There was a lot of fuss around the most recent COVID-19 stimulus bill, which President Trump signed into law shortly after Christmas. While most of what is in the bill is clear at this point–it has been about three weeks since it was signed–one area that seemed to produce at least a little confusion was whether the bill extends tax breaks from Coronavirus-related distributions (CRDs) from retirement accounts. I have written about CRDs in past blogposts over the past year. As you may recall, CRDs allowed you to take a aggregate distribution of up to $100,000 from your retirement accounts in you were directly impacted by COVID-19 (i.e. you were diagnosed and had to quarantine or you were laid off due to Coronavirus restrictions) and that the distribution was not subject to the 10% early withdrawal penalty and you have three years to pay back the distribution. CRDs were designed to help those in financial distress as a result of the Coronavirus pandemic and was most likely a lifeline for many struggling Americans in 2020. Back to the latest Stimulus package. It was reported by at least one news source that the new stimulus package extended CRDs into 2021. I want to be clear here that such information is incorrect and that the new legislation did not carry CRDs into 2021. This is important because if you planned on taking a CRD in 2021, you can’t and also as a reminder to do some research and read up on any Coronavirus-related relief legislation to see how it might impact you. Now, I don’t know what the future holds and depending on how this pandemic continues to play out, the next administration might put CRDs back on the table, but I have heard no definite inklings about that, I’m just saying anything is a possibility at this point. If you took a CRD in 2020 and want to figure out how to pay it back or find yourself in further Coronavirus-related financial hardships in 2021, you will want to speak with a certified financial planner or wealth manager to figure out what the best moves might be best for you.
You may recall that the ability to recharacterize a Roth IRA conversion went away as part of the tax cut that passed in 2017. It wasn’t a major sticking point of the legislation, but it did create some concern about how it could affect those saving for retirement. However, I want to remind you that only recharacterization of Roth IRA conversions went away and that the ability to recharacterize other types of transactions still remains a possibility. For example, if you made a Roth IRA contribution but did not realize that you were above the income threshold to do so, you could potentially recharacterize that contribution to that of a traditional IRA. Obviously, you will want to avoid situations like the aforementioned example, but they do happen often enough to be discussed. Recharacterizations can be tricky and involve and in-depth understanding of how they work. If you think you may have mistakenly made an IRA contribution, then you will want to speak with your IRA custodian. Be sure to provide them with information regarding the transaction you want to recharacterize (i.e. amount of contribution, when it was conducted, etc.). Once they have that information they can find the amount and properly process it as a recharacterization. If you are considering a recharacterization or are unsure of whether a contribution you made should be recharacterized, you will first want to speak with a certified financial planner or wealth manager to make sure you actually can do a recharacterization. From there you can then move forward with the transaction.
I want to start out by stating that this post is not meant to knock employer retirement plans. Such plans can be a great way to get started in saving for retirement or as another source of retirement savings. However, if you do reach a point where rolling a 401(k) or other employer plan into an IRA is a real opportunity/thought, then you should strongly consider doing so. First off, if you are still working and your 401(k) isn’t a huge amount, you could save yourself some serious tax money down the road if you convert to an IRA, especially a Roth IRA. That can be a huge boost when you do retire and don’t have to pay taxes when you take a withdrawal. One of the biggest advantages to an IRA, though, over an employer plan or other retirement accounts is the freedom you have to choose what to invest in. With an IRA you can invest in just about any stocks and markets you wish and can also invest in other things such as certain types of real estate (this can be complicated and not many IRA custodians can do this) and, in some instances, bitcoins/cryptocurrency. You also have more say in your investment strategies with an IRA over an employer plan. Since an IRA is yours–and not an employer benefit–you are the sole person who can decide things such as what you invest in, how much you invest in certain stocks, and when to buy and sell. This freedom can be very enticing for some people and can allow for better customization of goals and benchmarks when it comes to saving for retirement. If it’s too much you can also still start an IRA and have a financial advisor or wealth manager look after it too. You can also have an IRA and a employer-sponsored retirement plan. Many people do this as there are strategic advantages to having both. If you have questions about setting up an IRA or whether it’s even a good idea for your situation, you should speak with a certified financial planner or wealth manager.
With the stock market appearing to head towards a–dare I say it–recession, now might seem like an odd time to talk about converting your traditional IRA to a Roth IRA. However, converting when the markets are low actually might be the best time to do so. When it comes to Roth IRA conversions, the tax bill for doing so is based on the value of your traditional IRA assets. Thus, when the markets are down, there’s a really good chance your IRA assets are down too, which means a lower tax number. As for the actual tax hit, as you may well know, when you convert a traditional IRA to a Roth IRA, the pre-tax funds you convert–your traditional IRA monies–will be included as part of your income for the year. That can be a hefty tax increase depending on how much you are converting and it’s important to keep in mind that that tax hit will only be for the year in which the conversion occurs. It will hurt short term, but long term, you may just avoid a bigger tax hit further down the road if you follow the Roth IRA rules. In other words, you won’t feel great about it now, but when you take your future Roth IRA distributions tax-free you’ll probably feel pretty good about the decision. Keep in mind that a Roth IRA conversion isn’t the easiest thing to do and not doing it right can open you up to some serious issues and penalties. Therefore, I encourage you to reach out to a certified financial planner or wealth manager or your plan custodian. Even if you don’t actually go through with a conversion, you can at least talk to them about the process and when it might make sense for you.
If you have more than one IRA, you can aggregate the required minimum distributions (RMDs) and take them from one IRA. Most IRA owners are familiar with this allowance. However, not everyone is aware of that fact that you cannot include inherited IRAs as part of that aggregation. It can be easy to overlook. It should be noted though, that if you inherited multiple IRAs of the same type (Roth vs. traditional) from the same person, you can aggregate the RMDs from those. In short, if you have multiple IRAs, one of which is an inherited IRA, you will need to take at least two RMDs. One for the inherited IRA and an aggregation of the others–should you choose to aggregate. As with everything else regarding RMDs, you want to make sure that you are following this rule as failure to properly take an RMD could open you up to IRS penalties and could be costly. If you have questions about whether you can aggregate your RMDs or need help with doing so, you should speak with a certified financial planner or wealth manager.
If you have an IRA, you are probably familiar with the one rollover per year rule it comes to rollovers between the same type of IRA (i.e. traditional to traditional IRA). As stated, the rule only allows one rollover per year between the same type of IRA, regardless of how many IRAs you have. If you have 3 traditional IRAs, you only get one rollover between them all. That’s it. It’s important to know when that 365 day period begins. It does not begin when the money ends up in the final retirement account, but rather when the distribution from the original account is received. This is important to know if you want to have an idea as to when you can complete another rollover and to prevent being penalized. It should be noted, however, that this limitation does not count in regards to traditional IRA to Roth IRA conversions, trustee to trustee transfers, IRA to employer plan, employer plan to IRA, and employer plan to employer plan transactions. Basically, it only counts for Roth to Roth or Traditional to Traditional IRA transactions. If you are considering a rollover, you should speak with a wealth manager or certified financial planner to make sure you can do on and to ensure that you do it correctly.
If you are a freelancer or small business owner, you probably have a lot to worry about when it comes to your work or business. You have expenses to track, work to do, clients to satisfy, and maybe an employee or two to oversee. With all that, it can be easy to forget about saving for retirement. Not only that, but you don’t have the reminders regarding opening a retirement account or automatic retirement account enrollment that are standards in larger business and corporations. Thus, it’s imperative that you take it upon yourself to think about and take the required steps to start saving for retirement. If you are freelancing as a semi-retirement gig or started your own business after putting in time in the corporate world, then you may already have an IRA or 401(k) where you have built up a nice nest egg. If you don’t, then go and open a traditional or Roth IRA (401(k)s are employer sponsored). There are other options too that are geared towards those that own their own small business. A SEP IRA is another great option for freelancers and the self-employed as eligibility is fairly wide-ranging and it offers a lot of flexibility regarding contributions. However, it should be noted that it has required minimum distributions (RMDs) just like that of a traditional IRA. Another option that can be enticing if you own a business with a few employees–or work for a small business–is a SIMPLE IRA. A SIMPLE IRA offers options for both employees and employers and requires employer matching, which is a win for employees. You could also consider just doing a traditional IRA or a Roth IRA, which are fairly common retirement saving options for many Americans. Regardless of what you decide to do, all that matters is that you are saving for retirement and are preparing for your future. If you need help deciding, you should talk with a financial advisor, particularly one who works with a lot of small business owners.
A backdoor Roth IRA conversion can be tempting if you are considering retiring early and are currently over the income limits for a Roth IRA contribution. In case you are unfamiliar, a backdoor Roth IRA conversion is where you contribute money to a traditional IRA and then convert that money into a Roth IRA. This is a useful transaction for those who earn too much income to contribute to a Roth IRA as Traditional IRAs have no income limits. It’s also a perfectly legal transaction. However, when doing a backdoor conversion, keep in mind that the taxman will get his due and that this is not a way to avoid paying taxes on IRA contributions. The money you convert will most likely count as income and you will have to pay taxes on the money in your Traditional IRA that hasn’t already been taxed. It’s also important to understand how the IRS looks at your retirement funds. If you have more than one IRA, the IRS looks at the total of your IRAs and not just the IRA you make the conversion from. This can really pose a problem if you have more than one IRA with a large balance and may make you walk away from doing a backdoor Roth IRA conversion if the taxes are too high. Income limits are another important thing to understand when doing a backdoor Roth IRA conversion. Doing one backdoor conversion doesn’t mean you can start making regular contributions to the newly created Roth IRA. Rather, you will need to do a backdoor conversion every year that you are over Roth IRA income limits, which can potentially be for many years, especially if you are a high-income earner early in your career. That’s a lot of backdoor conversions and that can leave you open to the possibility of making more mistakes. A mistake on a backdoor Roth IRA conversion can be costly depending on the amount you convert and it can be as much as 6% of the conversion if you do so over the income limits. Since backdoor Roth IRA conversions are not particularly common and require a lot of thought, you should seek out the advice of a certified financial planner before doing one.
Do you want to know a little financial secret on how to avoid rollover headaches? It’s simple, don’t do them! I’m not kidding. Rollovers, especially 60-day rollovers, can be complex as there are limitations on how many you can do each year and how long you have to move the funds. If you don’t read up on the rules or track the time between when the funds are disbursed to when they must go back into an account, you and your retirement funds could be in for a world of hurt. And yes, there are ways to avoid a rollover altogether. The best–and most efficient–ways to do so are through transfers and direct rollovers (yes, I know this is about avoiding rollovers, but direct rollovers are an exception). If you are moving money between IRAs of the same type (i.e. Roth IRA to Roth IRA), then you will want to do so through a direct transfer. If you are moving money from an employer plan to an IRA, then you will want to do so through a direct rollover. By using either of these types of transactions, you can avoid rollover issues, particularly those pertaining to 60-day rollovers. Aside from avoiding 60-day rollover rules, direct transfers in particular, also allow you to circumvent the once-per-year rollover rule too. This means that you can do as many as you need or want to do. The key to these types of transactions is that the money moves from custodian to custodian and not from custodian to you. If the money is sent to you, then it’s treated like a distribution and can open you up to certain rules and limitations. You don’t want to deal with that! As always, if you have questions about direct rollovers and transfers, you should speak with a certified financial planner.
It’s not uncommon for retirees to have more than one retirement account. Usually it’s a result of having worked at multiple employers throughout the course of a career and having opened a retirement account at each place of employment. If you do have more than one retirement account, don’t worry as there’s nothing wrong with that. You may want to consider consolidating similar accounts as you near or enter retirement, but that’s a discussion for another post. If you do have multiple accounts–especially more than one Roth-type account–you may want to make sure that you are maximizing your contributions to those accounts. And yes, if you have more than one account, such as Roth IRA and Roth 401(k), you can make max contributions to both at the same time. That includes any catch-up contributions if you are over the age of 50, which could total up to tens of thousands of dollars when combined with regular (not catch-up) contribution amounts. The same goes for if you have multiple Roth IRA accounts, although, you may want to consider consolidating them at some point for efficiency’s sake. Most retirement accounts allow you to maximize contributions regardless of whether you have multiple accounts or not. However, if you do have more than one retirement account and you want to make max contributions, your best best is to speak with a certified financial planner to make sure there are not issues with that.