Roth IRA

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 You should keep track of the money withdrawn prior to age 59½, and tell the trustee to use only contributions, if you’re withdrawing funds early.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withdrawal of a Roth IRA at age 55 without the 10% penalty: the Roth IRA is “reverse rolled” into the 401(k) and then withdrawn under the age 55 exception.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?”

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”

Single Parents Need to Plan and Balance for Financial Stability

In addition to naming a guardian in a will, there are five other critical financial moves.

Without the security of a spouse’s income, single parents must balance their children’s needs with their own retirement savings goals.

MP900448410Single parents who have to say no to their children over and over again, struggle with wanting to say yes when money is tight and there’s no room in the budget for the latest fashions or games.  However, the last thing a single parent wants to do is convey a lack of financial discipline. A financial plan can help a single parent stay on track.

CNBC’s recent article, “Five financial essentials for single parents,” says that when single parents try to satisfy their kids, it can lead to a severe unintended consequence: placing their children ahead of their own retirement needs.

In addition to naming a guardian in a will, there are five other critical financial moves.

  1. Set up an emergency cushion. A solid emergency fund is the initial step. You should have three to nine months' expenses in that fund. Don’t forget to add whatever costs the kids have each month, like sports and activity fees, school lunches, clothing, and school supplies.
  2. Check on the right amount of insurance.Life insurance can help your family cope financially without your income. Your income could be lost through illness, so consider disability insurance. If you own a home, purchase flood insurance.
  3. Create definitive savings goals. You most likely have things that you'd like to do for your family, such as purchase a home, pay for college or plan a special vacation. Each of these will be on a different timeline. Divide this into near-, medium-, and long-term savings goals. Your near-term goals will happen within five years. The way in which you invest these three silos of money is based upon your unique time horizon. If you have decades before you retire or need to pay tuition for a newborn, you can take on more risk. Examine your allocation among these accounts and review them once a year, to see if the amounts you're putting in each—and the investment strategies—still match your goals.
  4. Have a set savings percentage. There's no set number that works for everyone. There are recommendations to save at least 6% or 9% of your income, but it’s not always possible. If you can only save $30 a month, do it and be glad! Just creating a positive habit of saving is important. Even if you save as little $10 a month, do it with the notion that you'll increase the amount, when your finances permit. A good rule of thumb is to put away 10% of your gross, not take-home, pay and as you get raises, increase your savings rate. Developing that disciplined habit of saving can help you accomplish many of your financial goals.
  5. Make your retirement plan. With your savings and Social Security, achieving a 50% replacement of income may be enough for people with modest salaries. However, a person who earns $100,000 will be more likely to want 85 to 90% of income. Therefore, they’ll have to save more. In sum, the more you have, the more you’ll need to save to be able to spend the same amount of money and live the same way in retirement.

For those lucky enough to work at a company with a retirement plan, contribute as much as you can, especially if your employer offers a match to your IRA contribution. If your company does not have any kind of retirement savings plan in place, the next best thing is to set up your own IRA and have money taken from your paycheck automatically. How much you save is up to you, but saving something is better than nothing.

Reference: CNBC (August 20, 2018)“Five financial essentials for single parents”

Wait, Social Security Benefits are Taxed?

How much of your Social Security benefits are taxable depends on several factors.

How much of your Social Security benefits are taxable depends on several factors. You’ll need the bigger picture of your retirement income to know how much of a hit you can expect.

TaxDepending on the amount of other income and Social Security benefits, those benefits are included with other taxable income. It could be 85%, 50%, or zero. There are steps you can take to reduce your tax exposure.  However, it takes planning and knowing the formulas.

Investopedia’sarticle, “How to Avoid the Social Security Tax Trap,”explains what’s includable in Social Security income and what’s taxed.

To know if your Social Security benefits will be partially taxed or fully tax-free, you need to use these formulas. Add up your gross income with certain adjustments. This is the amount from line 21 of Form 1040. Then add back any excluded income from interest on U.S. savings bonds used for higher education purposes, employer-provided adoption benefits, foreign earned income or foreign housing and income earned by residents of American Samoa or Puerto Rico.

To see if 50% of your Social Security benefits are taxed, review the amount listed on Form SSA-1099, Social Security Benefit Statement, which is sent to you by the Social Security Administration by the end of January following the year in which benefits were paid. For income tax purposes, the benefits are the gross amountlisted in Box 3, not the net amount you actually received after premiums for Medicare were withheld.

All tax-exempt interest is interest from municipal bonds listed on line 8a of Form 1040.

Look at the results compared to a “base amount” fixed for your filing status. If you’re below this amount, then none of your benefits are taxed:

  • $32,000 if married filing jointly; or
  • $25,000 if single, head of household, qualifying widow(er) and married filing separately, where spouses lived apart for the entire year.

If the income mix you figured earlier is equal to or above this base amount, then see if 50% or 85% of benefits is includible. For married persons filing jointly, 50% is includible for income between $32,000 and $44,000, and 85% is includible, if income is more than $44,000.

For singles, head of household, qualifying widow(er) and married filing separately, where spouses lived apart for the entire year, 50% is includible of income, if between $25,000 and $34,000, and 85% of benefits is includible, if income is above $34,000. For a married person filing separately who did not live apart from their spouse for the full year, 85% of benefits are includible.

There are also some special situations. The usual computation isn’t used if you:

  • Made deductible IRA contributions and you or your spouse were covered by a qualified retirement plan through your job or self-employment. (Instead, use the worksheet in IRS Publication 590-A);
  • Repaid any Social Security benefits during the year (see in IRS Publication 915); or
  • Received benefits this year for an earlier year (You can make a lump-sum election that will reduce the taxable amount for this year. Use worksheets in IRS Publication 915).

Since 85% of benefits are includible, once you exceed the $44,000/$34,000 income threshold, it may be wise to defer income to a particular year. Say that you know your income is going to be above this threshold and you’re planning on converting a traditional IRA to a Roth IRA. You could make the conversion in this year and pay the taxes on it. This won’t result in any additional inclusion of Social Security benefits. As a result, in the future, you won’t have to take required minimum distributions (RMDs) because you have a Roth IRA, not a traditional one. This will keep your income lower in future years than it would have been without the conversion.

Remember that your federal income tax isn’t the only tax to worry about. Thirteen states tax Social Security benefits. However, 37 states don’t (either because they have no state income tax or fully exempt Social Security benefits).

Among the 13 states, seven of them (Connecticut, Kansas, Missouri, Nebraska, New Mexico, Rhode Island, and Utah) have high-income thresholds for taxing benefits. So, even if you’re a resident, your benefits may not actually be taxed.

 However, if you live in Minnesota, North Dakota, Vermont, or West Virginia—and your benefits are taxable for federal income tax purposes—they’re automatically taxable for stateincome tax purposes. This is because these states use the federal determination. Remember this, if you’re thinking of relocating in retirement.

You’ll want to gather up all your retirement income information and estate planning documents to see what can be done to reduce Social Security tax exposure. Your estate planning attorney should be able to help guide you through the process.

Reference: Investopedia(March 13, 2018) “How to Avoid the Social Security Tax Trap”

When is the Best Time to Start Taking Social Security?

Consider these twin concepts—opportunity cost and delayed retirement credits—before you decide

Consider these twin concepts—opportunity cost and delayed retirement credits—before you decide when to start taking Social Security.

MP900411753By waiting until age 70, you’ll increase your monthly benefit, but at what cost?A recent article inForbes,“Social Security Benefits: Getting Paid To Wait,”examines the dilemma. Money managers call it “opportunity risk:” if you take money from retirement accounts that would otherwise be invested and grow, in order to delay taking Social Security, you are risking the potential for that money to grow.

Can you plan for opportunity cost? Start by looking at whether to wait to take Social Security after your “normal” retirement age, which is 66 for most people. If you wait to claim at age 70, you’ll see the largest-possible Social Security benefit. If you’re not working, you’ll probably be withdrawing money from your retirement funds, which means that those funds won’t be able to grow for a period of several years. As a result, you’ll need to weigh the opportunity cost of not having funds growing tax-deferred in your retirement accounts, against the larger Social Security benefit you will eventually get.

The math isn’t always easy to calculate, but there’s a simple, indirect rule of thumb that Social Security provides. It is known as “delayed retirement credits.” Based on your birth year, Social Security will give you a bonus for waiting to claim benefits. Take a look at how that works:

Delayed Retirement Credits

Year of birth     Credit per year

1917-24                         3.0%

1925-26                         3.5%

1927-28                         4.0%

1929-30                         4.5%

1931-32                         5.0%

1933-34                         5.5%

1935-36                         6.0%

1937-38                         6.5%

1939-40                         7.0%

1941-42                         7.5%

1943 and later              8.0%

 Therefore, if you were born after 1943, for every year you wait to claim benefits after age 66 or so, you get an 8% bump in potential benefits up until age 70. That can be a sweet deal, especially if your portfolio isn’t giving you that kind of return. If it’s doing better than that (after taxes), then you might want to leave as much money as you can in your own savings.

If you elect to work, you can build up a larger nest egg, avoid withdrawals and take Social Security later for the maximum benefit. However, not everybody can work later, nor will they be able to plan to delay retirement withdrawals or Social Security. However, if you see that your work/lifestyle situation is flexible, you should run several scenarios.

Your decision needs to be made after reviewing every source of income, considering your tax and estate plan. Of course, the more assets you own, the more complex the analysis will become. Taxes are a considerable concern, since most of your retirement fund withdrawals (except for Roth IRAs) will be taxable. Another factor to consider: your expected life span. If you come from a family with long life spans, your planning may be different than if you have a chronic condition, like diabetes or heart disease.

Reference: Forbes (June 1, 2018)“Social Security Benefits: Getting Paid To Wait”

Did the New Tax Law Change Roth IRA Contribution Limits for 2018?

Unlike contributions to a traditional IRA—which may be tax-deductible—a Roth IRA has no up-front tax break.

If you are 50 or older, you can put $6,500 into your Roth IRA: that includes a “catch up” contribution of $1,000. Typical Roth IRA contributions are still limited to $5,500 a year. There are income limits,  which you’ll need to be careful about.

MP900404926One good thing about the new tax law: it raised income limits to qualify for the maximum contribution to a Roth IRA.  However, the maximum contribution to a Roth IRA in 2018 is the same as 2017.

Kiplinger’s recent article on this topic asks “How Much Can You Contribute to a Roth IRA for 2018?”In its answer, the article explains that the maximum amount you can contribute to a Roth IRA for 2018 is $5,500, if you're younger than 50. Those age 50 and older can add an extra $1,000 per year in "catch-up" contributions. That is $6,500, which is the maximum contribution amount and the same as 2017.

The actual amount you can contribute to a Roth IRA is based on your income. To be eligible to contribute the maximum for 2018, your modified adjusted gross income (AGI) must be less than $120,000 if you’re single or $189,000 if you’re married and filing jointly. The contributions start to phase out above those amounts. You can't put any money into a Roth IRA once your income reaches $135,000 if single or $199,000, if married and filing jointly. Roth IRA income limits have increased slightly from 2017.

Unlike contributions to a traditional IRA—which may be tax-deductible—a Roth IRA has no up-front tax break. Money goes into the Roth after it’s been taxed. However, when you begin withdrawing funds in retirement, your contributions and all the earnings will be tax-free.

Roth’s are also more flexible than traditional, deductible IRAs. You can withdraw contributions to a Roth account anytime, tax- and penalty-free.  However, if you want to withdraw earnings tax-free, you need to be at least age 59½ and must have owned the Roth for at least five years.

Roth’s aren’t subject to required minimum distributions (RMDs) after age 70½, and you can deposit money at any age, provided you have earned income from a job or self-employment. Traditional IRAs prohibit new contributions once you reach 70½, even if you’re working.

There’s no minimum age limit to open a Roth IRA, and you can contribute to another individual's Roth account as a gift. However, the recipients must have earned income, and you can only contribute an amount up to that person's annual earnings or $5,500, whichever isless.

The popular Roth IRA accounts are used by many to leave money to heirs. Beneficiaries do have to take distributions over time, but they don’t have to pay taxes on the distributions. That’s an attractive benefit!

Reference: Kiplinger(April 22, 2018) “How Much Can You Contribute to a Roth IRA for 2018?”

Under New Tax Law, Roth IRAs are More Attractive

Here are the two biggest tax advantages from Roth IRAs

The new Tax Cuts and Jobs Act have made the Roth more attractive as retirement savings vehicles.

MP900398747Here are the two biggest tax advantages from Roth IRAs: withdrawals are tax free, and you don’t have to worry about required minimum distributions. According to MarketWatch’s article, “How the new tax law creates a ‘perfect storm’ for Roth IRA conversions,”today’s federal income tax rates might be the lowest you’ll see for the rest of your life.

Tax-Free Withdrawals. Unlike traditional IRA withdrawals, qualified Roth IRA withdrawals are federal-income-tax-free and most often state-income-tax-free. A qualified withdrawal is one taken after you, as the Roth account owner, have met both of the following requirements: (i) you’ve had at least one Roth IRA open for more than five years; and (ii) you’ve reached age 59½ or become disabled or dead. To satisfy the five-year requirement, the clock starts on the first day of the tax year for which you make your initial contribution to your first Roth account. That initial contribution can be a regular annual contribution or a conversion contribution.

RMD Exemption. Unlike a traditional IRA, you don’t have to start taking annual required minimum distributions (RMDs) from Roth accounts after reaching age 70½. Instead, you can leave your Roth account(s) untouched for as long as you live if you want. This makes your Roth IRA a great asset to leave to your family, if you don’t need the Roth money to help finance your retirement.

Annual Roth contributions make the most sense for those who think they’ll pay the same or higher tax rates during retirement. Higher future taxes can be avoided on Roth account earnings, because qualified Roth withdrawals are federal-income-tax-free (and typically not taxed at the state level).  However, the downside is you don’t get a deduction for making Roth contributions.

Therefore, if you anticipate paying lower taxes in retirement, you might want to make deductible traditional IRA contributions (if your income allows). That’s because the current deductions may be worth more to you, than tax-free withdrawals down the road.

 What is the other best-case scenario for annual Roth contributions? It is when you’ve maxed out on deductible retirement plan contributions. Annual contributions are limited, and earned income is required. The maximum you can contribute to a Roth for any tax year is the lesser of: (1) your earned income for the year; or (2) the annual contribution limit for the year. Earned income is wage and salary income (including bonuses), self-employment income, and alimony received that is included in your gross income (believe it or not). If you’re married, you can add your spouse’s earned income to the total. Remember, after reaching age 70½, you can still make annual Roth IRA contributions, provided there are no problems with the earned income limitation or the income-based phase-out rule. However, you can’t make any more contributions to traditional IRAs after you reach age 70½.

Roth conversions. Converting a traditional IRA to a Roth IRA, is the fastest way to get a large amount of money into a Roth IRA. This conversion is considered a taxable distribution, since you have received a payout from the traditional IRA. Once that money is deposited into a new Roth IRA, it will trigger a tax bill. However, with federal income taxes so low, now is the time to do this, since you’ll be avoiding the possibility of higher rates on the post-conversion income that will be in the Roth account. You should also remember that if you’ve had at least one Roth account open for more than five years, withdrawals are federal income tax free.

Reference: MarketWatch(March 27, 2018) “How the new tax law creates a ‘perfect storm’ for Roth IRA conversions”

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