
Roth Option – The 401(k) portion of the contribution can be designated as a non-deductible qualified Roth contribution, provided the plan document permits Roth contributions.
If you think a Solo 401(k) might be right for you, please call Dagley & Co. at (202) 417-6640 for further details. We will help you to determine if your particular circumstances permit you have, and whether you will benefit from a Solo 401(k).
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At Dagley & Co. we hear a lot about the complexity of the tax code, as well as a lot of rhetoric from Washington about simplifying it. Tax codes were originally written to bring in money (taxes) to pay for government costs. But over the years, Congress has used tax codes more as a tool to manage social reform. As a result, the code has become very complex.
So with taxes becoming more complex with each passing year, why do people think they can prepare their own returns? We use software-costing thousands of dollars, so why do individuals, not educated in tax law and using low-cost computer software, think they can get their tax result right? Well, they may not, and they may miss deductions, credits, income exclusions, retirement benefits, and even more beneficial filing options just to save a few bucks on tax preparation costs.
However, paying a little more in tax than they need to should not be their biggest concern. A more troublesome situation is getting more tax refund than they are entitled to, and then a year or two later getting a letter from the IRS wanting the excess back. This is especially devastating to lower-income individuals and families that spend what they bring in just making ends meet and have no savings to fall back on when the IRS comes calling, leaving them with even a bigger financial hole.
To make matters worse, they may not even understand the IRS letter or the issue it is dealing with, and since they did their own return, they have no one to call for help in getting the tax assessment reduced or knowing how to get penalties abated.
Professional tax preparation offers more than just entering numbers into a computer program. If you usually file your own tax returns, perhaps you should consider a firm that can not only prepare your taxes properly, but also provide tax, financial and retirement guidance. We are also here to help plan for the future. Give Dagley & Co., CPA’s a call this year, we are here to help.
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Some Americans end up owing and cannot pay their tax liabilities. Are you one of these unfortunate people?
The IRS encourages you to pay the full amount of your tax liability on time by imposing significant penalties and interest on late payments if you don’t. So if you are unable to pay the tax you owe, it is generally in your best interest to make other arrangements to obtain the funds for paying your taxes rather than be subjected to the government’s penalties and interest. Here are a few options to consider.
Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.
Credit Card – Another option is to pay by credit card with one of the service providers that work with the IRS. However, since the IRS will not pay the credit card discount fee, you will have to pay it and pay the higher credit card interest rates.
Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement where you can make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. Interest will also be charged at the current rate, and there is a user fee to set up the payment plan. In making the agreement, a taxpayer agrees to keep all future years’ tax obligations current. If the taxpayer does not make payments on time or has an outstanding past due amount in a future year, they will be in default of their agreement and the IRS has the option of taking enforcement actions to collect the entire amount owed. Taxpayers seeking installment agreements exceeding $50,000 will need to validate their financial condition and need for an installment agreement by providing the IRS with a Collection Information Statement (financial statements). Taxpayers may also pay down their balance due to $50,000 or less to take advantage of the streamlined option.
Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because you are jeopardizing your retirement and the distributions are generally taxable at your highest bracket, which adds more taxes to your existing problem. In addition, if you are under age
59½, the withdrawal is also subject to a 10% early withdrawal penalty that compounds the problem even further.
Whatever you decide, don’t just ignore your tax liability because that is the worst thing you can do. Please call Dagley & Co. for assistance.
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Were you aware that even after the close of the tax year you can make tax-deductible retirement savings contributions? Well, you can, and with the April tax deadline looming, the window of opportunity to maximize retirement and other special-purpose plan contributions for 2015 is closing. Many of those contributions not only build the retirement nest egg but also deliver tax deductions for the 2015 tax return. Let’s take a look at some of the ways a taxpayer can benefit.
Traditional IRA – The maximum contribution to an IRA for 2015 is $5,500 ($6,500 if over 49 years old). The 2015 contribution can be made up until April 18th. If the taxpayer is covered by another retirement plan, some or all of the contribution may not be deductible. To be eligible to contribute to an IRA of any type, the taxpayer, or spouse if married filing jointly, must have earned income, such as wages or self-employment income.
Roth IRA – This is a nondeductible retirement account, but the earnings are tax-free upon withdrawal, provided that the holding period and age requirements are met. Roth IRAs are a good alternative for many taxpayers who aren’t eligible to deduct contributions to a traditional IRA. The maximum deductible contribution for the 2015 tax year is $5,500 ($6,500 if the taxpayer is over 49 years old). The 2015 contribution can be made up until April 18th.
Caution: The combined traditional IRA and Roth IRA contributions are limited to $5,500 ($6,500 if the taxpayer is over 49 years old).
Spousal IRA – A non-working spouse can open and contribute to a traditional IRA or Roth IRA based upon the working spouse’s earned income, subject to the same contribution limits as the working spouse, but the combined contributions of both spouses cannot exceed the earned income of the working spouse. Contributions to spousal IRAs for 2015 must also be made by April 18th.
SEP-IRA (Simplified Employee Pension) – SEP-IRAs are tax-deferred plans for sole proprietorships and small businesses. They are probably the easiest way to build retirement dollars, requiring virtually no paperwork. Maximum contributions depend on your net earnings from your business. For 2015, the maximum contribution is the lesser of 25 percent of compensation or $53,000. The 2015 contribution can be made up to the due date of the return, including extensions. Thus, unlike a traditional or Roth IRA, funding of a SEP-IRA for 2015 may occur up to October 17, 2016, when an extension has been granted.
Solo 401(k) Plans – A growing number of self-employed individuals with no employees are forsaking the SEP-IRA for a newer type of retirement plan called the Solo 401(k), or Self-Employed 401(k), mostly for its higher contribution levels.
For 2015, the maximum contribution to a Solo 401(k) is the sum of (A) up to 25% of compensation and (B) salary deferral up to $18,000. The total of A and B can’t exceed $53,000 or 100% of compensation. Note that a Solo 401(k) account must have been established by December 31, 2015, to make 2015 contributions, which can then be made up to the extended due date of the return (October 17, 2016, for most taxpayers). If a Solo 401(k) account was not established by the end of 2015, open one now for 2016 contributions.
Health Savings Accounts (HSA) – An HSA is a tax-exempt trust or custodial account established exclusively for the purpose of paying qualified medical expenses of the account beneficiary. An HSA is designed to assist individuals who have high-deductible health plans (HDHP). A taxpayer is only eligible to establish an HSA if he or she has an HDHP. For 2015, this means that the plan must have a deductible amount of $1,300 or more for self-only coverage or $2,600 for family coverage. In addition, the annual maximum out-of-pocket costs for covered expenses can’t exceed $6,450 for a self-only plan or $12,900 for a family plan.
The maximum 2015 contribution for eligible individuals with self-only coverage under an HDHP is $3,350, while an eligible individual with family coverage under an HDHP can contribute up to $6,650. The contribution limit is increased by $1,000 for an eligible individual who was age 55 or older at the end of 2015; however, no contribution can be made as of the month that an individual is enrolled in Medicare.
Amounts contributed to an HSA belong to individuals and are completely portable. Every year, the money not spent on medical expenses stays in the account and gains interest tax-free, just like an IRA. Unused amounts remain available for later years (unlike amounts in Flexible Spending Arrangements that may be forfeited if not used by the end of the year). Contributions to an HSA for 2015 can be made through April 18, 2016.
Coverdell Education Savings Account – These plans were originally called Education IRAs, but that moniker created confusion because they were really not retirement accounts. They are now called Coverdell Education Savings Accounts, named after the late Senator from Iowa. Contributions, which can be made for a beneficiary who is under 18 years of age, are not tax-deductible, but the money grows tax-free if the distributions are used to pay qualified education expenses. The maximum annual contribution is $2,000 per beneficiary, but this amount could be reduced partly or totally depending on income. Contributions do not count toward IRA annual contribution limits; they are also due by April 18, 2016, to be considered as having been made for 2015.
Please note that information for each plan or account above has been abbreviated. Contact Dagley & Co. for specific details on how they may apply to your situation.
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