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.

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.

Traditional to Roth IRA Conversions – Should you? Did you? Wish you Hadn’t?

The tax provision that allows taxpayers to convert a Traditional IRA to a Roth IRA is a great tax-planning tool when used properly, and timing is everything.

To make a conversion, you must pay income taxes on the amount of the traditional IRA converted to a Roth IRA. So why would one want to do that? Well, the answer is that Roth IRAs enjoy tax-free accumulation and distributions, whereas the earnings in and contributions made to a traditional IRA are fully taxable whenever they are withdrawn. (An exception is if the contributions to the traditional IRA were treated as non-deductible. In that case, each distribution is nontaxable or partly nontaxable if only some of the contributions had not been deducted.)

So, you might consider converting during a year in which your income is abnormally low or a year in which your income might even be negative due to abnormal deductions or business losses. Under such cases, you might even be able to make a conversion tax-free. Keep in mind that you do not have to convert the entire amount in the traditional IRA; rather, you can choose any amount you wish to convert to fit your circumstances, and with proper tax planning, you can substantially minimize the conversion tax and the tax on your future retirement benefits.

You might also consider a conversion at a time when the IRA value is low due to a decline in the stock market, like the dip in stock values that occurred in September this year when the Dow index dropped from the low 18,000s to close to 16,000.

Those examples demonstrate when timing might be right for a conversion. On the flip side, if you converted earlier in the year, you could end up paying taxes on an amount that has declined in value due to the market downturn and wish you hadn’t converted. Well, the good news is that you can undo a conversion.

A taxpayer who converts a traditional IRA to a Roth IRA during 2015 can back out of the conversion by recharacterizing the Roth IRA as a traditional IRA any time up to the extended due date of the 2015 return. This involves transferring the converted amount (plus earnings or minus losses) from the Roth IRA back to a traditional IRA via a direct (trustee-to-trustee) transfer.

IRA Conversion Issues

Everyone’s financial circumstances are unique and other issues to consider are:

  • Are there enough years before retirement to recoup the conversion tax dollars through tax-free accumulation?
  • Will you be in a lower or higher tax bracket in the future?
  • Where would the money to pay the conversion tax come from? Generally, it must be from separate funds. If it is taken from the IRA being converted, for individuals under age 59½, the funds withdrawn to pay the tax will also be subject to the 10% early-distribution penalty in addition to being taxed.
  • It might be appropriate for you to design your own custom conversion plan over a number of years rather than converting everything at once.

Conversions can be tricky! If you are considering a conversion, it might be appropriate to call 212-697-8540 for an appointment so that we can help you properly analyze your conversion options.

Plan for the Potential IRA-to-Charity Provision Extension

If you are 70.5 or over, have not taken all or any of your 2015 required minimum distribution (RMD) from your IRA, and plan to but have not yet made a significant charitable contribution, here is a tip that could save some tax dollars.

In previous years, there has been a tax provision allowing an individual age 70.5 or older to make a direct transfer of money, up to $100,000, from his or her IRA account to a qualified charity. That provision expired on December 31, 2014. However, Congress has extended that provision in the past, and there is a good chance it may be extended again. In fact, the Senate Finance Committee working group on individual tax reform, just recently, recommended extending the provision.

If Congress does not extend it, you will have still satisfied your minimum distribution requirement, and the amount transferred to the charity will still count as a charitable contribution. If Congress does extend it, you can take advantage of the tax benefits described later in this article.

If you wait to see whether the provision will be extended, and Congress waits until the last minute, like it did last year, you may not have time to take action, as was the case for most taxpayers last year, or you may have already taken your RMD or made that charitable contribution.

If the provision is extended, here is how it will play out on a tax return:

  1. The distribution is excluded from income;
  2. The distribution counts towards the taxpayer’s Required Minimum Distribution for the year; and
  3. The distribution does NOT count as a charitable contribution.

At first glance, this may not appear to provide tax benefits. However, by excluding the distribution, a taxpayer lowers his or her income (AGI) for other tax breaks pegged at AGI levels such as medical expenses, passive losses, taxable Social Security, etc. Non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.

If you think that this tax provision may affect you and you would like to explore the possibilities with some tax planning, please call this office.

Planning Your IRA Withdrawal?

Advance planning can, in many cases, minimize or even avoid taxes on IRA distributions and other qualified plan distributions. When contemplating future retirement and when to begin tapping taxable IRA and other qualified retirement accounts, taxpayers need to consider a number of important issues.

Early Distributions (before 59.5) – If funds are withdrawn before reaching age 59 ½, the taxpayer is also subject to a 10% early withdrawal penalty (and state penalties if applicable) in addition to the income tax on the IRA distribution, unless what is referred to as the substantially equal payment exemption is utilized. Under this exception, an early retiree can begin taking substantially equal payments at least once a year over the owner’s life or joint lives of the owner and designated beneficiary. The payments must not cease before the end of the five-year period beginning with the date of the first payment, BUT after the taxpayer reaches age 59.5.

Age 59.5 to age 70.5 Distributions – After attaining age 59.5, an individual can take out of their IRA as much or as little as he or she wishes in any year until reaching age 70.5. This withdrawal liberty leaves the retiree to plan his or her distributions to minimize taxes. Techniques involve matching distributions with no- or low-income years.

Age 70 ½ and Older – Once a taxpayer reaches age 70 ½, he or she must withdraw at least a minimum amount from their Traditional IRA each year. A taxpayer who fails to take a distribution in the year age 70 ½ is reached, can avoid a penalty by taking that distribution no later than April 1st of the following year. However, that means the IRA owner must take two distributions in the following year, one for the year in which they reached age 70 ½ and one for the current year. Distributions that are less than the required minimum distribution for the year are subject to a 50% excise tax (excess accumulation penalty) for that year on the amount not distributed as required. The excess accumulation penalty can generally be abated by following IRS abatement procedures.

Quite frequently, taxpayers have multiple IRA accounts in addition to one or more types of other retirement plans. This gives rise to a commonly asked question, “Must I take a distribution from each individual account?” For purposes of the annual required minimum distribution, a separate distribution must be taken from each type of plan. However, a taxpayer may have multiple accounts for each type of plan, which for tax purposes are treated as one plan. For example, if you have three IRA accounts, the three separate accounts are treated as one for tax purposes, and the distribution can be taken from any combination of the accounts.

Generally, the minimum amount that must be withdrawn in a particular year, after reaching age 70 ½, is the total value of all IRA accounts (as determined on December 31st of the prior year) divided by a factor based on the owner’s age from the table below, illustrated for ages 70 – 87 only (the complete table goes to age 115 and over).

Minimum Distribution Table

 

Age Factor Age Factor
70 27.4 80 18.7
71 26.5 81 17.9
72 25.6 82 17.1
73 24.7 83 16.3
74 23.8 84 15.5
75 22.9 85 14.8
76 22.0 86 14.1
77 21.2 87 13.4
78 20.3
79 19.5

 

Estate and Beneficiary Considerations – When planning your distributions, keep in mind that the value of your undistributed IRA account will be included in your gross estate when you pass on, and depending upon the size of your estate, it may be subject to inheritance taxes. In addition, the inherited IRA distributions will be taxable to the individual who inherits the IRA. Therefore, it could be appropriate to utilize the IRA funds first and then dip into other assets after the IRA funds have been depleted. On the other hand, funds left in an IRA do continue to accumulate tax-free which might be better in certain circumstances.

If you would like assistance with your tax planning needs or to develop an IRA distribution plan, please call this office for an appointment.

Retirement Savings: the Earlier, the Better

Generally, teenagers and young adults do not consider the long-term benefits of retirement savings. Their priorities for their earnings are more for today than that distant and rarely considered retirement. Yet contributions to a retirement plan early in life can enjoy years of growth and provide a substantial nest egg at retirement.

Due to its long-term benefits of tax-free accumulation, a nondeductible Roth IRA may be the best option. During most individuals’ early working years, their income is usually at its lowest, allowing them to qualify for a Roth IRA at a time where the need for a tax deduction offered by other retirement plans is not important.

Because retirement will not be their focus at that age, young adults may balk at having to give up their earnings. Parents, grandparents, or other individuals might consider funding all or part of the child’s Roth contribution. It could even be in the form of a birthday or holiday gift. Take, for example, a 17-year-old who has a summer job and earns $1,500. Although the child is not likely to make the contribution from his or her earnings, a parent could contribute any amount up to $1,500 to a Roth IRA for the child.*

But keep in mind that young adults, like anyone else, must have earned income to establish a Roth IRA. Generally, earned income is income received from working, not through an investment vehicle. It can include income from full-time employment, income from a part-time job while attending school, summer employment, or even babysitting or yard work. The amount that can be contributed annually to an IRA is limited to the lesser of earned income or the current maximum of $5,500.

Parents or other individuals who contribute the funds need to keep in mind that once the funds are in the child’s IRA account, the funds belong to the child. The child will be free to withdraw part or all of the funds at any time. If the child withdraws funds from the Roth IRA, the child will be liable for any early withdrawal tax liability.

Consider what the value of a Roth IRA at age 65 would be for a 17-year-old who has funds contributed to his or her IRA every year through age 26 (a period of 10 years). The table below shows what the value will be at age 65 at various investment rates of return.

 

Value of a Roth IRA—Annual Contributions of $1,000
for 10 years beginning at age 17
Investment Rate of Return
2%
4%
6%
8%
Value at Age 65
$23,703
$55,449
$127,900
$291,401

 

What may seem insignificant now can mean a lot at retirement. Individuals who are financially able to do so should consider making a gift that will last a lifetime. It could mean a comfortable retirement for your child, grandchild, favorite niece or nephew, or even an unrelated person who deserves the kind gesture.

*Amounts contributed to an IRA on behalf of another person are nondeductible gifts by the donor and are counted toward the donor’s annual $14,000 (2014 and 2015 gift exclusion per done).

If you would like more information about Roth IRAs or gifting contributions to a Roth on behalf of someone else, please contact this office.

Beware of the One-per-12-Month IRA Rollover Limitation Beginning in 2015

The tax code allows an individual to take a distribution from his or her IRA account and avoid the tax and early distribution penalties if the distribution is redeposited to an IRA account owned by the taxpayer within 60 days of receiving the distribution.

Early in 2014, in a tax court case, the court ruled that taxpayers could only have one IRA rollover per 12-month period. This was contrary to the IRS’s long-standing one rollover per every IRA account every 12 months. This far more liberal position was also included in published IRS guidance. However, contrary to general public opinion, guidance provided by the IRS in their publications is not citable, carries no weight in audit or court, and only represents the IRS’ interpretation of tax law.

As a result, the IRS has adopted the Court’s more restrictive position, but will not apply the new interpretation until 2015, giving taxpayers time to become aware of the new restrictions. The IRS is modifying its published 2015 guidance to reflect this new position.

The IRS announced in November that the one-per-12-month-period rollover rule also applies to Simplified Employer Pension Plans (SEPs) and SIMPLE plans. Included in the November announcement, the IRS indicated it would not count a distribution taken in 2014 and rolled over in 2015 (within the 60-day limit) as a 2015 rollover.

Not counted towards the one-per-12-month rule are traditional to Roth IRA conversions or trustee-to-trustee IRA transfers where the funds are directly transferred from one IRA trustee to another.

Please call this office if you are planning an IRA distribution and subsequent rollover and are not positive it falls within the one-per-12-month limit.