- Contribute to your retirement accounts.
If you work for a company that matches your 401(k) contribution, try to contribute at least up to the percentage they match. Otherwise, you’re leaving money on the table.
- Make your required minimum withdrawal from your IRA.
Do you have a traditional IRA? Starting at 70 ½, the IRS requires you to withdraw a certain amount each year, known as a required minimum distribution (RMD).
- Use up your flexible spending account (FSA).
Find out the deadline for using this money if you have an FSA, since you will lose it if you don’t use it by the deadline.
- Think through your holiday spending.
Now is the time to also think about paying down any debt or padding your emergency fund.
- Check your credit reports.
If you haven’t checked your credit reports in the last 12 months, the end of the year is a great time to do so.
- Consider year‑end charitable giving.
In addition to using your dollars to support a cause you are passionate about; many charitable contributions of money or property are also tax deductible.
- Assess the last 12 months.
Reflect on how you did this year from a financial standpoint. Think about what went right and what would you like to adjust.
- Plan for the next 12 months.
If your assessment of the past year calls for some changes, use that information to start planning for the new year.
Take these eight steps now:
These 5 Internal Revenue Tax Code sections put the power of life insurance to work helping you reach your financial goals:
Keep reading to see more detailed discussions of these 5 Internal Revenue Tax Codes and their applications in Life Insurance Products.
1. Early withdrawal penalties
If you are age 55 or older with a 401(k) plan, you may leave your job and take money out of the 401(k) plan without the 10% penalty. You will still pay tax, but no 10% penalty. However, if you take a 401(k) plan and roll it over to an IRA, you will lose that age 55 exception; you’ll have to wait until age 59½ before you can avoid the 10% penalty unless you meet one of the other exceptions.
2. Taking your first RMD
If you have a traditional IRA, you have to remember that you will be subject to those required minimum distributions (RMDs). These begin during the calendar year in which you become 70½ years old. RMDs do not apply to Roth IRAs.
Q. If I work in state A but live in state B, which state should I pay income tax?
A. States generally tax the income of nonresidents who generate income in that state. Income subject to tax can include:
The map below shows income tax rates by different states in U.S.
What’s a QLAC?
It’s a special type of deferred income annuity (DIA). A DIA provides protected lifetime income starting in the future. A QLAC allows income from a traditional IRA to be deferred from taxation beyond age 70½ without running afoul of the RMD rules.
How does QLAC work?
A DIA, including a QLAC, works much like a qualified SPIA (single premium immediate annuity) — except that the payments do not begin for at least 13 months and may be deferred up to age 85. The income date is selected at issue. Income payments will be made provided the annuitant is alive at the income start date. (If no annuitant survives, no income payments will be made, and no other benefits provided, unless the owner has elected a return of premium (ROP) death benefit.) Funds in an IRA can be transferred tax-free to the insurance carrier for the purchase of a QLAC.
The account value of the QLAC is disregarded for purposes of calculating the client’s RMDs. A QLAC has to meet many requirements, but it can help address longevity risk by reducing the probability of outliving savings by providing an income stream in the later stages of retirement.
How long can income payments – and thus RMDs – be delayed?
Distributions must begin no later than the first day of the month following the annuitant’s 85th birthday. The longer the deferral period, the larger the income payout amount.
Can I access the funds?
No. A QLAC does not have any cash surrender value or commutation benefit. QLACs may allow limited changes to the income date and payment frequency.
What IRS reporting applies to QLACs?
Insurance carriers will report to purchasers and the IRS using Form 1098-Q, Qualifying Longevity Annuity Information. Form 1098-Q must be furnished to individuals by January 31 of the year following the first year of purchase and every following year while the QLAC is in existence.
How much can be contributed?
Contributions to a QLAC are limited to the lesser of either $130,000 (subject to annual cost-of-living adjustment) or 25% of qualified funds, less premiums for other QLACs.
The dollar limit – $130,000, as indexed for 2019 – applies across all qualified funds. The 25% limit applies to each qualified plan separately based on its most recent valuation date. It applies to IRAs on an aggregate basis as of the prior December 31. Roth IRAs and Inherited IRAs are excluded.
Example: Jesse had $260,000 in his 401(k) as of the latest valuation date and had $260,000 in his traditional IRA as of the prior December 31. He can only use 25% of his IRA or $65,000 to purchase a QLAC. If his 401(k) plan allowed for the purchase of a QLAC, he could purchase a QLAC for 25% of his 401(k) or $65,000. Many defined contribution plans do not yet provide for the purchase of QLACs. Thus, Jesse would need to have at least $520,000 in his IRA as of the prior December 31 if he wanted to purchase the maximum QLAC for $130,000. If Jesse elected to roll over any amounts from his 401(k) plan into his IRA, he would need to wait until the following year to purchase a QLAC with those rolled over funds. Remember, the 25% limit is applied to the fair market value of the IRA as of the prior December 31.
What happens if the contribution limit is exceeded?
Any excess premium must be returned by the end of the calendar year following the calendar year in which the excess premium was paid to avoid jeopardizing the contract’s QLAC status. If not returned in a timely manner, the annuity then fails to be a QLAC beginning on the date that the premium payment was made. The value of the annuity contract thereafter cannot be disregarded for purposes of calculating RMDs. It is the client’s responsibility to comply with the contribution limit. Clients should consult with their own tax and legal advisors before purchasing a QLAC.
Can additional premiums be added as the account value increases and/or the indexed limit increases?
More premium may be added to flexible premium QLACs to take advantage of any unused portion of the then-current contribution limit. What if part of the IRA has already been used to purchase a qualified SPIA? Is that value included in determining the fair market value of the IRA? The fair market value of any IRA SPIAs should be included in determining the account value of all aggregated IRAs (except Roth and Inherited) as of the prior December 31 for purposes of calculating the 25% limitation for QLAC contributions. Insurance carriers annually send clients a fair market valuation letter for IRA SPIAs.
What are the QLAC payment options?
Options are limited to single or joint life only and single or joint life with cash refund. Payments, once begun, must satisfy RMD rules.
What happens if the last annuitant dies during the deferral period?
If the ROP death benefit option was not selected and no annuitant survives, no income payments will be made and no other benefits provided.
If the last annuitant dies during the deferral period, can the ROP death benefit be directly rolled over or transferred to an IRA?
It depends. If the annuitant dies after their required beginning date (RBD), the ROP payment is treated as an RMD and cannot be rolled over. Likewise, if the surviving joint annuitant dies after their RBD, the ROP payment will be an RMD and not eligible for rollover. If the annuitant or survivor annuitant dies before their RBD, however, the ROP payment may be rolled over.
In last blogpost, we wrapped up introducing the 6 deductions available. The $12,000/$24,000 standard deduction hurdle — for individuals and married filing jointly, respectively, increasing to $12,200 and $24,400 in 2019 — presents a significant challenge to itemize deductions because only a few deductions in practice are capable of sustaining such a large deduction annually on an ongoing basis.Accordingly, the so-called big six itemized deductions that can actually sustain ongoing itemized deductions include:
1. Big mortgages:
Homeowners with a sizable mortgage used to acquire, build or substantially improve their primary residence or a second home can generate enough in ongoing interest deductions to exceed the standard deduction thresholds.
Notably though, in an environment where mortgage interest rates have long hovered around 4%, it still takes a very sizable mortgage balance to actually generate enough interest to trigger itemized deductions, especially since it’s only the interest portion of the mortgage payment, not the entire mortgage payment, that is deductible. For an individual, generating a $12,000 mortgage interest deduction at 4% would require at least a $300,000 mortgage; for a married couple the trigger is a $600,000-plus mortgage.
2. Big, ongoing charitable deductions:
For higher income individuals it’s not uncommon for annual charitable giving to top the $12,000/$24,000 standard deduction thresholds. And at higher income levels the charitable deduction AGI thresholds are not an impediment to exceeding these targets. Of course, giving away money just to get a tax deduction isn’t necessarily a net positive, as the household still gives more away than it receives back in tax benefits. Still, for those who already engage in sizable, ongoing charitable giving, sustained charitable giving alone can support ongoing itemized deductions.
3. Big SALT deductions:
One of the unique peculiarities of the current tax planning environment is that when TCJA imposed a maximum cap on SALT deductions, it imposed the same cap of $10,000 for both individuals and married couples. This is significant because the standard deduction threshold for individuals is only $12,000, while it is $24,000 for married couples.
This means maxing out the $10,000 SALT deduction is at best only part of the way to the $24,000 threshold for married couples, but gets an individual almost all the way to their $12,000 threshold. Still, it takes a sizable income with the associated tax deductions or a big home with substantial property taxes to reach the individual threshold. Assuming an average state income tax rate of 5% and a 1% property tax rate, reaching the SALT cap still typically requires around a $100,000-plus annual income and a $500,000-plus property, or for those who rent, a $200,000-plus annual income.
4. Big margin investing:
While mortgage deductions are limited as to the amount of debt principal on which interest can be deducted, investment interest is limited only by the amount of interest and dividends generated by the investments themselves and that the interest be taxable — i.e., no investment interest deductions for municipal bonds.
As with the mortgage interest deduction though, generating sufficient interest requires a substantial amount of debt principal. On the other hand, since margin interest rates tend to be higher — currently averaging around 8% — it doesn’t take quite as much debt principal, potentially just on the order of $150,000 for individuals or $300,000 for married couples.
5. Big long-term care events:
Most medical events are covered by health insurance, and while individuals may still have to pay a non-trivial deductible, coverage is usually sufficient to prevent medical expenses alone from triggering the $12,000/$24,000 thresholds, particularly on an ongoing basis.
However, long-term care insurance is adopted far less often than health insurance, and tends to have much larger annual expenditures, whereas semi-private care alone averages $225 per day or over $80,000 per year. Those who have an ongoing long-term care event consequently often trigger more than enough in annual medical expenses — over and above the 10%-of-AGI threshold — to trigger ongoing itemized deductions.
6. Big, IRD-eligible stretch IRAs:
One of the largest and most commonly overlooked itemized deductions is the Income in Respect of a Decedent, or IRD, deduction, which provides beneficiaries of inherited retirement accounts and other inherited pre-tax assets an income tax deduction for any Federal estate taxes that were caused by that IRD asset.
This means the IRD deduction is only available to those who inherit a pre-tax asset like an IRA from someone who actually paid a Federal estate tax — which isn’t many, given the sizable Federal estate tax exemption. Nonetheless, with a top Federal estate tax rate of 40%, those for whom the IRD deduction is available effectively receive an itemized deduction for 40% of their inherited IRA withdrawals.
This in turn means inheriting a big IRA from a big estate can trigger a big IRD deduction and, therefore, ongoing itemized deductions. It will still take an IRA of $1 million or more for an individual, or of $2 million or more for a married couple to generate enough in IRD deductions to claim ongoing sustained itemized deductions — assuming the stretch IRA faces an annual RMD of only about 3% per year.
In last blogpost, we showed you 3 deduction areas to consider, now the next 3 areas.
4. Charitable giving:
Under IRC Section 170, taxpayers are allowed to deduct charitable contributions made in the current tax year, whether donated in cash or as in-kind property. However, charitable deductions are subject to a number of limitations on the maximum amount that can be deducted relative to total AGI, depending on the type of receiving charity and the nature of the property being donated.
5. Casualty and theft losses:
Akin to allowing tax deductions for interest paid to generate income, IRC Section 165 also allows a tax deduction for losses incurred in income-producing activities — i.e., a trade or business. Personal losses are much more restricted, though they may still be available in the event of a loss due to “firm, storm, shipwreck, or other casualty, or from theft.”
Such personal casualty losses are subject to additional limitations though, including that only losses above $100 for each incident are deductible; total casualty and theft losses must exceed 10% of AGI; and, from 2018 through 2025, IRC Section 165(h)(5) limits such losses to only those that were attributable to a federally declared disaster.
6. Miscellaneous deductions:
While the tax legislation eliminated the category of “miscellaneous itemized deductions [subject to the 2%-of-AGI floor]” under IRC Section 67, there are still several other miscellaneous deductions that don’t fall into the preceding categories, but are still tax deductible because of their own separate standalone sections of the tax code to authorize them as deductions.
This includes gambling losses to the extent of gambling winnings; Ponzi scheme losses and other similar casualty/theft losses of income-producing property; income with respect to a decedent deduction for pre-tax assets inherited from someone who paid estate taxes; investment-related deductions for amortizable bond premiums and certain losses on contingent-payment or inflation-indexed debt instruments, e.g., TIPS; the unrecovered portion of basis in a pension or lifetime annuity that isn’t recovered when payments cease, e.g., due to death before life expectancy; and certain types of qualified disaster losses.
In our next blospost, we will discuss the significance of the big six itemized deductions that can actually sustain ongoing itemized deductions.
In last blogpost, we showed you 6 core types of deductions still available, now we will discuss each of them in details.
1. Medical expenses:
IRC Section 213 allows for the deduction of a wide range of medical expenses, including payments for medical and dental care, health insurance premiums and even a portion of long-term care insurance premiums. However, medical expenses are only deductible to the extent they exceed 10% of AGI in 2019, up from a 7.5%-of-AGI threshold in 2018.
2. Taxes paid to other governmental entities:
IRC Section 164 allows taxpayers to deduct for Federal tax purposes any taxes that were paid to other governmental entities, effectively ensuring that the individual doesn’t have to pay Federal taxes on the money they used to pay other taxes.
In practice, the deduction for taxes paid applies broadly to real estate, personal property and income taxes, whether paid to a state or local municipality, or even to a foreign government. That said, under the tax legislation and IRC Section 164(b)(6)(A), foreign real estate taxes are not deductible. However, the taxes-paid SALT deduction is limited under IRC Section 164(b)(6)(B) from 2018 through 2025 to only a $10,000 maximum deduction — and it’s the same $10,000, whether individual or married filing jointly.
3. Interest paid:
Under the general principle that borrowing money to make money should be treated as a cost of generating income — i.e., a deductible expense/cost of producing that income — IRC Section 163 allows a deduction for at least some types of interest paid. This includes not only interest paid for investment purposes — albeit limited the total amount of investment income generated from taxable interest and dividends in the first place — but also for mortgage interest paid on up to $750,000 of debt principal used to acquire, build or substantially improve a primary residence or designated second home, and even mortgage points that were paid out of pocket and not themselves financed.
We will discuss the next 3 deduction areas in next blogpost.
The tax reform passed in 2017 led to significant increase in the threshold to itemize, it also,reduced the number and size of available itemized deductions, including placing a $10,000 cap on state and local tax, or SALT, deductions; a reduction in the maximum debt balance eligible for mortgage interest deductions to just $750,000 of debt principal; an elimination of the deduction of interest on home equity indebtedness; the limitation of casualty and theft losses to just those in a federally declared disaster area; and the repeal of the entire category of “miscellaneous itemized deductions subject to the 2%-of-AGI floor,” which included unreimbursed employer business expenses, variable annuity losses, tax preparation fees and, notably, the deductibility of an investment advisor’s own fees.
IRS data showed in the past that approximately 30% of households were able to itemize deductions rather than claiming the standard deduction, but the Tax Policy Center estimates only about 10% of households will be able to itemize deductions going forward.
However, there are still 6 core types of deductions you could consider, as shown in the highlighted areas below.
We will discuss each of the 6 core types of deductions in next blogpost.
If you own a business and have kids, you need to take full advantage of the tax savings from hiring your kids, especially if you are to give them allowance anyway!
This article from Financial-Planning online magazine has a great and very detailed discussion about the tax advantages of hiring your kids, definitely worth a read!
Q. What if I wait a year to cash a retirement plan distribution check? Do I owe tax in previous year or the year the check was cashed?
A. IRS' ruling (2019-19) was addressed primarily to the plan administrators for company retirement plans who wanted clarification on when uncashed checks should be considered distributions.
The IRS ruled that a payment from a 401(a) tax-qualified retirement plan was taxable in the year distributed — even though the recipient failed to cash the check. The ruling does not indicate whether the same holding would apply if the check were actually received in a subsequent year. The IRS also did not say whether the ruling is limited to 401(a) plan distributions or whether it also applies to IRA distributions.
The IRS also ruled that the plan administrator’s obligations for withholding and reporting arose in the year of distribution, and those obligations were not altered by the recipient’s failure to cash the check during that year.
Q. What is the tax-smart strategy to withdraw money from retirement accounts?
A. The conventional strategy is to withdraw money from your taxable accounts first (as they are usually taxed at long term capital gain tax rates), then tax-deferred accounts such as traditional IRAs and 401k (this will be subject to income tax rates), and finally Roth IRA (so the tax-free money has more time to grow).
However, if the bulk of your assets are in 401k or traditional IRA accounts, since these accounts face RMD requirements from IRS and a large withdrawal after age 70.5 could bump you into much higher tax brackets, you need to start reducing future RMDs by withdrawing money out of those accounts while still in lower tax brackets. If you don't need such money, you can convert them into Roth IRA.
In last blogpost, we discussed stealth-type tax increases result from the increase in adjusted gross income from a Roth IRA conversion. Now we will show some examples.
Roth IRA conversion income is ordinary income and is taxed the same as wages, pensions and other IRA distributions and short-term capital gains.
A married couple filing jointly has no income other than a $100,000 LTCG. In 2019, they will owe zero tax. The LTCG of $100,000 is first reduced by the standard deduction (assuming both spouses are under age 65) of $24,400, resulting in a net LTCG of $75,600, which is under the $78,750 limit for the 0% rate, so no tax will be owed.
Now let’s add a $50,000 Roth conversion. That will increase the tax on the LTCG from zero dollars to $7,028. The tax on the Roth conversion is only $2,684, but the total tax bill will be $9,712.
The $50,000 Roth conversion (or any other additional ordinary income) will get taxed first using the ordinary income tax brackets. The $50,000 Roth conversion (assuming this is the only other income) will be first reduced by the 2019 standard deduction of $24,400, leaving taxable ordinary income of $25,600, and that amount reduces the 0% capital gains bracket available for the $100,000 LTCG.
The $25,600 is taxed using the regular tax brackets, so that tax is $2,684. Here's the math if you'd like to follow along:
$19,400 at 10% = $1,940
$6,200 at 12% = $744
The $100,000 LTCG tax now goes from zero to $7,028. That’s a substantial — and often unexpected — increase.
The benefit of the zero to $78,750 LTCG bracket is reduced by $25,600, which was taxed at ordinary income tax rates, so only $53,150 is being taxed at 0% (the $78,750 less the $25,600 = $53,150). The remaining $46,850 of the $100,000 LTCG is now being pushed into the 15% LTCG bracket and the tax on that $46,850 x15% = $7,028.
$53,150 at 0% = $0
$46,850 at 15% = $7,028
Bottom line: In this simple example, the $50,000 Roth conversion was not only subject to its own ordinary income tax of $2,684, but also triggered a $7,028 tax on the LTCG that, without the Roth conversion, would have incurred zero tax.
Now let’s say we change the example by adding a Roth conversion of $120,000 to the LTCG of $100,000. The $120,000 Roth conversion eliminates the entire benefit of the 0% LTCG bracket, triggering a LTCG tax of $15,000 — all at 15%, and none at 0% on a LTCG that, without the Roth conversion, would have incurred zero tax. In addition, there will be a tax of $12,749 on the Roth conversion, for a total tax bill of $27,749.
In last blogpost, we discussed Roth Conversion could significantly affect tax on LTCGs. Now we will discuss some other stealth taxes triggered when income is increased by actions like a Roth conversion.
Stealth taxes are other indirect tax increases that occur when income is increased. If not addressed, one may see a higher tax bill than was planned. That won't go over well at tax time next year.
Some of these stealth-type tax increases result from the increase in adjusted gross income (AGI) from a Roth IRA conversion. AGI is a key amount on the tax return and an increase can cause the loss of valuable tax deductions, credits and other benefits.
Some of these well-known items include:
These very favorable LTCG rates generally apply to capital assets held for more than one year. The rates have been made more attractive by the tax law change. For example, the rate is 0% for capital gains of up to $78,750 in 2019 for a married couple filing jointly. But a Roth conversion can reduce or even eliminate the benefits of the lower capital gains rates. This is something that is not widely noticed until it is seen on the completed tax return, which, of course, is too late. Capital gains should be added to the list of stealth taxes to be considered when projecting the true overall tax cost of a Roth conversion.
In next blogpost, we will show some examples how if Roth IRA conversion not carefully planned could drive up taxes.
Q. Can a Roth conversion affect the taxation of long-term capital gains?
A. Yes, and could be significantly if you are not careful!
That’s because Roth conversion income, like all other ordinary income, reduces the benefit of the LTCG rates, increasing the overall tax cost of the conversion. This interplay can easily throw off even the best tax projections, especially when they rely on the low (or even 0%) LTCG rates stated in the Tax Code. When there is additional ordinary income, like Roth conversion income, those favorable tax brackets are not as attractive as they appear to be.
What's worse, Roth conversions cannot be undone anymore — the tax law changes eliminated recharacterization of Roth IRA conversions beginning in 2018 — one should be careful to do an accurate projection of the tax effect of a Roth conversion. But the permanency of a Roth conversion does not mean it should be avoided. Roth IRAs still offer long-term tax benefits — mainly tax-free growth and no lifetime required minimum distributions for Roth IRA owners, allowing more tax-free accumulation and a hedge against future tax increases.
In fact, if IRA funds are not converted, eventually those IRA funds will be subject to RMDs and those RMDs will similarly cause an increase in capital gains taxes — and at possibly higher future tax rates. That’s why Roth conversions should still be seriously considered while today’s tax rates are at historic lows. However, the tax cost of the conversion needs to be more accurately projected since the tax due cannot be reversed.
In next blogpost, we will discuss some other so-called stealth taxes triggered when income is increased by actions such as a Roth conversion.
Q. If I convert a traditional IRA to a Roth, how long do I have to wait to take penalty-free withdrawals?
A. You have to wait 5 years from the start of the tax year in which you made the conversion. That means if you convert a regular IRA to a Roth IRA in January 2020, you must wait until January 2025 to avoid penalties. But depending on when you convert your account, you may not need to wait a full 60 months.
For example, if you convert an account in December 2020, you will still need to wait until January 2025, which means your countdown will have 11 fewer months.
We’re roughly halfway through 2019, which means the 2020 tax season will soon be upon us. But rather than wait until next March or April to think about tax returns, here are top 5 common 2020 tax problems to consider:
1. The individual mandate penalty
Almost all of the Tax Code changes stemming from the Tax Cuts and Jobs Act went into effect during 2018. However, a few didn’t become active until this year. The change to the shared responsibility payment is one of these.
The shared responsibility payment, which is commonly referred to as the individual mandate penalty, was previously introduced under the Affordable Care Act. It essentially required people to have some form of health insurance (Obamacare, private or otherwise). If a taxpayer couldn’t prove they had health insurance, they owed a penalty with their taxes.
Starting with the 2020 tax season (fiscal year 2019), there’s no longer a federal penalty. However — and this is where the confusion exists — there are still some state-based penalties. For example, New Jersey, Massachusetts and Washington, D.C., all still have some form of penalty in place. Taxpayers will need to be cautious in this regard and do their research.
2. Changes to HSA contribution limits
In addition to increasing the amount of money taxpayers can contribute to qualifying retirement plans, health savings accounts are also getting a tiny boost this year. For those with high-deductible policies that qualify under HSA guidelines, the changes are as follows:
Again, these slight adjustments won’t make anyone rich, but they are worth noting and could cause some confusion come April 2020.
3 The medical expense deduction threshold
There’s been a lot of back and forth regarding the threshold for deductible medical and dental expenses over the past decade. In 2010, the Affordable Care Act raised the number from 7.5 percent to 10 percent of adjusted gross income. This made it a lot more difficult for people to qualify.
Then came the Tax Cuts and Jobs Act, which brought the threshold back down to 7.5 percent in 2017 and 2018. Unfortunately, it’s returning to 10 percent this year.
What does all of this mean? Basically, if a taxpayer plans on itemizing in 2019, their unreimbursed medical and dental expenses need to exceed 10 percent of their adjusted gross income in order to qualify as a deduction.
4. Failure to report all income
Reporting income used to be a pretty straightforward process. Most people were either W-2 employees or self-employed with one or two 1099s. But as the gig economy has expanded, more and more taxpayers have three, four or five different streams of taxable income that nobody else is reporting. Expect to see less-organized taxpayers fail to report all of their income in 2020. Some of this will go undetected, while others will get slapped with penalties.
5. Underpaying estimated tax payments
Making quarterly estimated tax payments on time is only half the battle. For inexperienced freelancers, underestimating the amount of taxes they owe is another huge problem.
As the name suggests, quarterly tax payments are estimates of what a taxpayer thinks they’ll earn over the course of a given year. In order to accurately estimate their tax burden, they must keep meticulous records and run calculations to generate a ballpark estimate. It’s OK if they slightly underpay, but it’s much better if they slightly overpay. This ensures they end up getting a small amount of money back in April (as opposed to forking over even more money).
While every taxpayer has different earnings and deductions, it’s a good rule of thumb for most taxpayers to set aside somewhere between 22 and 25 percent of every payment into a savings account that’s explicitly reserved for making payments throughout the year.
As the chart below shows, life insurance products are a good way to prefund your retirement taxes today!
We discussed strategy 2 here, now strategy 3.
Strategy No. 3: Maximize the survivor benefit
Maximize Social Security—for you and your spouse—by claiming later.
How it works: When you die, your spouse is eligible to receive your monthly Social Security payment as a survivor benefit, if it's higher than their own monthly amount. But if you start taking Social Security before your full retirement age (FRA), you are permanently limiting your partner's survivor benefits. Many people overlook this when they decide to start collecting Social Security at age 62. If you delay your claim until your full retirement age—which ranges from 66 to 67, depending on when you were born—or even longer, until you are age 70, your monthly benefit will grow and, in turn, so will your surviving spouse's benefit after your death.
Who it may benefit: This strategy is most useful if your monthly Social Security benefit is higher than your spouse's, and if your spouse is in good health and expects to outlive you.
Example: Consider a hypothetical couple who are both about to turn age 62. Aaron is eligible to receive $2,000 a month from Social Security when he reaches his FRA of 66 years and 6 months. He believes he has average longevity for a man his age, which means he could live to age 85. His wife, Elaine, will get $1,000 at her FRA of 66 years and 6 months and, based on her health and family history, anticipates living to an above-average age of 94.
The couple was planning to retire at 62, when he would get $1,450 a month, and she would get $725 from Social Security. Because they’re claiming early, their monthly benefits are 27.5% lower than they would be at their FRA. Aaron also realizes taking payments at age 62 would reduce his wife's benefits during the 9 years they expect her to outlive him.
We shared strategy 1 here, now strategy 2.
Strategy No. 2: Claim early due to health concerns
A couple with shorter life expectancies may want to claim earlier.
How it works: Benefits are available at age 62, and full retirement age (FRA) is based on your birth year.
Who it may benefit: Couples planning on a shorter retirement period may want to consider claiming earlier. Generally, one member of a couple would need to live into their late 80s for the increased benefits from deferral to offset the benefits sacrificed from age 62 to 70. While a couple at age 65 can expect one spouse to live to be 85, on average, couples who cannot afford to wait or who have reasons to plan for a shorter retirement, may want to claim early.
Example: Carter is age 64 and expects to live to 78. He earns $70,000 per year. Caroline is 62 and expects to live until age 76. She earns $80,000 a year.
By claiming at their current age, Carter and Caroline are able to maximize their lifetime benefits. Compared with deferring until age 70, taking benefits at their current age, respectively, would yield an additional $113,000 in benefits—an increase of nearly 22%.
Read strategy 3 here.
Strategy No. 1: Maximize lifetime benefits
A couple with similar incomes and ages and long life expectancies may maximize lifetime benefits if both delay.
How it works: The basic principle is that the longer you defer your benefits, the larger the monthly benefits grow. Each year you delay Social Security from age 62 to 70 could increase your benefit by up to 8%.
Who it may benefit: This strategy works best for couples with normal to high life expectancies with similar earnings, who are planning to work until age 70 or have sufficient savings to provide any needed income during the deferral period.
Example: Willard's life expectancy is 88, and his income is $75,000. Helena's life expectancy is 90, and her income is $70,000. They enjoy working.
Suppose Willard and Helena both claim at age 62. As a couple, they would receive a lifetime benefit of $1,100,000. But if they live to be ages 88 and 90, respectively, deferring to age 70 would mean about $250,000 in additional benefits.
See Strategy 2 here.
Q. Are ETFs more tax efficient than mutual funds?
A. The answer is yes, but not for the reason you might think.
A recent Morningstar research paper “Measuring ETFs’ Tax Efficiency Versus Mutual Funds“ finds that the overwhelming majority of ETFs (84%) track market-cap-weighted indexes, which means there’s relatively little turnover in the fund to trigger tax events in the first place, with a median turnover rate of just 17% (compared to 48% for the average active mutual fund).
However, non-cap-weighted strategic beta ETFs have a turnover rate of 47%, very similar to active mutual funds, while cap-weighted index mutual funds have a turnover rate of only 19% (similar to ETF index funds), which means in practice the turnover factor is less a function of ETFs in particular, and just that the majority of ETFs invest in a different (cap-weighted indexing) strategy than most mutual funds (which are still more actively managed).
The real driver of ETF tax efficiency is the structure by which it adds and removes securities held by the ETF, and the ability to “purge” low-cost-basis securities in-kind as part of the creation/redemption process for ETFs (thus why ETFs have a slightly more favorable tax profile than mutual funds even when tracking the same index, and why mutual funds are more prone to tax events when facing net outflows as compared to ETFs). However, it’s important to recognize that ETFs are not immune to tax events, not only because they still distribute any interest and dividends, but because ETFs can still face capital gains distributions (albeit not common).
Q. I want to use my IRA distribution as a short-term loan, then pay it back within 60 days. Is there anything I could do if I missed the 60-day deadline?
A. There are three solutions: an automatic hardship waiver, a PLR, and self-certification.
1) Automatic Hardship WaiverThe automatic hardship waiver is a free way to immediately salvage a late rollover. Note that there is a strict deadline for this fix. Under Rev. Proc. 2003-16, an automatic waiver is granted when the following two conditions are BOTH met:
(1) The funds are deposited into an eligible retirement plan within one year from the date the distribution was received.
(2) The rollover would have been a valid rollover if the financial institution had deposited the funds as instructed.
A PLR is a written statement issued to a taxpayer in which the IRS applies tax laws to a particular set of facts represented by the taxpayer. In Rev. Proc. 2003-16, the IRS allowed taxpayers to apply for a waiver of the 60-day rule by requesting a PLR, and hundreds of taxpayers have taken advantage of that opportunity.
But PLR requests are expensive — the IRS user fee is $10,000 and professional fees can add thousands of dollars more. They are also slow — a ruling can take as long as nine months. Even then, there is no guarantee of success. For example, the IRS will typically not issue a PLR for a late rollover if the taxpayer uses the IRS funds as a “60-day loan.” This may explain why Burack did not request a PLR.
If you missed the 60-day rollover deadline, you can obtain relief through self-certification under Rev. Proc. 2016-47 — a cheaper and faster alternative to a PLR. An individual can use self-certification only if the late rollover was for one or more of the 11 reasons specified in the Revenue Procedure.
The most important thing is this: Using a direct transfer instead of a 60-day rollover so you don't have to worry about complying with all of the strict IRS rules or about fixing the rollover if those rules aren’t complied with.
In our last blogpost, we discussed how to qualify for NUA treatment.
Now we will discuss when to use NUA treatment.
You should consider the following factors as you decide whether to roll all your assets into an IRA or to transfer company stock separately into a taxable account:
Please consult your tax advisor for more details, this blog series is for information only.
PFwise's goal is to help ordinary people make wise personal finance decisions.