Retirement Savers Get a Boost – IRA Contribution Limits Increased for 2019.

There is good news for those of you who are actively saving for retirement. The IRA contribution limit, presently $5,500 for 2018, will increase to $6,000 for 2019. If you are age 50 or older in 2019, you can add an additional $1,000 to your IRA, for a total contribution of $7,000 for 2019. The increase applies to both traditional and Roth IRAs. This increase applies to contributions for the 2019 tax year, not for contributions made in 2019 for the 2018 tax year.  Non-working spouses may also benefit by making contributions to their own IRAs to boost retirement savings.

The increase is the result of cost-of-living adjustments made recently by the IRS to retirement account limits. This increase is the first since 2013!

Don’t forget, other IRA eligibility rules still apply. You must have earned income to contribute to an IRA. Generally, earned income is income from employment. Investment income and Social Security income is excluded. Furthermore, there are income limits that will affect your ability to make a fully deductible contribution to a traditional IRA. Your income may be too high to contribute to a Roth IRA. Finally, you cannot make a contribution to a traditional IRA in 2019 if you will be age 70½ or older.

For those of you participating in an employer sponsored 401(k) or 403(b) plan, the limit for salary deferrals into those types of plans will go up to $19,000 in 2019 ($25,000 if you are age 50 or older).

You can see all of the COLA increases for retirement accounts and other retirement related items HERE.

Having trouble putting together a retirement plan, or looking for ways to boost retirement savings?  Give me a call, I can help.

Costly IRA Rollover Mistake – Easily Made; Impossible to Fix.

The rules governing IRA accounts are maddeningly complex, especially the rules for inherited IRAs. I was working with a client on an issue involving the control of an inherited IRA account when I was reminded of a case that shows just how easy it is to make a mistake that cannot be fixed.

Mrs. Beech was the adult beneficiary of her deceased mother’s traditional IRA. The account was managed by a professional money management firm, Citi Smith Barney. Citi made two distributions to Mrs. Beech from the IRA – one for $2,828, and the second for $35,358. The larger distribution was made on May 23, 2008, and the check was made out to Mrs. Beech.

Mrs. Beech deposited the $35,358 into the inherited IRA with American Funds in June 2008. Mrs. Beech reported both distributions on her 2008 income tax return, and reported the smaller $2,828 amount as the taxable amount of the distribution. Thereafter, the IRS issued Mrs. Beech a notice of deficiency for income taxes due in the amount of $9,212 for the $35,358 distribution, plus penalties in the amount of $1,842. The deficiency and penalties were sustained by the United States Tax Court.

Wait a second! Mrs. Beech deposited the distribution check for $35,358 into a new inherited IRA account well within 60 days from the date the check was issued by Citi. What did she do wrong?

Amounts paid or distributed from a traditional IRA are generally includible in gross income by the recipient payee. The Internal Revenue Code (the “Code”) provides that a distribution is not includible in gross income if the entire amount of the distribution received by an individual is redeposited into a qualified IRA for the benefit of that individual within 60 days of the distribution. This redeposit is known as a “rollover contribution.”

However, rollover treatment is not available to a non-spouse beneficiary in the case of an inherited IRA. Any distribution from an inherited IRA is taxable if the distribution is paid to a non-spouse beneficiary. Under the Code, an IRA is treated as inherited if the individual for whose benefit the account or annuity is maintained acquired that account by reason of the death of another individual who was not his or her spouse.

In Mrs. Beech’s case, the $35,358 was paid from her mother’s IRA to Mrs. Beech as the named beneficiary. She then redeposited the funds into an inherited IRA account. Since the IRA account belonged to Mrs. Beech’s mother, it was deemed to be an inherited IRA for the benefit of Mrs. Beech and, therefore, rollover treatment was not available for the distribution.  The entire $35,358 distribution was taxable income to Mrs. Beech!

Mrs. Beech would not have been treated as having received a taxable distribution from an IRA, however, if the funds in the IRA were transferred directly from Citi to American Funds without her ever gaining control or use of the funds. This is commonly known as a “trustee-to-trustee transfer.”
A trustee-to-trustee transfer is the only way for the beneficiary of an inherited IRA to make a nontaxable transfer of funds in the IRA account.

What makes a case like Mrs. Beech’s so difficult is that there is no way in the Code for the mistake to be corrected. Once Citi issued the check, it became taxable income. Neither the tax court nor the Internal Revenue Service could grant Mrs. Beech any relief from the income taxes and penalties incurred for her mistake.

The lesson from Mrs. Beech’s mistake is that in every case where a non-spouse is the beneficiary of an IRA, a transfer should only be made via the trustee-to-trustee method to avoid income taxation of the transferred amount.

The case of Beech v. Commissioner of Internal Revenue can be read here.

IRA rules and regulations are extremely complex and costly mistakes can be easily made.  If you need help navigating the IRA rules and regulations, call me, I can help.

Year-End IRA Housekeeping

The end of the year is fast approaching, and with it several important deadlines for IRA account owners and beneficiaries. In my experience helping clients address year-end IRA matters, the following are the most problematic areas:

Required Minimum Distribution (RMD) Deadline:

December 31 is the deadline for taking RMDs from an IRA for an account owner who reached age 70½ before 2018. The RMD has to be withdrawn from the account before January 1. The account owner cannot merely request a distribution before year end. RMDs not withdrawn from the account are assessed a 50% penalty, in addition to regular income taxes. If you haven’t taken all of your RMDs yet for 2018, make sure you take them in time to avoid the 50% penalty.

RMDs for a Deceased IRA Owner:

If an IRA owner died in 2018 before all of his RMDs were taken for the year, the remaining RMDs must be paid to the account beneficiary before the end of 2018. This is not a pro-rated amount. The RMDs are calculated for the full year. This can often times be overlooked especially if the IRA owner died late in the calendar year. Undistributed RMDs from a decedent’s IRA are subject to the 50% penalty on missed distributions.

RMDs for Inherited Traditional IRAs or Roth IRAs:

A non-spouse beneficiary of an inherited IRA can elect to take annual RMDs over their remaining life expectancy. If they do, the first RMD distribution must be taken before December 31 of the year following the year of the IRA owner’s death, and then each year thereafter over their remaining life expectancy. If you are the beneficiary of an inherited IRA, you too must take an RMD before the end of 2018 if the account owner died in 2017 or earlier. Undistributed RMDs from an inherited IRA are also subject to the 50% penalty on missed distributions. This applies to the beneficiaries of Roth IRA accounts too. While a Roth IRA owner does not have to take distributions from a Roth IRA at any time, beneficiaries are subject to the same RMD rules as beneficiaries of traditional IRAs. So don’t get caught thinking you don’t have to take distributions from an inherited Roth IRA. You do!

Splitting Inherited Traditional IRAs or Roth IRAs:

If there are multiple beneficiaries of a traditional or Roth IRA account whose owner died in 2017, the account must be split into separate accounts for each beneficiary before December 31 of 2018. This is to ensure that each beneficiary gets to use his own life expectancy in determining annual RMDs for his share of the account. If the account is not split and the RMD taken before the end of 2018, the life expectancy of the oldest beneficiary will be used to calculate the annual RMDs for all of the beneficiaries. This results in younger beneficiaries paying more income taxes each year on their distribution from the account.

No “Still Working” Exception for Older and Still Working IRA Owners:

There is no “still working” exception to the RMD rules for traditional IRA owners who are still employed beyond age 70½. While an owner of a 401(k) account may work beyond age 70½ and delay RMDs from his 401(k) account while his employment continues, that same employee must take RMDs from his traditional IRA if he reached age 70½ before 2018. This includes owners of SEP-IRAs and SIMPLE IRAs.

While not exhaustive, these are the most common areas where mistakes are made.  Even if you’ve taken your RMDs for 2018, it won’t hurt to go back and review your situation and your math to avoid any negative consequences from unrealized errors.

The rules governing required distributions from IRAs are extremely complex.  The penalties for making a mistake can be severe.  If you need help navigating the year-end complexities of managing IRA distributions, please contact me.  I can help.

You Reached Age 70½ This Year, So When Must You Take Your First IRA Distribution?

We are approaching the end of the year and for many of you, 2017 is the first year you must begin taking a required minimum distribution from your traditional IRAs. As you may already know, the Internal Revenue Service rules require you to take a minimum distribution (known as “RMD”) from a traditional IRA each year once you reach age 70½. An RMD must be taken for the year in which you reach age 70½. The IRS rules allow you to delay that first RMD from your IRA to no later than April 1 following the year in which you reach age 70½. Thereafter, your annual RMD must be taken from the IRA no later than December 31. Let’s take a look at how these rules work in practice:

A client contacted me today with questions about taking the first RMD from his IRA. In my client’s case, he turned 70 in January of this year (2017). So he also reached age 70½ in 2017 (July). Under the applicable IRS rules, he must take an RMD for 2017 because that is the year he attained the age of 70½. While the ordinary deadline for taking the RMD from his IRA is December 31, he has the option of waiting to take the 2017 RMD until no later than April 1, 2018. There is a catch to waiting: He’ll also have to take an RMD for 2018 (before December 31, 2018), so he’ll have to take two distributions in 2018, one for his 2017 RMD and the second for the 2018 RMD. Doing so will increase his taxable income for 2018 resulting in a higher tax bill. To avoid this, he’ll have to take his 2017 RMD no later than December 31, 2017.  Fortunately, he still has time to decide whether to wait until 2018 to take the distribution.

To calculate his RMD, my client, like most IRA owners, will refer to the IRS uniform life expectancy table. To calculate his first RMD, he must also use the balance in the IRA as of December 31, 2016. He’ll use that balance even if he elects to defer taking his 2017 RMD until 2018 (remember, the distribution is for 2017). He’ll use the balance in the IRA as of December 31, 2017, to calculate his RMD for 2018.

If he fails to take his first RMD from the IRA before April 1, 2018 (or any subsequent RMD by the applicable December 31 deadline), the IRS will impose a penalty equal to 50% of the amount of the RMD that he should have taken out from his IRA for the year. Note, the RMD is the minimum that must be withdrawn from the IRA for the year, you can withdraw more than the RMD if you so choose.

The rules governing distributions from an IRA other other retirement account are extremely complex. Always work with a competent advisor.  If you are struggling with questions regarding retirement account distributions, give me a call, I can help.

Want to Dip Into Your IRA to Pay College Education Expenses? Read This First!

It’s time to get back to school for you or a family member. You may be looking for a way to pay a tuition bill and other school expenses and considering taking money out of your IRA to do so. Ordinarily you have to be over age 59½ to take a penalty free, but taxable, withdrawal from an IRA. There are exceptions to this rule, and one of those exceptions allows for penalty free withdrawals to pay for certain higher education expenses, but you have to follow the rules!

1. You can take a penalty free – but taxable – withdrawal to pay for “qualified higher education expenses.” These expenses include tuition, room and board, required books, supplies, and fees. (Computer and other technology purchases qualify, even if not required by the school.) There is no dollar limit that can be taken out of the IRA account, as long as the money is used for qualified higher education expenses. (You should maintain a record of all paid expenses, including receipts.)

2. The qualified higher education expenses must be incurred at an “eligible educational institution.” An eligible educational institution is any college, university, vocational school or other post-secondary educational institution eligible to participate in the federal student aid program. This includes all accredited public, private, nonprofit and proprietary post-secondary institutions. Expenses related to elementary or high school, public or private, are not eligible.

3. The IRA distribution may be used for qualified education expenses of the IRA owner, the owner’s spouse, or any child or grandchild of the owner or the owner’s spouse.

4. The education expenses must be incurred in the year you take the IRA distribution. So, you can’t take a distribution from your IRA in 2018 to cover an expense incurred in 2017. This is an important rule that trips up a lot of people.

5. The exception to the early distribution penalty for higher education expenses only applies to distributions from your IRA account. The exception does not apply to distributions from an employer plan. [401(k), 403(b), etc.]

6. You can take a distribution from your IRA to pay eligible higher education expenses, but should you? That is the bigger issue here. Your IRA is not a piggy bank. That money is for your retirement. I generally do not recommend taking any preretirement distributions from any retirement account to pay expenses or a debt for a couple of reasons.  First, even though the distribution escapes the 10% early withdrawal penalty, income taxes must be paid on the entire distribution. Second,  you lose the advantage of the tax deferred growth on the funds withdrawn from the IRA.  You simply won’t make that up even if you are able to replace the funds withdrawn later on. If you have other options available to pay college expenses, you should explore them first, even loans, before taking a distribution from an IRA.

There are other exceptions to the 10% penalty on pre-age 59½ IRA distributions.  We’ll explore those in a future post.

2017 Retirement Plan Contribution Limits

It’s a new year and time to look at retirement plan contribution limits for 2017:

IRA and Roth IRA limits for 2017 did not change from 2016. The maximum an individual with earned income can contribute to a traditional or Roth IRA (or between the two) is $5,500. Individuals age 50 or older this year may contribute an additional $1,000.

Contribution limits for 401(k) and 403(b) plan participants likewise remain the same. The maximum a participant can contribute to a 401(k) and 403(b) plan or a Roth-type plan is $18,000. Participants who are at least 50 years of age in 2017 can elect to defer an additional $6,000, making a total contribution limit of $24,000.

SIMPLE-IRA contribution limits do not change for 2017. A SIMPLE participant may defer $12,500 of income for the year. Participants who are at least 50 years of age this year can defer an additional $3,000 into the plan for a total deferral of $15,500.

SEP-IRA contribution limits increase $1,000 to a maximum contribution of $54,000. This limit also applies to Keogh and other profit sharing plans. SEP IRA participants who are at least 50 years of age in 2017 cannot make a catch-up contribution.

The phase-out ranges for deductible IRA contributions, and the ability to make Roth IRA contributions changes slightly. If you are married filing jointly, the phase-out range to make a deductible IRA contribution is between $99,000 and $119,000. For single or head of household filers, the phase-out range for 2017 is $62,000 – $72,000. The phase-out range for those who are married but filing separately remains $0 – $10,000.

The income limits for making Roth IRA contributions increased slightly for 2017. For those who married filing jointly, the ability to make an eligible Roth IRA contribution phases out between $186,000 – $196,000 for 2017. For single or head of household filers, the phase-out range is between $118,000 – $133,000. Those who are married filing separate get a phase-out range of $0 – $10,000 (unchanged for 2017).

If you are struggling with your retirement planning, please contact me. I can help!

5 Ways to Put Your Tax Refund to Good Use This Year.

Expecting a big, fat refund from the government this year? Rather than spending it on something frivolous, put it to a good long term use. Here are 5 effective ways to use your tax refund to improve your financial health:

1. Pay off a credit card. A tax refund can jump-start a debt repayment plan. If you carry a balance on a high interest (or any) credit card, use the refund to pay it off! And then use the money freed up every month to pay off another card balance. If you have no other credit card debt, then start paying yourself by banking the monthly savings.

2. Start an emergency fund. Many people live paycheck-to-paycheck with no financial cushion in case of an emergency. If you are one of them, it’s time to create an emergency fund – your own stash – for “just in case.” Who knows when the transmission on your car will need repair, or if you’ll have a medical emergency. These things happen when we least expect, or can afford them. An emergency fund will give you peace of mind and protect you should the unexpected occur.

3. Save for retirement. It’s never too late to start saving for your retirement. Use your refund to open an IRA (traditional or Roth), or consider upping your contribution to your 401(k) or other employer provided plan. Your refund can help make up the difference in your take home pay.

4. Start a college fund. If you have a child, consider starting a college savings account through a state-sponsored 529 college education savings plan. The money grows tax free, and when your child starts college, withdrawals used for qualifying education expenses are tax free. (Bonus – Michigan allows its residents a tax deduction for contributions to accounts under its program.)

5. Make a long neglected home repair. Roof worn out, furnace on its last leg, windows leaking or drafty?   Use the refund to make necessary home repairs.  Repairs can save you money in the long run in lower energy costs, improve your home’s livability, and even boost its market value.

Don’t Overlook Beneficiary Designations In Your Estate Planning

I’ve written previously about the importance of making sure that you have beneficiaries designated for assets such as life insurance and retirement accounts. Proper beneficiary designations are a key component of estate planning. Naming beneficiaries of certain assets, like life insurance or retirement accounts, is the most effective way to make sure assets pass to the intended parties upon your death in the most efficient way possible.

Unfortunately, many people make the mistake of overlooking this important aspect of estate planning. Failing to designate beneficiaries, or not keeping beneficiary designations up to date can result in assets being subject to the expense and delay of probate.

WealthManagement.com has a short, but very good article on the importance of beneficiary designations in your estate planning. Please take a few minutes to read the article here.

The Markets are Declining; Is It Time to Convert to a Roth IRA?

The last few weeks have been pretty dismal for investors.  (As of this writing, the Dow Jones Industrial Index is down about 2,000 points from its 2015 highs.) No one likes to see the value of their retirement accounts decline, but long-term investors know that market declines are inevitable. One of the keys to successful long term investing is the ability to use market declines to one’s advantage.

Declining markets present a great opportunity to convert a traditional IRA to a Roth IRA. Once converted, the funds in the Roth grow tax fee, are not subject to minimum distribution rules, and may be withdrawn 100% tax free.

To convert a traditional IRA to a Roth, you must pay income tax on the amount converted. If you were to convert an $80,000 traditional IRA to a Roth, $80,000 would be added to your income for tax purposes. But as markets have fallen recently, so too have IRA account values. A traditional IRA worth $80,000 several weeks ago may only be worth $60,000 today. That would be $20,000 less income subject to tax on the conversion. If your IRA has decreased in value, you can convert the account balance (or a portion) to a Roth and lock in a lower tax bill before the markets turn back upward.

But, the markets may decline even lower and so too, the post-conversion value of the Roth IRA.  Or, maybe you completed a Roth conversion earlier in 2015 before the markets began to fall.  Fortunately, you have the ability to undo (recharacterize) the Roth conversion, eliminating the tax otherwise due. (If you converted a traditional IRA to a Roth at any time in 2015, you have until October 15, 2016, to recharacterize it and avoid the taxes.) After the recharacterization you can reconvert the IRA to a Roth at the lower account value, paying even less tax than you would have on the original conversion. However, reconversions are extremely complex and require proper timing to avoid running afoul of the complicated tax rules that apply.

In the right situation, market declines can present substantial planning opportunities with IRAs. Remember, the rules governing IRAs are complex, and a Roth IRA conversion or recharacterization done incorrectly can result in disastrous tax consequences.

Your situation is unique. Please do not rely on the information contained in this article as it may not apply to your situation. Before making any move with any type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.