by Daniel Kittell | Accounting News, Budget, News, Retirement Savings
If you’re in the market for a new house, you might be wondering if you can tap into your workplace 401(k) to cover the down payment. The short answer is yes, but there are definite disadvantages in doing so. Let’s take a look at some of the pros and cons to this approach.
Benefits of Borrowing from a 401(k) to Make a Down Payment on a House
- You’re borrowing from yourself rather than another lender, which means you might not be losing as much money on interest payments as you would if you acquire the funds through other means, like taking out a larger home loan to cover your down payment costs.
- The loan approval is typically hassle-free. Provided your workplace plan allows for loans, and you do indeed have sufficient funds in your 401(k), your credit score and other financial credentials shouldn’t impact your ability to borrow against it.
- The process is typically quick. Every plan is different and works on its own timeframe, but once you’ve decided to borrow from your 401(k), it’s usually just a matter of filling out a few forms to gain quick access to the funds.
- More money for a down payment may equal more options. Borrowing against your 401(k) plan will allow for a larger down payment, which will allow for wider options when it comes to mortgage lenders. It could also help you qualify for a better interest rate as well as help you dodge Private Mortgage Insurance (PMI).
A Note on PMI
PMI is customarily required when you have a conventional loan and make a down payment of less than 20 percent of the home’s purchase price. The most common way to pay for PMI is a monthly premium that is added to your mortgage payment. Because it protects the lender and not the borrower, many home owners want to avoid this added expense, but some choose to see it as just another expense of owning a home.
Disadvantages of Borrowing from a 401(k)
- You are diminishing your retirement savings, both in its immediate drop in balance and its future growth potential. Most likely, the return on investment (ROI) you would gain by keeping your money invested would be greater than the ROI from the interest you pay yourself (or the appreciation on your house).
- Your budget will take a hit. You are required to repay the 401(k) loan, which means that a portion of your future paychecks will go toward repayment. That means less money at your disposal for other expenses, such as homeownership costs.
- You will be on a repayment deadline. Borrowers typically get five years to repay a 401(k) loan. Depending on the size of your loan, you could potentially face large monthly payments in order to meet the repayment deadline.
- Inability to repay the loan will result in penalties. Your loan will be treated as a withdrawal if you are unable to pay it back in full by the deadline, which means that you will owe income taxes on it. You will also be subject to a 10% penalty associated with early withdrawals unless you were older than 59 ½ when you took the money out.
- Beware of the cost of leaving your job before the loan is paid. If you quit your job or experience a layoff, the entire loan amount will need to be paid by the due date for filing taxes that year. This could result in a need to repay the loan quickly in order to avoid penalties.
by Stephen Reed | Accounting News, COVID-19, Financial goals, News, Retirement, Retirement Savings
The COVID-19 pandemic has been more than a health crisis—it’s been a financial crisis as well. Business closures, job loss, reduced hours, and limited financial relief led to many savings accounts taking a major hit. As a result, more than 2 million Americans took advantage of the waived penalty for early withdrawal from a 401(k) or other qualifying account set forth in the CARES Act of 2020. This benefit may have been a financial life raft for some, but the move to tap into retirement funds isn’t without short- and long-term impact.
401(k) Early Withdrawal in 2020
Dipping into a retirement savings plan such as a 401(k) before age 59 ½ typically is not without penalty. However, in response to the ongoing COVID-19 crisis, the CARES Act of 2020 made it possible for retirement savers younger than 59 ½ to withdraw, for Covid-related reasons, up to $100,000 from qualified accounts without paying the usual 10% early-withdrawal penalty. For Americans who took a withdrawal, the money is yours and you don’t need to figure out a repayment plan. However, the flip side to this move is that retirement funds you’d planned to live on in the future are now diminished.
Taxes Upon Withdrawal Still Apply
The CARES Act temporarily eliminated the 10% early-withdrawal penalty, but the legislation didn’t pardon the taxes due. While you don’t generally pay taxes on contributions to traditional 401(k)s and IRAs, you do need to report income and pay taxes upon withdrawal. This holds true even though the CARES Act canceled the 10% early-withdrawal penalty for a short time. The temporary rules allow for the distribution to be spread across three years, but you need to account for a least one-third of the taxes due on that amount on your 2020 tax return.
Paying it Back is Recommended
Though you’re not required to pay back this type of withdrawal, experts agree that it’s generally in the saver’s best interest. Doing so allows you to avoid the taxes and to replenish your retirement account. If you pay back the full distribution amount within the three years, you can amend your tax returns and get all the money back paid in taxes.
For those who took a plan loan, you generally have five years to pay it back. You’ll need to be diligent in sticking to the plan’s repayment schedule. A loan that isn’t paid back could be counted as a distribution, therefore taxes (and possibly a penalty) will apply.
Strategize
Savers who took a coronavirus-related distribution have more leeway in developing repayment strategies that best serve their personal situations. Those who took a plan loan have less flexibility, but some repayment strategies could be advantageous, including:
- A mortgage refinance. Given the current low interest rates, refinancing might save a few hundred dollars a month. That savings could then be redirected to repay the 401(k) funds.
- A home equity line of credit. Take advantage of low interest rates, with the ability to pay back the line of credit over at least 10 years.
- Student loans. For savers with college-age children, don’t count out the possibility of relying on federal student loans to help fund college costs while using the freed-up out-of-pocket cash to help pay back funds taken from a 401(k), perhaps in a lump sum. A federal undergraduate loan interest rate of 2.75% through June 30, 2021 combined with conventional thinking that you can borrow to pay for college make a potentially attractive avenue. Just be aware to not overborrow and dig yourself deeper into debt.
Some people may need to apply more than one strategy to return the money to their 401(k), relying on different options that will get them through the next few years. Work with a financial advisor to help determine the best path forward to getting back on track.
by Pete McAllister | Accounting News, Business Consulting, News, Retirement
As a small business employer, signifying your commitment to employees’ long-term financial goals by offering a tax-favored retirement benefit is a solid way to draw in and retain valuable employees. Retirement plans may seem complex and costly, but there are straightforward and easily-enacted options available that are more affordable than you might think.
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) is a tax-favored retirement plan in which both employees and employers contribute to traditional IRAs. As long as an employer has no other retirement plan in place and doesn’t employ more than 100 workers, they are eligible to institute a SIMPLE IRA. Essential aspects of this plan include:
- Tax credits: Employers may be eligible for tax credits of $500 for the first three years of the SIMPLE IRA plan in order to counterbalance the costs of providing and managing the plan.
- Contributions: Employers are required to either make a matching contribution of one to three percent, depending on circumstances, to participating employees, or contribute two percent of each participating employee’s compensation.
- Tax deductions: In most cases employer contributions are tax deductible to the employer.
401(k) Plan
A 401(k) is a defined contribution plan in which an employer contributes a certain amount of employee’s pay (as chosen by the employee) to the plan. Essential aspects of this plan include:
- Contributions: Unlike SIMPLE IRAs, employers are not required to match contributions. An employee’s contributions to a traditional 401(k) are typically made on a pre-tax basis, with taxes on contributions and earnings deferred until they are distributed, usually upon retirement. 401(k) plans tend to be more appealing to employers than IRA-based plans because the maximum contributions are generally higher.
- Roth 401(k): This is an option in which an employee contributes to the plan on an after-tax basis. Distributions and earnings may be made tax-free in retirement after meeting certain conditions.
- Administrative costs: Because 401(k) plans are more complicated to maintain than SIMPLE IRAs, the administrative costs tend to be higher.
- Non-discrimination testing: 401(k) plans are subject to testing requirements designed to ensure that contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees (in 2020, this is someone who earned more than $130,000 the previous year). Those who fall into the “highly compensated” group can establish a Safe Harbor 401(k) plan in order to avoid nondiscrimination testing.
SEP Plan
With a Simplified Employee Pension (SEP) plan, employees receive IRAs that are funded entirely through company contributions. Essential aspects of this plan include:
- Eligibility: SEP plans are more popular among smaller businesses with fewer employees, but employers of any size are eligible.
- Contributions: Employers who institute a SEP plan determine an amount to contribute each year, with a limit set by the IRS.
- Tax credits: Qualified employers may qualify for a tax credit of $500 per year for the first three years of the plan, and employer contributions are tax deductible on the employer’s tax return.
myRA
This Roth IRA plan invests in a U.S. Treasury retirement savings bond. Essential aspects of the plan include:
- Contributions: Employees contribute to their account on an after-tax basis through payroll deductions, a checking or savings account, or income tax refunds. Earnings and distributions are generally tax-free.
- Cost: Because employers don’t administer or make contributions to these accounts, the employer only needs to share the information about a myRA option with employees and set up payroll deductions when applicable.
by Daniel Kittell | Accounting News, Business Consulting, News, Tax Planning, Tax Planning - Individual
The Setting Every Community Up for Retirement Enhancement (SECURE) Act changed the rules for employers on retirement plans, making it easier for employers to offer 401(k) plans and for employees to take part in them. Here’s how.
Multiple Employer Plans
Known as MEPs, multiple employer plans permit businesses to band together to offer employees a defined contribution plan such as a 401(k) or SIMPLE IRA, effectively allowing workers access to the same low-cost plans offered by large employers. While MEPs existed before the SECURE Act, here’s how they are now easier to establish and maintain.
- The “one bad apple rule”, where one employer’s failure to comply jeopardized the entire plan, was done away with.
- The “common nexus” requirement, which restricted the MEP option to small business employers who operated either in the same industry or same geographic location, was eliminated, permitting an “open MEP” that can be administered by a pooled plan provider (typically a financial services firm).
- MEPs with fewer than 1,000 participants (and no more than 100 participants from a single employer) are excluded from a potentially expensive audit requirement.
- Small business employers are also eligible for new tax credits for offering retirement savings options to employees.
Changes to Safe Harbor Plans
A provision of the SECURE Act provides more flexibility for employers who offer safe harbor 401(k) plans, which are 401(k) plans with an employer match that allows for avoidance of most annual compliance tests. If a 401(k) includes a Safe Harbor provision, the employer makes annual contributions on behalf of employees, and those contributions are vested immediately. Flexibility offered by the SECURE Act includes:
- Increasing the automatic enrollment escalation cap under a qualified automatic contribution arrangement (QACA) 401(k) plan from 10 to 15%.
- Removing the notice requirement for nonelective contributions. (The notice requirement is still applicable, however, for plans that implement the safe harbor match.)
- Whereas pre-SECURE Act, switching to a safe harbor plan had to be done before the start of the plan year, employers are now allowed to switch to a safe harbor 401(k) plan with nonelective contributions anytime up to 31 days before the end of the plan year. Amendments after that time are approved if (1) a nonelective contribution of at least 4% of compensation is granted for all eligible employees for that year, and (2) the plan in amended by the close of the following plan year.
Automatic Enrollment Credit
The SECURE Act added an incentive for small businesses to feature automatic enrollment in their plans by allowing businesses with fewer than 100 employees to qualify for a $500 per year tax credit when they create a new plan that includes automatic enrollment. Business can also take advantage of this by converting an existing plan to one with an automatic enrollment. The tax credit is available for three years following the year the plan automatically begins enrolling participants.
Part-Time Employee Participation
Previously, employers could exclude employees who work fewer than 1,000 hours per year from defined contribution plans, including 401(k) plans. Starting in January of 2021, the SECURE Act requires employers to include employees who work at least 500 hours in three consecutive years. This means that in order to qualify under this rule, employees would need to meet the 500-hour requirement for three years starting in 2021 in order to become eligible in 2024.
Choosing the Right Plan for Your Business
- Research 401(k) plan options for your business, keeping in mind that retirement plans can be customized to meet the needs of you and your employees.
- Carefully read through costs and fees of each plan. Recordkeeping fees, transaction fees, and investment fees are some to be mindful of, and these fees might increase if you add more employees and the plan grows (i.e. low-cost plans upfront might not be the best plan for your business in the long term.)
- Look for a 401(k) plan that presents a variety of investment opportunities for employees in terms of stocks, bonds, broad-based international exposure, and emerging markets.
Work with a financial expert who can help you establish and oversee a 401(k) plan. These professionals can include third-party administrators, recordkeepers, and investment advisors and managers.
by Jean Miller | Estate / Trust Tax - Individual, Estate Planning - Individual, Healthcare, News, Retirement, Tax Planning - Individual, Tax Preparation - Individual
As the clock winds down to the end of the year, there are a few last-minute money moves to make in order to lower your tax bill.
Maximize Your 401(k) and HSA Contributions
While tax deductible contributions can be made to traditional and Roth IRA accounts until April 15 of 2020, the deadline for 401(k)s and HSA accounts is December 31 of this year. You can contribute up to $19,000 to a 401(k), 403(b), most 457 plans, and federal Thrift Savings Plans (plus $6,000 in catch-up contributions for those who are 50 or older). As for HSA accounts, the maximum contribution for 2019 is $3,500 for individuals and $7,000 for family coverage. And if you’re 55 or older you can contribute an additional $1,000.
Start Thinking About Retirement Contributions for 2020
Retirement contributions to 401(k)s have increased for 2020. Individuals can contribute $19,500 next year, and those 50 or older can contribute an additional $6,500. If you prefer to spread out your contributions evenly throughout the year, you’ll need to adjust your monthly contribution amounts by January.
Take Advantage of Your Flexible Spending Account
Funds in a flexible spending account revert back to the employer if not spent within the calendar year. Some companies might provide a grace period extending into the new year, but others end reimbursements on December 31.
Prevent Taxes on an RMD with Charitable Donations
After seniors reach age 70 ½ they must take a required minimum distribution each year from their retirement accounts (an exception to this rule is a Roth IRA account). Seniors who aren’t dependent on this money for living expenses should consider having it sent directly from the retirement account to a charity as a qualified charitable distribution, effectively preventing the money from becoming taxable income.
Consider a Roth Conversion
Because withdrawals from traditional IRAs are taxed in retirement while distributions from Roth IRAs are tax-free, you might think about converting some funds from a traditional IRA to a Roth IRA. Just be sure this move doesn’t tip you into the next tax bracket. You’ll need to pay taxes on the initial conversion, but the money will then grow tax-free in the Roth IRA.
Take Stock of Losses
Sell any losses in stocks for a deduction of up to $3,000, but be aware that purchasing the same or a substantially similar stock within 30 days of the sale would violate the wash-sale rule. If that happens your capital loss would be deferred until you sell the new shares.
Meet with a Tax Advisor
If you’re unsure whether or not you’re ending the year in a favorable tax bracket, check in with an advisor who can identify actionable steps to reduce taxable income through retirement contributions or itemized deductions.
