Many Americans choose to make charitable donations with their retirement funds. For some it’s a way to give back to the community, while others use it as a way to support causes that are important to them. Whatever the reason for donating–if you choose to do so–you should understand the ramifications of that decision as well as the most efficient way to make a donation. It’s been a while since I’ve written about it, but qualified charitable distributions (QCDs) are probably the most efficient and effective way to make a charitable donation from your retirement funds. In case you forgot what a QCD is, it’s a charitable donation of up to $100,000 to a qualified 501(c)(3) charity made from an IRA. A QCD can offset any RMDs that need to be made for that year, but can only be made if you are 70 1/2 years old. QCDs offer a similar tax outcome to itemizing your charitable giving, if that matters to you. And yes, QCDs are allowed this year even though RMDs are suspended. Which leads me to my next part of charitable giving–the tax implications. While I cannot offer tax advice, I can advise you to speak with a tax professional if you are making substantial charitable donations in the hopes of taking advantage of tax incentives for doing so. That goes for whether you are over 70 1/2 and are making a QCD or are not yet retired, but want to make a substantial donation to your favorite charity. A tax professional should be able to give you a good idea as to how a donation may impact your taxes and whether it’s overall a good idea. However, if you want to know how a QCD or other charitable giving might affect your nest egg or financial plans, you will want to also speak with a certified financial planner or wealth manager.
There are probably very, very, (very) few people out there excited for the announcement of new life expectancy tables used to determine required minimum distribution (RMD). I mean, let’s be honest, nobody is every really gets excited for IRS announcements. While I can’t say this announcement made my day, I did think it was some really good information worth sharing with you as it could have a substantial impact on your retirement savings and financial plans. Furthermore, the IRS does not normally revise their RMD tables, so this was notable (In fact, it’s been almost 20 years since the last revision). As you probably well know, RMDs are waived for 2020 and 2021 RMDs will follow the existing RMD tables. Again, these RMD changes won’t go into effect until 2022 so, of course, I encourage you to start thinking about it now when it comes to what you want to do with your RMDs and whether your current retirement plans might be impact by an RMD change. If you aren’t familiar with life expectancy tables, there are three that the IRS uses when determining RMDs for those old enough to take them and their beneficiaries: The Uniform Lifetime Table (used to calculate YOUR lifetime RMDs), the Joint and Last Survivor Table (used for when your spouse is your sole beneficiary and is more than 10 years younger than you), and the Single Life Table (when used by an “eligible designated beneficiary” such as a minor child or a surviving spouse). The new changes will most likely lower RMDs for most Americans, which also means lower taxes on your RMDs. Lower taxes means you can spend more of your nest egg on retirement and you. Maybe some IRS announcements aren’t so bad after all.
Have you made an IRA contribution for 2019 yet? Are you worried that you might not get the chance to? Well, there is good news. While you probably heard that the IRS extended the deadline for filing taxes to July 31, you probably did not know that the deadline for making a prior year contribution was pushed back to July 15. That’s three extra months! That might not seem like a big deal, but it could be for many Americans who didn’t get to make a contribution for 2019. If you didn’t get to make a contribution–and of course have the money to do so–you should strongly consider taking advantage of the extended deadline. If you already made your 2019 contribution, then no worries, just focus on your 2020 contribution. Of course, if you do take advantage of the extended contribution deadline, be sure to notify your IRA custodian of the year the contribution is for and to ensure that it is properly designated so that there are no issues with taxes or anything else that could open you to penalties. If you have questions about Roth or traditional IRA contributions, you should talk 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.
Don’t let taxes do a number on your nest egg. The years leading up to retirement are a great time to look at your tax projections and determine strategies to keep your tax hit minimized. They can also help you to determine how you will spend your money in retirement and where you will take money out of and when. For example, if you have multiple Roth IRAs, you may decide to tap one before the other. Or maybe you have assets that you plan to sell off to help fund your retirement, so you can use a tax projection to determine the order in which assets should be sold off or which ones have the lowest tax hits. Of course, you will want to hire a tax expert to help you with your tax projections. That means finding a reputable tax planner or accountant who understands what you are looking to do and knows to ask the right questions. So, have you thought about taxes in retirement?
If you aren’t participating in your company’s retirement plan (i.e. a 401(k)), then you are really missing out. Not only is it a great way to save for retirement, there may be numerous perks and benefits that you may be giving up. For one, if your company offers contributing matching, you could be leaving extra money on the table. Even if the match is only a small amount–such as 3%–that’s still better than nothing and can go a long way over a long period. Being an active participant in an employer retirement plan can also potentially allow you to deduct a traditional IRA contribution from your taxes should you fall within the proper range. A deduction of a contribution on your taxes doesn’t have to do with your salary or Modified Adjusted Gross Income (MAGI). Furthermore, you don’t have to contribute a large amount to your retirement plan nor do you need to be a participant for a long period of time. So long as you make a contribution and are active for the required period each year, then you will be considered an “active participant” for tax purposes. Even if you don’t intend to use your employer retirement plan as your main source of retirement savings, it can still be a good idea to at least set up an account and contribute a little each year. If you have questions about your company’s retirement benefits, you should speak with the benefits manager or human resources contact where you work. So, are you an active participant?
It can be easy to forget about required minimum distributions (RMDs), especially as you move into retirement or if you inherit an IRA. Now, forgetting to take an RMD isn’t the absolute end of the world, but it should not be taken lightly. The penalty to missing an RMD is half the amount that was to be distributed, which is quite harsh and can be a substantial amount of money depending on the size of your retirement savings. So, what should you do if you forgot to take an RMD or you learned that you needed to take one from an inherited RMD? First off, withdraw the RMD out of the account as soon as you realize you need to take it. Next you will need to report the mistake to the IRS on the Form 5329, which can be filed along with your annual tax returns. On the form, make sure to report the RMD that should have been distributed, the amount distributed before the deadline, any reasonable cause amounts you would like waived, the penalty amount, and a letter explaining the reason for missing the RMD. Finally, and this is very important, do not pay the penalty until you hear back from the IRS with a denial or approval of your reason for the mistake. If your reason is denied, the IRS will then ask for payment of the penalty. As with anything involving the IRS, unless you are absolutely certain you know what you are doing, you should consider either hiring a financial advisor or tax professional to fill out and file your From 5329 so as to make sure it is done correctly. If you don’t want to have them actually file for you, you may want to at least consider talking to them during the process so as to make sure you’re doing things right. Remember, the key thing is that you correct your mistake as soon as you realize it and that you be honest with the IRS. Chances are your excuse won’t be accepted, but you will only have to pay the RMD penalty and nothing more. Missing and RMD is no laughing matter, but it’s not something you need to have a meltdown over, either. Just stay calm and do what you need to do!
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.
Contrary to what you may think, you don’t need to earn income to be able to make contributions to an IRA. You’re probably familiar with spousal contributions, but did you know that you can make contributions from when you exercise non-qualified stock options? The taxable portion is considered taxable income for IRA purposes. If you receive alimony, that too is taxable as ordinary income and is eligible for IRA contribution. Some scholarships and fellowships may be considered taxable income, depending on reported on the W-2 form. This last one can be valuable to young savers, such as your children or grandchildren. If you have a child (or grandchild) in graduate school living on a fellowship or scholarship money, you may want to see if that money is considered taxable income. If it is, you should talk to them about either setting up an IRA or, if they already have one, making a contribution. This could go a long way towards getting them on the right track towards retirement early on. If you have questions have whether or not something is considered taxable income or whether you are in a position to make a contribution to your IRA, you should speak with a certified financial planner.
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.