IRA

How Will My IRA Be Taxed?

The most common of IRA tax traps results in tax bills through Unrelated Business Taxable Income (UBTI). The sources of business income from stocks, bonds, and funds like interest income, capital gains, and dividends are exempt from UBTI and the corresponding tax.

Careful consideration of your IRA’s tax treatment is necessary to avoid high taxes.

Fox Business’s recent article, “Your IRA and taxes: Don’t get a surprise tax bill” explains that IRAs that operate a business, have certain types of rental income, or receive income through certain partnerships will be taxed, when the total UBTI exceeds $1,000. This is to prevent tax-exempt entities from gaining an unfair advantage on regularly taxed business entities.

UBIT can take a chunk from an IRA, and the Tax Cuts and Jobs Act of 2017 replaced the tiered corporate tax structure with a flat 21% tax rate. That begins in tax year 2018 (this tax season). These tax bills often have penalties, because IRA owners aren’t even aware that the bill exists.

Master Limited Partnerships (MLPs) held within IRAs are a good example of how UBTI can catch investors by surprise. MLPs are fairly popular investments, but when they’re held within an IRA, they’re subject to UBIT. When the tax is due, the IRA custodian must get a special tax ID number and file Form 990-T to report the income to the IRS. That owner must pay the tax, and is typically unaware of the bill, until it arrives as a completed form to be submitted to the IRS (completed and signed on behalf of the owner). In some instances, the owner may have to pay estimated taxes throughout the year. This can mean a significant underpayment penalty.

Working with prohibited investments will also result in a tax bill. Self-directed IRAs can violate the rules. Alternative investments such as artwork, antiques, and precious metals (with some exceptions) are generally considered as distributions and are subject to taxes.

Prohibited transactions are a step above prohibited investments and can result in the loss of tax-deferred status for the entire IRA. This includes using an IRA as security to obtain a loan, using IRA funds to purchase personal property, or paying yourself an unreasonable compensation for managing your own self-directed IRA. Executing a prohibited transaction can result in the entire IRA being treated as a taxable distribution to you.

Therefore, like fund holdings, and other investments, it’s critical to understand exactly what you own and how to deal with the tax liabilities.

Reference: Fox Business (March 6, 2019) “Your IRA and taxes: Don’t get a surprise tax bill”

What Will The Taxes Be on My IRA Withdrawal?

Sometimes, the amount of taxes owed on your IRA withdrawal will be zero. However, in other cases, you will owe income tax on the money you withdraw and sometimes have to pay an additional penalty, if you withdraw funds before age 59½. After a certain age, you may be required to withdraw money and pay taxes on it.

IRA Withdrawals
Know the rules for IRA Withdrawals

Investopedia’s recent article, “How Much are Taxes on an IRA Withdrawal?” says there are a number of IRA options, but the Roth IRA and the traditional IRA are the most frequently used types. The withdrawal rules for other types of IRAs are similar to the traditional IRA, but with some minor unique differences. The other types of IRAs—the SEP-IRA, Simple IRA, and SARSEP IRA—have different rules about who can start one.

Your investment in a Roth IRA is with money after it’s already been taxed. When you withdraw the money in retirement, you don’t pay tax on the money you withdraw or on any gains you made on your investments. That’s a big benefit. To use this tax-free withdrawal, the money must have been deposited in the IRA and held for at least five years, and you have to be at least 59½ years old.

If you need the money before that, you can take out your contributions without a tax penalty, provided you don’t use any of the investment gains. You should keep track of the money withdrawn prior to age 59½, and tell the trustee to use only contributions, if you’re withdrawing funds early. If you don’t do this, you could be charged the same early withdrawal penalties charged for taking money out of a traditional IRA. For a retired investor who has a 401(k), a little-known technique can allow for a no-strings-attached withdrawal of a Roth IRA at age 55 without the 10% penalty: the Roth IRA is “reverse rolled” into the 401(k) and then withdrawn under the age 55 exception.

Money deposited in a traditional IRA is treated differently, because you deposit pre-tax income. Every dollar you deposit decreases your taxable income by that amount. When you withdraw the money, both the initial investment and the gains it earned are taxed. But if you withdraw money before you reach age 59½, you’ll be assessed a 10% penalty in addition to regular income tax based on your tax bracket. There are some exceptions to this penalty. If you accidentally withdraw investment earnings rather than only contributions from a Roth IRA before you are 59½, you can also owe a 10% penalty. You can, therefore, see how important it is to maintain careful records.

There are some hardship exceptions to penalty charges for withdrawing money from a traditional IRA or the investment portion of a Roth IRA before you hit age 59½. Some of the common exceptions include:

  • A required distribution in a divorce;
  • Qualified education expenses;
  • A qualified first-time home purchase;
  • The total and permanent disability or the death of the IRA owner;
  • Unreimbursed medical expenses; and
  • The call to duty of a military reservist.

Another way to avoid the tax penalty, is if you make an IRA deposit and change your mind by the extended due date of that year’s tax return, you can withdraw it without owing the penalty (but that cash will be included in the year’s taxable income). The other time you risk a tax penalty for early withdrawal, is when you’re rolling over the money from one IRA into another qualified IRA. Work with your IRA trustee to coordinate a trustee-to-trustee rollover. If  you make a mistake, you may end up owing taxes.

With IRA rollovers, you can only do one per year where you physically remove money from an IRA, receive the proceeds and within 60 days subsequently deposit the funds in another IRA. If you do a second, it’s 100% taxable.

You shouldn’t mix Roth IRA funds with the other types of IRAs, because the Roth IRA funds will be taxable.

When you hit 59½, you can withdraw money without a 10% penalty from any type of IRA. If it’s a Roth IRA, you won’t owe any income tax. If it’s not, there will be a tax. If the money is deposited in a traditional IRA, SEP IRA, Simple IRA, or SARSEP IRA, you’ll owe taxes at your current tax rate on the amount you withdraw.

Once you reach age 70½, you will need to take a Required Minimum Distribution (RMD) from a traditional IRA. The IRS has specific rules as to the amount of money you must withdraw each year. If you don’t withdraw the required amount, you could be charged a 50% tax on the amount not distributed as required. You can avoid the RMD completely, if you have a Roth IRA because there aren’t any RMD requirements. However, if money remains after your death, your beneficiaries may have to pay taxes.

The money you deposit in an IRA should be money you plan to use for retirement. However, sometimes there are unexpected circumstances. If you’re considering withdrawing money before retirement, know the rules for IRA penalties, and try to avoid that extra 10% payment to the IRS.

If you think you may need emergency funds before retirement, use a Roth IRA for those funds, and not a traditional IRA.

Reference: Investopedia (February 9, 2019) “How Much are Taxes on an IRA Withdrawal?”

What’s the Difference Between Per Capita And Per Stirpes Beneficiary Designations?

A will covers the distribution of most assets upon your death. However, any assets that require beneficiary designations, like 401(k), IRAs, annuities, or life insurance policies, are distributed according to the designation for that account. A beneficiary designation takes precedence over the instructions in a will or trust.

Benzinga’s recent article addresses this question: “Estate Planning: What Are Per Capita And Per Stirpes Beneficiary Designations?” Have you changed the beneficiary designations, since the account or policy was first started? If you need to update your beneficiary designation, talk to the company responsible for maintaining the account. They’ll send you a form to complete, sign and return. Keep a copy for your own records.

You should also name a contingent beneficiary to receive the account, in case the primary beneficiary passes away before you can update the beneficiary list. Without a listed contingency, your account designation goes to a default, based on the original agreement you signed and the state law.

With per capita distribution, all members of a particular group receive an equal share of the distribution. Within a will or trust, that group can be your children, all your combined descendants, or named individuals. Under per capita, the share of any beneficiary that precedes you in death is shared equally among the remaining beneficiaries. Within a beneficiary designation, per capita typically means an equal distribution among your children.

Per stirpes distribution uses a generational approach. If a named beneficiary precedes you in death, then the benefits would pass on to that person’s children in equal parts. Spouses are generally not part of a per stirpes distribution.

Assume that you had two children. With per stirpes, if one child were to precede you in death, the other child would receive half, and the children of the deceased child would get the other half.

Create a list of all your accounts that have beneficiary designations and keep it with your will. If you don’t have a copy of the latest beneficiary designation form, write down the primary beneficiary, contingent beneficiary, and the date the beneficiary designation was last updated for each one.

Remember, it’s important to keep both your will and all beneficiary designations up to date.

Reference: Benzinga (December 26, 2018) “Estate Planning: What Are Per Capita And Per Stirpes Beneficiary Designations?”

Celebrated Your 50th Birthday? Here’s What You Need to Do Next

The 50s are the time of life when your kids are starting to become more independent and may have moved out. If that’s true, you may have a little more disposable income. That presents a good opportunity to ramp up your retirement savings, advises Sioux City Journal in the article “In Your 50s? Do These 3 Things to Plan for Your Retirement.”

Unfortunately, many people who turn 50 start thinking now is the time to retire early, go on extravagant vacations or buy themselves big ticket items that they’ve always wanted. A better approach: consider this a time to make the most of your income, keep saving for retirement and stay on a steady course.

Use the catch-up options available to you. The federal government knows that many people don’t have the means or the motivation to save for retirement until later in their careers. That’s why there are several provisions in the tax laws that let you catch up, once you reach 50.

  • You can put away an additional $1,000 above the annual contribution limit to an IRA.
  • You can add $6,000 in annual contribution to 401(k)s and similar employer-sponsored plans after age 50.
  • Once you pass your 55th birthday, you can make an additional $1,000 annual contribution to health savings accounts.

If you’ve got the cash to spare, these are great opportunities.

Educate yourself about Social Security. Many people rely on Social Security for their retirement, while others use it as a safety net. You’ll want to start learning about the rules.

When you take your first benefits has an impact on how much you’ll receive over your lifetime. Yes, you can start at age 62, but the difference in the amount you’ll get at 62 versus 70 is substantial. If you plan to keep working indefinitely, maximizing earnings is the best way to boost your Social Security benefits.

Get access to savings in the early years of retirement. If you can afford to retire in your 50s, know when you can tap your retirement savings. If you’ve used regular taxable accounts to invest your savings, it won’t matter when you make withdrawals. However, if your money is locked up in 401(k)s, SEPs, IRAs and other tax favored accounts, you’ll need to know the rules. Penalties for taking withdrawals before the specified age, can take a big bite out of your retirement accounts.

It is hard to think about working every day for another 15 or 20 years, once you’ve celebrated your 50th birthday.  However, keeping these three key ideas in mind as you plan for the future will help put you in the best financial state possible.

Another post-50th birthday task? Meet with an estate planning attorney and make sure you have a will, Power of Attorney and other legal documents to protect yourself and your loved ones in case something unexpected should happen.

Reference: Sioux City Journal (Aug. 25, 2018) “In Your 50s? Do These 3 Things to Plan for Your Retirement”

Can I Trade Options in My Roth IRA?

There are opportunities to trade options using Roth IRAs, but investors must follow many of the same rules that apply to traditional IRAs.

From the time they were introduced, Roth IRAs were quickly adopted by many Americans. The appealing features: you pay taxes on contributions, but generally not on withdrawals, and not on capital gains in the future. It’s a good option for those who expect taxes to be higher after retirement. However, there’s even more that you can do with a Roth IRA.

MP900422543In Investopedia’s article,“Trading Options in Roth IRAs,” the use of options in Roth IRAs and some important considerations for investors are examined. Unlike stocks themselves, options can lose their entire value if the underlying security price doesn’t reach the strike price. This makes them much more risky than the traditional stocks, bonds, or mutual funds that are typically in Roth IRA retirement accounts.

Although risky, there are situations when they might be good for a retirement account. Put options can be used to hedge a long stock position against short-term risks, by locking in the right to sell at a certain price. Covered call option strategies can be used to generate income, if an investor is okay selling her stock.

Many of the riskier strategies in options aren’t permitted in Roth IRAs, because retirement accounts are designed to help individuals save for retirement—not become a tax shelter for risky speculation. Investors should understand these restrictions to avoid issues that could have potentially costly consequences. IRS Publication 590 has several of these prohibited transactions for Roth IRAs. The most important is that funds or assets in a Roth IRA can’t be used as security for a loan. Since it uses account funds or assets as collateral by definition, margin trading usually isn’t allowed in Roth IRAs to comply with the IRS’ tax rules and avoid any penalties.

Roth IRAs also have contribution limits that may prevent the depositing of funds to make up for a margin call, placing more restrictions on the use of margin in these accounts. In addition, the IRS rules imply that many different strategies are off-limits, such as call front spreads, VIX calendar spreads and short combos. These all involve the use of margin.

It’s also important to note that different brokers have different regulations, when it comes to what options trades are permitted in a Roth IRA. The brokers permitting some of these strategies, have restricted margin accounts, where some trades that traditionally require margin are permitted on a limited basis.

A word of caution: these strategies depends on separate approvals for certain types of options trades, and some may not be permitted. Traders need to have substantial knowledge and experience to avoid taking on too much risk. Remember that Roth IRAs were not designed for active trading. An experienced investor may be able to use stock options to hedge their portfolios against losses, or generate income. However, if you are using your Roth IRA funds as a speculative tool, you may want professional input to ensure that you are not creating problems with the IRS, or putting your retirement at risk.

Reference: Investopedia “Trading Options in Roth IRAs”

Do I Have All the Beneficiaries Set Up Correctly on My Assets?

The typical example is an ex-spouse getting all your retirement savings. However, what if you have a child with an opioid addition, you die, and he or she inherits hundreds of thousands of dollars—that vanish in less than a year?

The assets that you own can be passed to your family members in three basic ways: title of ownership is transferred, you name them to inherit assets in your will, or they are the designated beneficiaries named on your various banking and investment accounts and insurance policies.

Many of our assets are transferred through this beneficiary designation, yet we don’t spend enough time tracking and updating these names.

When’s the last time you’ve reviewed your beneficiaries? This question was explored in a recent InsideNoVa article, “Naming Beneficiaries: A Quick Tip to Reduce the Surprise Factor.”

For example, if your checking account is titled in your spouse’s and your name “with rights of survivorship” (WROS), you effectively co-own the account. That one should be all set, at least until the surviving spouse dies.

Your will instructs your executor on the transfer of any assets that aren’t transferred by title or contract. That’s probably at least some of your estate. Therefore, if you don’t have a will, make an appointment with an estate planning attorney to make sure you have this important document.

Next, the beneficiary designation contacts for assets like your retirement accounts, pension plans and insurance policies should be reviewed whenever there’s a major life event, like a birth or adoption of a child, a divorce, or a marriage.

Bigstock-Financial-consultant-presents--14508974Start the process by identifying all the accounts you own, including life insurance policies, annuities, investments, etc. that will pass by beneficiary designation. You should then see who the primary and secondary beneficiaries are for each. You can usually assign percentages to your beneficiaries. Therefore, you could name your spouse as primary beneficiary, 100%. Your children could then be secondary beneficiaries in equal shares.

Some contracts allow you to have your funds be distributed “per stirpes.” In that case, if you name your three children as primary beneficiaries, they each would receive a third. However, if your eldest son dies with you, with per stirpes, his share will go to his children.

In addition, there may be situations when you might designate a trust as a beneficiary. This can get complicated, so work with an experienced trust and estate attorney.

Don’t overlook this detail, as it can have a very big impact, and not always for the good, on your family and loved ones.

Reference: InsideNoVa (October 26, 2018) “Naming Beneficiaries: A Quick Tip to Reduce the Surprise Factor”

More Information Equals A Better Outcome in Retirement Planning

Most people who work for a living dream of retirement. However, for many workers, the idea of retirement comes with its own worries. Will there be enough money? Will I be healthy enough to enjoy it?

Money and health are the two biggest worries about retirement. There are other unknowns: where will we live? How long will we be able to travel? What’s all this about paying estimated taxes, and how does Medicare work? Getting prepared for retirement will be less stressful, says the article “3 Ways to Approach Retirement More Confidently,” from The Motley Fool, if you follow these steps:

MP900398819Start with a budget. The chances are that you don’t know how much money you spend every month. You’re working, money comes in and it goes out. However, if you know how much money you are spending, and what you are spending it on, you’ll be able to have a handle on how much money you’ll need for retirement. You’ll also be able to see where your discretionary dollars are going and make a conscious decision, as to whether those are dollars that should be going into long-term savings for your retirement.

Remember that while some expenses may go down—like commuting—others will stay the same. You won’t be going to the office every day, but you will want to enjoy yourself. What will your leisure and entertainment activities be, and how much will they cost? How will you handle health care costs?  You should also remember that there will be quarterly taxes to be paid.

The more information you can pull together about your spending, savings and unavoidable costs like taxes and health care, the better you’ll be able to plan for this next phase of your life.

How much income will your retirement accounts provide? We tend to focus on how much we need to save, but we should really focus on how much income our retirement savings will generate. How much will your IRA or 401(k) provide on a monthly basis?

Let’s say you’ve saved $500,000 in time for retirement. If you use an annual 4% withdrawal rate, which is the going rule these days, you’ll only have $20,000 a year generated for annual income. If you add Social Security to that amount, you may find that it’s not enough to enjoy the lifestyle you’ve anticipated for retirement. You may find that part-time employment can fill the gap, or you may need to work for a few more years.

Be smart about Social Security. Despite your years of saving, you will likely come to rely on Social Security to pay some of your bills. The smarter you are about your filing strategy, the better positioned you’ll be to maximize your Social Security benefits. If you wait until your Full Retirement Age, you’ll get the full monthly benefit you’re entitled to. If you can hold off claiming your benefits until age 70, you’ll max out as the monthly benefits increase every year you delay claiming.

One of your key resources as you move towards your retirement years will be your estate planning attorney. The process of creating an estate plan will also answer some of your questions about what retirement will bring and planning for aging now will give you a lot more confidence about enjoying your early years of retirement.

Reference:The Motley Fool(September 23, 2018) “3 Ways to Approach Retirement More Confidently.”

Nothing Saved for Retirement? At Least You’re Not Alone

The big picture presented by the National Institute on Retirement Security is not a good one. Working Americans are completely unprepared for retirement.

The National Institute on Retirement Security is a non-profit research and educational organization that focuses on the development of public policies that help retirement security in America. A recent report using U.S. Census Bureau data looked at median retirement account balances for people ages 21 to 64.

MP900404926Think Advisor’s recent article, “Most Americans Have $0 Saved for Retirement: NIRS” says that the report revealed that nearly 60% of all working-age individuals don’t have assets in a retirement account. That’s based on the Census Bureau’s Survey of Income and Program Participation data from the year 2014.

With 59.3% of people not owning a retirement account, a worker in the middle of the overall workforce would have a goose egg in retirement savings. The National Institute on Retirement Security report found that nearly about three-quarters of workers in the 21-to-34 age bracket, over half of those ages 35 to 44, half ages 45 to 54 and also about half in the 55-to-64 age range don’t have a retirement account.

The report included in its definition of retirement accounts employer-sponsored plans like 401(k)s, 403(b)s, 457(b)s, SEP IRAs and Simple IRAs, as well as private retirement accounts—such as traditional and Roth IRAs. In the report’s analysis, an individual was deemed to own a retirement account, if her total retirement account assets were more than zero. There’s a significant gap between older and younger folks in retirement account ownership, and the report found that that this gap is much wider across income groups.

“Individuals with retirement accounts have a higher median income of $51,024, compared to $17,004 among individuals without retirement accounts—three times as large,” the report states.

The research also showed that the median account balances were insufficient, even among individuals withretirement accounts. In fact, for those approaching retirement (age 55 to 64) with retirement accounts, the average balance was $88,000. The report suggested this amount would only provide a “few hundred dollars per month in income if the full account balance is annuitized, or if an individual follows the traditionally recommended strategy of withdrawing 4% of the account balance per year (this amounts to less than $300 per month).”

Digging into the details presents an even more worrisome scenario. A look at working individuals age 21 to 64 who had any retirement savings found that 22% of them had saved less than a year’s income. And among those closest to retirement—ages 55 to 64—only 17% of those who had retirement savings had a year’s worth of income.

Regardless of your age, anyone who is working should be saving something for retirement, even if it is a small amount from every paycheck. The younger you are, the more important it is to start early. For older Americans, the savings target is far more daunting, but saving something is still better than nothing.

Reference: Think Advisor (September 18, 2018) “Most Americans Have $0 Saved for Retirement: NIRS”

How Does Rolling a 401(k) into an IRA Fit into My Retirement Plan?

Whether or not to roll a 401(k) into an IRA when you are changing jobs or retiring early, does not have a simple yes/no answer. There are a number of factors to consider.

If your retirement plan includes retiring before you reach age 59 ½, you may not want to move your 401(k) into an IRA at all. It may be better to move it into your current employer’s 401(k) plan. Moving those funds into an IRA, may limit your withdrawal options in retirement, says Forbes in the article, “Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”

MP900409252There’s a 10% penalty to withdraw funds from your traditional IRA before 59½, unless you qualify for an exception. However, many people don't know that the IRS lets employees who retire or otherwise leave a company at age 55 or older, to withdraw from their employer's plan without a penalty. Therefore, if you retire at age 55 and roll over your 401(k) to an IRA, you'll have to wait 4½years longer to withdraw your funds without a penalty.

At any age, there will be income taxes to pay on withdrawals. If you have a traditional 401(k), you got a tax break when you invested. Your funds then grew tax-deferred all those years. The IRS now wants to tax your money. When you withdraw from your traditional 401(k), your funds will be taxed at ordinary income tax rates.

There are also some side benefits to staying with a 401(k), instead of opening up a rollover IRA. First, it simplifies your investments. If you roll your 401(k) to your current firm when you switch jobs, you know exactly what your funds are invested in and can check the balance all in one place. It could also protect you from legal judgments. Keeping retirement funds in a company plan, instead of an IRA, will keep it safe.

You should discuss your asset protection strategy with your estate planning attorney.

Remember, not everyone qualifies to invest in a Roth. However, it is possible to contribute to a Roth IRA in a roundabout way, called a "backdoor” Roth IRA. It is complicated and you will need to talk to your tax advisor. Basically, you can open a non-deductible IRA and contribute to it, up to the maximum of $5,500 (or $6,500 if you are over age 50), then immediately convert it to a Roth IRA. Because you haven’t earned any interest, you don’t have any taxes to pay on the conversion.  Now you have a Roth IRA!

However, if you own any other traditional IRAs, you may have to pay pro-rata taxes on the conversion. If you want to try a backdoor Roth IRA, transferring your old 401(k) to your new employer’s plan may be the best way to go.

Speak with an experienced estate planning attorney to ensure that you don’t run afoul of any IRS rules on retirement accounts, if you intend to retire early. Making an expensive mistake could undo your early retirement.

Reference: Forbes (August 31, 2018)“Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”

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