By Justin Fundalinski, MBA | March 20, 2017

There are some very confusing rules when it comes to whether or not you are able to contribute to Traditional IRAs and Roth IRAs and whether or not your contribution is deductible. In this month’s article I aim to clarify these rules so you will be able to catch your mistakes before the IRS subjects you to a nasty penalty.

Let’s get the basics out of the way:

• For 2017, the maximum amount of contributions (without penalty) that an individual can make is $5,500 ($6,500 if you’re age 50 or older).
• You can only contribute an amount equal to or less than your earned compensation (as long as that amount does not exceed the maximum allowed contribution). Compensation includes wages, salaries, and commissions, self-employment income, taxable alimony, jury fees, and more. However, other sources of income such as pension, annuity, Social Security, IRA distributions, rental, interest, dividend, capital gain, child support, and more do not count as earned income.
• You can contribute to a Traditional IRA (without penalty) only until you are age 70½. Roth IRA’s on the other hand are not subject to this age restriction.
• Traditional IRA contributions may be Don’t just assume that they are. If you or your spouse has a retirement plan at work (defined contribution plan, IRA based plan, or defined benefit plan) there are some rules in play that reduce the deductibility.
• Roth IRA contributions are never deductible. However, don’t just assume you can always make a Roth contribution because there are rules that restrict the amount of Roth contributions you can make based on your income.

What if you don’t have earned compensation?

Just because you don’t have earned compensation does not mean you are totally out of luck and cannot contribute to an IRA. If you are married and filing jointly an IRA contribution can be made to your IRA based off of your spouses earned compensation.

What if you are covered by a Retirement Plan at work?

When you are covered by a retirement plan at work you can always contribute to a Traditional IRA; however, you may not be able to deduct the contributions on your taxes.  Whether or not you can deduct your contribution depends entirely on your Modified Adjusted Gross Income  (MAGI) and your filing status.

• Single or Head of Household with MAGI of $62,000 or less can take a full deduction. If MAGI is above $72,000 then there is no deduction. Anywhere in-between you get a partial deduction.
• Married filing jointly or qualifying widow(er) with MAGI of $99,000 or less can take a full deduction. If MAGI is above $119,000 then there is no deduction. Anywhere in-between you get a partial deduction.
• Married filing separately with MAGI of 10,000 or less can take a full deduction. If MAGI is above $10,000 then there is no deduction. Ouch!

What if your spouse is covered by a retirement plan at work but you are not?

You guessed it, there is a completely different set of restrictions on how much you can deduct of your contribution if your spouse is covered by a retirement plan at work but you are not.

• Married filing jointly with a spouse covered by a plan at work and MAGI of $186,000 or less can take a full deduction. If MAGI is above $196,000 then there is no deduction. Anywhere in-between you get a partial deduction.
• Married filing separately with a spouse covered by a plan at work and MAGI of $10,000 or less can take a full deduction. If MAGI is above $10,000 then there is no deduction. Anywhere in-between you get a partial deduction. Ouch again!

If you are putting the puzzle pieces together as you read this you can see that it is very possible that you may not be able to deduct your Traditional IRA contribution while your spouse can (or vice versa). Talk about muddy waters!

What are the restrictions on Roth IRA contributions?

As I noted earlier, you can never deduct Roth contributions and there are rules that restrict how much of a contribution you can make. Again, it comes down to MAGI and filing status.

• Single, head of household, or married filing separately with MAGI of $118,000 or less can make a full contribution. If MAGI is above $133,000 then no contribution can be made. Anywhere in-between you can make a partial contribution.
• Married filing jointly or qualifying widow(er) with MAGI of $186,000 or less can make a full contribution. If MAGI is above $196,000 then no contribution can be made. Anywhere in-between you can make a partial contribution.
• Married filing separately with MAGI of $10,000 or less can make a full contribution. If MAGI is above $10,000 then no contribution can be made. Ouch Ouch Ouch!

There are plenty more rules that come into play but these cover the majority of the rules that can get you in trouble.  As always, we are here to help with all of your retirement questions so feel free to reach out to us at the office anytime.

By Justin Fundalinski, MBA | February 26, 2017

Considering the reader base of this newsletter, I assume most reading this are attempting to be  good savers for retirement and are patting themselves on the back each year for peeling off portions of their earned income to save into 401(k)s and IRA’s, all while reducing their current year’s tax bill.  I commend you for your discipline and urge you to look even deeper into the future.  As we all know the only thing guaranteed in life is death and taxes. While we can’t help you with death (perhaps my wife could as a Board Certified Palliative and Hospice Nurse Practitioner), I do think we can help reduce the tax liability you are creating for yourself in the future when defer those taxes by saving into accounts like 401(k)s and Traditional IRAs.

What Is the Tax Void?

We have coined another term in the office called the “tax void.”  As eloquently as possible, it is defined as the period of time between retirement and age 70[1] when retirees have the most discretion over where their income sources are coming from and thus they have the most control of their tax liability.  By “where” I mean what type of account they are debiting from(qualified or non-qualified, taxable or not taxable, etc…) as well as whether or not they are deferring  income from Social Security, Pension, and/or annuities.

As an extreme example, if somebody could delay taking withdrawals from 401(k), Traditional IRAs, or other similar tax deferred retirement accounts as well as defer their taxable income sources like Social Security and pension income, then they would enjoy a temporary luxury of not having to pay any taxes between retirement and age 70. While most people don’t have the ability to have such complete discretion, most people do have some discretion and such discretion can create a tax void (although maybe not as deep as the one made in my extreme example). However, simply avoiding paying taxes during this time period is the worst choice a retiree can make because of how short sighted it is (more on that soon).

Creating a Bigger Tax Void

Creating the opportunity to have a large tax void is probably the most difficult step in this type of tax planning, but it essentially comes down to one thing – tax diversification of retirement savings.  Tax diversification simply means how one is allocated between different types of accounts based on how withdrawals will be taxed when they take distributions from the account.

For Example:

All income from a Traditional IRA will be fully taxed as ordinary income; however, income from a non-qualified account is taxed based on how much gain was taken (as well as taxes at capital gains rates), and funds from a Roth IRA or 401k are not taxed at all.  Unfortunately, because everybody does such a good job of avoiding taxes today by saving into their 401(k) and/or Traditional IRA, the vast majority of people tend not have much in the way of tax diversification later. If it makes sense from a long term tax perspective, saving into other types of accounts such as Roth IRA’s or Non-Qualified (Taxable) accounts will enhance your tax diversification when you retire and provide the opportunity for a greater tax void.

Filling the Tax Void

As most know, we are taxed in a tiered fashion. The first chunk of taxable income is taxed at 10%, the second chunk of taxable income is taxed at 15%, the third at 25%, and so on. As I mentioned earlier, simply avoiding paying taxes during a tax void is a bad idea. Knowing which of these tiers (or tax brackets) will be filled up entirely by income that is not discretionary once you reach age 70 is very important when it comes to filling your tax void appropriately.

For Example:

If you know that your Social Security and Pension income will fill up your 10% and 15% brackets fully at age 70 then you also know that all of your Required Minimum Distributions (forced distributions for tax deferred retirement accounts) will be taxed at least at 25%. Now if you know that all of your withdrawals or Required Minimum Distributions from your Traditional IRA’s or 401(k)s is going to be taxed at least at 25%, it’s probably a great idea to get any money out of those accounts at a lower tax rate whenever possible. When is it possible? During the tax void!

Roth Conversion strategies combined with other withdrawal strategies make this very achievable. The effect is that you will have less money in tax deferred retirement account, causing you to have smaller Required Minimum Distributions. This in turn causes you to have less income taxed at higher rates as well as more overall tax diversification.

Conclusion

Trust me when I say that while there seems to be a lot of moving parts here this is only a 30,000 foot view of the amount of detail that must be accounted for when trying to create and fill a tax void. If you are looking for ways to ultimately decrease unnecessary Required Minimum Distributions and the associated taxes, or are just simply looking to minimize taxes in retirement please reach out to the office for additional information.

[1] Why age 70? Age 70 is the longest you can delay your Social Security benefit. At age 70½ Required Minimum Distributions on tax deferred retirement accounts begin.

By Justin Fundalinski, MBA | January 20, 2017

By the time you are reading this article it is too late to make any estimated tax payments for 2016. However, now is the right time to start thinking about estimated tax payments for next year.  As many of our readers rely on various income sources in retirement, tax withholding is not as cut and dry as it was when employers took care of it all. Estimated taxes become an important thing to consider in retirement.

Do I need to pay estimated taxes?

The IRS wants you to pay your taxes throughout the year as you go. Unfortunately, you can’t just pay what you owe in April.  So, how do you know if you need to make quarterly estimates?  Well the IRS sets out some guidelines:

• If you owe less than $1,000 in taxes (after subtracting out your federal income tax withholding from the total amount of tax you owe) then you’re in the clear. But if you expect to owe more than $1,000 then you need to watch out more carefully.
• If your federal income tax withholding amounts to at least 90% of the tax you will owe this year then you are in the clear. For example if your tax bill will be $20,000 and you pay more than $18,000 throughout the year then you are in the clear. If not, then there is one more way out of avoiding estimated taxes (or penalties for that matter).
• If your federal income tax withholding amounts to at least 100% of the tax owed on your previous year’s return then you are in the clear (or 110% in the cases that your adjusted gross income is in excess of $150,000 for joint filers and $75,000 for single filers)

If none of these guidelines clear you of your duty to pay quarterly estimated taxes then it is important you make your payments timely to the IRS throughout the year or pay a penalty come April.

What if I don’t know what my income will be?

Unfortunately, the IRS calculates its default penalty by assuming that income is earned evenly throughout the year.  For those who have income from self-employment, rental properties, S Corps, Trusts, or capital gains from divestments it is often hard to know when or how much taxable income you will receive let alone when you will receive it. So, there are a couple of routes you can take:

• Plan to pay 100% of your previous year’s taxes (or 110% in some cases as explained earlier). This is your safest approach but it may force you to pay taxes to the IRS that will later be returned to you. Sometimes you might not want the IRS banking your money for you for the better part of a year.
• Sway from the default penalty/estimated payment calculation and implement what is called the Annualized Installment Method. This installment method is helpful for those who have erratic income (or capital gains). Tax payers can use this method to make estimated tax payments based on their income as it is earned rather than evenly throughout the year.  This method involves more in in-depth calculations and should be handled by a qualified professional.

If you have any questions regarding estimated tax payments please feel free to contact the office at any time.