The Procedures For Splitting Retirement Accounts In A Divorce
If you are going through a divorce and you or your spouse have retirement accounts, the processes for splitting the retirement accounts will vary depending on what type of retirement accounts are involved.
If you are going through a divorce and you or your spouse have retirement accounts, the processes for splitting the retirement accounts will vary depending on what type of retirement accounts are involved.
401(k) & 403(b) Plan
The first category of retirement plans are called ?employer sponsored qualified plans?. This category includes 401(k) plans, 403(b) plans, 457 plans, and profit sharing plans. Once you and your spouse have agreed upon the split amount of the retirement plans, one of the attorneys will draft Domestic Relations Order, otherwise known as a QDRO. This document provides instruction to the plans TPA (third party administrator) as to how and when to split the retirement assets between the ex-spouses. Here is the procedures from start to finish:
One attorney drafts the Domestic Relations Order (?DRO?)
The attorney for the other spouse reviews and approved the DRO
The spouse covered by the retirement plan submits it to the TPA for review
The TPA will review the document and respond with changes that need to be made (if any)
Attorneys submit the DRO to the judge for signing
Once the judge has signed the DRO, its now considered a Qualified Domestic Relations Order (QDRO)
The spouse covered by the retirement plan submits the QDRO to the plans TPA for processing
The TPA splits the retirement account and will often issues distribution forms to the ex-spouse not covered by the plan detailing the distribution options
Step number four is very important. Before the DRO is submitting to the judge for signing, make sure that the TPA, that oversees the plan being split, has had a chance to review the document. Each plan is different and some plans require unique language to be included in the DRO before the retirement account can be split. If the attorneys skip this step, we have seen cases where they go through the entire process, pay the court fees to have the judge sign the QDRO, they submit the QDRO for processing with the TPA, and then the TPA firm rejects the QDRO because it is missing information. The process has to start all over again, wasting time and money.
Pension Plans
Like employer sponsored retirement plans, pension plans are split through the drafting of a Qualified Domestic Relations Order (QDRO). However, unlike 401(k) and 403(b) plans that usually provide the ex-spouse with distribution options as soon as the QDRO is processed, with pension plans the benefit is typically delayed until the spouse covered by the plan is eligible to begin receiving pension payments. A word of caution, pension plans are tricky. There are a lot more issues to address in a QDRO document compared to a 401(k) plan. 401(k) plans are easy. With a 401(k) plan you have a current balance that can be split immediately. Pension plan are a promise to pay a future benefit and a lot can happen between now and the age that the covered spouse begins to collect pension payments. Pension plans can terminate, be frozen, employers can go bankrupt, or the spouse covered by the retirement plan can continue to work past the retirement date.
I would like to specifically address the final option in the paragraph above. In pension plans, typically the ex-spouse is not entitled to a benefit until the spouse covered by the pension plan is eligible to receive benefits. While the pension plan may state that the employee can retire at 65 and start collecting their pension, that does not mean that they will with 100% certainty. We have seen cases where the ex-husband could have retired at age 65 and started collecting his pension benefit but just to prevent his ex-wife from collecting on his benefit decided to delay retirement which in turn delayed the pension payments to his ex-wife. The ex-wife had included those pension payments in her retirement planning but had to keep working because the ex-husband delayed the benefit. Attorneys will often put language in a QDRO that state that whether the employee retires or not, at a given age, the ex-spouse is entitled to turn on her portion of the pension benefit. The attorneys have to work closely with the TPA of the pension plan to make sure the language in the QDRO is exactly what it need to be to reserve that benefit for the ex-spouse.
IRA (Individual Retirement Accounts)
IRA? are usually the easiest of the three categories to split because they do not require a Qualified Domestic Relations Order to separate the accounts. However, each IRA provider may have different documentation requirements to split the IRA accounts. The account owner should reach out to their investment advisor or the custodian of their IRA accounts to determine what documents are needed to split the account. Sometimes it is as easy as a letter of instruction signed by the owner of the IRA detailing the amount of the split and a copy of the signed divorce agreement. While these accounts are easier to split, make sure the procedures set forth by the IRA custodians are followed otherwise it could result in adverse tax consequences and/or early withdrawal penalties.
About Michael??...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Lower Your Tax Bill By Directing Your Mandatory IRA Distributions To Charity
When you turn 70 1/2, you will have the option to process Qualified Charitable Distributions (QCD) which are distirbution from your pre-tax IRA directly to a chiartable organizaiton. Even though the SECURE Act in 2019 changed the RMD start age from 70 1/2 to age 72, your are still eligible to make these QCDs beginning the calendar year that you
When you turn 70 1/2, you will have the option to process Qualified Charitable Distributions (QCD) which are distribution from your pre-tax IRA directly to a chartable organization. Even though the SECURE Act in 2019 changed the RMD start age from 70 1/2 to age 72, your are still eligible to make these QCDs beginning the calendar year that you turn age 70 1/2. At age 72, you must begin taking required minimum distributions (RMD) from your pre-tax IRA’s and unless you are still working, your employer sponsored retirement plans as well. The IRS forces you to take these distributions whether you need them or not. Why is that? They want to begin collecting income taxes on your tax deferred retirement assets.
Some retirees find themselves in the fortunate situation of not needing this additional income so the RMD’s just create additional tax liability. If you are charitably inclined and would prefer to avoid the additional tax liability, you can make a charitable contribution directly from your IRA and avoid all or a portion of the tax liability generated by the required minimum distribution requirement.
It Does Not Work For 401(k)’s
You can only make “qualified charitable contributions” from an IRA. This option is not available for 401(k), 403(b), and other qualified retirement plans. If you wish to execute this strategy, you would have to process a direct rollover of your FULL 401(k) balance to a rollover IRA and then process the distribution from your IRA to charity.
The reason why I emphases the word “full” for your 401(k) rollover is due to the IRS “aggregation rule”. Assuming that you no longer work for the company that sponsors your 401(k) account, you are age 72 or older, and you have both a 401(k) account and a separate IRA account, you will need to take an RMD from both the 401(k) account and the IRA separately. The IRS allows you to aggregate your IRA’s together for purposes of taking RMD’s. If you have 10 separate IRA’s, you can total up the required distribution amounts for each IRA, and then take that amount from a single IRA account. The IRS does not allow you to aggregate 401(k) accounts for purposes of satisfying your RMD requirement. Thus, if it’s your intention to completely avoid taxes on your RMD requirement, you will have to make sure all of your retirement accounts have been moved into an IRA.
Contributions Must Be Made Directly To Charity
Another important rule. At no point can the IRA distribution ever hit your checking account. To complete the qualified charitable contribution, the money must go directly from your IRA to the charity or not-for-profit organization. Typically this is completed by issuing a “third party check” from your IRA. You provide your IRA provider with payment instructions for the check and the mailing address of the charitable organization. If at any point during this process you take receipt of the distribution from your IRA, the full amount will be taxable to you and the qualified charitable contribution will be void.
Tax Lesson
For many retirees, their income is lower in the retirement years and they have less itemized deductions since the kids are out of the house and the mortgage is paid off. Given this set of circumstances, it may make sense to change from itemizing to taking the standard deduction when preparing your taxes. Charitable contributions are an itemized deduction. Thus, if you take the standard deduction for your taxes, you no longer receive the tax benefit of your contributions to charity. By making IRA distributions directly to a charity, you are able to take the standard deduction but still capture the tax benefit of making a charitable contribution because you avoid tax on an IRA distribution that otherwise would have been taxable income to you.
Example: Church Offering
Instead of putting cash or personal checks in the offering each Sunday, you may consider directing all or a portion of your required minimum distribution from your IRA directly to the church or religious organization. Usually having a conversation with your church or religious organization about your new “offering structure” helps to ease the awkward feeling of passing the offering basket without making a contribution each week.
Example: Annual Contributions To Charity
In this example, let’s assume that each year I typically issue a personal check of $2,000 to my favorite charity, Big Brother Big Sisters, a not-for-profit organization. I’m turning 70½ this year and my accountant tells me that it would be more beneficial to take the standard deduction instead of itemizing. My RMD for the year is $5,000. I can contact my IRA provider, have them issuing a check directly to the charity for $2,000 and issue me a check for the remaining $3,000. I will only have to pay taxes on the $3,000 that I received as opposed to the full $5,000. I win, the charity wins, and the IRS kind of loses. I’m ok with that situation.
Don’t Accept Anything From The Charity In Return
This is a very important rule. Sometimes when you make a charitable contribution, as a sign of gratitude, the charity will send you a coffee mug, gift basket, etc. When this happens, you will typically get a letter from the charity confirming your contribution but the amount listed in the letter will be slightly lower than the actual dollar amount contributed. The charity will often reduce the contribution by the amount of the gift that was given. If this happens, the total amount of the charitable contribution fails the “qualified charitable contribution” requirement and you will be taxed on the full amount. Plus, you already gave the money to charity so you have spend the funds that you could use to pay the taxes. Not good
Limits
While this will not be an issue for many of us, there is a $100,000 per person limit for these qualified charitable contributions from IRA’s.
Summary
While there are a number of rules to follow when making these qualified charitable contributions from IRA’s, it can be a great strategy that allows retirees to continue contributing to their favorite charities, religious organizations, and/or not-for-profit organizations, while reducing their overall tax liability.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Do Inherited IRA's Work For Non-Spouse Beneficiaries?
The SECURE Act was signed into law on December 19, 2019 which completely changed the distribution options that are available to non-spouse beneficiaries. One of the major changes was the elimination of the “stretch provision” which previously allowed non-spouse beneficiaries to rollover the balance into their own inherited IRA and then take small
The SECURE Act was signed into law on December 19, 2019 which completely changed the distribution options that are available to non-spouse beneficiaries. One of the major changes was the elimination of the “stretch provision” which previously allowed non-spouse beneficiaries to rollover the balance into their own inherited IRA and then take small required minimum distributions over their lifetime.
That popular option was replaced with the new 10 Year Rule which will apply to most non-spouse beneficiaries that inherit IRA’s and other types of retirements account after December 31, 2019.
New Rules For Non-Spouse Beneficiaries Years 2020+
The article and Youtube video listed below will provide you with information on:
New distribution options available to non-spouse beneficiaries
The new 10 Year Rule
Beneficiaries that are grandfathered in under the old rules
SECURE Act changes
Old rules vs New rules
New tax strategies for non-spouse beneficiaries
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Does A SEP IRA Work?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
What is a SEP?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
Special Establishment Deadline
SEP are one of the few retirement plans that can be established after December 31st which make them a powerful tax tool. For example, it’s March, you are meeting with your accountant and they deliver the bad news that you have a big tax bill that is due. You can setup the SEP IRA any time to your tax filing date PLUS extension, fund it, and capture the tax deduction.
Easy to Setup & Low Plan Fees
The other advantage of SEP IRA’s is they are easy to setup and you do not have a third-party administrator to run the plan, so the costs are a lot lower than a traditional 401(k) plans. These plans can typically be setup with 24 hours.
Contributions limits
SEP IRA contributions are expressed as a percentage of compensation. The maximum contribution is either 20% of the owners “net earned income” or 25% of the owners W2 wages. It all depends on how your business is incorporated. You have the option to contribution any amount less than the maximum contribution.
100% Employer Funded
SEP IRA plans are 100% employer funded meaning there is no employee deferral piece. Which makes them expense plans to sponsor for a company that eligible employees because the employer contribution is uniform for all employees. Meaning if the owner contributes 20% of their compensation to the plan for themselves they must also make a contribution equal to 20% of compensation for each eligible employee. Typically, once employees begin becoming eligible for the plan, a company will terminate the SEP IRA and replace it with either a Simple IRA or 401(k) plans.
Employee Eligibility Requirements
An employee earns a “year of service” for each calendar year that they earn $500 in compensation. You can see how easy it is to earn a “year of service” in these types of plans. This is where a lot of companies make an error because they only look at their “full time employees” as eligible. The good news for business owners is you can keep employees out of the plan for 3 years and then they become eligible in the 4th year of employment. For example, I am a sole proprietor and I hire my first employee, if my plan document is written correctly, I can keep that employee out of the SEP IRA for 3 years and then they will not be eligible for the employer contribution until the 4th year of employment.
Read This……..Very Important…..
There is a plan document called a 5305 SEP form that is required to sponsor a SEP IRA plan. This form can be printed off the IRS website or is sometimes provide by the investment platform for your plan. Remember, SEP IRA plans are “self-administered” meaning that you as the business owner are responsible for keeping the plan in compliance. Do cannot always rely on your investment advisor or accountant to help you with your SEP IRA plan. You should have a 5305 SEP for in your employer files for each year you have sponsored the plan. This form does not get filed with the IRS or DOL but rather is just kept in your employer files in the case of an audit. You are required to give this form to all employees of the company each year. It’s a way of notifying your employees that the plan exists and it lists the eligibility requirements.
Compliance Issues
The main compliance issues to watch out for with these plan is not having that 5305 SEP Form for each year the plan has been sponsored, not accurately identifying eligible employees, and miscalculating your “net earned income” for the max SEP IRA contribution.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Can I Use My 401K or IRA To Buy A House?
The most difficult part of buying a house is coming up with the down payment. This leads to the question, "Can I access cash in my retirement accounts to help toward the down payment on my house?". The short answer is in most cases, "Yes". The next important questions is "Is it a good idea to take a withdrawal from my retirement account for the down
The most difficult part of buying a house is coming up with the down payment. This leads to the question, "Can I access cash in my retirement accounts to help toward the down payment on my house?". The short answer is in most cases, "Yes". The next important questions is "Is it a good idea to take a withdrawal from my retirement account for the down payment given all of the taxes and penalties that I would have to pay?" This article aims to answer both of those questions and provide you with withdrawal strategies to help you avoid big tax consequences and early withdrawal penalties.
401(k) Withdrawal Options Are Not The Same As IRA's
First you have to acknowledge that different types of retirement accounts have different withdrawal options available. The withdrawal options for a down payment on a house from a 401(k) plan are not the same a the withdrawal options from a Traditional IRA. There is also a difference between Traditional IRA's and Roth IRA's.
401(k) Withdrawal Options
There may be loan or withdrawal options available through your employer sponsored retirement plan. I specifically say "may" because each company's retirement plan is different. You may have all or none of the options available to you that will be presented in this article. It all depends on how your company's 401(k) plan is designed. You can obtain information on your withdrawal options from the plan's Summary Plan Description also referred to as the "SPD".
Taking a 401(k) loan.............
The first option is a 401(k) loan. Some plans allow you to borrow 50% of your vested balance in the plan up to a maximum of $50,000 in a 12 month period. Taking a loan from your 401(k) does not trigger a taxable event and you are not hit with the 10% early withdrawal penalty for being under the age of 59.5. 401(k) loans, like other loans, change interest but you are paying that interest to your own account so it is essentially an interest free loan. Typically 401(k) loans have a maximum duration of 5 years but if the loan is being used toward the purchase of a primary residence, the duration of the loan amortization schedule can be extended beyond 5 years if the plan's loan specifications allow this feature.
Note of caution, when you take a 401(k) loan, loan payments begin immediately after the loan check is received. As a result, your take home pay will be reduced by the amount of the loan payments. Make sure you are able to afford both the 401(k) loan payment and the new mortgage payment before considering this option.
The other withdrawal option within a 401(k) plan, if the plan allows, is a hardship distribution. As financial planners, we strongly recommend against hardship distributions for purposes of accumulating the cash needed for a down payment on your new house. Even though a hardship distribution gives you access to your 401(k) balance while you are still working, you will get hit with taxes and penalties on the amount withdrawn from the plan. Unlike IRA's which waive the 10% early withdrawal penalty for first time homebuyers, this exception is not available in 401(k) plans. When you total up the tax bill and the 10% early withdrawal penalty, the cost of this withdrawal option far outweighs the benefits.
If You Have A Roth IRA.......Read This.....
Roth IRA's can be one of the most advantageous retirement accounts to access for the down payment on a new house. With Roth IRA's, you make after tax contributions to the account, and as long as the account has been in existence for 5 years and you are over the age of 59� all of the earnings are withdrawn from the account 100% tax free. If you withdraw the investment earnings out of the Roth IRA before meeting this criteria, the earnings are taxed as ordinary income and a 10% early withdrawal penalty is assessed on the earnings portion of the account.
What very few people know is if you are under the age of 59� you have the option to withdraw just your after-tax contributions and leave the earnings in your Roth IRA. By doing so, you are able to access cash without taxation or penalty and the earnings portion of your Roth IRA will continue to grow and can be distributed tax free in retirement.
The $10,000 Exclusion From Traditional IRA's.......
Typically if you withdraw money out of your Traditional IRA prior to age 59� you have to pay ordinary income tax and a 10% early withdrawal penalty on the distribution. There are a few exceptions and one of them is the "first time homebuyer" exception. If you are purchasing your first house, you are allowed to withdrawal up to $10,000 from your Traditional IRA and avoid the 10% early withdrawal penalty. You will still have to pay ordinary income tax on the withdrawal but you will avoid the early withdrawal penalty. The $10,000 limit is an individual limit so if you and your spouse both have a traditional IRA, you could potentially withdrawal up to $20,000 penalty free.
Helping your child to buy a house..........
Here is a little known fact. You do not have to be the homebuyer. You can qualify for the early withdrawal exemption if you are helping your spouse, child, grandchild, or parent to buy their first house.
Be careful of the timing rules..........
There is a very important timing rule associated with this exception. The closing must take place within 120 day of the date that the withdrawal is taken from the IRA. If the closing happens after that 120 day window, the full 10% early withdrawal penalty will be assessed. There is also a special rollover rule for the first time homebuyer exemption which provides you with additional time to undo the withdrawal if need be. Typically with IRA's you are only allowed 60 days to put the money back into the IRA to avoid taxation and penalty on the IRA withdrawal. This is called a "60 Day Rollover". However, if you can prove that the money was distributed from the IRA with the intent to be used for a first time home purchase but a delay or cancellation of the closing brought you beyond the 60 day rollover window, the IRS provides first time homebuyers with a 120 window to complete the rollover to avoid tax and penalties on the withdrawal.
Don't Forget About The 60 Day Rollover Option
Another IRA withdrawal strategy that is used as a “bridge solution” is a “60 Day Rollover”. The 60 Day Rollover option is available to anyone with an IRA that has not completed a 60 day rollover within the past 12 months. If you are under the age of 59.5 and take a withdrawal from your IRA but you put the money back into the IRA within 60 days, it’s like the withdrawal never happened. We call it a “bridge solution” because you have to have the cash to put the money back into your IRA within 60 days to avoid the taxes and penalty. We frequently see this solution used when a client is simultaneously buying and selling a house. It’s often the intent that the seller plans to use the proceeds from the sale of their current house for the down payment on their new house. Unfortunately due to the complexity of the closing process, sometimes the closing on the new house will happen prior to the closing on the current house. This puts the homeowner in a cash strapped position because they don’t have the cash to close on the new house.
As long as the closing date on the house that you are selling happens within the 60 day window, you would be able to take a withdrawal from your IRA, use the cash from the IRA withdrawal for the closing on their new house, and then return the money to your IRA within the 60 day period from the house you sold. Unlike the “first time homebuyer” exemption which carries a $10,000 limit, the 60 day rollover does not have a dollar limit.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Required Minimum Distribution Tax Strategies
If you are turning age 72 this year, this article is for you. You will most likely have to start taking required minimum distributions from your retirement accounts. This article will outline:
If you are turning age 72 this year, this article is for you. You will most likely have to start taking required minimum distributions from your retirement accounts. This article will outline:
Deadlines to take your RMD
Tax implications
Strategies to reduce your tax bill
How is my RMD calculated?
The IRS has a tax table that determines the amount that you have to take out of your retirement accounts each year. To determine your RMD amount you will need to obtain the December 31st balance in your retirement accounts, find your age on the IRS RMD tax table, and divide your 12/31 balance by the number listed next to your age in the tax table.
Exceptions to the RMD requirement........
There are two exceptions. First, Roth IRA’s do not require RMD’s. Second, if you are still working, you maintain a balance in your current employer’s retirement plan, and you are not a 5%+ owner of the company, you do not need to take an RMD from that particular retirement account until you terminate employment with the company. Which leads us to the first tax strategy. If you are age 72 or older and you are still working, you can typically rollover your traditional IRA’s and former employer 401(k)/403(b) accounts into your current employers retirement plan. By doing so, you avoid the requirement to take RMD’s from those retirement accounts outside of your current employers retirement plan and you avoid having to pay taxes on those required minimum distributions. If you are 5%+ owner of the company, you are out of luck. The IRS will still require you to take the RMD from your retirement account even though you are still “employed” by the company.
Deadlines
In the year that you turn 72, if you do not meet one of the exceptions listed above, you will have a very important decision to make. You have the option to take the RMD by 12/31 of that year or wait until the beginning of the following tax year. For your first RMD, the deadline to take the RMD is April 1st of the year following the year that you turn age 72. For example, if you turn 72 on June 2017, you will not be required to take your first RMD until April 1, 2018. If you worked full time from January 2017 – June 2017, it may make sense for you to delay your first RMD until January 2018 because your income will most likely be higher in 2017 because you worked for half of the year. When you take a RMD, like any other distribution from a pre-tax retirement account, it increases the amount of your taxable income for the year. From a pure tax standpoint it usually makes snese to realize income from retirement accounts in years that you are in a lower tax bracket.
SPECIAL NOTE: If you decided to delay your first RMD until after December 31st, you will be required to take two RMD’s in that year. One prior to April 1st and the second before Decemeber 31st. The April 1st rule only applies to your first RMD. You should consult with your accountant to determine the best RMD strategy given your personal income tax situation. For all tax years following the year that you turn age 72, the RMD deadline is December 31st.
VERY IMPORTANT: Do not miss your RMD deadline. The IRS hits you with a lovely 50% excise tax if you fail to take your RMD by the deadline. If you were due a $4,000 RMD and you miss the deadline, the IRS is going to levy a $2,000 excise tax against you.
Contributions to charity to avoid taxes
Another helpful tax strategy, if you make contributions to a charity, a church, or not-for-profit organization, you have the option with IRA’s to direct all or a portion of your RMD directly to these organization. In doing so, you satisfy your RMD but avoid having to pay income tax on the distribution from the IRA. The number one rule here, the distribution must go directly from your IRA account to the not-for-profit organization. At no point during this transaction can the owner of the IRA take possession of cash from the RMD otherwise the full amount will be taxable to the owner of the IRA. Typically the custodian of your IRA will have to issue and mail a third party check directly to the not-for-profit organization.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Tax Secret: Spousal IRAs
Spousal IRA’s are one of the top tax tricks used by financial planners to help married couples reduce their tax bill. Here is how it works:
Spousal IRA’s are one of the top tax tricks used by financial planners to help married couples reduce their tax bill. Here is how it works:
In most cases you need “earned income” to be eligible to make a contribution to an Individual Retirement Account (“IRA”). The contribution limits for 2021 is the lesser of 100% of your AGI or $6,000 for individuals under the age of 50. If you are age 50 or older, you are eligible for the $1,000 catch-up making your limit $7,000.
There is an exception for “Spousal IRAs” and there are two cases where this strategy works very well.
Case 1: One spouse works and the other spouse does not. The employed spouse is currently maxing out their contributions to their employer sponsored retirement plan and they are looking for other ways to reduce their income tax liability.
If the AGI (adjusted gross income) for that couple is below $198,000 in 2021, the employed spouse can make a contribution to a Spousal Traditional IRA up to the $6,000/$7,000 limit even though their spouse had no “earned income”. It should also be noted that a contribution can be made to either a Traditional IRA or Roth IRA but the contributions to the Roth IRA do not reduce the tax liability because they are made with after tax dollars.
Case 2: One spouse is over the age of 70 ½ and still working (part time or full time) while the other spouse is retired. IRA rules state that once you are age 70½ or older you can no longer make contributions to a traditional IRA. However, if you are age 70½ or older BUT your spouse is under the age of 70½, you still can make a pre-tax contribution to a traditional IRA for your spouse.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Strategies to Save for Retirement with No Company Retirement Plan
The question, “How much do I need to retire?” has become a concern across generations rather than something that only those approaching retirement focus on. We wrote the article, How Much Money Do I Need To Save To Retire?, to help individuals answer this question. This article is meant to help create a strategy to reach that number. More
The question, “How much do I need to retire?” has become a concern across generations rather than something that only those approaching retirement focus on. We wrote the article, How Much Money Do I Need To Save To Retire?, to help individuals answer this question. This article is meant to help create a strategy to reach that number. More specifically, for those who work at a company that does not offer a company sponsored plan.
Over the past 20 years, 401(k) plans have become the most well-known investment vehicle for individuals saving for retirement. This type of plan, along with other company sponsored plans, are excellent ways to save for people who are offered them. Company sponsored plans are set up by the company and money comes directly from the employees paycheck to fund their retirement. This means less effort on the side of the individual. It is up to the employee to be educated on how the plan operates and use the resources available to them to help in their savings strategy and goals but the vehicle is there for them to take advantage of.
We also wrote the article, Comparing Different Types of Employer Sponsored Retirement Plans, to help business owners choose a retirement plan that is most beneficial to them in their retirement savings.
Now back to our main focus on savings strategies for people that do not have access to an employer sponsored plan. We will discuss options based on a few different scenarios because matters such as marital status and how much you’d like to save may impact which strategy makes the most sense for you.
Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Not Maxing Out
A common strategy we use for clients when a covered spouse is not maxing out their deferrals is to increase the deferrals in the retirement plan and supplement income with the non-covered spouse’s salary. The limits for 401(k) deferrals in 2021 is $19,500 for individuals under 50 and $26,000 for individuals 50+. For example, if I am covered and only contribute $8,000 per year to my account and my spouse is not covered but has additional money to save for retirement, I could increase my deferrals up to the plan limits using the amount of additional money we have to save. This strategy is helpful as it allows for easier tracking of retirement accounts and the money is automatically deducted from payroll. Also, if you are contributing pre-tax dollars, this will decrease your tax liability.
Note: Payroll deferrals must be withheld from payroll by 12/31. If you owe money when you file your taxes in April, you would not be able to go back and increase your deferrals in your company plan for that tax year.
Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Maxing Out
If the covered spouse is maxing out at the high limits already, you may be able to save additional pre-tax dollars depending on your Adjusted Gross Income (AGI).
Below is the Traditional IRA Deductibility Table for 2021. This table shows how much individuals or married couples can earn and still deduct IRA contributions from their taxable income.
As shown in the chart, if you are married filing jointly and one spouse is covered, the couple can fully deduct IRA contributions to an account in the covered spouses name if AGI is less than $99,000 and can fully deduct IRA contributions to an account in the non-covered spouses name if AGI is less than $184,000. The Traditional IRA limits for 2017 are $5,500 if under 50 and $6,500 if 50+. These lower limits and income thresholds make contributing to company sponsor plans more attractive in most cases.
Single or Married Filing Jointly and Neither Spouse is Covered
If you (and your spouse if married filing joint) are not covered by an employer sponsored plan, you do not have an income threshold for contributing pre-tax dollars to a Traditional IRA. The only limitations you have relate to the amount you can contribute. These contribution limits for both Traditional and Roth IRA’s are $5,500 if under 50 and $6,500 if 50+. If married filing joint, each spouse can contribute up to these limits.
Unlike employer sponsored plans, your contributions to IRA’s can be made after 12/31 of that tax year as long as the contributions are in before you file your tax return.
Please feel free to e-mail or call with any questions on this article or any other financial planning questions you may have.
Below are related articles that may help answer additional questions you have after reading this.
Traditional vs. Roth IRA’s: Differences, Pros, and Cons
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
Traditional vs. Roth IRA’s: Differences, Pros, and Cons
Individual Retirement Accounts (IRA’s) are one of the most popular retirement vehicles available for savers and the purpose of this article is to give a general idea of how IRA’s work, explain the differences between Traditional and Roth IRA’s, and provide some pros and cons of each. In January 2015, The Investment Company Institute put out a research
Individual Retirement Accounts (IRA’s) are one of the most popular retirement vehicles available for savers and the purpose of this article is to give a general idea of how IRA’s work, explain the differences between Traditional and Roth IRA’s, and provide some pros and cons of each. In January 2015, The Investment Company Institute put out a research report with some interesting statistics regarding IRA’s which can be found at the following link, ICI Research Perspective. The article states, “In mid-2014, 41.5 million, or 33.7 percent of U.S. households owned at least one type of IRA”. At first I was slightly shocked and asked myself the following question: “If IRA’s are the most important investment vehicle and source of income for most retirees, how do only one third of U.S. households own one?” Then when I took a step back and considered how money gets deposited into these retirement vehicles this figure begins making more sense.
Yes, a lot of American’s will contribute to IRA’s throughout their lifetime whether it is to save for retirement throughout one’s lifetime or each year when the CPA gives you the tax bill and you ask “What can I do to pay less?” When thinking about IRA’s in this way, one third of American’s owning IRA’s is a scary figure and leads one to believe more than half the country is not saving for retirement. This is not necessarily the case. 401(k) plans and other employer sponsored defined contribution plans have become very popular over the last 20 years and rather than individuals opening their own personal IRA’s, they are saving for retirement through their employer sponsored plan.
Employees with access to these employer plans save throughout their working years and then, when they retire, the money in the company retirement account will be rolled into IRA’s. If the money is rolled directly from the company sponsored plan into an IRA, there is likely no tax or penalty as it is going from one retirement account to another. People roll the balance into IRA’s for a number of reasons. These reasons include the point that there is likely more flexibility with IRA’s regarding distributions compared to the company plan, more investment options available, and the retiree would like the money to be managed by an advisor. The IRA’s allow people to draw on their savings to pay for expenses throughout retirement in a way to supplement income that they are no longer receiving through a paycheck.
The process may seem simple but there are important strategies and decisions involved with IRA’s. One of those items is deciding whether a Traditional, Roth or both types of IRA’s are best for you. In this article we will breakdown Traditional and Roth IRA’s which should illustrate why deciding the appropriate vehicle to use can be a very important piece of retirement planning.
Why are they used?
Both Traditional and Roth IRA’s have multiple uses but the most common for each is retirement savings. People will save throughout their lifetime with the goal of having enough money to last in retirement. These savings are what people are referring to when they ask questions like “What is my number?” Savers will contribute to retirement accounts with the intent to earn money through investing. Tax benefits and potential growth is why people will use retirement accounts over regular savings accounts. Retirees have to cover expenses in retirement which are likely greater than the social security checks they receive. Money is pulled from retirement accounts to cover the expenses above what is covered by social security. People are living longer than they have in the past which means the answer to “What is my number?” is becoming larger since the money must last over a greater period.
How much can I contribute?
For both Traditional and Roth IRA’s, the limit in 2021 for individuals under 50 is the lesser of $6,000 or 100% of MAGI and those 50 or older is the lesser of $7,000 or 100% of MAGI. More limit information can be found on the IRS website Retirement Topics - IRA Contribution Limits
What are the important differences between Traditional and Roth?
Taxation
Traditional (Pre-Tax) IRA: Typically people are more familiar with Traditional IRA’s as they’ve been around longer and allow individuals to take income off the table and lower their tax bill while saving. Each year a person contributes to a Pre-Tax IRA, they deduct the contribution amount from the income they received in that tax year. The IRS allows this because they want to encourage people to save for retirement. Not only are people decreasing their tax bill in the year they make the contribution, the earnings of Pre-Tax IRA’s are not taxed until the money is withdrawn from the account. This allows the account to earn more as money is not being taken out for taxes during the accumulation phase. For example, if I have $100 in my account and the account earns 10% this year, I will have $10 of earnings. Since that money is not taxed, my account value will be $110. That $110 will increase more in the following year if the account grows another 10% compared to if taxes were taken out of the gain. When the money is used during retirement, the individual will be taxed on the amount distributed at ordinary income tax rates because the money was never taxed before. A person’s tax rate during retirement is likely to be lower than while they are working because total income for the year will most likely be less. If the account owner takes a distribution prior to 59 ½ (normal retirement age), there will be penalties assessed.
Roth (After-Tax) IRA: The Roth IRA was established by the Taxpayer Relief Act of 1997. Unlike the Traditional IRA, contributions to a Roth IRA are made with money that has already been subject to income tax. The money gets placed in these accounts with the intent of earning interest and then when the money is taken during retirement, there is no taxes due as long as the account has met certain requirements (i.e. has been established for at least 5 years). These accounts are very beneficial to people who are younger or will not need the money for a significant number of years because no tax is paid on all the earnings that the account generates. For example, if I contribute $100 to a Roth IRA and the account becomes $200 in 15 years, I will never pay taxes on the $100 gain the account generated. If the account owner takes a distribution prior to 59 ½ (normal retirement age), there will be penalties assessed on the earnings taken.
Eligibility
Traditional IRA: Due to the benefits the IRS allows with Traditional IRA’s, there are restrictions on who can contribute and receive the tax benefit for these accounts. Below is a chart that shows who is eligible to deduct contributions to a Traditional IRA:
There are also Required Minimum Distributions (RMD’s) associated with Pre-Tax dollars in IRA’s and therefore people cannot contribute to these accounts after the age of 70 ½. Once the account owner turns 70 ½, the IRS forces the individual to start taking distributions each year because the money has never been taxed and the government needs to start receiving revenue from the account. If RMD’s are not taken timely, there will be penalties assessed.
Roth IRA: As long as an individual has earned income, there are only income limitations on who can contribute to Roth IRA’s. The limitations for 2021 are as follows:
There are a number of strategies to get money into Roth IRA’s as a financial planning strategy. This method is explained in our article Backdoor Roth IRA Contribution Strategy.
Investment Strategies
Investment strategies are different for everyone as individuals have different risk tolerances, time horizons, and purposes for these accounts.
That being said, Roth IRA’s are often times invested more aggressively because they are likely the last investment someone touches during retirement or passes on to heirs. A longer time horizon allows one to be more aggressive if the circumstances permit. Accounts that are more aggressive will likely generate higher returns over longer periods. Remember, Roth accounts are meant to generate income that will never be taxed, so in most cases that account should be working for the saver as long as possible. If money is passed onto heirs, the Roth accounts are incredibly valuable as the individual who inherits the account can continue earning interest tax free.
Choosing the correct IRA is an important decision and is often times more complex than people think. Even if you are 30 years from retiring, it is important to consider the benefits of each and consult with a professional for advice.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
Do I Have To Pay Taxes On My Inheritance?
Whenever people come into large sums of money, such as inheritance, the first question is “how much will I be taxed on this money”? Believe it or not, money you receive from an inheritance is likely not taxable income to you.
Whenever people come into large sums of money, such as inheritance, the first question is “how much will I be taxed on this money”? Believe it or not, money you receive from an inheritance is likely not taxable income to you.
Of course there are some caveats to this. If the inherited money is from an estate, there is a chance the money received was already taxed at the estate level. The current federal estate exclusion is $5,430,000 (estate taxes and the exclusion amount varies for states). Therefore, if the estate was large enough, a portion of the inheritance may have been subject to estate tax which is 40% in most cases. That being said, whether the money was or was not taxed at the estate level, you as an individual do not have to pay income taxes on the money.
Although the inheritance itself is not taxable, you may end up paying taxes if there is appreciation after the money is inherited. The type of account and distribution will dictate how the income will be taxed.
Basis Of Inherited Property
Typically, the basis of inherited property is the fair market value of the property on the date of the decedent’s death or the fair market value of the property on the alternate valuation date if the estate uses the alternate valuation date for valuing assets. An estate will choose to value assets on an alternate date subsequent to the date of death if certain assets, such as stocks, have depreciated since the date of death and the estate would pay less tax using the alternate date.
What the fair market value basis means is that if you inherit stock that was originally purchased for $500 and at the date of death has appreciated to $10,000, you will have a “step-up” basis of $10,000. If you turn around and sell the stock for $11,000, you will have a $1,000 gain and if you sell the stock for $9,000, you will have a $1,000 loss.
Inheriting a personal residence also provides for a step-up in basis but the gain or loss may be treated differently. If no one lives in the inherited home after the date of death, it will be treated similar to the stock example above. If you move into the home after death, any subsequent sale at a loss will not be deductible as it will be treated as your personal asset but a gain would have to be recognized and possibly taxed. If you rent the property subsequent to inheritance, it could be treated as a trade or business which would be treated differently for tax purposes.
Inheriting An IRA or Retirement Plan Account
Please read our article “Inherited IRA’s: How Do They Work” for a more detailed explanation of the three different types of distribution options.
When you inherit a retirement account, and you are not the spouse of the decedent, in most cases you will only have one option, fully distribute the account balance 10 years following the year of the decedents death. The SECURE Act that was passed in December 2019 dramatically change the distribution options available to non-spouse beneficiaries. See the article below:
If you are the spouse of the of the decedent, you are able to treat the retirement account as if it was yours and not be forced to take one of the options above. You will have to pay taxes on distributions but you do not have to start withdrawing funds immediately unless there are required minimum distributions needed.
Note: If the inherited account was an after tax account (i.e. Roth), the inheritor must choose one of the options presented above but no tax will be paid on distributions.
Non-Qualified Annuities
Non-qualified annuities are an exception to the step-up in basis rule. The non-spousal inheritor of a non-qualified annuity will have to take either a lump sum or receive payments over a specified time period. If the inheritor chooses a lump sum, the portion that represents the gain (lump sum balance minus decedent’s contributions) will be taxed as ordinary income. If the inheritor chooses a series of payments, distributions will be treated as last in, first out. Last in, first out means that the appreciation will be distributed first and fully taxable until there is only basis left.
If the spouse inherits the annuity, they most likely have the option to treat the annuity contract as if they were the original owner.
This article concentrated on inheritance at a federal level. There is no inheritance tax at a federal level but some states do have an inheritance tax and therefore meeting with a professional is recommended. New York currently does not have an inheritance tax.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
