April 5, 2021 By

Q&A: IRA intricacies when one spouse isn’t working

Dear Liz: Due to the pandemic, I did not work during 2020. Can I contribute to a spousal IRA for 2020 since my husband still has an income and will be contributing to his Roth IRA? Does it need to be a separate account from my existing IRAs?

Answer: As long as your husband has earned income, you can contribute to your IRA. You don’t need to set up a separate account to make this spousal contribution.

Whether or not your contribution is deductible will depend on your income and whether your husband is covered by a workplace retirement plan such as a 401(k). If he’s not, your spousal contribution is fully deductible. If he is covered, then your ability to deduct your contribution phases out for a modified adjusted gross income of $196,000 to $206,000.

Filed Under: Q&A, Retirement Tagged With: , ,
March 22, 2021 By

Q&A: IRAs and tax considerations

Dear Liz: I’ve been researching the backdoor Roth IRA and I am finding some conflicting information regarding taxes owed on the conversions. I have two sizable rollover IRAs and one small ($1,600) traditional IRA. Can I make an after-tax contribution to the traditional IRA and convert that to a Roth and pay tax only on that IRA or do I have to consider all three IRAs?

Answer: Sorry, but you have to consider all three. The tax on your conversion will be based on the pre-tax portion of all your IRAs combined, not just the IRA where you make your contribution.

Backdoor Roths allow people to get money into a Roth when their incomes are too high to make a direct contribution. Instead, they contribute to a traditional IRA and convert that to a Roth because conversions don’t have income limits. Conversions require paying taxes proportionately on your pre-tax contributions and earnings, however, so the technique may not be advisable when you have sizable pre-tax IRAs that will trigger a large tax bill.

Filed Under: Q&A, Retirement, Taxes Tagged With: , ,
September 21, 2020 By

Q&A: Managing retirement savings

Dear Liz: I’m considering converting an old 401(k) to a Roth IRA. Will the gains from the 401(k) account be treated as capital gains? And can you only convert 401(k) plans you no longer participate in, or can you convert both current and former 401(k) plans?

Answer: You’ll pay income taxes on the conversion. Retirement plans, including 401(k)s and IRAs, don’t qualify for capital gains tax rates. You may be able to convert your current 401(k) as well. Ask your plan administrator if “in plan Roth conversions” are allowed.

Filed Under: Q&A, Retirement Tagged With: , ,
September 8, 2020 By

Q&A: A felony doesn’t preclude you from Social Security benefits

Dear Liz: If someone has a felony, is it true they cannot claim Social Security retirement benefits? If so, what is the best option: a Roth IRA or a brokerage account? How do they get started without a lot of money?

Answer: A felony does not prevent you from claiming Social Security in the future if you work enough years to qualify for benefits. If you were already receiving retirement benefits when you were convicted, your payments would typically be suspended while you were incarcerated but resumed when you got out.

That said, Social Security usually isn’t enough to live on, so you’ll want to have money in retirement accounts as well. An IRA or a Roth IRA are both good options. The IRA reduces your taxes upfront while Roth IRAs reduce your taxes in the future. Low- and moderate-income taxpayers also can get a tax credit, called the Savers Credit, for retirement contributions.

If you don’t have a lot of money to invest, look for brokerages that have low fees and no account minimums, such as Fidelity, ETrade, TD Ameritrade and Charles Schwab, among others.

Once you open the account, you’ll need to figure out how to invest.

If you’re new to investing, consider using target date funds. These investments are labeled by year, and you pick the year that’s closest to your future retirement. The fund does the rest of the work such as picking the stocks and bonds, rebalancing the mix and getting more conservative as the retirement date approaches.

Robo-advisors such as Betterment or SoFi are another low-cost solution that does most of the work for you.

Filed Under: Q&A, Social Security Tagged With: , ,
August 31, 2020 By

Q&A: Retirement funds and creditors

Dear Liz: I keep reading conflicting things about 401(k)s and IRAs. If I roll over my 401(k) from my previous employer into an IRA, is it still protected from creditors? I’ve left it in the old 401(k) plan for now because I’ve read IRAs can be seized in lawsuits or bankruptcy, or alternatively that only $1 million is protected and the rest could be at risk. I’ve read that if I leave it in the 401(k), the whole amount is protected. Can you please help clear up this confusion so I can make a wise decision?

Answer: Your 401(k) is protected from creditors, full stop. Federal law bans creditors from taking money in a pension plan that was set up under the Employee Retirement Income Security Act (ERISA), and that includes 401(k)s as well as traditional pensions.

Your IRA is protected in bankruptcy court up to a certain amount, currently $1,362,800. Whether creditors outside of bankruptcy court can access your IRA funds depends on state law. In California, for example, there’s no specific dollar amount.

If a creditor wins a judgment against you and goes after your IRA, a court would decide how much of the account was necessary for your support and protect that. The rest could go to the creditor.

Filed Under: Q&A, Retirement Tagged With: , , ,
August 24, 2020 By

Q&A: Here’s why two 401(k) accounts aren’t better than one

Dear Liz: I changed jobs more than three years ago and did not roll over my 401(k) when I started a 401(k) account with my new employer. I’m perfectly happy having separate accounts. However, I’ve read some IRS rules that I cannot understand about being penalized for not contributing to a 401(k) for five years. So my question: After turning 59½, will I face any sort of penalty or loss when I begin withdrawing funds from a 401(k) account that has been sitting idle?

Answer: There’s no penalty for not contributing to an old 401(k). In fact, you cannot contribute to an old 401(k). Once you leave the employer that sponsored the plan, you generally can’t put any more money into it.

What you may have stumbled upon are IRS rules that apply to employers who sponsor 401(k) plans that have a profit-sharing component.

Employers aren’t required to make contributions to these plans every year — there may be years when there’s no profit to share — but their contributions have to be “recurring and substantial.” If the employer hasn’t made contributions in three of the past five consecutive years, the plan could be terminated, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

That obviously doesn’t apply to your situation, and if you want to continue managing two 401(k) accounts, you’re welcome to do so. But consider rolling the money into your new employer’s plan, if it’s a good one and accepts such transfers. That would mean one fewer account you need to track and also could give you access to more money if you wanted to take out a loan.

Filed Under: Q&A, Retirement Tagged With: , ,
August 17, 2020 By

Q&A: IRA confusion leads to disappointment

Dear Liz: Many years ago, I read in a personal finance magazine about a mutual fund company that paid $1 million to a customer who had an IRA for 40 years. So I started an IRA at that company in December 1992 and paid $10,000. As of today, that account is worth only $80,000. What happened to the high payoff?

Answer: First things first. The maximum you were supposed to contribute to an IRA in 1992 was $2,000. If you were able to contribute more, you may have opened a different type of account, such as a regular taxable brokerage account. Either that or you have some explaining to do to the IRS.

Also, IRAs hadn’t been around for 40 years in 1992. They were created in 1974 by the Employee Retirement Income Security Act. So what you probably read in the magazine was a hypothetical example of what someone might accumulate over time in an IRA. Someone who contributed $2,000 a year to an IRA for 40 years could wind up with $1 million, but only with returns in excess of 10%.

Actual returns historically have been closer to 8%, but that’s an average. Some years it’s less, some years it’s more. There are no guarantees. What you end up with depends on how you invested the money and what fees you paid, among other factors. If your investment had done as well as the broader stock market, as measured by the Standard & Poor’s 500, you would have over $100,000 by now.

If your money is in an IRA, you could move it to be a better investment, such as a low-cost, broad-market index fund, without tax consequences. If it’s not in an IRA, then selling the investment to buy another could generate a tax bill, so consult a tax pro before taking any action.

Filed Under: Q&A, Retirement Tagged With: ,
June 29, 2020 By

Q&A: The IRS is finally staffing up. Here’s how to get your coronavirus stimulus money

Dear Liz: We do not make enough income to file tax returns, so we used the IRS site to apply for our economic stimulus payment ($1,700 for one adult and one teenage child). We received a response email stating our information was received successfully by the IRS several weeks ago. We included our bank deposit information for a fast direct deposit but the money has not arrived and we hear that the government ran out of money. We are desperate. What can we do or who can we speak with about this delay?

Answer: The government did not run out of money, and at a minimum you should be able to file a tax return next year to get your stimulus payment as a refundable credit. Since you need the money now, though, you should follow up with the IRS.

The IRS has reopened the general taxpayer helpline that was shuttered because of the coronavirus pandemic, but it has also added thousands of phone reps to a special hotline to deal with stimulus payment problems: (800) 919-9835. That’s the number you should call to inquire about your payment.

(Previous columns have dealt with people’s refunds being held up because the IRS didn’t have enough workers to open its mail. Tax processing centers are reopening, but it will take awhile to work through the backlog. You can check the status of a refund through the “Where’s My Refund?” tool on the IRS site or by calling (800) 829-1954.)

Filed Under: Coronavirus, Q&A Tagged With: , , , ,
June 29, 2020 By

Q&A: Tapping IRA creates a taxing problem

Dear Liz: I took $250,000 out of my retirement account in 2019 to set up five 529 accounts for my young grandchildren. As a result, my federal and state tax bills are $80,000. I’ll need to take that money out of my IRA. Will I keep having to pay large tax bills in order to pay for that one-time large withdrawal?

Answer: While your heart was in the right place, your money wasn’t. Withdrawals from IRAs are taxable, and such a large withdrawal almost certainly pushed you into a much higher tax bracket. If you had consulted a financial planner or a tax pro, they would have advised you to either fund the 529s from a non-retirement account or to make smaller withdrawals over several years to avoid such a big tax hit.

If you continue to tap your IRA, you will continue to owe taxes on the money you withdraw. The $80,000 will incur state and federal taxes. If you again pay the tax bill on the $80,000 using your IRA, you’ll owe taxes on that money as well, and so on.

You may not think that’s fair, but the reason your IRA is taxable now is because you got a tax deduction when you made the original contributions, and the money has been growing tax deferred in the meantime. Eventually, the government wants to get paid back for those tax breaks.

Filed Under: Q&A, Retirement, Taxes Tagged With: , ,
March 30, 2020 By

Q&A: Inheriting an IRA can get messy

Dear Liz: My brother passed away at age 47. My mother was named beneficiary of his retirement account. We opened an inherited IRA under her name. Sadly, my mother recently passed away, and my father is the beneficiary of the account. Does my father open a regular IRA or inherited IRA? How would the title on the account be listed with my mother and brother deceased? Are they both listed?

Answer: Inheriting an inherited IRA complicates an already complex set of rules.

The regulations are different depending on whether the person inheriting is a spouse. Spouses can treat the inherited account as their own. They can leave the money where it is, make new contributions or transfer the funds to another retirement account they own. They also have more flexibility in how to take required minimum distributions from the account.

Non-spouse beneficiaries, like your mother, don’t have the option of treating the IRA as their own. They must set up a new inherited IRA and start distributions. Until this year, non-spouse beneficiaries could take distributions over their lifetimes. Now non-spouse beneficiaries are required to drain their inherited IRAs within 10 years.

How the account is titled is important, because improper titling can cause it to lose tax deferral and accelerate the tax bill. Let’s say your brother’s name was Tom Johnson and he died in March 2019, leaving his IRA to your mother, Mabel Johnson. A correct title for the new inherited IRA would be “Tom Johnson (deceased March 2019) Inherited IRA for the benefit of Mabel Johnson.”

Your family’s situation creates a hybrid of the two situations. Your dad would have an inherited spousal IRA, but his mandatory withdrawals would be based on your mother’s required minimum distributions, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

Your dad should open a new inherited IRA, Luscombe says. Assuming his name is Bill Johnson, the title of the inherited IRA should be “Tom Johnson (deceased March 2019) Inherited IRA for the benefit of Bill Johnson, successor beneficiary of Mabel Johnson.”

Filed Under: Inheritance, Q&A Tagged With: , ,