Retirement

Take Advantage of Roth 401(k) IRA Plans

Contributing to a Roth 401(k) or Roth IRA is a sound investment option. Roth accounts allow for retirement savings that provide significant, long-term tax advantages. Before committing to a retirement option, weigh the pros and cons and consider what is right for your particular financial goals.

The main difference between a Roth and traditional retirement plan lies in when you pay taxes on the income contributed to your account. With a traditional 401(k)/IRA, you contribute pre-tax dollars now and pay taxes when you withdraw the income later. A Roth plan allows you to do the opposite. Your current contributions are made with after-tax dollars. Then there are no tax implications when you make withdrawals during retirement.

Benefits of Roth Plans vs. Taxable Accounts

When you choose a Roth plan instead of a standard taxable 401(k)/IRA, the real value is in looking at how the plan is used. You will get the same investment options with a Roth or standard plan, but a Roth 401(k)/IRA typically provides liability protection. While taxable accounts are not exempt from bankruptcy protection and lawsuits, Roth 401(k)/IRA accounts are generally protected.

There is also no need for tax reporting, since Roth plans do not require annual reporting. With other taxable accounts, you need to pay income tax annually. A Roth plan is handled differently. Both accumulated income and qualified distributions are tax free.

Benefits of Roth Plans vs. Tax-Deferred Retirement Accounts

With a Roth 401(k)/IRA, you experience greater tax savings than you would with a tax-deferred retirement account. The long-term level of tax-free growth makes these plans particularly popular, since paying taxes on their proceeds in the future is not required. If they have strong growth, it will basically set you up to receive tax-free money in retirement.

There is also no age limit to make Roth contributions, as long as you are still earning income. Also, you will not have to take required minimum distributions. Roth plans can continue to grow if the owner of the plan does not want to withdraw money.

Benefits of Roth Plans for Estate Planning

For estate planning, the Roth 401(k)/IRA has some notable benefits. With tax-free distributions, there is no income tax incurred on a Roth plan’s distributions. Additionally, the Roth 401(k)/IRA offers an opportunity for tax-free growth for beneficiaries, who only have to take minimum required distributions. They can leave the lump sum to grow, if they wish. Bypassing probate is also a valuable benefit, as most Roth plans simply pass to the beneficiary.

Backdoor Roth IRA Option

If your annual income is above the IRS Roth cap, you can plan for retirement using a “backdoor” Roth IRA. This unofficial, IRS-approved approach can be complicated but well worth the effort. There are a few ways to contribute to a backdoor Roth IRA, including:

Contributing to an established IRA and rolling the funds to a Roth IRA account. Or, passing existing money from a traditional IRA to a Roth account.
Converting your entire traditional IRA account into a Roth IRA account.
Making after-tax contributions to a traditional 401(k). Then rolling it over to a Roth IRA.

Going with one of those methods doesn’t mean you’re exempt from paying taxes—you will still owe taxes on the entire amount transferred to your Roth IRA.

Choosing a Roth 401(k)/IRA option makes sense, especially in the long term. With a Roth account, you can maximize your savings and capitalize on a retirement strategy that gives you a strong financial future.

Insogna CPA is experienced and well-equipped to deliver a seamless retirement planning experience to its clients. For more information on building wealth and creating a comfortable future for yourself, contact our team of licensed CPAs.

Can I take money from my ROTH IRA?

A: Yes, a qualified distribution that occurs at least 5 years after the year you made the ROTH contribution, you an take money out for either:

You’re over the age of 59 ½,
Distribution is related to your disability (defined in I.R.C. § 72)
Money is paid to a beneficiary or estate on or after your death, or
Taken for a qualified special purpose, including for a first-time homebuyer expense up to $10,000

A. You can qualify as a first-time homebuyer even if you’ve owned a home in the past. As far as the Internal Revenue Service (IRS) is concerned, you’re a first-time homebuyer if, “you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse also must meet this no-ownership requirement.”

Making Two IRA Rollovers in One Year Can Be Costly

Article Highlights:

One Rollover per Year Rule
Exceptions
Tax Consequences
Disqualified Rollover
Early Withdrawal Penalty

Tax law permits you to take a distribution from your IRA account, and as long as you return the distribution to your IRA within 60 days, there are no tax ramifications. However, many taxpayers overlook that you are only allowed to do that once in a 12-month period, and violating this rule can have some nasty and unexpected tax ramifications.

The one-year period is measured based on the date a distribution is received. If the second distribution is received before the same date one year later, it is a disqualified rollover.

Example – Jack takes a distribution from his IRA on June 30 of year one and subsequently rolls over the distribution (puts the funds back into the IRA) within the 60-day rollover period. Jack must wait until June 30 of year two before another distribution is eligible for a rollover. Any additional distributions taken during the one-year waiting period would be taxable.

Example – A taxpayer received a distribution from his IRA with Chase bank in February, which he immediately rolled into a new IRA with Wells Fargo. Then, in May, he took a distribution from the Wells Fargo IRA and rolled it back into the IRA at Wells within 60 days. Even though he rolled the exact amount back into the same institution within 60 days, the distribution from Chase had started the running of the one-year waiting period. Thus, his second distribution was in violation of the one-year waiting period and was a taxable distribution. The redeposit of what he thought was a rollover was actually a contribution to the IRA.

Like everything taxes, there are exceptions to the one-year rule, including the following:

Direct Transfers – As long as IRA funds are transferred directly between trustees, the transaction is not considered a rollover. A taxpayer can make as many direct transfers in a year as he or she wants; in fact, utilizing direct transfers is the preferred way to move funds from one IRA to another because it eliminates certain tax-return reporting issues.

Roth Conversions – Traditional IRA to Roth IRA conversions are not considered rollovers for purposes of the one-year rule.
Distributions to and from Qualified Plans – Since the one-year rule only applies to IRA-to-IRA rollovers, rollovers to and from other types of retirement plans are not governed by the one-year rule. However, SEPS and SIMPLE plans are treated as an IRA for purposes of the one-year waiting period.
Failed Financial Institutions – An IRA distribution made from a failed financial institution by the Federal Deposit Insurance Corporation is generally disregarded for purposes of applying the one-rollover-per-year limitation.

Tax Consequences – When the one-year rule is violated, any distribution after the first made within the one-year waiting period will not be treated as a rollover, with the following tax consequences:

Traditional IRA – In the case of a traditional IRA, the entire distribution will be taxable, and if the taxpayer is under age 59½ at the time of the distribution, the 10% early distribution penalty will apply to the taxable portion.
Roth IRA – In the case of a Roth IRA that is a:o Non-Qualified Distribution – A non-qualified distribution is one where the Roth IRA has not met the five-year aging requirements. Five-year aging generally means the Roth IRA has been in existence for a continuous period of five years, although the first and last years do not need to be full years. A distribution from a Roth IRA that has not met the five-year aging requirements would be a non-qualified distribution, and the earnings would be taxable. Of course, the original contributions are never taxable based on a specific distribution sequence: contributions, then conversions from traditional IRAs or rollovers from qualified plans (first the part that was taxed when the funds went into the Roth and then the nontaxable part), and lastly earnings. A 10% early distribution penalty applies to any amount attributable to the part of the conversion or rollover amount that had to be included in income at the time of the conversion or rollover (the recapture amount).

Qualified Distribution – No tax or penalty applies if a distribution from a Roth IRA is a “qualified distribution,” which is a distribution made after the five-year aging period is met if the taxpayer:

– Is age 59½ or older,
– Is disabled,
– Is deceased, or
– Qualifies for the first-time homebuyer exception (maximum $10,000).

Disqualified Rollover – An additional problem arises because the disqualified rollover amount will be treated as an IRA contribution, subject to the normal annual contribution and AGI limitations. Tax law includes a penalty when someone contributes more than is allowed (excess contribution). Thus, an excess contribution (except for on the year of the distribution) would be subject, annually, to a 6% excess contribution penalty.

There are a couple of possible remedies available for a disqualified rollover:

Corrective Distribution – The excess contribution and the interest attributable to it can be withdrawn by the extended due date of the return for the year the distribution was made, thus undoing the rollover. The distribution that resulted in a disqualified rollover will be subject to tax, as outlined earlier, depending upon whether it was a traditional or Roth IRA. The earnings attributable to withdrawn funds are taxable. However, the annual 6% excess contribution penalty is avoided.
Contributions in Future Years – The excess contribution could be left in the IRA and can be treated as an IRA contribution for a later year. However, until the excess contribution is fully absorbed as eligible future contributions, the annual 6% excess contribution penalty will apply.

Early Withdrawal Penalty – If the disallowed rollover occurs before reaching age 59½, an early distribution penalty of 10% of the taxable amount will apply and is in addition to the normal tax.

Although there are a number of exceptions to the under-age-59½ early distribution penalty, the following might be used to avoid or mitigate an early withdrawal penalty associated with a disqualified rollover:

Contributions Returned before the Due Date – If the taxpayer already made an IRA contribution for the tax year, the amount of that contribution can be withdrawn tax-free by the extended due date of the tax return, provided:

1. The taxpayer did not take a deduction for the contributions withdrawn, and
2. The taxpayer also withdraws any interest or other income earned on the contributions, and
3. The taxpayer includes in income, for the year during which the withdrawal was made, any earnings on the contributions withdrawn.

Medical Insurance Exception – The amount that is exempt from the penalty is the amount the taxpayer paid during the year for medical insurance for the taxpayer and his or her spouse and dependents. To qualify for this exception, the taxpayer must have:

1. Lost his/her job,
2. Received unemployment compensation for 12 consecutive weeks,
3. Made IRA withdrawals during the year he/she received unemployment or in the following year, and
4. Made the withdrawals no later than 60 days after being reemployed.

Higher Education Expense Exception – The part not subject to the penalty is generally the amount that is not more than the qualified higher education expenses for the taxpayer and his or her spouse, children, or grandchildren for the year at an eligible educational institution.

Bottom line, make sure you don’t have more than one IRA rollover in a year. However, if you inadvertently do, please call this office as soon as you realize the error so we can determine what actions can be taken to mitigate the resulting taxes and penalties.

Understanding Tax-Deferred Investing

Article Highlights:

Income Deferral
Earnings Deferral
Individual Retirement Accounts
Retirement Accounts
Bank Savings
Short- and Long-Term Capital Gains
Education Savings Accounts
Health Savings Accounts

When you are attempting to save money for your children’s future education or your retirement, you may do so in a number of ways, including investing in the stock market, buying real estate for income and appreciation, or simply putting money away in education savings accounts or retirement plans.

Knowing how these various savings vehicles are taxed is important for choosing the ones best suited to your particular circumstances. Let’s begin by examining the tax nuances of IRA accounts.

Individual Retirement Account (IRA) – There are two types of IRA accounts—the traditional and the Roth—and even though they are both IRAs, there is a huge difference in their tax treatment.

Traditional IRA – Contributions to a traditional IRA are generally tax-deductible unless you have a retirement plan at work, and then the IRA contribution may not be deductible if you are a higher-income taxpayer. All of the earnings from a traditional IRA are tax-deferred, meaning they are not taxable currently but will be when funds from the account are withdrawn; since the contributions were tax-deductible, everything you withdraw from the traditional IRA will be taxable. An exception to that last statement is when you didn’t claim a deduction for money that you contributed to the IRA, either by choice or when the law didn’t allow a deduction. In this case, withdrawals from a traditional IRA would be prorated as partly taxable and partly tax-free.
Roth IRA – Roth IRA contributions are never tax-deductible, but the earnings are never taxable if the account meets a 5-year aging rule and the distributions begin after you reach age 59.5.

So, which is best? Well, that depends upon your particular circumstances. If you need the tax deduction to fund the IRA, then by all means use the traditional IRA. However, if you can afford to the make a contribution without the deduction, then the Roth IRA will be the best because everything is tax-free when withdrawn, usually at retirement.

retirement plans – The tax code provides for a variety of retirement plans, both for employees and for self-employed individuals. These include: 401(k) deferred compensation plans, Keogh self-employed retirement plans, simplified employee plans (SEP), tax-sheltered annuity (403(b)) plans – most commonly for teachers and employees of nonprofits), and government employee plans (457) plans. For the most part, the consequences of these arrangements are the same as for a traditional IRA, allowing the amount contributed to be excluded from income (deferred), and then the distributions are fully taxable when they are taken. However, 401(k) and 457 plans may have a Roth option, under which there is no income exclusion for the contributions but the distributions at retirement are tax-free. If individuals have used both methods, the non-Roth contributions are deferred, and the earnings are fully taxable.

Bank Savings – When money is put away into a bank savings account or CD, the earnings are fully taxable in the year earned. However, after the tax on the annual earnings is paid, the full balance in the account is available, without any further tax.

Short- and Long-Term Capital Gains – Capital gains refers to the gain from the sale of capital assets – typically stocks, bonds, and real estate. Short-term capital gains are taxed at ordinary tax rates, while long-term capital gains enjoy special lower rates. For lower-income taxpayers, there is actually no tax on capital gains; for very high-income taxpayers, the capital gains rate maxes out at 20%, whereas the top regular tax rate for high-income taxpayers is 37%. However, for the average taxpayer, the capital gains rate is 15%, which provides a significant savings over the regular tax rates. To qualify for long-term treatment, the capital asset must be held for a year and a day.

Education Savings Accounts – The tax code provides two tax-advantaged plans that allow taxpayers to save for the cost of college for each eligible student: the Coverdell Education Savings Account and the Qualified Tuition Plan (frequently referred to as a Sec. 529 Plan). Neither provides tax-deductible contributions, but both plans' earnings are tax-deferred and are tax-free if used for allowable expenses, such as tuition. Therefore, with either plan, the greatest benefit is derived by making contributions to the plan as soon as possible—even the day after a child is born—to accumulate years of investment earnings and maximize the benefits.

However, there are different limitations for the two plans, in that only $2,000 per year per student can be contributed to a Coverdell account, while huge amounts can be contributed to Sec. 529 plans, limited only by the estate-planning issues of each contributor and each state's cap on account contributions, which goes into six figures.

Health Savings Accounts – A health savings account (HSA) can generally be established by taxpayers only if they have high-deductible health plans. The contributions are tax-deductible, the earnings accumulate tax-free, and the distributions are tax-free if used for qualified medical expenses. When part of an employer-sponsored plan, HSA contributions are excluded from the employee's wages. Once the account owner reaches age 65, taxable but penalty-free distributions can be taken, even if they are not used to pay for medical expenses or to reimburse the taxpayer for medical expenses previously paid for out-of-pocket. Thus, these plans can serve as a combination tax-free medical reimbursement plan and taxable retirement savings arrangement. The maximum annual contribution is inflation adjusted; for 2018, it is $3,450 for self-only coverage and $6,900 for family coverage. Like other tax-advantaged plans, the key is to allow the account to grow through tax-deductible contributions and the accumulated earnings.

Unqualified Withdrawals – Be careful about making unqualified withdrawals – those that are taken before reaching retirement age, in the case of retirement plans, and those taken for unqualified expenses, in the case of education savings accounts and health savings accounts. Doing so can result in costly tax ramifications and potential penalties.

Like all things tax, nothing is simple, and a myriad of rules apply to the foregoing arrangements, so please contact this office for more information or a planning appointment.

Is a Roth Conversion Right for You? But Be Careful, They Can No Longer Be Undone!

Article Highlights:

Conversion Timing
Why Convert?
When to Convert?
Issues to Consider Before Making the Decision

Roth IRA accounts provide the benefits of tax-free accumulation and, once you reach retirement age, tax-free distributions. This is the reason why so many taxpayers are converting their traditional IRA account to a Roth IRA. However, to do so, you must generally pay tax on the on the converted amount. After making a conversion, your circumstances may change, and you may find yourself wishing you had not made the conversion. In the past, you could change your mind later and undo the conversion. But that option is no longer available under tax reform. So, be careful: once a conversion is made, there is no going back.

Timing is everything, and a favorable time to make a traditional IRA to Roth IRA conversion is a year when your income is abnormally low or the value of your traditional IRA has declined. You can also convert portions of your traditional IRA over a number of years, thereby gradually converting the traditional IRA to a Roth IRA, spreading the tax liability over a number of years, and keeping it in a lower tax bracket. If you previously made non-deductible contributions to a traditional IRA, those amounts can be converted tax-free but must be converted ratably with the other funds in the traditional IRA.

Many taxpayers overlook some great opportunities to make conversions, such as years when your income is abnormally low or a year when your income might even be negative due to abnormal deductions or business losses. Even the new higher standard deductions may offer a taxpayer the opportunity to convert some or all of their traditional IRA to a Roth IRA without any conversion tax.

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

Will there be enough years before retirement to recoup the conversion tax dollars through tax-free accumulation?
Is your income low enough or are your deductions high enough to enable a tax-free or minimal tax conversion?
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, and once made, they can no longer be undone. If you are considering a conversion, it might be appropriate to call for an appointment so that this office can help you properly analyze your conversion options or develop a conversion plan that fits your particular circumstances.