by Jean Miller | Accounting News, Estate / Trust Tax - Individual, Estate Planning - Individual, News
Contrary to popular belief, estate planning isn’t just for the wealthy. Your estate includes everything you own, and it’s worth taking the time to plan for what will happen to it. Below we’ll go over steps you can take to be sure your money and assets are kept safe from unwanted surprises, like excessive taxes and unintended heirs.
Create a Will
This may seem like an obvious step, but according to a recent study published by Caring.com, only 33% of the 2,500 Americans who were surveyed said they have a will. If you don’t have a will, your estate goes to probate court—a process whereby state laws determine how your estate will be divvied up and to whom your assets will go. It’s a time-consuming and expensive process. To be clear, even with an established will, your heirs will still need to go through the court system in order to confirm the validity of the will.
Specify Your Beneficiaries
Name beneficiaries for your assets if you want to avoid probate court. Check to see if certain accounts like retirement funds and life insurance policies will allow you to designate beneficiaries for that specific asset. Some accounts will even permit transfer-on-death (TOD) provisions, which is a hassle-free way to pass assets to heirs. You can also check if your state allows beneficiary deeds, which allow property to be automatically transferred to a new owner when the current owner dies, without the requirement to go through probate.
It’s important to note that a beneficiary or TOD specification tops a will, so be sure to review beneficiary information after every milestone event (i.e., marriage, divorce, birth of a child).
Set Up a Trust
Trusts are established in order to control distributions from the estate to the surviving spouse and children, and to assure that assets are used in a way in which the person setting up the trust feels suitable. If you hold your property in a trust, your heirs won’t be required to go through a probate court.
- Revocable living trust: You can assign parts of your estate to go toward certain things while you’re alive, and you can modify the trust after it’s created. If you fall ill or become incapacitated, your chosen trustee can take over. Upon your death, the trust assets transfer to your designated beneficiaries.
- Irrevocable trust: You cannot modify the trust after it’s created, but irrevocable trusts offer tax shelters that revocable trusts do not.
Reduce Taxes with a Roth Account
Because regular income tax must be paid on distributions from all traditional retirement accounts, those with traditional 401(k) or IRA accounts could unwittingly leave their heirs a hefty tax bill. Converting those accounts to Roth accounts can help to reduce taxes considerably for heirs. While a Roth’s converted amount is subject to regular income taxes, withdrawals—whether by you or your heirs—are tax free.
Gift Your Money While You’re Still Living
As of 2021, the IRS permits individuals to gift up to $15,000 per person per year. If you’re looking to bypass estate taxes, gifting can bring the value of your estate down. The money is also tax-free for recipients. Just be careful not to give away assets that appreciate in value. The taxable amount of these assets, such as stocks or a house, is adjusted upon the owner’s death. Therefore, it may be favorable to transfer certain assets after death rather than before.
by Stephen Reed | Accounting News, News, Retirement Savings, Uncategorized
The Roth IRA is a unique retirement savings tool. While there is no upfront tax break with a Roth IRA, it grants you tax-free management of your income and gains as long as you retain your investments within the account. Roth IRAs are also flexible, which allows for better access to your funds than traditional retirement accounts. However, the five-year rule—which is actually a set of rules—dictates the penalty and tax-free eligibility of your Roth IRA withdrawals. Here are the rules investors need to be aware of.
Your First Contribution
In order to avoid taxes on distribution from your Roth IRA, you must wait five years after your first contribution to withdraw your earnings tax-free. The five-year period begins on the first day of the tax year for which you made a contribution to any Roth IRA, not necessarily the specific Roth IRA account you’re withdrawing from. For example, if you put money into a Roth IRA for the first time in early 2020 but contributed it toward the 2019 tax year, then the five-year waiting period will end on January 1, 2024.
Because the money you contributed to the Roth IRA was an after-tax contribution, if you withdraw funds before the five-year period, only the growth of the account is potentially subject to income tax.
One more point to make note of in regards to the five-year rule: This rule supersedes the one that states you must be 59 ½ in order to withdraw from a Roth IRA without incurring taxes and penalties. This means that even if you meet the age requirement when you withdraw, you still must have made your first contribution at least five years prior in order to avoid being taxed. You won’t owe a 10% penalty fee for early withdrawals, but you’ll still owe tax on any withdrawals above the amount contributed.
- Penalty for breaking this rule: You will be required to pay taxes on the earnings portion of the withdrawals. However, Roth IRA withdrawals give preference to contributions before earnings. Therefore, if you have enough cumulative contributions to cover the amount you wish to withdrawal before the five-year mark of your first contribution, you may be able to make the withdrawal tax-free.
Roth Conversions
There is an additional five-year rule that was established in order to prevent people from using Roth conversions to gain penalty-free access to their traditional retirement accounts. This rule, therefore, applies to those who convert other kinds of retirement accounts, such as a 401(k), into Roth IRAs. This rule starts on Jan. 1 of the year in which you do the conversion. As a result, if you convert in, say, Nov. 2021, you will only need to wait a bit longer than four years (Jan. 2026) before taking withdrawals.
However, unlike the first-contribution five-year rule, this rule applies individually to each Roth conversion you do. All new conversions start their own five-year clock, and you’ll need to account for multiple conversions to be sure you don’t withdraw too much money too soon.
It’s important to note that if you’re using the backdoor Roth IRA strategy (i.e., contribute to a traditional IRA then immediately convert the account to a Roth IRA), this five-year rule will treat your “Roth contributions” as conversions, and you can’t withdraw them for five years without penalty.
- Penalty for breaking this rule: You will be required to pay a 10% penalty on any withdrawals, including withdrawals of the amount you initially converted (this is on top of the taxes you already paid on that amount). However, if you are over age 59 ½, the age exception will apply, and you can immediately take withdrawals penalty-free.
Inherited IRAs
First, inherited IRAs are also subject to the first-contribution five-year rule. Therefore, if the original owner’s initial contribution was less than five years before you inherited the account, the earnings are subject to taxes.
If you inherit a Roth IRA from someone who is not your spouse, you have a couple of options. The first is to spread out distributions from the inherited IRA up to 10 years, taking required minimum distributions (RMDs) based on your life expectancy each year (if the account owner lived beyond the RMD age, this is your only option.). The second option is to take lump-sum distributions. If you choose this option, you are obliged to exhaust the account by Dec. 31 of the fifth year succeeding the death of the original owner. While you can take distributions of any amount up to that date, you are required to withdraw 100% of the funds by the end of the fifth year.
- Penalty for breaking this rule: If you don’t withdraw 100% of funds from an inherited IRA by the end of the fifth year after the owner’s death, the remaining balance is subject to a 50% penalty.
by Jean Miller | Accounting News, Financial goals, News, Retirement Savings
One of the easiest ways to start saving for retirement is through a Roth IRA, and some would say it’s the smartest move a beginner saver can make. A Roth IRA could be a better choice than a 401(k) or a traditional IRA for a few key reasons.
Roth IRA: A Primer
A Roth IRA is an individual retirement account (IRA) that permits qualified withdrawals on a tax-free basis provided specific conditions are reached. The greatest distinction between a Roth IRA and a traditional IRA is that Roth IRAs are funded with after-tax dollars. While the contributions are not tax-deductible, this account offers tax-free growth and tax-free withdrawals in retirement. As long as you have owned your Roth IRA account for 5 years and you’re age 59 ½ or older, you are allowed to withdraw your money without owing federal taxes. In 2021, you can contribute up to $6,000 to a Roth IRA ($7,000 if you are age 50 or older and eligible for catch-up contributions). This is lower than the limit for a 401(k) but it’s still a sizable amount to help keep you on track for a secure retirement.
Roth IRA Advantages
- No RMDs. Unlike 401(k)s and traditional IRAs, which are subject to required minimum distribution (RMD) withdrawals after age 72 (and penalties if you fail to make the withdrawals), there are no RMDs with Roth IRAs, so you can withdraw funds on your own schedule.
- No time limit. You may invest money into your account for as many years as you have earned income that qualifies. This includes wages, salaries, commissions, and bonuses from an employer. If you are self-employed or in a business partnership, this would include net earnings from your business, less any deduction authorized for contributions made to retirement plans on the individual’s behalf and further reduced by 50% of the individual’s self-employment taxes. Funds pertaining to divorce, such as alimony, child support, or in a settlement, may also be contributed.
- No employer-plan restrictions. Regardless of whether you are covered by an employer’s retirement plan, such as a 401(k), you are still eligible to contribute the maximum annual amount to a Roth IRA as long as you don’t exceed the IRS’s income limits. For 2021, those with modified adjusted gross incomes (MAGI) below $140,000 (single filers) or $208,000 (married filing jointly) are eligible.
- No Impact on Social Security. Whereas distributions from a 401(k) or traditional IRA contribute to determining if your Social Security benefits are taxed (that happens once income hits a certain limit), Roth IRA distributions do not. This means that your Roth IRA withdrawals will never affect your Social Security checks.
- No taxes for heirs. You may pass your Roth IRA on to your beneficiaries, and their withdrawals will be tax-free. (If you inherit a Roth IRA, you are required to take RMDs, but they are tax-free as long as the original account owner held the account for at least 5 years.)
Before You Invest in a Roth IRA
An important element to keep in mind is the 401(k) match. If your employer matches 401(k) contributions, make sure you take full advantage of this free investment money before investing in a Roth IRA.
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, News, Retirement
Legislative passages in 2020, including the SECURE Act, which made changes to beneficiary distributions, and the CARES Act, which included a waiver of required minimum distributions (RMDs), helped to expand the playing field for savers. These two factors, combined with the lowest tax rates in recent history, make for a potentially optimal time for Roth conversions, and many Americans have jumped on board. Is it the right move for you?
The Difference Between Traditional and Roth IRAs
- Traditional IRA or 401(K): enjoy a tax deduction upon contribution but pay taxes upon withdrawal
- Roth: no tax-deduction upon contribution but enjoy tax-free growth and no additional taxes upon withdrawal
The decision comes down to whether to pay taxes now or later. If only a crystal ball existed in which future tax rates could be known.
What Is a Roth Conversion?
A Roth IRA conversion is when an investor transfers money directly from a traditional IRA or 401(k) to a post-tax account such as a Roth IRA. The move is considered a distribution, and thus is taxed in that year. Due to today’s historically low tax environment, Roth conversions are having their moment in the sun.
Advantages of Converting to a Roth IRA
An essential benefit of converting to a Roth IRA is the potential for lower taxes in the future. While it’s obviously not possible to predict future tax rates, you can likely estimate if you’ll be earning more money, and thus, land in a higher tax bracket. If such is the case, odds are typically in your favor to pay less taxes in the long run than you most likely would with the same amount of money in a traditional IRA. Additionally, contribution withdrawals are tax-free (withdrawals from earnings are not tax-free). However, avoid using a Roth IRA like a bank account as any withdrawn funds today, however small, can impact your future savings.
Transferring to a Roth also means you won’t be required to take minimum distributions (RMDs) once you reach age 72. If you’re able to keep the funds in the account, you can watch it grow tax-free, and you would have the option to pass the money to your heirs.
Disadvantages of Converting to a Roth IRA
The biggest deterrent for a Roth IRA is the potentially immense tax bill. If, for example, an investor has $100,000 of pre-tax dollars in a traditional IRA and falls within the 24% tax bracket, the investor would owe $24,000 in taxes, due upon their next quarterly tax bill. Additionally, if the investor is under age 59 ½ and uses the IRA funds to pay the tax bill, they’ll also pay a 10% early withdrawal penalty on that distribution. In other words, be sure you have the liquid assets to cover the tax bill as a result of the conversion.
To Convert or Not to Convert?
If your taxes rise due to government increases, or you begin earning more money and land in a higher tax bracket, a Roth IRA conversion could save you substantial money in taxes in the long run. However, there’s a potential for a hefty tax bill that can be complicated to calculate, especially if you have other IRAs funded with pre-tax dollars, so if you think it might be a good move, it’s best to consult with a tax advisor on your specific circumstances.
