Q&A: How contribution rules differ for IRA and 401(k) accounts

Dear Liz: I recently changed jobs. Typically I max out my 401(k) contributions each year. I contributed $20,700 to my previous company’s plan before quitting. Eligibility for my new company’s 401(k) doesn’t kick in until after 12 months of continuous employment, so I won’t be able to access this benefit until 2023. Can I set up an IRA or Roth IRA to reach the $27,500 limit for people 50 and older? I am married, filing jointly and our combined income exceeds $214,000.

Answer: Please talk to your company about fixing this outmoded requirement, which is costing its workers enormously in lost matching funds and compounded returns. Most companies have much shorter waiting periods, and the most enlightened employers enroll workers immediately. It’s hard enough to save adequately for retirement without an arbitrary yearlong delay.

The limits for contributing to workplace plans are separate from those for IRAs and Roth IRAs. For 2022, the limits for 401(k)s are $20,500 for people under 50 and $27,500 for people 50 and older. The contribution limits for IRAs (regular or Roth) are $6,000 for people under 50 and $7,000 for people 50 and older.

If you had access to a workplace plan at any point during the year, your ability to deduct your contribution would phase out with modified adjusted gross income between $109,000 and $129,000 if you are married filing jointly, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. The phaseout is between $68,000 and $78,000 for single taxpayers.

Normally when you can’t deduct an IRA contribution, you’re better off contributing to a Roth IRA. Contributions to a Roth aren’t deductible but withdrawals are tax-free in retirement.

However, the ability to contribute to a Roth IRA phases out with modified adjusted gross incomes between $204,000 and $214,000 for married joint filers and between $129,000 and $144,000 for single filers.

If you can’t contribute directly to a Roth, you could consider what’s called a “back door” Roth contribution, in which you contribute to a regular IRA and then convert the money to a Roth. Although direct Roth contributions have income limits, Roth conversions do not. However, you are required to pay income taxes on a typical conversion, so this maneuver works best if you don’t already have a large pretax IRA.

Q&A: Mortgage payoff or emergency savings?

Dear Liz: My husband was laid off recently, and he quickly took a new job with a 25% pay cut to continue insurance benefits and the same retirement program. We regularly pay $500 to $1,300 extra on our house payment. We cannot keep that up. However, with his severance package and vacation day payout, we now have more in our bank account than we owe on our mortgage. If we paid off the $80,000 mortgage now (house is valued at $600,000), we’d have an emergency fund of only $10,000, but we could replenish those savings slowly each month with no house payment. We have no other debts. How do we know when is the right time to pay off the mortgage?

Answer: Think about what would happen if you paid off the mortgage and your husband were to be laid off again or you suffered some other financial setback. The $10,000 left in your emergency fund could be depleted quickly. If you don’t have stocks or other assets you could sell, you might have to raid your retirement accounts or turn to high-cost loans.

This is why financial planners recommend having an emergency fund equal to three to six months’ worth of expenses if possible — and why using your savings to pay off a low-rate debt might not be the best use of your money.

If you’re determined to pay off your mortgage, consider setting up a home equity line of credit first. That will give you a relatively inexpensive source of credit in an emergency.

Q&A: Identity theft fears? Get a credit report, credit freeze

Dear Liz: I divorced 32 years ago. Recently, I received calls from a collection agency about a debt that has not been paid. I discovered that my ex used my phone number as one of his contact numbers. My number is supposed to be unlisted and unpublished, but he found it online. I have stopped receiving calls from the agency, but how do I stop this from happening again?

Answer: Please check your credit reports to make sure your ex didn’t swipe even more sensitive digits: namely, your Social Security number. If his credit is bad, he may be tempted to pretend to be you in order to get credit cards, loans or other accounts. That’s identity theft, and there are steps you should take now to protect yourself.

You can access your credit reports for free at AnnualCreditReport.com. (If you’re asked for a credit card number, you’re on the wrong site.) Look for any accounts that aren’t yours and consider freezing your credit reports at each of the bureaus. Credit freezes prevent someone from opening new accounts in your name. You can thaw the freeze whenever you need credit, also for free.

You can’t prevent someone from adding your phone number to their credit applications, but under federal law you can tell a collection agency to stop contacting you, and it must comply. Make the request in writing.

Q&A: Revisiting a Medicare penalty

Dear Liz: As a county employee of 44 years, I was offered the option to contribute to Social Security in the mid-1970s. It was not mandatory and I declined. When I retired in 2004, I did not apply for Medicare as I wrongly assumed that I would not qualify. I have since learned that I can apply for Medicare but that I would have to pay $499 per month as a late enrollment penalty on top of the monthly premium. Do you know any way that I can get a portion of the late penalty waived?

Answer:
As your situation shows, not getting sound advice about Medicare can be expensive. Failing to sign up for Part B coverage, which pays for doctor’s visits, can incur penalties of 10% for each 12 months you were eligible but didn’t enroll. The penalties are typically permanent.

There is an appeals process, but your chances of success may not be great unless you can prove that you delayed enrollment because of bad advice you got from a government representative. Medicare has more information on its site.

Q&A: Profit sharing and retirement

Dear Liz: I work for a wonderful company that has a generous profit-sharing plan. I am 61 years old and plan on working until I am 65 and eligible for Medicare. Due to some health issues, I am reducing my hours and this will significantly reduce my income for the next four years. I thought this was a good plan because it keeps my health insurance intact, but now I am wondering if the lower earnings will affect my profit sharing when I retire. I know the final distribution is based on earnings and time on the job. Should I retire now, while my income is up, or should I wait until I am 65?

Answer: There are a lot of moving parts to any decision about retirement. How much will health insurance cost and how will you pay for it? How much do you have saved and how long are those funds likely to last? What’s the best time to apply for Social Security and how will that affect your retirement fund withdrawals? (It’s often best to delay Social Security as long as possible and draw down retirement savings instead, especially if you’re the primary earner, but individual situations vary.)

Money is a finite resource, but so are time and energy. Every additional year you work could put you in better financial shape, but means one less year in which you could be enjoying retirement.

Consider talking to your human resources department to find out exactly how your reduced hours are likely to affect your profit sharing payout. Then take those numbers to a fee-only financial planner who can examine the rest of your finances and talk with you about the best glide path into retirement.

Q&A: How to start an IRA for your new Gen Z college graduate

Dear Liz: My son is about to graduate from college and, as a present, I want to use $10,000 to start an IRA for him. But which is better? A Roth or a standard IRA?

Answer: Congratulations to both of you! Starting a retirement account is a great idea, but you should be aware of the numerous rules that limit who can contribute and how much.

Let’s start with the annual contribution limit, which for 2022 is $6,000 for people under 50. (People 50 and older can make an additional $1,000 “catch up” contribution.) Also, your son needs to have earned income — such as wages, salary or self-employment income — that is at least equal to the size of the contribution you want to make. In other words, he needs to earn $6,000 for you to contribute $6,000. If he’s about to start a full-time job, that probably won’t be an issue, but if he’s not working, or working only part time before starting graduate school, that might further limit how much you can contribute.

For all of those reasons, a Roth IRA contribution may be best. He won’t get an upfront tax deduction but withdrawals in retirement will be tax free. He can withdraw Roth contributions at any time without taxes or penalties, so the Roth can serve as a de facto emergency fund. Obviously, it’s better to leave the money alone to grow, but having access to the cash could be helpful while he builds a regular emergency fund.

Q&A: How to get tax return copies

Dear Liz: Isn’t it the duty of an accountant to send their client the final tax forms that they filed with the IRS and the state? My accountant keeps “forgetting” to do so, and I’ve called him twice to do this. I’m not sure if his constant “forgetfulness” is due to laziness or a health issue such as dementia. I suspect it might be the latter, as he never used to be this way in past years.

Is there another way to get a copy of my returns? I will obviously be looking for a new accountant.

Answer: Yes, you can request copies or transcripts of your returns from the IRS and your state tax agency.

Transcripts are free, and are available for the previous three years. Personally identifiable information such as your name, address and Social Security number will be hidden, but you’ll be able to see all the financial entries, such as your adjusted gross income, taxes paid and so on. You can request transcripts online at irs.gov/individuals/get-transcript, by phone at (800) 908-9946 or by mail using either Form 4506-T or Form 4506-T-EZ and using the IRS address listed on the form.

Copies of your actual tax returns will cost you $43 each. You can request those by filling out and mailing Form 4506.

Your state will have similar procedures, which you can find by searching for your state’s name and the phrase “How do I get a copy of my state tax return?”

Q&A: Why credit scores drop suddenly

Dear Liz: The same thing happened to me as to the person in your column whose credit score dropped more than 100 points after large purchases. We bought plane tickets for international travel and our credit score took a significant but temporary hit. This also happened when we made a charitable gift by credit card. After an appeal, I was able to get the credit limit on the credit card we use the most increased, and I’m waiting to see if that prevents the credit score from dropping going forward. I did check our credit reports and there were no missed payments or other problems.

Answer: Credit scores can drop when you use a lot of your available credit, but a 100-plus-point drop is unusual and should be investigated. You’re smart to look for ways to mitigate the damage from high usage. Asking to have credit limits increased is one way; another is making a payment before the statement closing date. The balance on that closing date is what’s generally reported to the credit bureaus, and thus what’s factored into your scores. Just remember to pay off any remaining balance before the due date.

Q&A: Homeownership and taxes

Dear Liz: Five years ago I co-signed on a mortgage for my daughter’s condo in another state. I provided the down payment and paid to upgrade the water, HVAC and kitchen appliances. She paid the mortgage and all other expenses. She also claimed the mortgage interest on her taxes every year. She just sold the condo and is moving to another state. The net proceeds will mostly be used for the down payment on the next property. My name will not be on that one. She will pay me back for the down payment in installments.

I’m aware that the year a property is sold is the only time to claim the upgrades for a deduction. I haven’t been claiming any part of the condo in the last five years. Is there some way to do that on my 2022 taxes? Or should she take the deduction and pay me back in more installments down the road? Obviously, I don’t want to make a claim that will hurt her 2022 taxes, but it would be nice to recoup some of it.

Answer: Home improvements on a personal residence aren’t deductible. If your daughter had paid for the upgrades, she could use the cost to reduce the amount of home sale profits that might otherwise be subject to capital gains taxes. These upgrades can be added to the home’s tax basis, which is typically the amount that was paid to purchase the home. The basis is what is deducted from the amount realized from the sale. It’s the sales price minus any selling costs, such as real estate commissions.

People who live in a home for two of the five years prior to the sale can exclude up to $250,000 of those profits from taxes. (Married couples can exclude up to $500,000.) Unfortunately, those limits haven’t changed since 1997 even as the average home sale price has nearly tripled.

Too often, people don’t discover they owe a tax bill until after they’ve invested the money in another home or otherwise spent it. If your daughter hasn’t already, she should consult a tax pro so she understands what, if any, taxes she may owe on her sale.

Q&A: This retiree’s tax preparer allowed IRS fines to accumulate for 15 years. Now what?

Dear Liz: I have a question about an unethical accountant. I am a retiree living on my investments. My accountant continually put me on extension and every October told me how much to pay. Finally, I created an account with the state tax agency and discovered I was being billed for interest, fees and penalties for failing to pay estimated quarterly taxes. What really gets me angry is how I was never told I needed to pay these taxes each quarter. This has been going on at least 15 years. What are my options? Is there an entity that governs the behavior of accountants?

Answer: There is — if your tax preparer is actually an accountant. Some tax preparers use that title even if they don’t have an accounting credential, said Henry Grzes, lead manager for tax practice and ethics with the American Institute of CPAs.

If your tax preparer is in fact a certified public accountant, then you can make a complaint to your state’s board of accountancy. You can find a list of boards here. Otherwise you can consider contacting the Better Business Bureau, your state’s consumer protection agency or the Consumer Financial Protection Bureau, Grzes said.

A good tax preparer will alert clients to ways they can reduce their tax bill and will discuss the reasons for filing an extension as well as the need to make quarterly estimated payments, Grzes said. But there are no federal regulations governing tax return preparation, although some states have such laws, he said.

For example, anyone who is physically in California and prepares tax returns for a fee, and who is not an attorney, CPA or enrolled agent, is required to register with the California Tax Education Council, Grzes said. The CTEC site has information about how to file a complaint against a tax preparer who isn’t governed elsewhere.