Converted Your Traditional IRA to a Roth IRA? Worried You May Have Done It Too Soon if Tax Reform Passes?

When you convert a traditional IRA to a Roth IRA, you have to pay the tax on the conversion. However, individuals frequently do this so they can take advantage of future tax-free accumulations. Distributions from Roth IRAs are generally tax free, including any earnings (accumulations) while the account is a Roth account.

Are you considering converting your traditional IRA to a Roth IRA in 2017? Are you hesitant to do so because of uncertainty about the timing and specifics of the Administration’s and Congress’ proposal to cut tax rates for individuals? Have no fear, because you can convert your traditional IRA to a Roth IRA this year, and if tax reform passes with lower tax rates effective next year, you can undo the conversion for 2017 and then re-convert for 2018.

Tax law allows individuals who convert in one year to undo that conversion by a procedure referred to as recharacterization. The procedure has been used for years, primarily by individuals whose IRA funds are invested in stocks and who converted from their traditional IRA funds to a Roth IRA only to see the value of their Roth IRA decline after the conversion due to stock market fluctuations. Recharacterizations are also used by individuals who converted their traditional IRA to a Roth IRA and then found they could not or did not want to pay the conversion tax.

This same process can be used by anyone for any purpose. So, for example, if you converted your regular IRA to a Roth IRA in 2017 and tax reform is enacted effective in 2018, you can recharacterize (undo) your 2017 conversion back to a traditional IRA. However, the recharacterization must be accomplished by the extended due date of your 2017 tax return, which is October 15, 2018. If you choose to, you then can then reconvert the traditional IRA to a Roth IRA in 2018 and take advantage of the new lower tax rates.

Generally, you must wait at least 30 days to make the reconversion. However, if you make the recharacterization of the Roth IRA back to your a traditional IRA in 2017, you may not reconvert that amount from the traditional IRA to a Roth IRA before the beginning of 2018 or, if it is later, the end of the 30-day period beginning on the day on which you transferred the amount from the Roth IRA back to a traditional IRA by means of a recharacterization.

Example: For years, Jack has been making deductible traditional IRA contributions. Then, during the summer of 2017, Jack decided to convert $25,000 of those traditional IRA funds into a Roth IRA. After the conversion is completed, late in 2017, Congress passes and the president signs a tax reform bill that reduces Jack’s marginal tax rate in 2018. To take advantage of the lower tax rate, Jack recharacterizes (undoes) the conversion back to a traditional IRA for 2017 and then reconverts it back to a Roth IRA in 2018. To do that, Jack first transfers the $25,000 (plus earnings or minus losses since the original conversion) back to a traditional IRA by way of a trustee-to-trustee transfer (it’s OK for the transfer to be with the same financial institution). He could make the recharacterization as late as October 15, 2018, but chooses to do so on January 15, 2018. Then, after making the transfer back to the traditional IRA, Jack reconverts the amount back to a Roth IRA on Feb. 20, 2018.

For more information on recharacterizations and conversions, and how they might fit into your tax planning, please give us a call.

Want to Reduce Required Minimum Distributions and Extend Your Retirement Benefits?

If you are one of the boomer generation, and if you find that your required minimum distributions (RMDs) from qualified plans and IRAs are providing unneeded income (along with a high tax bill), or if you are afraid that the government’s RMD requirements will leave too little in your retirement plan for your later years, you can use a qualified longevity annuity contract (QLAC) to reduce your RMDs and extend the life of your retirement distributions.

The government allows individuals to purchase QLACs with their retirement funds, thus reducing the value of those funds (subject to the RMD rules) and in turn reducing the funds’ annual RMDs.

A QLAC is a deferred-income annuity that begins at an advanced age and that meets the stringent limitations included in the tax regulations. One benefit of a retirement-planning strategy involving QLACs is that they provide a form of longevity insurance, allowing taxpayers to use part of their retirement savings to buy an annuity that helps protect them from outliving their assets.

The tax-planning benefits of QLACs are twofold:

(1) Because the QLAC is purchased using funds from a qualified retirement plan or IRA, that plan’s year-end balance (value) is lowered. This causes the RMDs for future years to be less than they otherwise would be, as the RMD is determined by dividing the account balance (from 12/31 of the prior year) by an annuity factor that is based on the retiree’s age.

Example: Jack is age 74, and the annuity table lists his remaining distribution period as 23.8 years. The balance of his IRA account on 12/31/2016 is $400,000. Thus, his RMD for 2017 would be $16,807 ($400,000 / 23.8). However, if Jack had purchased a $100,000 QLAC with his IRA funds during 2016, his balance would have been $300,000, and his 2017 RMD would be $12,605 ($300,000 / 23.8). By purchasing the $100,000 QLAC, Jack would have reduced his RMD for 2016 by $4,202 ($16,807 – $12,605). This reduction would continue for all future years. Later, the $100,000 QLAC would provide retirement benefits, likely beginning when Jack reaches age 85.

(2) Tax on the annuity will be deferred until payments commence under the annuity contract.

A deferred-income annuity must meet a number of requirements to be treated as a QLAC, including the following:

Limitation on premiums – When buying a QLAC, a taxpayer can use up to the lesser of $125,000 or 25% of his or her total non-Roth IRA balances. The dollar limitation applies to the sum of the premiums paid on all QLAC contracts.

When distributions must commence – Distributions under a QLAC must commence by a specified annuity starting date, which is no later than the first day of the month after the taxpayer’s 85th birthday.

For additional details about how QLACs might fit into your retirement strategy, please give this office a call.

Thinking of Tapping Your Retirement Savings? Read This First

If you are looking for cash for a specific purpose, your retirement savings may be a tempting source. However, if you are under age 59½ and plan to withdraw money from a traditional IRA or qualified retirement account, you will likely pay both income tax and a 10% early-distribution tax (also referred to as a penalty) on any previously untaxed money that you take out. Withdrawals you make from a SIMPLE IRA before age 59½ and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited. These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.

Thus, before making any withdrawals from an IRA or other retirement plan, including a 401(k) plan, a 403(b) tax-sheltered annuity plan, or a self-employed retirement plan, carefully consider the resulting decrease in retirement savings and increase in taxes and penalties.

There are a number of exceptions to the 10% early-distribution tax; these depend on whether the money you withdraw is from an IRA or a retirement plan. However, even if you are not subject to the 10% penalty, you will still have to pay taxes on the distribution. The following exceptions may help you avoid the penalty:

  • Withdrawals from any retirement plan to pay medical expenses – Amounts withdrawn to pay unreimbursed medical expenses are exempt from penalty if they would be deductible on Schedule A during the year and if they exceed 10% of your adjusted gross income. This is true even if you do not itemize.
  • Withdrawals from any retirement plan as a result of a disability – You are considered disabled if you can furnish proof that you cannot perform any substantial gainful activities because of a physical or mental condition. A physician must certify your condition.
  • IRA withdrawals by unemployed individuals to pay medical insurance premiums – The amount that is exempt from penalty cannot be more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You also must have received unemployment compensation for at least 12 weeks during the year.
  • IRA withdrawals to pay higher education expenses – Withdrawals made during the year for qualified higher education expenses for yourself, your spouse, or your children or grandchildren are exempt from the early-withdrawal penalty.
  • IRA withdrawals to buy, build, or rebuild a first home – Generally, you are considered a first-time homebuyer for this exception if you had no present interest in a main home during the 2-year period leading up to the date the home was acquired, and the distribution must be used to buy, build, or rebuild that home. If you are married, your spouse must also meet this no-ownership requirement. This exception applies only to the first $10,000 of withdrawals used for this purpose. If married, you and your spouse can each withdraw up to $10,000 penalty-free from your respective IRA accounts.
  • IRA withdrawals annuitized over your lifetime – To qualify, the withdrawals must continue unchanged for a minimum of 5 years, including after you reach age 59½.
  • Employer retirement plan withdrawals – To qualify, you must be separated from service and be age 55 or older in that year (the lower limit is age 50 for qualified public-service employees such as police officers and firefighters) or elect to receive the money in substantially equal periodic payments after your separation from service.

You should be aware that the information provided above is an overview of the penalty exceptions and that conditions other than those listed above may need to be met before qualifying for a particular exception. You are encouraged to contact this office before tapping your retirement funds for uses other than retirement. Distributions are most often subject to both normal taxes and other penalties, which can take a significant bite out of the distribution. However, with carefully planned distributions, both the taxes and the penalties can be minimized. Please call for assistance.

Want To Make An IRA Contribution For 2016? You Still Have Time

If you wish to make an IRA contribution for 2016, you still have time. Contributions can be made up to the unextended due date of your tax return, which for 2016 is April 18, 2017.

There are several benefits to making an IRA contribution, the most important one being that you are putting money aside for your future retirement. The following is a rundown of the rules and tax tips relating to making IRA contributions and the potential tax benefits.

Age Rules – You must be under age 70 ½ at the end of the tax year to contribute to a traditional IRA. There is no age limit to contribute to a Roth IRA.

Compensation Rules – You must have taxable compensation to contribute to an IRA. This includes income from wages and salaries and net self-employment income. It also includes tips, commissions, bonuses and alimony. If you are married and file a joint tax return, only one spouse needs to have compensation in most cases.

When to Contribute – You can contribute to an IRA at any time during the year. For the contribution to count for 2016, you must contribute by the due date of your tax return. This does not include extensions. This means most people must contribute by April 18, 2017. If you contribute between January 1 and April 18 of 2017 for 2016, make sure your plan sponsor designates it as a 2016 contribution.

Contribution Limits – In general, the most you can contribute to your IRA for 2016 is the smaller of either your taxable compensation for the year or $5,500. If you were age 50 or older at the end of 2016, the maximum you can contribute increases to $6,500. If you contribute more than these limits, an additional tax will apply. The additional tax is six percent of the excess amount contributed that is in your account at the end of the year.

Deductibility – Contributions to a Traditional IRA are generally tax deductible, but the deductible amount phases out for taxpayers who are active participants in their employer’s retirement plan. (Box 13 on your W-2 form from your employer will be checked if you are an active participant in your employer’s plan.) A higher phaseout threshold applies to unemployed spouses who make contributions based on the other spouse’s income. For 2016, the adjusted gross income (AGI) phaseout range is:

Filing Status Phaseout Threshold Fully Phased Out
Unmarried
$61,000
$71,000
Married Filing Jointly
$98,000
$118,000
Married Filing Separately
$0
$10,000
Spousal IRA
$184,000
$194,000

If you can deduct the Traditional IRA contribution, it will lower your AGI, taxable income and tax liability. The amount of your AGI is used to limit certain other deductions and tax credits. So deductible IRA contributions are a way to reduce your AGI and potentially increase other deductions and credits. For example, if you are obtaining your health insurance from a Government Marketplace, lowering your AGI could actually increase the amount of your premium tax credit that helps to pay for your insurance.

Saver’s Credit – For lower income taxpayers, there is a tax credit that helps you pay for your IRA contribution. The credit is a percentage of your IRA contribution ranging from 50% to 10% of your first $2,000 of IRA contributions. If you are married, it applies to each spouse individually. For 2016, the credit applies to married taxpayers with an AGI less than $61,500, single taxpayers under $30,750 and head of household filers under $46,125.

Choosing Between Traditional & Roth IRAs – Generally distributions (except for non-deductible contributions) from Traditional IRAs are taxable, while distributions from Roth IRAs are tax-free.

For more details on how an IRA contribution will impact your 2016 tax return, please give this office a call. We can also determine the effect at your tax appointment.

Little-Known Tactic Increases Child Care Credit

When both spouses in a married couple are jointly involved in the operation of an unincorporated business (generally a Schedule C), it is fairly common – but incorrect – for all of that business’s income to be reported as just one spouse’s income, even when they both work in the business.

In such cases, the spouse not taking credit for his or her portion of the earned income loses out on the chance to accumulate his or her own eligibility for Social Security benefits. In addition, to claim a child care credit, both spouses on a joint return must have earned income (or imputed income if one of the spouses is a full-time student or is disabled), so unless the spouse not including a portion of the income from the joint business has another source of earned income, the couple will not be allowed a child care credit.

There are ways to remedy this situation, however. One option is to file a partnership return for the activity, in which case each spouse will receive a K-1 that reports his or her share of the net profit. An approach that avoids the necessity of filing a partnership return, and that is probably less complicated, is a qualified joint-venture election, in which each spouse elects to file a separate Schedule C for his or her respective share of the business. This gives them both self-employed income for the purposes of the self-employment tax and for claiming the child care credit.

A qualified joint venture refers to any joint venture involving the conduct of a trade or business if:

(1) The only members of the joint venture are husband and wife,
(2) Both spouses materially participate in the trade or business, and
(3) Both spouses elect to apply this rule.

Generally, to meet the material participation requirement, each spouse will have to participate in the activity for 500 hours or more during the tax year.

If the net income from the business exceeds the annual cap on income subject to the Social Security tax, the combined self-employment tax for the spouses with split Schedule Cs will exceed what a single spouse would have paid if he or she had filed a single Schedule C.

An additional benefit when filing split Schedule Cs is the opportunity for both spouses to participate in IRAs and self-employed retirement plans.

If you have questions about how splitting the business income between spouses might apply to your specific situation, please contact this office.

Taking Advantage of Back-Door Roth IRAs

If you are a high-income taxpayer who cannot contribute to a Roth IRA due to income limitations, there is a work-around that will allow you to fund a Roth IRA.

High-income taxpayers are limited in the annual amount they can contribute to a Roth IRA. In 2016, the allowable contribution phases out for joint-filing taxpayers with an AGI between $184,000 and $194,000 (or an AGI between $0 and $9,999 for married taxpayers filing separately). For unmarried taxpayers, the phaseout is between $117,000 and $132,000. Once the upper end of the range is reached, no contribution is allowed for the year.

However, those AGI limitations can be circumvented by what is frequently referred to as a back-door Roth IRA. Here’s how it works:

  1. First, you contribute to a traditional IRA. For higher-income taxpayers who participate in an employer-sponsored retirement plan, a traditional IRA is allowed but is not deductible. Even if all or some portion is deductible, the contribution can be designated as not deductible.
  2. Then, since the law allows an individual to convert a traditional IRA to a Roth IRA without any income limitations, you now convert the non-deductible Traditional IRA to a Roth IRA. Since the Traditional IRA was non-deductible, the only tax related to the conversion would be on any appreciation in value of the Traditional IRA before the conversion is completed.

Potential Pitfall — There is a potential pitfall to the back-door Roth IRA that is often overlooked, that could result in an unexpected taxable event upon conversion. For distribution or conversion purposes, all of your IRAs (except Roth IRAs) are considered as one account and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable.

This may or not may affect your decision to use the back-door method but does need to be considered prior to making the conversion.

There is a possible, although complicated, solution. Taxpayers are allowed to roll over or make a trustee-to-trustee transfer of IRA funds into employer qualified plans if the employer’s plan permits. When permitted, such rollovers or transfers are limited to the taxable portion of the IRA account, leaving behind the non-taxable contributions, which can then be converted to a Roth IRA without any taxability.

Please call this office if you need assistance with your Roth IRA strategies or in planning traditional-to-Roth IRA conversions.

Time for Baby Boomers to Pay Up

All you baby boomers who have been stashing away tax-deferred retirement savings, take note: it is getting close to the time to start withdrawing funds from those accounts and, of course, paying taxes on those withdrawals. This includes distributions from traditional IRAs and 401(k)s.

The same Internal Revenue Code that allowed you to save tax dollars when you contributed to those tax-deferred retirement plans also generally requires you to begin withdrawals on the year you reach age 70½. These distributions are called required minimum distributions (RMDs) and are based on annuity tables. Generally, most individuals will utilize the single life table, but the joint life annuity tables are used if the individual’s spouse is more than 10 years younger.

Keep in mind that you can always take as much as you wish from your tax-deferred retirement accounts, but you must take the RMD amount each year, beginning with the year you turn age 70½, or you will be subject to a very severe penalty, which we will discuss later. One exception is that you can delay the payout for the year you become 70½ until no later than April 1 of the following year. However, since you will also need to make an RMD for that following year, you will end up with two years’ worth of distributions being taxed in one year if you use the delayed distribution option.

The following is an abbreviated single life table. The actual table goes to age 111.

Age 70 71 72 73 74 75
Distribution Period (Years) 27.4 26.5 24.7 24.7 23.8 22.9

Required Minimum Distribution – To determine an RMD, first determine the distribution period (life expectancy) based on your current age. So, for the year you turn 70½, the distribution period would be 27.4 years. Next, determine the retirement account’s balance on December 31 of the prior year. The account balance divided by the distribution period equals the RMD. For example, say you will turn age 70½ in 2016 and your tax-deferred retirement account had a balance of $500,000 on December 31, 2015. Your 2016 RMD would be $18,248 ($500,000/27.4).

Failure to Take an RMD Penalty – When the full amount of an RMD is not taken, the penalty is 50% of the amount you didn’t withdraw. Luckily, the IRS is very lenient on this penalty and will generally waive it when an under-distribution is inadvertent or due to ignorance of the law, provided that the RMD amounts are made up as soon as possible once the error is discovered. Avoid RMD problems by having your account custodian or trustee determine the RMD annually and then transfer the distribution directly to your checking, savings or non-retirement plan brokerage account.

Multiple Retirement Accounts – When you have multiple accounts, the question often is, “Which account should I take the RMD from?” All traditional IRAs are treated as one for distribution purposes. So, you can take the RMD for the IRA accounts from any combination of the accounts that you choose. However, that may cause a problem with a trustee of the IRA account(s) from which you didn’t take a distribution, who may think you didn’t take your RMD for the year. So, it is less problematic to take a distribution from each account.

You may wish to simplify the RMD distributions by transferring all of your traditional IRAs into one account, if you have several traditional IRAs. This is best done by having the trustees make direct transfers to the target IRA, rather than you receiving the distributions and then rolling over the funds, since you are only allowed one IRA rollover each twelve months (trustee-to-trustee transfers don’t count as rollovers). Note that spouses must maintain their accounts separately and cannot combine their accounts with yours when figuring RMDs.

If you have a 401(k) account, the RMD for it must be figured separately from any IRA accounts you also have. And, if you have multiple 401(k)s, each 401(k) account’s RMD is figured separately from those of your other 401(k) plans.

Non-Taxable Amounts – If your tax deduction for the contribution was limited when you made your traditional IRA contribution because you were a high-income taxpayer, you would have created a non-taxable basis in your IRA. If this is true, then that non-taxable basis is recovered tax-free in proportion to your distribution.

Roth Conversions – The ability of individuals to convert amounts of their traditional IRAs to Roth IRAs gives rise to some possible tax-saving moves in the years leading up to the RMD age. Things to consider are:

  • Is you tax bracket lower now than it will be after retirement? If so, you might consider converting some portion of your traditional IRA to a Roth IRA now. You will pay tax on the traditional IRA distribution in the year of the conversion, but when you withdraw it from the Roth IRA, it will be tax-free.
  • If you have a low-income year for some reason, and if you are age 59½ or older, it might be appropriate to take a distribution in that year and pay little or no tax. You won’t get a credit against a future RMD by doing so but you will be lowering the balance in the account for the eventual calculation of RMDs.

These types of strategies require careful planning, and you should consult this office first.

Effect on Taxable Income Once RMDs Start – Your taxable income may be increased by more than just the amount of the RMD. Adding your RMD to your income that is already taxed will increase your adjusted gross income (AGI); as a result, the amount of your Social Security benefits that is taxed may also increase. In addition, since the AGI is the amount on which the phaseout or reduction of many tax deductions is based, you may also find that you are getting less tax benefit from such items as medical expenses, charitable contributions, and investment-related expenses – all of which means your tax bill will go up by more than it otherwise would by just adding the RMD to your income.

Plan for Additional Withholding or Estimated Tax – Once you start taking distributions from your IRA or 401(k), and to avoid a potential underpayment of tax penalty, you will likely need to increase your tax prepayments, either by having federal (and possibly state) income taxes withheld from the distributions or by making quarterly estimated tax payments. If you already make estimated tax payments, you may need to increase the installment amounts.

If You Don’t Need the RMD – If you simply don’t need the retirement distribution, after reaching age 70½, you can donate up to $100,000 of IRA funds per year to a qualified charity without having to include the distribution in your income, and it will still count towards your RMD. If you are married and your spouse has an IRA and is also 70½ or older, he or she may also make a charitable IRA distribution of up to $100,000. So, if you are someone who gives substantial amounts to charity each year, this is a distribution strategy you may want to consider after reaching RMD age. CAUTION: To qualify under this provision, the funds must be directly transferred from the IRA account to the charity.

RMD issues can be quite complicated, and it is highly suggested that you consult with this office for pre-RMD planning, determining the correct RMD amounts, and analyzing your withholding and/or estimated tax obligations.

Back-Door Roth IRAs

Many individuals who are saving for retirement favor Roth IRAs over traditional IRAs because the former allows for both accumulation and post-retirement distributions to be tax-free. In comparison, contributions to traditional IRAs may be deductible, earnings are tax-deferred, and distributions are generally taxable. Anyone who is under age 70.5 and who has compensation can make a contribution to a traditional IRA (although the deduction may be limited). However, not everyone is allowed to make a Roth IRA contribution.

High-income taxpayers are limited in the annual amount they can contribute to a Roth IRA. The maximum contribution for 2016 is $5,500 ($6,500 if age 50 or older), but the allowable 2016 contribution for joint-filing taxpayers phases out at an adjustable gross income (AGI) between $184,000 and $194,000 (or an AGI between $0 and $9,999 for married taxpayers filing separately). For unmarried taxpayers, the phase-out is between $117,000 and $132,000.

However, tax law also includes a provision that allows taxpayers to convert their traditional IRA funds to Roth IRAs without any AGI restrictions. Although deductible contributions to a traditional IRA have AGI restrictions (for those who are in an employer’s plan), nondeductible contributions do not.

Thus, higher-income taxpayers can first make a nondeductible contribution to a traditional IRA and then convert that IRA to a Roth IRA. This is commonly referred to as a “back-door Roth IRA.”

BIG PITFALL: However, there is a big pitfall to back-door IRAs, and it can produce unexpected taxable income. Taxpayers and their investment advisers often overlook this pitfall, which revolves around the following rule: For distribution purposes, all of a taxpayer’s IRAs (except Roth IRAs) are considered to be one account, so distributions are considered to be taken pro rata from both the deductible and nondeductible portions of the IRA. The prorated amount of the deducted contributions is taxable. Thus, a taxpayer who is contemplating a back-door Roth IRA contribution must carefully consider and plan for the consequences of this “one IRA” rule before making the conversion.

There is a possible, although complicated, solution to this problem. Rolling over IRAs into other types of qualified retirement plans, such as employer retirement plans and 401(k) plans, is permitted tax-free. However, a rollover to a qualified plan is limited to the taxable portion of the IRA. If an employer’s plan permits, a taxpayer could roll the entire taxable portion of his or her IRA into the employer’s plan, leaving behind only nondeductible IRA contributions, which can then be converted into a Roth IRA tax-free.

Before taking any action, please call this office to discuss strategies for making Roth IRA contributions or to convert existing traditional IRAs into Roth IRAs.

Don’t Have a Retirement Plan? Maybe a SEP Is the Answer

If you are like many small business owners, you probably find the year-end period to be a very busy time. You can’t close your books and determine your business’s profit until after the close of the year, and if this has been a good year, you may want to establish a retirement plan and make a contribution for 2015.

There are a number of retirement plan options available, including Keogh plans and 401(k)s. However, a simplified employee pension plan (SEP) may be your best option. Unlike with a Keogh plan, you don’t have to scramble to get a SEP established before year-end.

The reason a SEP is “simplified” is that its retirement contributions are deposited into an IRA account under the control of the SEP participant, thus eliminating most of the employer’s administrative duties. That is why these plans are sometimes referred to as SEP-IRAs.

Simplified Retirement Plan

SEPs function much like Keogh plans, and they allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2015 is the lesser of 25% of that employee’s compensation or $53,000. These contributions are excluded from the employees’ wages and are not subject to withholding for income tax or FICA. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution, which boils down to the smallest of 20% of the business’ net profit or $53,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).

SEPs are a great option for startups and other small businesses that have unpredictable income and that may be leery of the long-term contribution matches required with other types of retirement plans. SEPs are also a great option for self-employed individuals with no employees, as the contributions are based upon net profits, allowing the business owner to select the maximum percentage while knowing that the required contribution will be small in low-income years.

Except for when employees are covered by collective bargaining agreements, an employer that elects to make a SEP contribution for the year must contribute to an employee’s retirement account if the employee is at least 21 years of age, has worked for the employer in at least three of the prior five calendar years, and has compensation for the year of at least $600.

Another advantage of SEP plans is that contributions are allowed after the account owner has reached the age of 70½—the age limit for traditional, non-SEP IRA contributions. This is true even though individuals must begin the required minimum distributions (RMDs) from the SEP once age 70½ is reached.

As with all traditional IRAs and qualified plans, distributions from a SEP are taxable and subject to a 10% early withdrawal penalty if withdrawn before age 59½.

To set up a SEP plan, you can adopt the IRS model plan by using Form 5305-SEP. This form is completed and retained for your records (not filed with the IRS). You can also open one with a financial institution. It may be prudent to adopt whatever plan is offered by the financial institution you’ll be dealing with to ensure that all plan requirements are met. If using a financial institution’s plan, be sure to discuss the plan’s fees.

A SEP may be the best option for your business’s retirement fund. Please call this office for more information on how a SEP plan might work for your particular business structure or to determine whether other options should be considered.

Are You Ignoring Retirement?

Are you ignoring your future retirement needs? That tends to happen when you are younger, retirement is far in the future, and you believe you have plenty of time to save for it. Some people ignore the issue until late in life and then have to scramble at the last minute to fund their retirement. Others even ignore the issue altogether, thinking their Social Security income (assuming they qualify for it) will take care of their retirement needs.

By current government standards, a single individual with $11,770 or a married couple with $15,930 of annual household income is at the 100% poverty level. If you compare those levels with potential Social Security income, you may find that expecting to retire on just Social Security income may result in a bleak retirement.

You can predict your future Social Security income by visiting the Social Security Administration’s Retirement Estimator. With the Retirement Estimator, you can plug in some basic information to get an instant, personalized estimate of your future benefits. Different life choices can alter the course of your future, so try out different scenarios—such as higher and lower future earnings amounts and various retirement dates—to get a good idea of how these scenarios can change your future benefit amounts. Once you’ve done this, consider what your retirement would be like with only Social Security income.

If you are fortunate enough to have an employer-, union- or government-funded retirement plan, determine how much you can expect to receive when you retire. Add that amount to any Social Security benefits you are entitled to and then consider what retirement would be like with that combined income. If this result portends an austere retirement, know that the sooner you start saving for retirement, the better off you will be.

With today’s relatively low interest rates and up-and-down stock market, it is much more difficult to grow a retirement plan with earnings than it was 10 or 20 years ago. With current interest rates barely mirroring inflation rates, there is little or no effective growth. That means one must set aside more of one’s current earnings for retirement to prepare for a comfortable retirement.

Retirement Planning Options

Because the government wants you to save and prepare for your own retirement, tax laws offer a variety of tax incentives for retirement savings plans, both for wage earners and for self-employed individuals and their employees. These plans include:

  • Traditional IRA – This plan allows up to $5,500 (or $6,500 for individuals age 50 and over) of tax-deductible contributions each year until reaching age 70½. However, the amount that can be deducted phases out for higher-income taxpayers who also have retirement plans through their employer.
  • Roth IRA – This plan also allows up to $5,500 (or $6,500 for individuals age 50 and over) of contributions each year. Like the Traditional IRA, the amount that can be contributed phases out for higher-income taxpayers; unlike the Traditional IRA, these amounts phase out even for those who do not have an employer-related retirement plan.
  • myRA Accounts – This relatively new retirement vehicle is designed to be a starter retirement plan for individuals with limited financial resources and those whose employers do not offer a retirement plan. The minimum amount required to establish one of these government-administered plans is $25, with monthly contributions as little as $2. Once the total value of the account reaches $15,000 or after 30 years, the account must be converted to a commercial Roth IRA account.
  • Employer 401(k) Plans – An employer 401(k) plan generally enables employees to contribute up to $18,000 per year, before taxes. In addition, taxpayers who are age 50 and over can contribute an extra $6,000 annually, for a total of $24,000. Many employers also match a percentage of the employee’s contribution, and this can amount to a significant sum for those who stay in the plan for many years.
  • Health Savings Accounts – Although established to help individuals with high-deductible health insurance plans pay medical expenses, these accounts can also be used as supplemental retirement plans if an individual has already maxed out his or her contributions to other types of plans. Annual contributions for these plans can be as much as $3,350 for individuals and $6,750 for families.
  • Tax Sheltered Annuities – These retirement accounts are for employees of public schools and certain tax-exempt organizations; they enable employees to make annual tax-deferred contributions of up to $18,000 (or $24,000 for those age 50 and over).
  • Self-Employed Retirement Plans – These plans, also referred to as Keogh plans, allow self-employed individuals to contribute 25% of their net business profits to their retirement plans. The contributions are pre-tax (which means that they reduce the individual’s taxable net profits), so the actual amount that can be contributed is 20% of the net profits.
  • Simplified Employee Pension (SEP) – This type of plan allows contributions in the same amounts as allowed for self-employed retirement plans, except that the retirement contributions are held in an IRA account under the control of the employee or self-employed individual. These accounts can be established after the end of the year, and contributions can be made for the prior year.

Each individual’s financial resources, family obligations, health, life expectancy, and retirement expectations will vary greatly, and there is no one-size-fits-all retirement savings strategy for everyone. Purchasing a home and putting children through college are examples of events that can limit an individual’s or family’s ability to make retirement contributions; these events must be accounted for in any retirement planning.

If you have questions about any of the retirement vehicles discussed above, please give this office a call.