Individual Retirement Account

Tax bills for inherited IRAs

August 19, 2013 By Liz Weston

Dear Liz: I am 64. My grown children, ages 23 and 25, are the beneficiaries of my retirement accounts. I have a Roth IRA, a SIMPLE IRA and a Rollover IRA. When I die, what will be the tax consequences for them? Will they have to pay any tax upon inheriting the accounts, and will they have to pay any tax when they withdraw the money over time?

Answer: If your estate is worth less than $5 million, it’s unlikely it will incur federal estate taxes. Some states have lower exemption limits and a few have inheritance taxes. New Jersey and Delaware have both. An online search for “state estate and inheritance taxes” should turn up the situation for your state.

Your children won’t have to pay income taxes on distributions from your Roth, but unlike you or a spouse they are required to take distributions once they inherit the account. They can either do so within five years of your death or they can opt to spread the distributions over their lifetimes (which is usually the better option).

Minimum distributions also will be required from your IRAs. Your heirs will have to pay income taxes on those distributions.

Advise your children to consult a tax pro after you die, since these accounts need to be properly handled and titled to get the most benefit.

Combat zone contractors don’t get Roth IRA perk

March 4, 2013 By Liz Weston

Dear Liz: I’m working as a contractor in Afghanistan. Since we are overseas in a combat zone, our pay is nontaxable. Can I contribute some of this untaxed money to a Roth IRA and still be able to withdraw it tax free in retirement? I’ve heard that’s true, but the way I read the law it seems that the money has to come from “taxable” wages or something along those lines. I need clarification.

Answer: If you were serving in the military, rather than as a contractor, you would be able to contribute some of your untaxed combat-zone pay to a Roth IRA and have tax-free withdrawals in retirement. That’s a unique perk of the military, however.

Service members’ tax-free combat zone pay qualifies as income for purposes of making an IRA or Roth IRA contribution because of the 2006 Heroes Earned Retirement Opportunities Act, said Joseph Montanaro, a certified financial planner with USAA.

If your pay is tax free as a contractor, it’s probably because you qualify for the foreign earned income exclusion, which protects some or all of your pay from U.S. taxes (up to $95,100 for 2012), Montanaro said. Your eligibility for this exclusion has nothing to do with working in a combat zone. It has to do with your residence or physical presence abroad.

Income that is excluded this way cannot be used as compensation for the purpose of making an IRA contribution, Montanaro said. It would, however, have to be included when determining your eligibility to make a Roth contribution.

No 401(k)? Set up transfers to IRA

January 21, 2013 By Liz Weston

Dear Liz: I started a new job, but unfortunately it does not offer a 401(k). I have an IRA but don’t contribute to it. What is the best way to contribute so I can discipline myself in saving for retirement? I am 47.

Answer: The best way to save for retirement is to leave the issue of discipline out of it. If you have to discipline yourself to make the right choice every paycheck, you’ll wind up spending the money rather than saving it.

Instead, put your savings on automatic. You can contribute $5,500 year to your IRA. Divide $5,500 by the number of paychecks you get in a year and set up an automatic transfer of that amount. If you’re paid every other week, for example, you would divide $5,500 by 26 paychecks to get $211.54, which is the amount you should have transferred into your IRA every two weeks.

If you can save more, then open a regular brokerage account and set up automatic transfers into that. You won’t get a tax break for your contributions, but if you hold your investments for at least one year you’ll qualify for long-term capital gains rates that are lower than regular income tax rates.

Once you’ve set up these transfers you need to keep your hands off the money. Don’t treat your retirement funds as emergency cash or tap into them for any other reason. You’re getting a late start and you’ll need every dollar you can save if you want a comfortable retirement.

How good is your 401(k)?

October 1, 2012 By Liz Weston

Dear Liz: I just turned 65 and have left my job for a part-time position. My 401(k) is being transferred to a new investment company that I’ve never heard about before. Their fees seem to be lower. Is there a website where I can compare different firms?

Answer: There is. BrightScope at http://www.brightscope.com analyzes and rates the 401(k) plans of more than 46,000 companies. The ratings take into account total plan cost, investment options and the company match, among other factors. You find the ratings by entering the name of your employer, rather than that of the 401(k) manager.

If you investigate and decide you’re not comfortable with the new investment manager, you should have the option of rolling your account into an IRA, since you’ve left your old job.

Retiree can contribute to IRA

March 5, 2012 By Liz Weston

Dear Liz: I’m 64 and retired on a Social Security income of $10,000. My wife is also 64 and is still working, earning $91,000 a year. She contributes $13,000 to a 401(k). Can both of us also contribute the maximum $6,000 to our IRAs?

Answer: Since your wife has earned income, you both can contribute to IRAs, and you would be able to deduct your contribution. She, however, probably would be able to deduct only part of hers.

Because she’s covered by a retirement plan at work, her ability to deduct an IRA contribution for 2011 phases out at a modified adjusted gross income of between $90,000 and $110,000, said Mark Luscombe, principal analyst for tax research firm CCH, a Wolters Kluwer business. The portion of your Social Security benefits that are taxable would be added to her earned income to determine how much of her contribution is deductible.

“The working spouse would appear, therefore, based on the facts available, to only qualify for a partial deduction of her IRA contribution,” Luscombe said.

You’re luckier. As a non-working spouse, the phase-out range for deducting an IRA contribution is higher: In 2011, it applied to modified adjusted gross income between $169,000 and $179,000. “The non-working spouse would therefore, under these facts, qualify for a full deduction for a $6,000 contribution to an IRA,” Luscombe said.