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

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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 Note, the RMD is the minimum that must be withdrawn from the IRA for the year, you can withdraw more than the RMD if you so choose.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.

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

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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.

Transferring Company Stock From a 401(k) to an IRA? Don’t Forget The NUA!

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So, you are newly retired and thinking about what to do with your employer sponsored 401(k) account.  The stock market has gone up quite a bit recently and you’re pleased with the value of your 401(k) (or other employer sponsored account) – especially the value of the company stock in your account. You may be thinking about transferring your 401(k) to an IRA for greater investment flexibility. Before you do, you may want to consider a nifty strategy to potentially save a bundle on income taxes.

The strategy involves the net unrealized appreciation (NUA) on the company stock in your 401(k). In a nutshell, NUA is the difference between the current market value of the company stock and the price originally paid for the stock (cost basis). This NUA may be eligible for favorable capital gains tax treatment when the company stock is sold.

If you roll over your 401(k) account, including the company stock, to an IRA, and then later take distributions from the IRA, the entire distribution (including any company stock) will be subject to income tax at your ordinary income tax rate. That rate could be as high as 39.6% just for federal income taxes depending upon your tax situation.

If, instead of transferring your account balance (including the company stock) to an IRA, you take a lump-sum distribution of the entire account balance, including the company stock (sometimes called an “in-kind” distribution), the distribution of the stock will be subject to income taxes, but you will only pay long term capital gains taxes (from 0% to 20%) on the NUA when the stock is sold (you’ll pay taxes at ordinary tax rates on the cost basis portion). If you are able to complete a tax-free rollover of the remainder of the distribution (less the company stock) to an IRA, the amount rolled over escapes income taxation. The NUA strategy will not work if the stock is liquidated inside the 401(k), or rolled over to an IRA.

In order to make the strategy work, you must take an in-kind distribution of the company stock from your company retirement account as part of a lump-sum distribution of the entire account balance.  The lump sum distribution must follow a “triggering event,” such as retirement or other separation from service, attainment of age 59½, death [yes, the beneficiary of an inherited 401(k) or other employer plan account can take advantage of NUA], or disability.  The entire balance of the account must be distributed – you can’t just take an in-kind distribution of the company stock.

For those with appreciated company stock in their 401(k) or other employer-sponsored account, taking advantage of the NUA rules can help save on income taxes when the stock is sold. But like any other income tax saving strategy, especially involving retirement plan distributions, it’s complicated, and it may not work in every situation. So, before you go ahead and transfer your 401(k) account with the company stock to an IRA, sit down and consult with a qualified professional who can help you determine whether the NUA strategy is right for you.

Think the NUA strategy may work for you? Give me a call, I can help.

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2017 Retirement Plan Contribution Limits

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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!

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

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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.

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

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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.

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3 Popular Retirement Planning Loopholes That May Be Closed

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Advisers have plenty of tricks and techniques to help clients maximize retirement savings and income, and minimize taxes. Many are considered “loopholes” in existing laws that advisers and their clients exploit to great advantage. Unfortunately, when use of these loopholes becomes too widespread, the government steps in to close them. This may happen soon to 3 popular retirement planning techniques according to a recent Reuter’s article.

The “stretch” IRA. Beneficiaries of an IRA or other retirement accounts have the option of taking distributions from the inherited account over their remaining life expectancies. And in the case of Roth IRAs, this means a lifetime of tax free distributions. Lawmakers on both sides of the political isle don’t like this. They believe that retirement accounts should be for retirement – not a tax windfall for heirs.

Law changes have been proposed in Washington that would require the balance of an inherited retirement account to be paid out to beneficiaries within 5 years of the account owner’s death. In the case of a traditional IRA, the acceleration of distributions will increase the income taxes that beneficiaries will pay on the distributions.  People contemplating Roth conversions for the benefit of children or other heirs may need to rethink this strategy if the beneficiaries have to withdraw the funds within 5 years.

Back-door Roth IRA conversions. The law creating Roth IRAs contains restrictions that prohibit certain high-income individuals from contributing to a Roth IRA. However, the law contains a loophole that allows these high-income earners to make a non-deductible contribution to a traditional IRA, and then convert the funds to a Roth IRA. In a typical transaction of this type, zero income tax has to be paid on the conversion. Once converted, the funds grow income-tax free and no tax is due on distributions from the account, which lawmakers believe hands beneficiaries an unintended tax-free windfall.

Aggressive Social Security benefit claiming strategies. One of these likely to be ended is known as “file and suspend.” Married couples can claim benefits based on their own work record or on the work record of their spouse. A person who reaches full retirement age (currently 66) can apply for their own retirement benefit and then immediately “suspend” the application so that their monthly benefit continues to grow until they reach age 70, when they must begin collecting. If their spouse is also at full retirement age and hasn’t claimed their own retirement benefit yet, the spouse can apply for a spousal benefit, which can be as much as ½ of their partner’s monthly retirement benefit. He or she can collect the spousal benefit until age 70 and then switch to their own monthly retirement benefit.

Experts opine that people who are already receiving Social Security benefits or those close to retirement age probably don’t have to worry. The government isn’t likely to take back something that has already been given. Changes will likely have to be phased in to avoid political backlash. Government gridlock may also prevent anything from happening soon.

See Liz Weston, Three retirement loopholes seen likely to close, Reuters, June 29, 2015.

My Siblings And I Inherited Our Dad’s IRA, Now What?

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A prospective client contact me regarding the disposition of an IRA account he and his siblings inherited from their father. They wanted to know what had to be done now that they were to receive the IRA funds.

Many people will name multiple beneficiaries to an IRA or other retirement account. They’ll do this when they want the account balance to go to more than one person, but they don’t want to incur the additional fees or paperwork by maintaining separate accounts for each beneficiary. While it makes things easier for the account holder, handling the IRA after his death can be very a complex task for the beneficiaries.

The first step is to split the IRA into separate accounts, one for each sibling named as a beneficiary. The due date for splitting an IRA is December 31 of the year following the year of the account owner’s death. In this case, because the father died in 2015, the children have until December 31, 2016, to split the IRA into separate accounts.

The December 31 deadline is important because it allows each beneficiary to “stretch” distributions from his or her separate account over their own remaining life expectancy. This can be important where there is a large age difference from the oldest to the youngest beneficiary. If the deadline is missed, money must be withdrawn from dad’s IRA based upon the life expectancy of the oldest designated beneficiary.

This split must be done by direct transfer. Non-spouse beneficiaries may not roll over a deceased account owner’s IRA. Each new “inherited” IRA account must also keep the deceased account owner’s name on the account.

Once the split is completed, each beneficiary must begin taking distributions from his or her inherited IRA account by the same December 31 account splitting deadline to take advantage of the life expectancy method of distribution. In this case, they must begin taking distributions out by December 31, 2016. The life expectancy method allows a beneficiary to maximize tax deferred growth of the balance of the IRA account over their remaining lifetime.

Seems very simple. But the rules governing IRA and other retirement account distributions are very complex. Even something as seemingly simple as splitting up an IRA or other retirement account can be done incorrectly, resulting 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 an IRA or any other type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

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How to Take an IRA Required Minimum Distribution in 5 Steps

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What is a required minimum distribution*, or “RMD,” you ask? An RMD is the minimum amount that must be withdrawn from an IRA or other retirement account each year. Failure to withdraw the required minimum amount by the annual deadline will cause you to incur a hefty penalty equal to 50% of the amount that should have been withdrawn from the account.  (*Sometimes referred to as a “minimum required distribution,” or “MRD.”)

In general, owners of traditional IRAs must start taking RMDs beginning with the year they turn age 70½. Beneficiaries of both traditional and Roth IRAs are required to begin taking RMDs the year following the year of the account owner’s death, if they do not elect to take a lump sum distribution.

Step 1: Determine the distribution year. The distribution year is the year for which the RMD is being calculated. This may not be the year in which the RMD is actually taken. A person turning age 70½ in 2015 does not have to take their 2015 RMD until April 1 of 2016. But if he does wait until 2016 to take the 2015 RMD, he must still take an RMD for 2016. After the year the IRA owner turns 70½, all subsequent RMDs must be taken by December 31 of each year.

Step 2: Determine the account balance. One must use the account balance as of December 31 of the prior year, adding back any outstanding rollovers and recharacterizations. For example, to determine the RMD for 2015, the account balance as of December 31, 2014, is used.

Step 3: Determine the applicable distribution period, or “ADP.” Most IRA owners will use the Uniform Lifetime Table to determine their ADP. If the IRA owner is married and his spouse is more than 10 years younger than he, the Joint Life Expectancy Table is used. In most situations, account beneficiaries determine their ADP for the year following the year of the account owner’s death using the Single Life Table. The ADP is the divisor used to determine the RMD for the distribution year. Whether determining the ADP for the account owner or an account beneficiary, one must use the age he or she will be at the end of the distribution year. For some RMD types, the ADP is recalculated each year. For other RMD types, the ADP is determined once, in the first distribution year, and reduced by one each year thereafter.

Step 4: Divide the account balance by the ADP. The result is the RMD that must be taken for the distribution year.

Step 5: Withdraw the RMD on time to avoid penalty. If the RMD is for the year in which the account owner turned age 70½, the RMD must be withdrawn by April 1 of the following year. In all other situations the RMD must be withdrawn by December 31 of the distribution year.

It seems very simple. But the rules governing IRA and other retirement account distributions are very complex. Even something as seemingly simple as taking an RMD from an IRA or other retirement account can be done incorrectly, resulting 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.

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You Can’t Do That! 5 Prohibited IRA Transactions.

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5 (of many) things you cannot do with your IRA – ever:

1. Transfer an IRA to a spouse. Unless incident to a divorce judgment, you may not transfer an IRA to your spouse. Doing so creates a taxable distribution. (Oh, and you can’t transfer it to anyone else either.)

2. Retitle your IRA to your trust for estate planning purposes. Only individuals can own an IRA. Your trust is not an individual. So, changing the owner of your IRA from you to your trust is a taxable distribution.

3. Pledge your IRA as security for a loan. You are not allowed to use your IRA as collateral for a loan. If you do, you’ve made a “deemed” distribution from the IRA, a taxable event.

4. Lend money from your IRA to yourself or a family member. IRAs are prohibited from lending money to any “disqualified persons.” “Disqualified persons” include the account owner, members of the IRA owner’s family, and certain business entities owned by the IRA owner.

5. Invest IRA funds in collectibles. “Collectibles” include artwork, antiques, gems, stamps, and coins (with certain narrow exceptions). Any IRA funds invested in collectibles are deemed to have been distributed from the IRA, a taxable event.

Generally, when IRA assets are used in a prohibited transaction, the IRS treats them as having been distributed from the IRA on the first day of the year in which the transaction took place. The amount of the distribution must be included in the IRA owner’s income for that year and, if the owner is under age 59½, early distributions penalties will apply.