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Posts from the ‘Retirement’ Category

19
Oct

Is the Back-Door Roth IRA Going Away for Good?

Among the many provisions in the multi-trillion-dollar legislative package being debated in Congress is a provision that would eliminate a strategy that allows high-income investors to pursue tax-free retirement income: the so-called back-door Roth IRA. The next few months may present the last chance to take advantage of this opportunity.

Roth IRA Background
Since its introduction in 1997, the Roth IRA has become an attractive investment vehicle due to the potential to build a sizable, tax-free nest egg. Although contributions to a Roth IRA are not tax deductible, any earnings in the account grow tax-free if future distributions are qualified. A qualified distribution is one made after the Roth account has been held for five years and after the account holder reaches age 59½, becomes disabled, dies, or uses the funds for the purchase of a first home ($10,000 lifetime limit).

Unlike other retirement savings accounts, original owners of Roth IRAs are not subject to required minimum distributions at age 72 — another potentially tax-beneficial benefit that makes Roth IRAs appealing in estate planning strategies. (Beneficiaries are subject to distribution rules.)

However, as initially passed, the 1997 legislation rendered it impossible for high-income taxpayers to enjoy Roth IRAs. Individuals and married taxpayers whose income exceeded certain thresholds could neither contribute to a Roth IRA nor convert traditional IRA assets to a Roth IRA.

A Loophole Emerges
Nearly 10 years after the Roth’s introduction, the Tax Increase Prevention and Reconciliation Act of 2005 ushered in a change that relaxed the conversion rules beginning in 2010; that is, as of that year, the income limits for a Roth conversion were eliminated, which meant that anyone could convert traditional IRA assets to a Roth IRA. (Of course, a conversion results in a tax obligation on deductible contributions and earnings that have previously accrued in the traditional IRA.)

One perhaps unintended consequence of this change was the emergence of a new strategy that has been utilized ever since: High-income individuals could make full, annual, nondeductible contributions to a traditional IRA and convert those contribution dollars to a Roth. If the account holders had no other IRAs (see note below) and the conversion was executed quickly enough so that no earnings were able to accrue, the transaction could potentially be a tax-free way for otherwise ineligible taxpayers to fund a Roth IRA. This move became known as the back-door Roth IRA.

(Note: When calculating a tax obligation on a Roth conversion, investors must aggregate all their IRAs, including SEP and SIMPLE IRAs, before determining the amount. For example, say an investor has $100,000 in several different traditional IRAs, 80% of which is attributed to deductible contributions and earnings. If that investor chose to convert any traditional IRA assets — even recent after-tax contributions — to a Roth IRA, 80% of the converted funds would be taxable. This is known as the “pro-rata rule.”)

Current Roth IRA Income Limits
For 2021, you can generally contribute up to $6,000 to an IRA (traditional, Roth, or a combination of both); $7,000 if you’ll be age 50 or older by December 31. However, your ability to make contributions to a Roth IRA is limited or eliminated if your modified adjusted gross income, or MAGI, falls within or exceeds the parameters shown below.

If your federal filing status is:Your 2021 Roth IRA contribution is reduced if your MAGI is:You can’t contribute to a Roth IRA for 2021 if your MAGI is:
Single or head of householdMore than $125,000 but less than $140,000$140,000 or more
Married filing jointly or qualifying widow(er)More than $198,000 but less than $208,000$208,000 or more
Married filing separatelyLess than $10,000$10,000 or more

Note that your contributions generally can’t exceed your earned income for the year (special rules apply to spousal Roth IRAs).

Now or Never … Maybe
While no one knows for sure what may come of the legislative debates, the current proposal would prohibit the conversion of nondeductible contributions from a traditional IRA after December 31, 2021. If you expect your MAGI to exceed this year’s thresholds and you’d like to fund a Roth IRA for 2021, the next few months may be your last chance to use the back-door strategy. Contact your financial and tax professionals for more information.

There is no assurance that working with a financial professional will improve investment results.

You can make 2021 IRA contributions up until April 15, 2022, but if the legislation is enacted, a Roth conversion involving nondeductible contributions would have to be conducted by December 31, 2021.

Keep in mind that a separate five-year rule applies to the principal amount of each Roth IRA conversion you make unless an exception applies.

8
Jul

Should You Be Concerned About Inflation?

If you pay attention to financial news, you are probably seeing a lot of discussion about inflation, which has reared its head in the U.S. economy after being mostly dormant for the last decade. In May 2021, the Consumer Price Index for All Urban Consumers (CPI-U), often called headline inflation, rose at an annual rate of 5.0%, the highest 12-month increase since August 2008.1

The CPI-U measures the price of a fixed market basket of goods and services purchased by residents of urban and metropolitan areas — about 93% of the U.S. population. You have likely seen price increases in some of the goods and services you purchase, and if so it’s natural to be concerned.

The larger question is whether these price increases are temporary, caused by factors such as supply-chain issues and labor shortages that will be resolved as the economy continues to emerge from the pandemic, or whether they indicate a fundamental imbalance that could cause widespread long-term inflation and hold back economic growth.

Most economists — including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen — believe the current spike is primarily due to transitory factors that will fade in the coming months. One example of this, cited by Powell in a recent press conference, is the price of lumber.2–3

Supply and Demand

Early in the pandemic, many lumber mills shut down or cut back on production because they expected a major slowdown in building. In fact, demand for housing and home renovation increased during the pandemic, as many people who worked from home wanted more space, a different location, or  improvements to their current homes. Low supply and high demand sent lumber prices soaring.4

Sawmills geared up as quickly as they could and were reaching full capacity just as demand began to ebb, with builders cutting back due to high prices and homeowners using their discretionary income to buy other goods and services. Suddenly the supply exceeded demand, and prices began to drop. Wholesale lumber prices are still higher than before the pandemic, and it takes time for price drops to filter down to the retail level, but it’s clear that the extreme inflation was transitory and has been reversed. The lumber story also suggests that consumers and businesses will cut back on spending for a product that becomes too expensive rather than spend at any price and feed an inflationary spiral.5

Chips and Cars

Another example of pandemic-driven imbalance between supply and demand is used car and truck prices, which have skyrocketed almost 30% over the last 12 months and represent a substantial portion of the overall increase in CPI. Used vehicles are hard to find in large part because fewer new cars are being built — and fewer new cars are being built because there is a shortage of computer chips. A single new car can require more than 1,000 chips, and when auto manufacturers were forced to close their factories early in the pandemic and new vehicle sales plummeted due to lack of demand, chip manufacturers shifted from producing chips for cars to producing chips for high-demand consumer electronics such as webcams, phones, and laptops.6–8

As the economy reopened and the demand for cars increased, chip producers were unable to shift and increase production quickly enough to meet the needs of auto manufacturers. The chip shortage is expected to reduce global auto production by 3.9 million vehicles in 2021, a drop of 4.6%. Unlike lumber, the chip shortage may take some time to resolve, because chip manufacturing is a long, multi-step process and most chips are manufactured outside the United States. The federal government has stepped in to encourage U.S. manufacturers to build new facilities and increase production.9

Fundamental Forces

Imbalances between supply and demand are to be expected as the economy reopens, and most such imbalances should work themselves out in the marketplace. But other forces could fuel more extensive inflation. Massive federal stimulus packages have provided consumers with more money to spend, while ongoing stimulus from the Federal Reserve has increased the money supply and made it easier to borrow.

Although unemployment is still relatively high at 5.9%, millions of jobs remain open as workers are hesitant to return to positions they consider unsafe in light of the pandemic, are unable to work due to lack of child care, and/or are rethinking their careers in a post-pandemic world.10–11This may change in September as extended unemployment benefits expire and children return to school, but the current imbalance is forcing many businesses to raise wages, especially in lower-paying jobs.12

The increases so far are primarily “catching up” after many years of low wages and should be absorbed by businesses or passed on to consumers with moderate price increases.13 However, if wages and prices increase too quickly and consumers earning higher wages are willing to spend regardless of rising prices — because they expect prices to rise even higher — the wage-price inflation spiral could be difficult to control.

Reading the Economy

When considering the current situation, it’s helpful to look at other measures of inflation.

Base effect. On a purely mathematical level, high 12-month CPI increases in March, April, and May 2021 reflect the fact that the CPI is being compared with those months in 2020, when prices decreased as the economy closed in response to the pandemic. This comparison to unusually low numbers is called the base effect. To avoid this effect, it’s helpful to look at annualized inflation over a two-year period, comparing prices now with prices before the pandemic. By that measure, current inflation is about 2.5%, a little higher than the average over the last decade but not nearly as concerning as a 5.0% level.14

Core inflation. Prices of some items are more volatile than others, and food and energy are especially volatile categories that can change quickly even in a low-inflation environment. For this reason, economists tend to look more carefully at core inflation, which strips out food and energy prices and generally runs lower than CPI-U. Core CPI rose at an annual rate of 3.8% in May 2021, which sounds better than 5.0% until you consider that it is the highest core inflation since June 1992. The good news is that the 0.7% monthly increase from April to May was lower than the 0.9% rise from March to April, suggesting that core inflation may be slowing down.  (The CPI-U increase also slowed in May, rising 0.6% for the month after a 0.8% increase in April.)15

Sticky prices.  Another helpful measure is the sticky-price CPI, which sorts the components of the CPI into categories that are relatively slow to change (sticky) and those that change more rapidly (flexible). The sticky price CPI increased just 2.7% over the 12-month period ending in May 2021. By contrast, the flexible component of the CPI increased 12.4% over the year.16 This suggests that a variety of factors — such as problems with supply chains, labor, and extreme weather — may be moving prices on flexible items, but that underlying economic forces are moving more stable prices at a relatively moderate rate.

The Fed’s Arsenal

The Federal Open Market Committee (FOMC), an arm of the Federal Reserve, is charged with setting economic policy to meet its dual mandate of fostering maximum employment while promoting price stability. The Fed’s primary economic tools are the benchmark federal funds rate, which affects many other interest rates, and its bond-buying program, which injects liquidity into the economy. Put simply, the Fed lowers the funds rate and buys bonds to stimulate the economy and increase employment, and raises the rate and stops buying bonds or sells bonds to put the brakes on inflation.

The federal funds rate has been at its rock-bottom range of 0.0% to 0.25% since March 2020, when the Fed dropped it quickly in the face of the pandemic, and the Federal Reserve is buying $120 billion in government bonds every month, much less than it did early in the pandemic but still a substantial and steady injection of money into the economy.17 (Unlike an individual or a regular bank that must spend money to purchase bonds, the central bank buys bonds by creating an electronic deposit in one of its member banks, thus creating “new money” that can be used to lend and circulate into the economy.)

Some inflation is necessary for economic growth — without it, an economy is stagnant — and in 2012, the FOMC set a 2% target for healthy inflation, based on a measure called the Personal Consumption Expenditures (PCE) Price Index. The PCE price index uses much of the same data as the CPI, but it captures a broader range of expenditures and reflects changes in consumer spending.

More specifically, the FOMC focuses on core PCE (excluding food and energy), which remained below the 2% target for most of the last decade. In August 2020, the FOMC changed its policy to target an average PCE inflation rate of 2% and indicated it would allow inflation to run higher for some time to balance the time it ran below the target. This is the current situation. Core PCE increased at a 12-month rate of 3.4% in May 2021, but so far the Fed has shown little inclination to take action in the short term.18 The FOMC projects PCE inflation to drop to 3.1% by the end of the year and to 2.1% by the end of 2022.19

At its June meeting, the FOMC did indicate an important shift by projecting the federal funds rate would increase in 2023 to a range of 0.5% to 0.75%, effectively two quarter-point steps.  (In March, the projection had been to hold the rate steady at least through 2023.) Fed Chair Powell also indicated that the FOMC has begun “talking about talking about” reducing the monthly bond purchases.20 Neither of these signals suggests any immediate action or serious concern about inflation. However, the fact that the funds rate remains near zero and that the Fed continues to buy bonds gives the central bank powerful “weapons” to employ if it believes inflation is increasing too quickly.

The next few months may indicate whether inflation is slowing down or changes in monetary policy are necessary. Unfortunately, prices do not always come down once they rise, but it may be helpful to keep in mind that prices of many goods and services did decline during the pandemic, and the higher prices you are seeing today might not be far out of line compared with prices before the economic slowdown. As long as inflation begins trending downward, it seems likely that the current numbers reflect growing pains of the recovery rather than a long-term threat to economic growth.

U.S. Treasury securities are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, bonds could be worth more or less than the original amount paid. Projections are based on current conditions, are subject to change, and may not come to pass.

1, 6, 10, 14) U.S. Bureau of Labor Statistics, 2021

2, 17, 19–20) Federal Reserve, 2021

3) Bloomberg, June 5, 2021

4–5) The New York Times, June 21, 2021

7) CBS News, June 22, 2021

8–9) Time, June 28, 2021

11) CNBC, June 8, 2021

12–13) CNBC, May 22, 2021

15) The Wall Street Journal, June 22, 2021

16) Federal Reserve Bank of Atlanta, 2021

18) U.S. Bureau of Economic Analysis, 2021

13
Jan

Revisiting the 4% Rule

Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. How much of your savings can you withdraw each year? Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.

For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year with inflation-adjusted withdrawals in succeeding years.

The 4% rule has stimulated a great deal of discussion over the years, with some experts saying 4% is too low and others saying it’s too high. The most recent analysis comes from the man who invented it, financial professional William Bengen, who believes the rule has been misunderstood and offers new insights based on new research.

Original research

Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprising 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more.1)

Of course, no one can predict the future, which is why Bengen suggested the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprising 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries.2)

New research

In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase but just $58,000 with a 2% increase.

To measure market valuation, Bengen used the Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.

5% rule?

Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation.3)

For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession.4-5) In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years.6) While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.

One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research.7)  His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5%.8) (Inflation was 1.2% in November 2020.9) Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5%.10)

It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance.

Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.

All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.

The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

1-2) Forbes Advisor, October 12, 2020

3-4, 6, 8, 10) Financial Advisor, October 2020

5, 9) U.S. Bureau of Labor Statistics, 2020

7) multpl.com, December 31, 2020

4
Nov

IRA and Retirement Plan Limits for 2021

Many IRA and retirement plan limits are indexed for inflation each year. While some of the limits remain unchanged for 2021, other key numbers have increased.

IRA contribution limits

The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2021 is $6,000 (or 100% of your earned income, if less), unchanged from 2020. The maximum catch-up contribution for those age 50 or older remains $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2021, but your total contributions cannot exceed these annual limits.

Income limits for deducting traditional IRA contributions

If you (or if you’re married, both you and your spouse) are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. If you’re married, filing jointly, and you’re not covered by an employer plan but your spouse is, your deduction is limited if your modified adjusted gross income (MAGI) is between $198,000 and $208,000 (up from $196,000 and $206,000 in 2020), and eliminated if your MAGI is $208,000 or more (up from $206,000 in 2020).

For those who are covered by an employer plan, deductibility depends on your income and filing status.

If your 2021 federal income tax  filing status is:Your  IRA deduction is limited if your MAGI is      between:Your deduction is eliminated if your MAGI is:
Single or head of household$66,000 and $76,000$76,000 or more
Married filing jointly or qualifying      widow(er)$105,000 and $125,000 (combined)$125,000 or more      (combined)
Married filing separately$0      and $10,000$10,000 or more

If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2021 if your MAGI is $66,000 or less (up from $65,000 in 2020). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) if your MAGI is $105,000 or less (up from $104,000 in 2020).

Income limits for contributing to a Roth IRA

The income limits for determining how much you can contribute to a Roth IRA have also increased.

If your 2021 federal income tax filing status is:Your Roth IRA contribution is limited if your MAGI is:You cannot contribute to a Roth IRA if your MAGI is:
Single or head of householdMore than $125,000 but less than $140,000$140,000 or more
Married filing jointly or qualifying      widow(er)More than $198,000 but less than $208,000      (combined)$208,000 or more (combined)
Married filing separatelyMore than $0 but less than $10,000$10,000 or more

If your filing status is single or head of household, you can contribute the full $6,000  ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $125,000 or less (up from $124,000 in 2020). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $198,000 or less (up from $196,000 in 2020). Again, contributions can’t exceed 100% of your earned income.

Employer retirement plan limits

Most of the significant employer retirement plan limits for 2021 remain unchanged from 2020. The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan remains  $19,500 in 2021. This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2021. [Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.]

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) remains $13,500 in 2021, and the catch-up limit for those age 50 or older remains $3,000.

Plan type:Annual dollar  limit:Catch-up limit:
401(k), 403(b), governmental 457(b),      Federal Thrift Plan$19,500$6,500
SIMPLE plans$13,500$3,000

Note: Contributions can’t exceed 100% of your income.

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2021 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and  a 457(b) plan, you can defer the full dollar limit to each plan — a total of     $39,000 in 2021 (plus any catch-up contributions).

The maximum amount that can be allocated to your account in a defined contribution plan [for example, a 401(k) plan or profit-sharing plan] in 2021 is $58,000 (up from $57,000 in 2020) plus age 50 or older catch-up     contributions. This includes both your contributions and your employer’s     contributions. Special rules apply if your employer sponsors more than one retirement plan.

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2021 is $290,000 (up from $285,000 in 2020), and the dollar threshold for determining highly compensated employees (when 2021 is the look-back year) remains      $130,000 (unchanged from 2020).

27
Apr

Coping with Market Volatility: Be Willing to Take Advantage of Market Downturns

Anyone can look good during a bull market. Smart investors are prepared to weather the inevitable rough patches, and even the best aren’t successful all the time. When the market goes off the tracks, knowing why you originally made a specific investment can help you evaluate whether those reasons still hold, regardless of what the overall market is doing.

If you no longer want to hold an investment, you could take a tax loss, if that’s a possibility. Selling locks in any losses on an investment, but it also generates cash that can be used to purchase other investments that may be available at an appealing discount.  Sound research might turn up buying opportunities on stocks that have dropped for reasons that have nothing to do with the company’s fundamentals. In a down market, most stocks are available at lower prices, but some are better bargains than others.

There also are other ways to reap some benefit from a down market. If the value of your IRA or 401(k)  has dropped dramatically, you likely won’t be able to harvest a tax benefit from those losses, because taxes generally aren’t owed on those accounts until the money is withdrawn. However, if you’ve considered converting a tax-deferred plan to a Roth IRA, a lower account balance might make a conversion more attractive. Though the conversion would trigger income taxes in the year of the conversion, the tax would be calculated on the reduced value of your account. With some expert help, you can determine whether and when such a conversion might be advantageous.

A volatile market is never easy to endure, but learning from it can better prepare you and your portfolio to weather and take advantage of the market’s ups and downs.

For more information on these strategies, contact us. We’re here to help.

All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies.

To qualify for the tax-free and penalty-free withdrawal of earnings (and assets converted to a Roth), Roth IRA distributions must meet a five-year holding requirement, and the distribution must take place after age 59½ (with some exceptions). Under current tax law, if all conditions are met, the account will incur no further income tax liability for the rest of the owner’s lifetime or for the lifetime of the owner’s heirs, regardless of how much growth the account experiences.

17
Apr

CARES Act: Retirement Plan Relief Provisions

The Coronavirus Aid, Relief, and Economic Security (CARES) Act  was signed into law on March 27, 2020. This $2 trillion emergency relief package represents a bipartisan effort to assist both individuals and businesses in the ongoing coronavirus pandemic and accompanying economic crisis. The CARES Act provisions for retirement plan relief for individuals under federal tax law are discussed here.

For those seeking access to their retirement funds, these include special provisions for coronavirus-related distributions and loans. For those seeking to preserve their retirement funds, certain required minimum distributions from retirement funds have been suspended.

Coronavirus-related distributions

A 10% penalty tax generally applies to distributions from an employer retirement plan or individual retirement account (IRA) before age 59½ unless an exception applies. Due to the coronavirus pandemic, the penalty tax will not apply to up to $100,000 of coronavirus-related distributions to an individual during 2020. Additionally, income resulting from a coronavirus-related distribution is spread over a three-year period for tax purposes unless an individual elects otherwise. Coronavirus-related distributions can also be paid back to an eligible retirement plan within three years of the day after the distribution was received.

What does “coronavirus related” mean?

For purposes of the distribution and loan rules described here, “coronavirus related” applies to individuals diagnosed with the illness or who have a spouse or dependent diagnosed with the illness, as well as individuals who experience adverse financial consequences as a result of the pandemic. Adverse financial consequences could include quarantines, furloughs, and business closings.

Loans from qualified plans

Qualified plans such as a 401(k) can allow an employee to take out a loan. These loans can generally be repaid over a period of up to five years. They’re also generally limited to the lesser of $50,000 or 50% of the total benefit the employee has a right to receive under the plan. However, for a coronavirus-related loan made between March 27, 2020, and September 22, 2020, the loan limit is increased to $100,000 or 100% of the amount the employee can rightfully receive under the plan (whichever amount is less). In the case of a loan outstanding after March 26, 2020, the due date for any repayment that would normally be due between March 27, 2020, and December 31, 2020, may be delayed by coronavirus-related qualifying  individuals for one year, and the delay period is disregarded in determining the five-year period and the term of the loan.

Most required minimum distributions (RMDs) suspended for 2020

RMDs are generally required to start from an employer retirement plan or IRA by April 1 of the year after the plan participant or IRA owner reaches age 70½ (age 72 for those who reach age 70½ after 2019). If an employee continues working after age 70½ (age 72 for those who reach age 70½ after 2019), RMDs from an employer retirement plan maintained by the current employer can be deferred until April 1 of the year after retirement. (RMDs are not required from a Roth IRA during the lifetime of the IRA owner.) RMDs are also generally required to beneficiaries after the death of the plan participant or IRA owner. A 50% penalty applies to an RMD that is not made.

The CARES Act suspends RMDs from IRAs and defined contribution plans (other than Section 457 plans for nongovernmental tax-exempt organizations) for 2020. This waiver includes any RMDs for 2019 with an April 1, 2020, required beginning date that were not taken in 2019. This one-year suspension does not generally affect how post-2020 RMDs are determined.

A recent IRS Notice (2020-23) clarifies the application to RMDs taken between February 1 and May 15. The 60-day rollover rule is waived if rolled over by July 15, 2020. The one-per-year rule still applies to all rollover situations, and inherited IRA RMDs cannot be rolled over.

There may be additional guidance issued in the future. It is not clear why RMDs made in January and after May 15th are not covered. Maybe the one-per-year rule would be modified.

4
Feb

The SECURE Act and Your Retirement Savings

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted in December 2019 as part of a larger federal spending package. This long-awaited legislation expands savings opportunities for workers and includes new requirements and incentives for employers that provide retirement benefits. At the same time, it restricts a popular estate planning strategy for individuals with significant assets in IRAs and employer-sponsored retirement plans.

Here are some of the changes that may affect your retirement, tax, and estate planning strategies. All of these provisions were effective January 1, 2020, unless otherwise noted.

Benefits for retirement savers
Later RMDs. Individuals born on or after July 1, 1949, can wait until age 72 to take required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans instead of starting them at age 70½ as required under previous law. This is a boon for individuals who don’t need the withdrawals for living expenses, because it postpones payment of income taxes and gives the account a longer time to pursue tax-deferred growth. As under previous law, participants may be able to delay taking withdrawals from their current employer’s plan as long as they are still working.

No traditional IRA age limit. There is no longer a prohibition on contributing to a traditional IRA after age 70½ — taxpayers can make contributions at any age as long as they have earned income. This helps older workers who want to save while reducing their taxable income. But keep in mind that contributions to a traditional IRA only defer taxes. Withdrawals, including any earnings, are taxed as ordinary income, and a larger account balance will increase the RMDs that must start at age 72.

Tax breaks for special situations. For the 2019 and 2020 tax years, taxpayers may deduct unreimbursed medical expenses that exceed 7.5% of their adjusted gross income. In addition, withdrawals may be taken from tax-deferred accounts to cover medical expenses that exceed this threshold without owing the 10% penalty that normally applies before age 59½. (The threshold returns to 10% in 2021.) Penalty free early withdrawals of up to $5,000 are also allowed to pay for expenses related to the birth or adoption of a child. Regular income taxes apply in both situations.

Tweaks to promote saving. To help workers track their retirement savings progress, employers must provide participants in defined contribution plans with annual statements that illustrate the value of their current retirement plan assets, expressed as monthly income received over a lifetime. Some plans with auto-enrollment may now automatically increase participant contributions until they reach 15% of salary, although employees can opt out. (The previous ceiling was 10%.)

More part-timers gain access to retirement plans. For plan years beginning on or after January 1, 2021, part-time workers age 21 and older who log at least 500 hours annually for three consecutive years generally must be allowed to contribute to qualified retirement plans. (The previous requirement was 1,000 hours and one year of service.) However, employers will not be required to make matching or nonelective contributions on their behalf.

Benefits for small businesses
In 2019, only about half of people who worked for small businesses with fewer than 50 employees had access to retirement benefits.1 The SECURE Act includes provisions intended to make it easier and more affordable for small businesses to provide qualified retirement plans.

The tax credit that small businesses can take for starting a new retirement plan has increased. The new rule allows a credit equal to the greater of (1) $500 or (2) $250 times the number of non-highly compensated eligible employees or $5,000, whichever is less. The previous credit amount allowed was 50% of startup costs up to $1,000 ($500 maximum credit). There is also a new tax credit of up to $500 for employers that launch a SIMPLE IRA or 401(k) plan with automatic enrollment. Both credits are available for three years.

Effective January 1, 2021, employers will be permitted to join multiple employer plans (MEPs) regardless of industry, geographic location, or affiliation. “Open MEPs,” as they have become known, enable small employers to band together to provide a retirement plan with access to lower prices and other benefits typically reserved for large organizations. (Previously, groups of small businesses had to be related somehow in order to join an MEP.) The legislation also eliminates the “one bad apple” rule, so the failure of one employer in an MEP to meet plan requirements will no longer cause others to be disqualified.

Goodbye stretch IRA
Under previous law, nonspouse beneficiaries who inherited assets in employer plans and IRAs could “stretch” RMDs — and the tax obligations associated with them — over their lifetimes. The new law generally requires a beneficiary who is more than 10 years younger than the original account owner to liquidate the inherited account within 10 years. Exceptions include a spouse, a disabled or chronically ill individual, and a minor child. The 10-year “clock” will begin when a child reaches the age of majority (18 in most states).

This shorter distribution period could result in bigger tax bills for children and grandchildren who inherit accounts. The 10-year liquidation rule also applies to IRA trust beneficiaries, which may conflict with the reasons a trust was originally created.

In addition to revisiting beneficiary designations, you might consider how IRA dollars fit into your overall estate plan. For example, it might make sense to convert traditional IRA funds to a Roth IRA, which can be inherited tax-free (if the five-year holding period has been met). Roth IRA conversions are taxable events, but if converted amounts are spread over the next several tax years, you may benefit from lower income tax rates, which are set to expire in 2026.

If you have questions about how the SECURE Act may impact your finances, this may be a good time to consult your financial, tax, and/or legal professionals.
1) U.S. Bureau of Labor Statistics, 2019

The foregoing is provided for information purposes only.  It is not intended or designed to provide legal, accounting, tax, investment or other professional advice.  Such advice requires consideration of individual circumstances.  Before any action is taken based upon this information, it is essential that competent individual professional advice be obtained.  JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources. This legislation maybe revised to correct errors and/or clarified.

13
Nov

IRA and Retirement Plan Limits for 2020

IRA contribution limits

The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2020 is $6,000 (or 100% of your earned income, if less), unchanged from 2019. The maximum catch-up contribution for those age 50 or older remains at $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2020, but your total contributions can’t exceed these annual limits.

Traditional IRA income limits

If you are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. For those who are covered by an employer plan, the income limits for determining the deductibility of traditional IRA contributions in 2020 have increased. If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2020 if your modified adjusted gross income (MAGI) is $65,000 or less (up from $64,000 in 2019). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) in 2020 if your MAGI is $104,000 or less (up from $103,000 in 2019).

If your 2020 federal income tax filing status is Single or head of household your IRA deduction is limited if your MAGI is between $65,000 and $75,000 and the deduction is eliminated if your MAGI is $75,000 or more.

If your 2020 federal income tax filing status is Married filing jointly or a qualifying widow/widower your IRA deduction is limited if your combined MAGI is between $104,000 and $124,000 and the deduction is eliminated if your MAGI is $124,000 or more.

If your 2020 federal income tax filing status is Married filing separately your IRA deduction is limited if your MAGI is between $0 and $10,000 and the deduction is eliminated if your MAGI is $10,000 or more.

If you’re not covered by an employer plan but your spouse is, and you file a joint return, your deduction is limited if your MAGI is $196,000 to $206,000 (up from $193,000 to $203,000 in 2019), and eliminated if your MAGI exceeds $206,000 (up from $203,000 in 2019).

Roth IRA income limits

The income limits for determining how much you can contribute to a Roth IRA have also increased for 2020. If your filing status is single or head of household, you can contribute the full $6,000 ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $124,000 or less (up from $122,000 in 2019). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $196,000 or less (up from $193,000 in 2019). (Again, contributions can’t exceed 100% of your earn0 but under $139,000ed income.)

If your 2020 federal income tax filing status is Single or head of household your Roth IRA contribution is limited if your MAGI is more than $124,000 but under $139,000 and you cannot contribute to a Roth IRA if your MAGI is $139,000 or more.

If your 2020 federal income tax filing status is Married filing jointly or a qualifying widow/widower your Roth IRA contribution is limited if your combined MAGI is more than $196,000 but under $206,000 and you cannot contribute to a Roth IRA if your combined MAGI is $206,000 or more.

If your 2020 federal income tax filing status is Married filing separately your Roth IRA contribution is limited if your MAGI is more than $0 but under $10,000 and you cannot contribute to a Roth IRA if your MAGI is $10,000 or more.

Employer retirement plans

Most of the significant employer retirement plan limits for 2020 have also increased. The maximum amount you can contribute (your “elective deferrals“) to a 401(k) plan is $19,500 in 2020 (up from $19,000 in 2019). This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2020 (up from $6,000 in 2019). (Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.)

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2020 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2020 (plus any catch-up contributions).

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) is $13,500 in 2020 (up from $13,000 in 2019), and the catch-up limit for those age 50 or older remains at $3,000.

The annual dollar limit for 401(k), 403(b), government 457(b) or a Federal Thrift Plan is $19,500 and the catch-up limit is $6,500.

The annual dollar limit for SIMPLE plans is $13,500 and the catch-up limit is $3,000.

Note: Contributions can’t exceed 100% of your income.

The maximum amount that can be allocated to your account in a defined contribution plan (for example, a 401(k) plan or profit-sharing plan) in 2020 is $57,000 (up from $56,000 in 2019) plus age 50 catch-up contributions. (This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.)

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2020 is $285,000 (up from $280,000 in 2019), and the dollar threshold for determining highly compensated employees (when 2020 is the look-back year) is $130,000 (up from $125,000 when 2019 is the look-back year).

6
Jul

Qualified Charitable Distributions (QCD)

Changes in tax laws can require updating your planning.

The 2017 tax act has caused many to rethink their charitable giving. Charitable contributions for those over the age of 70.5 may benefit them by making their charitable contributions directly from their Individual Retirement Accounts (IRA).  These QCDs are treated as part of the Required Minimum Distribution (RMD) for the year they are distributed, but are not taxed.

You must be at least 70.5 when you make the contribution.

The contribution must be made from a traditional IRA. Payment from other retirement accounts do not qualify.

The payments must be to a public charity.

The maximum annual amount cannot exceed $100,000. There is no limit on the number of distributions or charities you make contributions to.

The distribution must be made directly from your IRA account to the charitable organization.

You may not receive benefits in exchange for the contribution. Examples include tickets to paid events and preferential seating.

The distribution must be part of your RMD. Amounts contributed after you have withdrawn your RMD do not qualify as QCD.  If you have already taken your annual RMD for the year, you cannot make a QCD for the year. Plan the timing of your QCD before you have taken your RMDs for the year. Distribute your QCDs early in the year before you have withdrawn all your RMDs for the year.

Include a cover letter specifying the payment is a QCD and request an acknowledgement.

The foregoing is provided for information purposes only.  It is not intended or designed to provide legal, accounting, tax, investment or other professional advice.  Such advice requires consideration of individual circumstances.  Before any action is taken based upon this information, it is essential that competent individual professional advice be obtained.  JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources. 

9
Dec

Prioritizing Savings for College and/or Retirement

The November 2018 AAII Journal, American Association of Individual Investors, included an interview with Harold Pollack. The discussion was about “The Index Card: Why Personal Finance Doesn’t Have to Be Complicated” (Portfolio, 2016). He wrote it with Helaine Olen.

The following passage is from a response to a question about prioritizing where to direct money.

There are different ways that people can do this. You should match your method with what gives you the mojo to actually do it.” … “Suppose I’m a young parent and I’m choosing between prioritizing my retirement and savings for my kid’s college. Mathematically, retirement tends to be the answer for most people, but your kid’s college gives you mojo in a different way. If you’re walking with your seven-year-old daughter in a store and you see a sweet $500 camera lens, you can point to it, and tell your daughter: “I really want that lens, I’m going to put that $500 toward paying for your college. Maybe some day you’ll do that for your daughter.’ That’s powerful and motivating.”  

2018 Nov.Beyond-the-Index-Card-Implement