Key Dates for Planning Retirement

Just as there are many types of retirement benefits, there are many dates to keep in mind when creating a retirement plan. Some concern when you can make larger contributions to retirement accounts and others have to do with withdrawals. Knowing the dates for each matters to your retirement planning, according to the recent article title “10 Important Ages for Retirement Planning” from U.S. News & World Report.

When should you max out retirement savings contributions? The sooner you start saving for retirement, the more likely you’ll retire with robust tax-deferred accounts. Tax breaks and employer matches add up, as do compounding interest returns. The 401(k) contribution limit in 2021 is $19,500. Wage earners can deposit up to $6,000 in a traditional IRA or Roth IRA. If you’re in your peak earning years, traditional IRAs and 401(k)s may be better, since your tax bracket is likely higher to be higher than when you started out.

Catch-up contributions begin at age 50. Once you’ve turned 50, you can make catch up contributions to 401(k)s—up to $6,500—and up to $7,000 in traditional IRAs. That’s for 2021. If you’re able to take advantage of these contributions, you can put away additional money and qualify for even bigger tax deductions.

401(k) withdrawals could start at 55. If you left your job in the same year you hit the double nickel, you can take 401(k) withdrawals penalty-free from the account associated with your most recent job. The “Rule of 55” lets you avoid a 10% early penalty, but you’ll still have to pay income taxes on any withdrawals from a 401(k) account. However, if you roll a 401(k) account balance into an IRA, you’ll need to wait until age 59½ to take IRA withdrawals without any penalties.

When does the IRA retirement age begin? The magic number is 59½. However, traditional IRA distributions are not required until age 72. All traditional IRA withdrawals are also taxable.

Social Security eligibility begins at age 62. The earlier you start collecting Social Security, the smaller your monthly benefit. Your full retirement age depends upon your date of birth, when the benefit amount will be higher than at age 62. If you work after signing up for Social Security, your benefits could be temporarily withheld if your salary is higher than the annual earnings limit. If you retire before your full retirement age and earn more than $18,960 per year, for every $2 above this amount, your benefits will be reduced by $1. Benefits will be recalculated once you reach full retirement age.

Medicare eligibility begins at age 65. Enrollment in Medicare may take place during a seven-month period that begins three months before the month you turn 65. Signing up on time matters, because Medicare Part B premiums increase by 10% for every 12-month period you were eligible for benefits but failed to enroll. Are you delaying enrollment because you or your spouse is still covered by a group health plan at work? Make sure to sign up within eight months of leaving your job or health plan and avoid the penalty.

Social Security Full Retirement Age is 66 for most Baby Boomers. 67 is the full retirement age for workers born in 1960 or later. Millennials and younger generations qualify after age 67.

If you can wait until 70, you’ll max out on Social Security. Social Security benefits increase by 8% for each year you wait to start payments between Full Retirement Age and age 70. After age 70, the number remains the same.

RMDs begin for 401(k) and IRA retirement accounts at age 72. These mistakes here are expensive! Your first distribution must be taken by April 1 of the year you turn 72. After that, annual withdrawals from 401(k)s and traditional IRAs must be taken by December 31 of each year. Missing a required distribution and you’ll get hit with a nasty 50% of the amount that you should have withdrawn.

Reference: U.S. News & World Report (July 28, 2021) “10 Important Ages for Retirement Planning”

How Do You Survive Financially after Death of Spouse?

The financial issues that arise following the death of a spouse range from the simple—figuring out how to access online bill payment for utilities—to the complex—understanding estate and inheritance taxes. The first year after the death of a spouse is a time when surviving spouses are often fragile and vulnerable. It’s not the time to make any major financial or life decisions, says the article “The Financial Effects of Losing a Spouse” from Yahoo! Finance.

Tax implications following the death of a spouse. A drop in household income often means the surviving spouse needs to withdraw money from retirement accounts. While taxes may be lowered because of the drop in income, withdrawals from IRAs and 401(k)s that are not Roth accounts are taxable. However, less income might mean that the surviving spouse’s income is low enough to qualify for certain tax deductions or credits that otherwise they would not be eligible for.

Surviving spouses eventually have a different filing status. As long as the surviving spouse has not remarried in the year of death of their spouse, they are permitted to file a federal joint tax return. This may be an option for two more years, if there is a dependent child. However, after that, taxes must be filed as a single taxpayer, which means tax rates are not as favorable as they are for a couple filing jointly. The standard deduction is also lowered for a single person.

If the spouse inherits a traditional IRA, the surviving spouse may elect to be designated as the account owner, roll funds into their own retirement account, or be treated as a beneficiary. Which option is chosen will impact both the required minimum distribution (RMD) and the surviving spouse’s taxable income. If the spouse decides to become the designated owner of the original account or rolls the account into their own IRA, they may take RMDs based on their own life expectancy. If they chose the beneficiary route, RMDs are based on the life expectancy of the deceased spouse. Most people opt to roll the IRA into their own IRA or transfer it into an account in their own name.

The surviving spouse receives a stepped-up basis in other inherited property. If the assets are held jointly between spouses, there’s a step up in one half of the basis. However, if the asset was owned solely by the deceased spouse, the step up is 100%. In community property states, the total fair market value of property, including the portion that belongs to the surviving spouse, becomes the basis for the entire property, if at least half of its value is included in the deceased spouse’s gross estate. Your estate planning attorney will help prepare for this beforehand, or help you navigate this issue after the death of a spouse.

It should be noted there is a special rule that helps surviving spouses who wish to sell their home. Up to $250,000 of gain from the sale of a principal residence is tax-free, if certain conditions are met. The exemption increases to $500,000 for married couples filing a joint return, but a surviving spouse who has not remarried may still claim the $500,000 exemption, if the home is sold within two years of the spouses’ passing.

There is an unlimited marital deduction in addition to the current $11.7 million estate tax exemption. If the deceased’s estate is not near that amount, the surviving spouse should file form 706 to elect portability of their deceased spouse’s unused exemption. This protects the surviving spouse if the exemption is lowered, which may happen in the near future. If you don’t file in a timely manner, you’ll lose this exemption, so don’t neglect this task.

Reference: Yahoo! Finance (July 16, 2021) “The Financial Effects of Losing a Spouse”

Are Roth IRAs Smart for Estate Planning?

Think Advisor’s recent article entitled “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool” says that Roth IRAs offer an great planning tool, and that the Secure Act 2.0 retirement bill (which is expected to pass) will create an even wider window for Roth IRA planning.

With President Biden’s proposed tax increases, it is wise to leverage Roth conversions and other strategies while tax rates are historically low—and the original Secure Act of 2019 made Roth IRAs particularly valuable for estate planning.

Roth Conversions and Low Tax Rates. Though tax rates for some individuals may increase under the Biden tax proposals, rates for 2021 are currently at historically low levels under the Tax Cuts and Jobs Act passed at the end of 2017. This makes Roth IRA conversions attractive. You will pay less in taxes on the conversion of the same amount than you would have prior to the 2017 tax overhaul. It can be smart to make a conversion in an amount that will let you “fill up” your current federal tax bracket.

Reduce Future RMDs. The money in a Roth IRA is not subject to RMDs. Money contributed to a Roth IRA directly and money contributed to a Roth 401(k) and later rolled over to a Roth IRA can be allowed to grow beyond age 72 (when RMDs are currently required to start). For those who do not need the money and who prefer not to pay the taxes on RMDs, Roth IRAs have this flexibility. No RMD requirement also lets the Roth account to continue to grow tax-free, so this money can be passed on to a spouse or other beneficiaries at your death.

The Securing a Strong Retirement Act, known as the Secure Act 2.0, would gradually raise the age for RMDs to start to 75 by 2032. The first step would be effective January 1, 2022, moving the starting age to 73. If passed, this provision would provide extra time for Roth conversions and Roth contributions to help retirees permanently avoid RMDs.

Tax Diversification. Roth IRAs provide tax diversification. For those with a significant amount of their retirement assets in traditional IRA and 401(k) accounts, this can be an important planning tool as you approach retirement. The ability to withdraw funds on a tax-free basis from your Roth IRA can help provide tax planning options in the face of an uncertain future regarding tax rates.

Estate Planning and the Secure Act. Roth IRAs have long been a super estate planning vehicle because there is no RMD requirement. This lets the Roth assets continue to grow tax-free for the account holder’s beneficiaries. Moreover, this tax-free status has taken on another dimension with the inherited IRA rules under the Setting Every Community Up for Retirement Enhancement (Secure) Act. The legislation eliminates the stretch IRA for inherited IRAs for most non-spousal beneficiaries. As a result, these beneficiaries have to withdraw the entire amount in an inherited IRA within 10 years of inheriting the account. Inherited Roth IRAs are also subject to the 10-year rule, but the withdrawals can be made tax-free by account beneficiaries, if the original account owner had met the 5-year rule prior to his or her death. This makes a Roth IRA an ideal estate planning tool in situations where your beneficiaries are non-spouses who do not qualify as eligible designated beneficiaries.

Reference: Think Advisor (May 11, 2021) “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool”

What Is Benefit of a Roth IRA at the Time of Retirement?

It’s been called the gold medal of retirement accounts, and for good reason. The Roth IRA is an excellent tool for savers who want to make the most of money they’ve already paid taxes on to invest in assets to supercharge their investments, says a recent article from The Motley Fool titled “4 Incredible Benefits of a Roth IRA.”

Here’s how to maximize your use of the Roth IRA:

Gain potentially tax-free income during retirement. This is one of the major attractions of a Roth IRA. As long as your income falls below the limits and you’ve earned income during the year, you may continue to contribute to your account, generating more tax-free growth.

When contributions come directly out of a paycheck or are made by you later, you’ve already paid the taxes on the assets that fund the Roth IRA. The funds grow tax-free, and there’s no taxes on withdrawals.

There are, however, limits to your annual contributions. For 2021, the most you can deposit into a Roth is $6,000 for anyone under age 50 and $7,000 if you are 50 plus. You also can’t contribute more than you’ve earned for the year.

There is no tax or penalty to withdrawing, whenever you want. You don’t want to be careless with your retirement accounts, but the flexibility makes the Roth IRA compelling. Let’s say you contribute $5,000 to your Roth and the market soars. Your investment grows to $7,000. And for whatever reason, you’re a little tight on cash. You can take out the original $5,000, whenever you want, tax free. Withdrawing the earnings in the account would trigger taxes and penalties. But the original $5,000 is yours whenever you need it. One more detail: you can’t put that $5,000 back.

No Required Minimum Distributions. When you are in your 70s, and non-Roth accounts require that you take RMDs, you’ll appreciate this more. RMDs are mandated minimum amounts that must be taken from tax-deferred retirement plans. They are considered income and taxable. Too big a withdrawal could also push you into a higher tax bracket. If you are lucky enough to have multiple sources of income and don’t want to take out the withdrawals, well, too bad. That’s the tax law.

With a Roth, you can leave it in the account as long as you like. As long as you qualify, you’re good to save and let the money grow.

Roth IRAs are Easy to Pass to Heirs. If your estate plan includes leaving a legacy and assets to your beneficiaries, your Roth IRA is a solid choice. With no RMDs, you can let it grow for years or decades, and then leave it to heirs through the use of beneficiary designations.

Speak with your estate planning attorney about how the Roth IRA fits into your overall estate plan and complements the trusts and other tools used to maximize your legacy. If you don’t have an estate plan in place, save your heirs from a legal and financial disaster by making an appointment with an estate planning attorney as soon as possible.

Reference: The Motley Fool (April 24, 2021) “4 Incredible Benefits of a Roth IRA”

How Does an Inherited IRA or 401(k) Work?
Inherited IRA written on a piggy bank

How Does an Inherited IRA or 401(k) Work?

The rules for inheriting retirement assets are complicated—just as complicated as the rules for having 401(k)s and IRA to begin with. Mistakes can be hard to undo, warns the article “Here’s how to handle the complicated rules for an inherited 401(k) or IRA” from CNBC.

The 2019 Secure Act changed how inherited tax deferred assets are treated after the original owner’s death. The options depend upon the relationship between the owner and the heir. The ability to stretch out distributions across the heir’s lifetime if the owner died on or after January 1, 2020 ended for most heirs. Exceptions are the spouse, certain disabled beneficiaries, or minor children of the decedent. Otherwise, those accounts must be depleted within ten years.

Non-spouses with flexibility include minor children. That’s all well and fine, but once the minor child turns 18 (in most states), the 10-year rule kicks in and the individual has 10 years to empty the account. Before that time, the minor child must take annual required minimum distributions (RMDs) based on their own life expectancy.

These required withdrawals typically begin when a retiree reaches age 72, and the amount is based on the account owner’s anticipated lifespan.

Beneficiaries who are chronically ill or disabled, or who are not more than ten years younger than the decedent, may take distributions based on their own life expectancy. They are not subject to the ten- year rule.

Beneficiaries subject to that ten-year depletion rule should create a strategy, including creating an Inherited IRA and transferring the funds to it. If the inherited account is a Roth or a traditional IRA, the process is slightly different. Distributions from a Roth IRA are generally tax-free, and traditional IRA distributions are taxed when withdrawals occur. One point about Roths—if you inherit a Roth that’s less than five years old, any earnings withdrawn will be subject to taxes, but the contributed after-tax amounts remain tax-free.

If an heir ends up with a retirement account via an estate, versus being the named beneficiary on the account, the account must be depleted within five years, if the original owner had not started taking RMDs. If RMDs were underway, the heir would need to keep those withdrawals going as if the original owner continued to live.

For spouses, there are more options. First, roll the money into your own IRA and follow the standard RMD rules. At age 72, start taking required withdrawals based on your own life expectancy. If you don’t need the income, you can leave the money in the account, where it can continue to grow. However, if you are not yet age 59½, you may be subject to a 10% early withdrawal penalty if you take money from the account. In that case, put the money into an Inherited IRA account, with yourself as the beneficiary.

IRAs and 401(k)s are complicated. Speak with your estate planning attorney to make an informed decision when creating an estate plan, so your inherited assets will work with, not against, your overall strategy.

Reference: CNBC (April 11, 2021) “Here’s how to handle the complicated rules for an inherited 401(k) or IRA”

Estate Planning Meets Tax Planning

Not keeping a close eye on tax implications, often costs families tens of thousands of dollars or more, according to a recent article from Forbes, “Who Gets What—A Guide To Tax-Savvy Charitable Bequests.” The smartest solution for donations or inheritances is to consider your wishes, then use a laser-focus on the tax implications to each future recipient.

After the SECURE Act destroyed the stretch IRA strategy, heirs now have to pay income taxes on the IRA they receive within ten years of your passing. An inherited Roth IRA has an advantage in that it can continue to grow for ten more years after your death, and then be withdrawn tax free. After-tax dollars and life insurance proceeds are generally not subject to income taxes. However, all of these different inheritances will have tax consequences for your beneficiary.

What if your beneficiary is a tax-exempt charity?

Charities recognized by the IRS as being tax exempt don’t care what form your donation takes. They don’t have to pay taxes on any donations. Bequests of traditional IRAs, Roth IRAs, after-tax dollars, or life insurance are all equally welcome.

However, your heirs will face different tax implications, depending upon the type of assets they receive.

Let’s say you want to leave $100,000 to charity after you and your spouse die. You both have traditional IRAs and some after-tax dollars. For this example, let’s say your child is in the 24% tax bracket. Most estate plans instruct charitable bequests be made from after-tax funds, which are usually in the will or given through a revocable trust. Remember, your will cannot control the disposition of the IRAs or retirement plans, unless it is the designated beneficiary.

By naming a charity as a beneficiary in a will or trust, the money will be after-tax. The charity gets $100,000.

If you leave $100,000 to the charity through a traditional IRA and/or your retirement plan beneficiary designation, the charity still gets $100,000.

If your heirs received that amount, they’d have to pay taxes on it—in this example, $24,000. If they live in a state that taxes inherited IRAs or if they are in a higher tax bracket, their share of the $100,000 is even less. However, you have options.

Here’s one way to accomplish this. Let’s say you leave $100,000 to charity through your IRA beneficiary designations and $100,000 to your heirs through a will or revocable trust. The charity receives $100,000 and pays no tax. Your heirs also receive $100,000 and pay no federal tax.

A simple switch of who gets what saves your heirs $24,000 in taxes. That’s a welcome savings for your heirs, while the charity receives the same amount you wanted.

When considering who gets what in your estate plan, consider how the bequests are being given and what the tax implications will be. Talk with your estate planning attorney about structuring your estate plan with an eye to tax planning.

Reference: Forbes (Jan. 26, 2021) “Who Gets What—A Guide To Tax-Savvy Charitable Bequests”

What Do I Need to Do to Calculate and Correct an Excess IRA Contribution?

It would be super if you could put all your money into a Roth and enjoy tax-free growth and withdrawals. However, Uncle Sam restricts the amount you can contribute annually, and eligibility is based on your income. However, if you make too much money, you might be able to use a work-around called a backdoor Roth.

Investopedia’s January article entitled “How to Calculate (and Fix) Excess IRA Contributions” says there’s also a contribution limit for traditional IRAs. However, these income limits concern deducting contributions on your taxes. If you violate a rule and make an ineligible, or excess, contribution, you’re looking at a 6% penalty on the amount each year, until you correct the mistake. However, note that Roth IRAs have an extra restriction: whether you can contribute up to the limit—or anything at all—depends on your modified adjusted gross income (MAGI). If you contributed to a Roth when you made too much to qualify—or if you contributed more than you’re allowed to either IRA—you’ve made an excess contribution, which is subject to a 6% tax penalty.

The $6,000 (or $7,000) maximum is the combined total that you’re allowed to contribute to all your IRAs. Therefore, if you have a traditional IRA and a Roth IRA, your total contribution to those two accounts must be $6,000 (or $7,000). The amount you contribute can’t be more than your earned income for the year. If your earned income is $4,000, that’s the maximum you can contribute to an IRA.

The penalty of 6% of the excess amount must be paid when you file your income tax return. If you fail to fix the mistake, you’ll owe the penalty each year the excess remains in your account. If you’re not eligible to take a qualified distribution from your IRA to fix the mistake, you’ll pay an additional 10% early withdrawal penalty on earnings (interest). The IRS has a specific formula to calculate earnings (or losses) attributable to an excess contribution. There are several ways to fix an excess contribution to an IRA:

Withdraw the excess contribution and earnings. You can avoid the 6% penalty, if you withdraw the extra contribution and any earnings before your tax deadline. You are required to declare the earnings as income on your taxes. You may also owe a 10% tax for early withdrawal on the earnings, if you’re younger than 59½.

File an amended tax return (if you’ve already filed). If you remove the excess contribution and earnings and file an amended return by the October extension deadline, you can also avoid the 6% penalty.

Apply the excess to next year’s contribution. You’ll still owe the 6% tax this year, but you’ll at least stop paying once you apply the excess.

Withdraw the excess next year. If you don’t do one of the other options, you can withdraw the excess funds by Dec. 31 of the next year. You can leave the earnings, but you must remove the entire excess contribution to avoid that 6% penalty for the following year.

In addition to the formula, you must correct the excess from the same IRA. Therefore, if you have multiple IRAs, you can’t choose the IRA you want to “fix.” The last contribution is also an excess contribution. If you made multiple contributions to an IRA, the last is considered the excess contribution. Finally, you are able to distribute the entire balance to correct the excess. If the excess amount is the only contribution you made to the IRA—and no other contributions, distributions, transfers, or recharacterizations occurred in the IRA—you can fix the excess, by simply distributing the entire IRA balance by the applicable deadline.

Most people who make ineligible contributions to an IRA do so by accident, and you could contribute too much if you meet the following criteria:

  • You make more money, and it moves you up to an income eligibility range
  • You overlook a contribution you made earlier in the year; or
  • You contributed more than your earned income for the year.

In a good faith attempt to fund your retirement accounts, you could make an excess contribution. The IRS has considered that this may occur. The agency provides guidelines to help you correct the error.

Reference: Investopedia (Jan.  19, 2020) “How to Calculate (and Fix) Excess IRA Contributions”

The SECURE Act and Your Retirement

For anyone who has saved a high six- or seven-figure balance in their retirement accounts, the SECURE Act will definitely affect their retirement plans. That includes 401(k)s, 403(b)s, and other workplace plans, as well as traditional IRAs and Roth IRA accounts. The article “How the new Secure Act affects your retirement” from the Daily Camera provides a clear picture of the changes.

Stretch IRAs are Curtailed. Anyone who inherited an IRA (traditional or Roth) from a parent before 2020, may take Required Minimum Distributions (RMDs) from those accounts over their own life expectancy. Let’s say a parent died when you were 48—you could stretch those distributions out over the course of 36 years. This option gave heirs the ability to spread income and the taxes that come with the income out over decades—with little distributions having little impact on taxes. If you inherited a Roth IRA, you could benefit from its tax-free growth over your entire lifetime.

All that’s changed now. A non-spousal heir (or one who is disabled, chronically ill or a minor child) now has ten years in which to take their distributions. They have to pay ordinary income taxes on the amount they take out, over a far shorter period of time. Newly inherited Roth IRAs have the same rules, but usually there are no taxes due. If a minor inherits an IRA, once they reach the age of majority, they have ten years in which to take their distributions.

A Small Break for Required IRA Distributions. Until the SECURE Act, retirees had to start taking their RMDs out of IRAs soon after turning 70½. The new age for taking RMDs is now 72 for those who are younger than age 70½ at the end of 2019. This won’t alter the plans of most retirees, since they usually start taking those distributions well before age 72 to cover expenses. Roth IRAs have another benefit: they continue to escape distribution requirements, unless they are inherited.

No Age Cap for Traditional IRA Contributions. Workers may now continue to contribute funds into a traditional IRA at any age. Before the SECURE Act, workers had to stop contributing funds once they turned 70½. Note that you or your spouse are still required to have earned income to put funds in a traditional or Roth IRA.

Other Changes. There are many more changes from the SECURE Act and thought leaders in the estate planning community will be reviewing and analyzing the law for months, or perhaps years, to come. Some of the changes that are widely recognized already include the ability to withdraw $5,000 penalty-free from retirement plan accounts per newly born or adopted child, although in most cases, income tax will need to be paid on the withdrawal.

Section 529 educational savings accounts can be used, up to a lifetime limit of $10,000 per student, to pay off student loans. In most states, this will be considered a non-qualified withdrawal and state income taxes will be due, but at least the money can be used for this purpose.

Lastly, there are new tax credits available to smaller companies that set up new retirement plans, and there are new rules regarding including part-time employees in company sponsored 401(k) plans.

The changes from the SECURE Act, particularly regarding the loss of the IRA Stretch, have created a need for people to review their estate plans, if they included leaving large retirement accounts to their children. Speak with your estate planning attorney to ensure that your plan still works.

Reference: Daily Camera (Jan. 11, 2020) “How the new Secure Act affects your retirement”