by Daniel Kittell | Accounting News, IRS, News, Newsletter, Tax, Tax Planning, Tax Planning - Individual
Inheriting an IRA might feel like a financial win, but the rules today are different than they were just a few years ago. If you’re not up to date, an unexpected tax bill could catch you off guard. Here’s what changed, and how to plan around it.
Changes Made by the SECURE Act
The SECURE Act of 2019 eliminated the “stretch IRA,” which allowed inherited funds to grow tax-deferred for decades while keeping annual withdrawals relatively low. Now, many non-spousal heirs must withdraw the entire inherited IRA within 10 years of the original owner’s death.
This is the 10-year rule, and it can be a tax trap for non-spouse beneficiaries.
If the IRA is traditional, any withdrawals are taxed as ordinary income. If you wait and withdraw everything in year 10, it could push you into a much higher tax bracket.
Who Gets a Pass from the 10-Year Rule?
Not everyone is subject to the 10-year rule. The IRS created a category called “eligible designated beneficiaries.” Beneficiaries in this category can still stretch distributions over their life expectancy. They include:
- A surviving spouse
- A minor child of the deceased IRA owner (until reaching adulthood)
- A disabled beneficiary
- A chronically ill beneficiary
- A beneficiary who is no more than 10 years younger than the original owner
A surviving spouse has the most flexibility. They can roll the inherited IRA into their own IRA and treat it as their own account, which allows them to follow standard RMD rules based on their age.
Minor children who inherit an IRA can take RMDs based on their life expectancy until they reach age 21. After that, the 10-year rule kicks in.
Why the 10-Year Rule Can Be a Problem
The 10-year rule can be problematic for tax purposes. If you inherit an IRA with significant funds and you’re forced to withdraw it within 10 years, those withdrawals could push you into a higher tax bracket. And that, of course, means paying more to the IRS than necessary.
It’s important to note that the 10-year rule enacted in the SECURE Act only applies to IRAs inherited in 2020 and beyond. If you inherited an IRA before 2020, you’re still covered under the old rules.
How to Avoid the Tax Trap
The key is in planning. Don’t wait until the ninth year to make withdrawals. Instead:
- Spread withdrawals over the 10-year period to manage your tax bracket.
- If possible or applicable, coordinate distributions with lower-income years.
- Work with a tax advisor to help you work through different withdrawal strategies.
Here’s the bottom line: the SECURE Act changed the rules for inherited IRAs, and without careful planning, the 10-year requirement can create significant tax bills for beneficiaries. Be prepared, understand the timing, and work with a tax professional to reduce the impact.
by Jean Miller | Accounting News, Financial goals, News, Retirement, Retirement Savings, Uncategorized
Individual Retirement Accounts (IRAs) allow for a tax-advantaged way to invest your money long-term. Whether you choose to invest in a traditional IRA or a Roth IRA (or a combination of the two), you’ll defer paying income tax on the money you set aside for retirement. Follow these IRA investment strategies to boost your retirement savings and maximize the value of you IRA.
Max it Out
The maximum amount you can contribute to an IRA for 2022 is $6,000, and it is generally worth making the maximum contribution. Note that there are income limits. You can make a full contribution if your income is less than $144,000 ($214,000 if you are married filing jointly). For 2022, retirement savers age 49 and younger can max out an IRA by saving $500 per month or making a deposit any time before the 2022 IRA contribution deadline of April 15, 2023.
Make Catch-Up Contributions
As of the calendar year you turn age 50, you are eligible to contribute an extra $1,000 to your IRAs for that year, and all following years. If you weren’t able to save as much as you would’ve liked earlier in your career, catch-up contributions offer an opportunity to boost your yearly savings until retirement.
Don’t Wait Until the Contribution Deadline
It’s true that you can make a contribution to an IRA up until the mid-April tax filing deadline and apply it to the previous tax year. By shifting some funds into an IRA, you may be able to reduce your tax bill or boost your refund. However, that may not be the most beneficial move depending on your circumstances. When you wait to contribute, you miss out on potential growth. There is also the chance that you will be making an investment at a high point in the market. Contributing to an IRA at the beginning of the tax year enables the funds to compound for a longer stretch of time. You can also consider making small monthly contributions as a budget-friendly approach that will still yield favorable results.
Low- and Moderate-Income Workers Can Claim the Savers Credit
If your adjusted gross income (AGI) is below $34,000 as an individual or $68,000 as a couple in 2022, you may be eligible to claim the saver’s tax credit as well as the tax deduction for your IRA contribution. This credit is worth between 10% and 50% of the amount you contribute to an IRA up to $2,000 for individuals and $4,000 for couples.
Use Your Tax Refund to Contribute to Your IRA
You can use IRS Form 8888 to deposit all or part of your tax refund directly into an IRA. Provided the deposit is made by the due date of your tax return, you can file a tax return claiming a traditional IRA contribution before the money has actually been deposited in the account. In other words, if you file earlier rather than later, it’s possible to use your tax refund to make an IRA contribution you already claimed on your tax return.
Consider Converting to a Roth IRA
For some taxpayers, it may be beneficial to convert an existing traditional IRA to a Roth IRA. Expect to pay income taxes on the conversion amount, which could be substantial, so be sure to do the math before you make the leap. The funds that are moved into the Roth grow tax-free and will be tax-free upon withdrawal in the future, provided the account is at least five years old. The decision to convert to a Roth IRA basically boils down to whether you want to take the tax hit now or later. The farther away you are from retirement, the more advantageous a Roth IRA could be, because the Roth’s earnings will have more years to compound.
by Daniel Kittell | Accounting News, Budget, Financial goals, News, Retirement, Retirement Savings
The Federal Reserve reports that 26% of working Americans have no retirement savings. And among the working Americans who have retirement investment funds, 45% feel that their savings projections fall short of their long-term goals. If you’re a late retirement investor, it’s still possible to build a solid nest egg by the time you retire. The tips below will help you make up for lost time and get back on track.
Estimate How Much You’ll Need
A general guideline for retirement savings is to have 10 times your income saved if you plan to retire at age 67. For example, if your annual salary is $50,000 per year, you should aim to have $500,000 saved by the time you turn 67 years old. However, you should adjust this number based on your individual retirement goals. Do you plan to travel extensively in retirement, or do you want to downsize and live frugally? Increase or decrease your estimate based on these goals.
Start Saving
One of the easiest ways to start saving for retirement is through an employer-sponsored plan, such as a 401(k) or 402(b). These plans are even more valuable if your company offers matching contributions. If you don’t have access to an employer-sponsored retirement plan, think about opening a traditional or Roth IRA.
- Traditional IRAs: Contributions are tax-deductible, but withdrawals in retirement are taxed.
- Roth IRAs: Contributions are not tax-deductible, but withdrawals in retirement are tax-free.
Small business owners and self-employed individuals can also look into retirement plans in the form of SEPs and Simple IRAs.
Pay Down Debt
Debt is holding you back financially, so create a plan to pay off credit card debt, car loans, and other high-interest debt. If your mortgage is fairly new, you might also consider making extra mortgage payments in order to pay down some of your principal. However, if you’re in the later stage of a mortgage, and your payments are mainly covering the principal, it might be more beneficial to invest in retirement rather than putting that money toward your mortgage.
Pay Yourself by Automating Investments
Regular, automatic investments can help close your savings gap between now and retirement. While it might seem smart to be sure you’re covering essential expenses with each paycheck before investing, chances are—unless you’re budgeting faithfully—more of your paycheck is going to impulsive and discretionary purchases than you realize. Get ahead of the game by allocating a portion of your paycheck to be automatically and directly deposited to your retirement account.
Start Cutting Costs Now
It is never too early to get organized and prepare for retirement, no matter how close or far off your golden years are. However, if you’re on the closer-to-retirement end of this spectrum, now is the time to start cutting costs in a meaningful way. Start by minimizing expenses and stashing the extra cash away in savings. In addition to cutting debt, find ways to save on everyday bills and costs. These savings can add up and offer some breathing room once you’re no longer receiving a regular paycheck.
Use Catch-Up Contributions
American workers ages 50 and older are qualified to contribute an additional $6,500 in catch-up contributions to their 401(k) per year, increasing the maximum contribution to a 401(k) to $27,000 per year, or $2,250 per month. This is a lofty monthly goal, and might not be possible for many workers, but aim to contribute as much as you possibly can in order to get you that much closer to your retirement goal. Even if you are just beginning to save at 50 years old, by funding your 401(k) up to the maximum amount—assuming an 8.7% annual return and considering compounded interest—it’s still possible to save $1 million by the time you retire.
by Jean Miller | Accounting News, IRS, News, Tax, Tax Planning, Tax Planning - Individual
What, or who, is a “Millennial”? Numerous individuals who find themselves in this generation do not like the connotations the word ascribes, but if you were born in the 80s or 90s, then you fit into what most researchers would call the Millennial generation. Many at this stage of life think that they’ve just barely entered adulthood, but it’s never too early to start considering “adult” things like investing for your future. And for those at this age and stage of life, a Roth IRA may be just the investment to consider.
What exactly is a Roth IRA?
A Roth IRA is an Individual Retirement Account where you set aside after-tax income up to a set amount each year.
How is it different from a traditional IRA?
One major difference is that funds put into the account are after-tax income, meaning, when you withdraw money from a Roth, taxes have already been paid. In a traditional IRA, you are taxed when money is withdrawn from the account, however, funds placed in the account may be fully or partially deducted at the time of placement. Therefore, a traditional IRA may seem enticing to Millennials initially because of the deductions, but a Roth is more financially viable since you do not pay taxes later in life. And, more likely than not, you will be paying less taxes earlier in your career (due to lower income). Eventually, you could even reach a point where you make more than allowed to invest in a Roth (eligibility phases out at $118,00 for individuals and $186,000 for a household).
Another big reason why Millennials should consider a Roth, is that you are not taxed or penalized on money withdraw at any time, even if you haven’t retired yet. So, for example, if you have been trying to establish an emergency fund (as many advisors suggest you do), but your monthly bill and loan payments make it nearly unattainable to save three months worth of expenses and maintain it only for emergencies. Having a Roth, however, could essentially serve as both a retirement and emergency fund because, in a Roth IRA, you can withdraw money in an emergency without penalization. Can is the operative word here because while it is possible, removing funds from a Roth is certainly not advised if you are really trying to save for retirement. Nevertheless, the funds are more accessible if needed.
While investing in your future is advised no matter what sort of account, for a generation who leans toward early retirement, but is less likely to have a 401(k) (due to being self-employed or working for a start-up/small business that does not offer one), a Roth IRA may be the best long-term alternative.
