March 23, 2020 By

Q&A: Reducing taxes in retirement

Dear Liz: I agree with this concept of delaying Social Security to lessen overall taxes and have a further suggestion. My spouse and I are gradually converting our traditional IRA account funds to Roth IRAs. The converted funds are immediately taxable but could continue to gain in value and future distributions would not be taxable. Also, Roth accounts don’t have required minimum distributions.

Answer: Conversions make the most sense when you expect to be in the same or higher tax bracket in retirement.

That’s not the case for most people because they’re in a lower tax bracket when they stop working. Some older people, however, do face higher tax rates in retirement — typically because they’ve been good savers, and required minimum distributions from their retirement accounts will push their tax rates higher.

When that’s the case, they may be able to take advantage of their current lower tax rate to do a series of Roth conversions.

The math can be tricky, though, so it’s advisable to get help from a tax pro or financial planner. You don’t want to convert too much and push yourself into a higher tax bracket, or trigger higher Medicare premiums.

If your intention is to leave retirement money to your heirs, Roth conversions may also make sense now that Congress has eliminated the stretch IRA.

Stretch IRAs used to allow non-spouse beneficiaries — often children and grandchildren — to take money out of an inherited IRA gradually over their lifetimes. This spread out the tax bill and allowed the funds to continue growing. Now inherited IRAs typically have to be drained within 10 years if the inheritor is not a spouse.

To compensate, some people are converting IRAs to Roths — essentially paying the tax bill now, so their heirs won’t have to do so later. Heirs would still have to withdraw all the money in an inherited Roth IRA within 10 years, but taxes would not be owed.

Filed Under: Q&A, Retirement Tagged With: , , , ,
March 16, 2020 By

Q&A: Which to tap first: IRA or Social Security?

Dear Liz: I retired in 2015 but have not started Social Security. My wife and I are living on a pension and savings. I read an article saying that taking early IRA withdrawals and holding off on Social Security can help minimize the so-called tax torpedo, which is a sharp rise and fall in marginal tax rates due to the way Social Security benefits are taxed.

I made a spreadsheet to compare the cumulative income we could expect by starting IRA withdrawals now and delaying Social Security until age 70, versus starting Social Security now and delaying the IRA withdrawals. The spreadsheets indicate that by taking early IRA distributions and delaying Social Security, we would get a significant increase in total cumulative income as the years go by.

We feel we need a professional to verify our results and perhaps advise us as to which might be our best route, as well as getting an assessment of our income tax implications for the next five years or so. My wife thinks we should ask a Certified Public Accountant and is concerned about the price of a fee-only advisor.

Answer: Your findings are similar to what researchers reported in the July 2018 issue of the Journal of Financial Planning. The tax torpedo increases marginal tax rates for many middle-income households. One solution is to delay Social Security until age 70 and tap IRAs instead. That maximizes the Social Security benefit while reducing future required minimum distributions.

It’s always a good idea to get an objective second opinion on retirement distributions, however. Mistakes can be costly and irreversible. A fee-only certified financial planner should have access to powerful software that can model various scenarios to help confirm your results and guide your next steps.

Filed Under: Q&A, Retirement, Social Security Tagged With: , , ,
February 25, 2020 By

Tuesday’s need-to-know money news

Today’s top story: Home Down payment – more attainable than you may think. Also in the news: The best balance transfer credit cards for business, the SmartMoney podcast tackles converting an IRA to a Roth, and how to avoid higher airline baggage fees.

Home Down Payment: More Attainable Than You May Think
Big down payments don’t have to be an obstacle.

Best Balance Transfer Credit Cards for Business
Three great options.

SmartMoney Podcast: ‘Should I Convert My IRA to a Roth?’
How to decide if and when to convert.

To Avoid Higher Airline Baggage Fees, Plan Ahead
Pay online to pay less.

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January 16, 2020 By

Thursday’s need-to-know money news

Today’s top story: How to get traction paying off your credit cards in 2020. Also in the news: 8 moves to consider for IRAs and 401(k)s under the new Secure Act, using points and miles for wedding travel, and the 5 best states for retirees in 2020.

How to Get Traction on Paying Off Your Credit Cards in 2020
Finding the right strategy for your situation.

8 Moves to Consider for IRAs, 401(k)s Under New Secure Act
Looking at the major changes to retirement savings plans.

Ask a Points Nerd: Should I Use Points and Miles to Book Wedding Travel?
To pay or not to pay?

Here are the 5 best states for retirees in 2020
Which one sounds good to you?

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December 17, 2019 By

Tuesday’s need-to-know money news

Today’s top story: New Year, Fresh Finances: How to rebound after banking troubles. Also in the news: Gift card expiration dates, 5 great reasons to carry a hotel credit card, and why lawmakers may kill this popular retirement tax break for the wealthy.

New Year, Fresh Finances: How to Rebound After Banking Troubles
Giving yourself a fresh start.

When Do Your Gift Cards Expire?
Checking the fine print.

5 Great Reasons to Carry a Hotel Credit Card
Extra perks that make it worthwhile.

Lawmakers may kill this popular retirement tax break for the wealthy
Say goodbye to the “stretch IRA”?

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November 18, 2019 By

Q&A: This forgotten account shouldn’t turn into a spending spree

Dear Liz: I just got a message about thousands of dollars I have in a 401(k) account from a job I had over 10 years ago. They are asking me what I want to do with the money, roll it over into an IRA or cash it out. What should I do?

Answer: Don’t cash it out.

Unexpected money can feel like a windfall, and it’s natural to dream about potential splurges you could afford. But this cash didn’t fall out of the sky. This is money you earned and that could grow substantially if you make the right moves now. If you cashed it out, you’d lose a substantial chunk to taxes and penalties, plus you’d lose all the future tax-deferred growth that money could earn.

Your best option probably would be to transfer the money directly into your current employer’s retirement plan, if you have one and it allows such transfers. Employer plans may offer lower-cost access to investments than you’d get with an IRA, plus consolidating the old plan into the new means one less account to monitor. Also, employer plans may offer more protection from creditors, depending on where you live.

Rolling the money directly into an IRA is another good option. You’ll need to open an account, preferably at a discount brokerage that keeps costs low. An IRA would give you access to more investment options, but beginning investors might just want to opt for a target date retirement fund or a robo-advisory service that invests using computer algorithms. With either option, the mix of investments and the risk over time would be professionally managed.

Whichever you choose, make sure the old plan sends the money directly to your chosen option, rather than sending you a check. If a check is sent to you, 20% of the money would be withheld for taxes and you’d have to come up with that amount out of your own pocket within 60 days or that portion would be considered a withdrawal that’s taxed and penalized.

Filed Under: Q&A, Retirement Tagged With: , , ,
May 6, 2019 By

Q&A: Here’s a big tax mistake you can easily avoid

Dear Liz: I’m self-employed and my wife wasn’t working last year. In December, we returned to California and found a small home to purchase using $107,000 I took out of my IRA. Since we weren’t quite certain of what our income would be, we received our health insurance in Oregon through an Affordable Care Act exchange.

When we filed our taxes we got hit with a $20,000 bill for the insurance, because we earned too much to qualify for subsidies, and a $10,000 bill for the IRA withdrawal. Our goal was to own our home outright, which we do, but now we have a $30,000 tax bill hanging over us.

Can we work with the IRS somehow on this? We didn’t “earn” the $107,000; we invested it in a home. It wasn’t income, so why should we be punished for using our savings to purchase a home?

Answer: If you mean, “Can I talk the IRS out of following the law?” then the answer is pretty clearly no. The IRA withdrawal was income. It doesn’t matter what you did with it.

Consider that you probably got a tax deduction when you contributed to the IRA, which means you didn’t pay income taxes on that money. The gains have been growing tax deferred, which means you didn’t pay tax on those, either.

Uncle Sam gave you those breaks to encourage you to save for retirement, but he wants to get paid eventually. That’s why IRAs and most other retirement accounts are subject to required minimum distributions and don’t get the step-up in tax basis that other investments typically get when the account owner dies.

(If you did not get a tax deduction on your contributions, by the way, then part of your withdrawal should have been tax-free. If you’d contributed to a Roth IRA, your contributions would not have been deductible but withdrawals in retirement would be tax-free.)

The IRS does offer long-term payment plans that may help. People who owe less than $50,000 can get up to six years to pay their balances off. You would file Form 9465 to request a payment plan. The IRS’ site has details.

Here’s a good rule to follow in the future: If you’re considering taking any money from a retirement account, talk to a tax professional first. People often dramatically underestimate the cost of tapping their 401(k)s and IRAs; a tax pro can set you straight.

Filed Under: Q&A, Real Estate, Taxes Tagged With: , , , ,
January 21, 2019 By

Q&A: Is it smarter to save for retirement or pay off debt first?

Dear Liz: I graduated from college in May and began a full-time job in October making $36,000. I also do freelance work and receive anywhere from $500 to $1,000 a month from that. I live at home, so I don’t have to pay for rent or groceries, which really helps. Currently, I have just over $18,800 in student loans at an average interest rate of 4.45%. I have also opened a Roth IRA.

My plan currently is to contribute $500 a month to my IRA in order to max it out, and pay $700 a month to my student loans in order to get them out of the way quickly. Or is it better to skip the Roth and put that extra $500 toward my student loans? That way, I would be debt free when I move out of my parents’ house next year. The stock market has done nothing but fall since I opened my account, and I am reading that it could do the same this year as well. But I have also read that it’s good to just keep consistently contributing to an IRA when your debt isn’t high-interest to reap the rewards of compounded returns.

Answer: It’s generally a good idea to start the habit of saving for retirement early and not stop. What the market is doing now doesn’t really matter. It’s what the market does over the next four or five decades that you should care about, and history shows that stocks outperform every other investment class over time.

The $6,000 you contribute this year could grow to about $100,000 by the time you’re in your 60s, if you manage an average annual return of around 7%. (The stock market’s long-term average is closer to 8%.) And Roth IRAs are a pretty great way to invest, because withdrawals are tax-free in retirement.

That said, your other option isn’t a bad idea either. You are not proposing to put off retirement savings for years while you pay off relatively low-rate debt, which clearly would be a bad idea. Instead, what you’re losing is the opportunity to fund a Roth for one year. That’s an opportunity you can’t get back — but you could fully fund the Roth next year, and perhaps use some of your freelance money to fund a SEP IRA or solo 401(k) as well.

Either way, you should be fine.

Filed Under: Q&A, Retirement, Student Loans Tagged With: , , ,
January 14, 2019 By

Q&A: Why do 401(k) and IRA contributions have such different rules?

Dear Liz: Can you please explain to me why the IRS allows an employee in a workplace 401(k) to contribute $19,000 but a wage earner without a 401(k) can contribute only $6,000 to an IRA? This seems grossly unfair. Why does one group get to save three times as much for retirement?

Answer: Congress works in mysterious ways, and this is far from the only weird byproduct of tax law.

The 401(k) and the IRA were created through different mechanisms.

The 401(k)’s birth was almost accidental. Benefits consultant Ted Benna created the first 401(k) savings plan in 1981, using a creative interpretation of a section of IRS code. Benna crafted the plan to provide an alternative to cash bonuses, not to replace traditional pensions — although that’s what it ended up doing.

IRAs, by contrast, were created deliberately by Congress in 1974 to provide a way for people to save independent of their employers.

Raising the IRA limit would be costly to the budget, while decreasing 401(k) limits would be unpopular, since so many people rely on them for the bulk of their retirement savings.

You aren’t, however, limited to saving only $6,000 annually for retirement. You can always save more in a taxable account. You wouldn’t get the tax deduction for contributions, but your investments can qualify for favorable long-term capital gains treatment if you hold them for at least one year.

Filed Under: Q&A, Retirement Tagged With: , , ,
December 3, 2018 By

Monday’s need-to-know money news

Today’s top story: Free investments can come at a cost. Also in the news: How to not be your own worst enemy when investing, 5 things to cut your tax bill by December 31st, and how to increase your 401(k) or IRA contributions for 2019.

Free Investments Can Come at a Cost
Free doesn’t always mean without cost.

Don’t Be Your Own Worst Enemy When Investing
Look for help.

Do These 5 Things by Dec. 31 to Cut Your Tax Bill
You’ve still got time.

Increase Your 401(k) or IRA Contributions for 2019
Boost your retirement savings.

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