In a crunch? The year-end period is probably a very busy time if you are like many small business owners. You can’t close your books and determine your business’s profit until after the close of the year, and if this has been a good year, you may want to establish a retirement plan and make a contribution for 2015.
There are a number of retirement plan options available, including Keogh plans and 401(k)s. However, a simplified employee pension plan (SEP) may be your best option. Unlike with a Keogh plan, you don’t have to scramble to get a SEP established before year-end.
The reason a SEP is “simplified” is that its retirement contributions are deposited into an IRA account under the control of the SEP participant, thus eliminating most of the employer’s administrative duties. That is why these plans are sometimes referred to as SEP-IRAs.
SEPs function much like Keogh plans, and they allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2015 is the lesser of 25% of that employee’s compensation or $53,000. These contributions are excluded from the employees’ wages and are not subject to withholding for income tax or FICA. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution, which boils down to the smallest of 20% of the business’ net profit or $53,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).
SEPs are a great option for startups and other small businesses that have unpredictable income and that may be leery of the long-term contribution matches required with other types of retirement plans. SEPs are also a great option for self-employed individuals with no employees, as the contributions are based upon net profits, allowing the business owner to select the maximum percentage while knowing that the required contribution will be small in low-income years.
Except for when employees are covered by collective bargaining agreements, an employer that elects to make a SEP contribution for the year must contribute to an employee’s retirement account if the employee is at least 21 years of age, has worked for the employer in at least three of the prior five calendar years, and has compensation for the year of at least $600.
Another advantage of SEP plans is that contributions are allowed after the account owner has reached the age of 70½—the age limit for traditional, non-SEP IRA contributions. This is true even though individuals must begin the required minimum distributions (RMDs) from the SEP once age 70½ is reached.
As with all traditional IRAs and qualified plans, distributions from a SEP are taxable and subject to a 10% early withdrawal penalty if withdrawn before age 59½.
To set up a SEP plan, you can adopt the IRS model plan by using Form 5305-SEP. This form is completed and retained for your records (not filed with the IRS). You can also open one with a financial institution. It may be prudent to adopt whatever plan is offered by the financial institution you’ll be dealing with to ensure that all plan requirements are met. If using a financial institution’s plan, be sure to discuss the plan’s fees.
A SEP may be the best option for your business’s retirement fund. Please call Dagley & Co. for more information on how a SEP plan might work for your particular business structure or to determine whether other options should be considered.
Image via. public domain
We’ve discussed this subject once before — and yes, we are harping on it because of the profound tax consequences — this is a reminder that, beginning this year, individuals are only allowed one IRA rollover in any 12-month period (this includes SEP and Simple accounts, traditional and Roth IRAs). Twelve months must have elapsed from the date a rollover is completed before another rollover can be made. Failure to abide by this rule can be expensive, and the rule applies no matter how many IRAs an individual owns.
Example – Joe makes an IRA rollover on March 1, 2015. He cannot roll over another IRA distribution, without penalties, until March 2, 2016.
If Joe, in the example, were to make another IRA rollover before March 2, 2016, that entire distribution would be treated as a taxable distribution and would also be subject to the 10% early distribution penalty if Joe is under the age of 59.5 at the time of the distribution. Additionally, if Joe deposited the distributed amount into another IRA, or redeposited the funds into the same IRA, those funds are treated as an excess contribution and are subject to a 6% penalty per year for as long as they remain in the IRA.
That doesn’t mean you can’t transfer funds between IRA trustees multiple times during the year. In a rollover, a taxpayer takes possession of the funds and then must redeposit them within 60 days to avoid being taxed on the distribution. In contrast, a transfer moves the funds directly from one trustee to another with the taxpayer never taking possession of the funds. Unlimited direct transfers are allowed, including moving traditional IRA funds to a Roth IRA (called a conversion).
If, through no fault of yours, a trustee does not follow your instructions to make a transfer and instead distributes the funds to you, procedures are available to obtain relief.
If you are planning an IRA rollover, before taking the distribution, please check with your IRA trustee or get in touch with us at Dagley & Co. to ensure you are not violating the 12-month rule.
Image via public domain
Your golden years come with new #tax rules. If you are turning 70½ this year, you may face a number of special tax issues. Not addressing these issues properly could result in significant penalties and filing hassles.
Traditional IRA Contributions – You cannot make a traditional IRA contribution in the year you reach the age of 70½. Contributions made in the year you turn 70½ (and from then on) are treated as excess contributions and are subject to a nondeductible 6% excise tax penalty for every year in which the excess contribution remains in the account. The penalty, which cannot exceed the value of the IRA account, is calculated on the excess contributed and on any interest it may have earned.
You can avoid the penalty by removing the excess and the interest earned on the excess from the IRA prior to April 15 of the subsequent year and including the interest earned on the excess in your taxable income.
Even though you can no longer make contributions to a traditional IRA in the year you reach age 70½, you can continue to make contributions to a Roth IRA, not to exceed the annual IRA contribution limits, provided you still have earned income, such as wages or self-employment income, at least equal to the amount of the contribution.
If you are married to a non-working or low-earning spouse who has not yet reached age 70½ and you have earned income, your earnings can still be used to qualify your spouse for a contribution to a spousal IRA, even if you are 70½ or older and can’t contribute to your traditional IRA.
Required Minimum Distributions (RMDs) – You must begin taking required minimum distributions from your qualified retirement plans and IRA accounts in the year you turn 70½. The distribution for the year in which you turned 70½ can be delayed to the subsequent year without penalty if the distribution is made by April 1 of the subsequent year. That means two distributions must be made in the subsequent year: the delayed distribution and the distribution for that year. In the following years, your annual RMD must be taken by December 31 of each year.
Still Working Exception – If you participate in a qualified employer plan, generally you need to start taking required minimum distributions (RMDs) by April 1 of the year following the year you turn 70½. This is your required beginning date (RBD) for retirement distributions. However, if your plan includes the “still working exception,” your RBD is postponed to April 1 of the year following the year you retire.
Example: You reached age 70½ in 2015, but chose to continue working and did not retire until June of 2017. Provided your employer’s plan includes the option, you can make the “still working election” and delay your RBD until no later than April 1, 2018.
Caution: This exception does not apply to an employee who owns more than 5% of the company. There is no “still working exception” for IRAs, Simple IRAs, or SEP IRAs.
Excess Accumulation Penalty – When you fail to take an RMD, you are subject to a draconian penalty called the excess accumulation penalty. This penalty is a 50% excise tax of the amount (RMD) that should have been distributed for the year.
Example: Your RMD for the year is $35,000, but you only take $10,000. Your excess accumulation penalty for failing to take the full amount of the distribution for the year would be $12,500 (50% of $25,000).
The IRS will generally waive the penalty for non-willful failures to take your RMD, provided you have a valid excuse and the under-distribution is corrected.
As you can see, turning 70½ can complicate your tax situation. If you need assistance with any of the issues discussed here, or need assistance computing your RMD for the year, please get in touch with us at Dagley & Co. You’ll find our information at the bottom of this page.
We know, we know: Most teenagers and young adults do not consider the long-term benefits of retirement savings. Their priorities for their earnings are more for today than that distant, and rarely considered, retirement. Yet contributions to a retirement plan early in life can enjoy years of growth and provide a substantial nest egg at retirement.
Due to its long-term benefits of tax-free accumulation, a nondeductible Roth IRA may be the best option. During most individuals’ early working years, their income is usually at its lowest, allowing them to qualify for a Roth IRA at a time where the need for a tax deduction offered by other retirement plans is not important.
Because retirement may not be their focus at that age, young adults may balk at having to give up their earnings. Parents, grandparents, or other individuals might consider funding all or part of the child’s Roth contribution. It could even be in the form of a birthday or holiday gift. Take, for example, a 17-year-old who has a summer job and earns $1,500. Although the child is not likely to make the contribution from his or her earnings, a parent could contribute any amount up to $1,500 to a Roth IRA for the child.*
But keep in mind that young adults, like anyone else, must have earned income to establish a Roth IRA. Generally, earned income is income received from working, not through an investment vehicle. It can include income from full-time employment, income from a part-time job while attending school, summer employment, or even babysitting or yard work. The amount that can be contributed annually to an IRA is limited to the lesser of earned income or the current maximum of $5,500.
Parents or other individuals who contribute the funds need to keep in mind that once the funds are in the child’s IRA account, the funds belong to the child. The child will be free to withdraw part or all of the funds at any time. If the child withdraws funds from the Roth IRA, the child will be liable for any early withdrawal tax liability.
Consider what the value of a Roth IRA at age 65 would be for a 17-year-old who has funds contributed to his or her IRA every year through age 26 (a period of 10 years). The table below shows what the value will be at age 65 at various investment rates of return.
Value of a Roth IRA
Annual Contributions of $1,000 for 10 years beginning at age 17
Investment Rate of Return 2% 4% 6% 8% Value at Age 65 $23,703 $55,449 $127,900 $291,401
What may seem insignificant now can mean a lot at retirement. Individuals who are financially able to do so should consider making a gift that will last a lifetime. It could mean a comfortable retirement for your child, grandchild, favorite niece or nephew, or even an unrelated person who deserves the kind gesture.
*Amounts contributed to an IRA on behalf of another person are nondeductible gifts by the donor and are counted toward the donor’s annual $14,000 (2014 and 2015 gift exclusion per done).
If you would like more information about Roth IRAs or gifting contributions to a Roth on behalf of someone else, please contact us at Dagley & Co.
Image via public domain
The IRS allows an individual to take a distribution from his or her IRA account and avoid the tax and early distribution penalties if the distribution is redeposited to an IRA account owned by the taxpayer within 60 days of receiving the distribution.
Early in 2014, in a tax court case, the court ruled that taxpayers could only have one IRA rollover per 12-month period. This was contrary to the IRS’s long-standing one rollover per every IRA account every 12 months. This far more liberal position was also included in published IRS guidance. However, contrary to general public opinion, guidance provided by the IRS in their publications is not citable, carries no weight in audit or court, and only represents the IRS’ interpretation of tax law.
As a result, the IRS has adopted the Court’s more restrictive position, but will not apply the new interpretation until 2015, giving taxpayers time to become aware of the new restrictions. The IRS is modifying its published 2015 guidance to reflect this new position.
The IRS announced in November that the one-per-12-month-period rollover rule also applies to Simplified Employer Pension Plans (SEPs) and SIMPLE plans. Included in the November announcement, the IRS indicated it would not count a distribution taken in 2014 and rolled over in 2015 (within the 60-day limit) as a 2015 rollover.
Not counted towards the one-per-12-month rule are traditional to Roth IRA conversions or trustee-to-trustee IRA transfers where the funds are directly transferred from one IRA trustee to another.
Please get in touch with Dagley & Co. if you are planning an IRA distribution and subsequent rollover and are not positive it falls within the one-per-12-month limit.
Image via public domain