Not all income is treated the same by the IRS. There are actually multiple types of income that you could generate and which are taxed differently from one another. For example, the income your generate from working is looked upon differently by the IRS than income generated from the sale of stock. Thus, it’s important that you understand the different types of income and how they are taxed. I’m not going to get into a detained examination in the blog post, but I will describe them in a nutshell. The first type of income is ordinary income, which includes things like wages and retirement income (i.e. distributions). The next type of income is capital gains income, which is income that is generated from the sale of certain assets, such as bonds, stocks, and some forms of real estate. The third type of income is interest income, which is just what it sounds like, it’s income generated from assets such as savings accounts, CDs, and money market accounts. Now keep in mind too that there may be various ways that income within each group is taxed. For example, within the capital gains group, income generated from the sale of a stock will most likely be taxed differently than income generated from the sale of real estate. Understanding that there are different types of income can be important in retirement planning because you may need to calculate those taxes as part of your savings. A good examples of this is if you are planning on selling stocks or bonds to help pay for things in retirement, it’s good to know how much you will pay in taxes on such a transaction. Finally, I want to remind you that taxes are tricky and complex, so be sure to consult with a certified tax expert when trying to figure out what your tax situation is and how much you may owe to the IRS.
According the Pew Research Center Data, the number of people 50 and over divorcing has doubled since 1990. While that my not necessarily be an epidemic to worry about, it is something you may want to think about as you move into retirement. Keep in mind–and I’ve mentioned this is past blog posts–retirement can put a strain on a relationship, especially if you find that you are not on same page with your spouse or significant other. Now, I’m not encouraging divorce, but sometimes relationships do change and it doesn’t hurt to think about how such a change may impact your retirement plans. For example, a divorce will most likely involve the splitting of assets, which will most likely include your nest egg, joint bank accounts, real estate holdings, etc. Unless you are an extremely rich couple, such division of assets will probably change your retirement plans and force you to reconsider how you will fund your retirement. You may have to consider working longer than intended or finding a second job to further make up for those lost retirement funds when your assets are divided. You will also want consider how divorce may impact your Social Security benefits, if such benefits will be playing a role in your retirement. If you have specific questions about how divorce might impact your retirement plans or want to discuss hypothetical situations with a financial planner, I encourage you to do so.
Do you see yourself staying in your current house in retirement? It’s not uncommon for retirees to seek to downsize during retirement. Reasons for doing so often focus on cutting costs, reducing maintenance work, and relocation a different locale or region. Furthermore, it can be tempting to use the profit from a home sale–especially if you live in a seller’s market–to pay down debts or add a boost to your retirement savings. For example, for an empty nester couple with a 2,500-square-foot house and a mortgage to pay off, the profits from the sale could go a long way towards paying off all or most of that mortgage and possibly still leave enough to help with the purchase of a smaller home. If you don’t have a mortgage, that profit could go towards funding your retirement plans (i.e. travel) or help to provide a cushion for your savings. For those looking to sell and use the profit to pay down debt or fund retirement, it’s not really downsizing, but rather, “rightsizing”. Aside from freeing you from the financial restraints of a large home, rightsizing can also help you to de-clutter your lifestyle and get rid of things (i.e. old furniture, clothes, etc.) that you no longer need or want. Rightsizing can also serve as a chance to refresh your lifestyle and inject new energy into your life, especially if you are moving to a new location. Also, rightsizing doesn’t need to be done right when you enter retirement, but can be done anytime after you retire. Is rightsizing right for you?
Did you know that you can invest in real estate with your IRA? However, it’s not as simple as just buying property with IRA money. There is a lot of thought and consideration that should go into such as decision as the rules for using an IRA to invest in land are limiting and leave very little room for error. First off, you need to make sure you have the right IRA for such an investment. Most Roth and traditional IRA custodians do not allow investments in real estate, thus it’s highly likely you will have to set up a self-directed IRA to do so. Next, you need to make sure that the transaction occurs within the IRA. This means that if you intend to rollover property between accounts, only that property can be rolled over, as opposed a cash amount that is equal to the value of the property or a similarly valued property. The biggest issue you need to be aware of if you invest in real estate with your IRA is prohibited transactions. If a prohibited transaction occurs, it could make your entire IRA taxable and open you up to IRS penalties. And yes, prohibited transactions include any transactions in which you or your family benefit. Usage is also important, especially if you intend to use the real estate to generate income. It’s perfectly fine to generate income, but you could end up in serious trouble if you also use it yourself, even if you pay to do so. There also fees associated with real estate investments, usually involving annual appraisals or other measures of the valuation of the property. As you can see there are numerous considerations that need to be taken when it comes to investing in property with your IRA. If you are seriously considering doing so, your best bet is to do so with the help and knowledge of an investment advisor or financial professional with experience in this area.
A self-directed IRA can be a unique way to fund your retirement. If you are considering investments that are most often outside purview of the traditional asset classes–which are usually stocks, bonds, or mutual funds–then a self-directed IRA might be a great option. With a self-directed IRA, you can hold alternative investments–such as real estate or futures–which can help fund your retirement. While there are IRS rules that rule out certain investments when it comes to self-directed IRAs (i.e. most collectibles, investing in life insurance, etc.), what can really trip you up is the custodial agreement. While IRS rules govern all self-directed IRAs, regardless of the custodian, some custodians may place limits of their own, especially regarding investments that tend to carry a high risk factor. Thus, if you are considering a particular investment with a self-directed IRA, along with researching any potential IRS limitations, you will want to speak with your account custodian to make sure it’s not prohibited by them. Chances are, if you ignore the custodian’s rules and end up in court because of a violation of one of those rules, there is a high probability that the court will side with the custodian. If you are unsure of a particular investment you plan on making with a self-directed IRA, reach out to a certified financial planner or to the custodian to find out if your investment is actually conceivable.
There are many ways to improperly use your IRA. From borrowing money from it to using the funds to buy property for yourself, it’s not hard to run afoul of IRA rules. While the vast majority of IRA owners never violate the rules, some do and others seek to run up as close to the legal boundaries as possible without crossing over. You may also find that you end up crossing the prohibited IRA transactions line despite making an investment that is legal to own in an IRA. For example, you may own real estate in an IRA, which is perfectly legal. However, what you do with that real estate and how you finance improvements or repairs can get you into trouble very quickly. Overall, you will want to avoid investments that may require a cash infusion and which may require more cash than is already in the IRA. Finally, a prohibited transaction is a death sentence for your IRA and most likely a good chunk of your retirement savings and plans. The penalty is that is IRA is considered disqualified and deemed to have been distributed on the first day of the year in which the transaction takes place. With all that in mind, why jeopardize your hard work and savings with a prohibited (or even questionable) transaction?