mok-financial-planning

Traditional or Roth IRA?

Wed, 01 Jan 2020 16:16:47 GMT

The tax code offers two types of IRAs; one is referred to as the traditional individual retirement account (IRA), so named because it was the first type of IRA available, having been created by Congress back in the 1970s. The second type is the Roth IRA, established in 1997 and named after William Roth, who was a senator from Delaware.

Traditional IRA – The tax benefit of a traditional IRA is that it provides a tax deduction for the amount of the contribution up to the maximum allowed for the year. Higher income taxpayers that also participate in their employers’ retirement plans, such as a traditional pension plan or a 401(k) plan, can make contributions, but the deductibility of their contributions phase out as their adjusted gross income (AGI) increases.

The annual contribution limits are inflation adjusted periodically and include an additional catch-up amount for taxpayers age 50 and over.

To make a contribution, an individual must have earned income (income from working, such as wages or some form of self-employment income). There are special provisions in the tax law that allow taxable alimony, non-taxable military combat pay, and certain taxable fellowships and stipends to be treated as earned income for purposes of the earned income limit. The maximum contribution is the lesser of the earned income or the IRA contribution limit amount for the year.

Example: Phil, who is age 65, only worked part time during 2020 and his wages were $5,000. His contribution limit is the lesser of his earned income, $5,000, or the IRA contribution limit, $7,000. Thus, Phil can contribute any amount up $5,000 for 2020.

The traditional IRA deduction begins to phase-out when an individual who makes a traditional IRA contribution is also an active participant in a qualified retirement plan and their AGI has reached certain inflation-adjusted thresholds. The deduction is fully phased out for unmarried filers when their AGI reaches an amount $10,000 over the threshold. For married taxpayers and certain surviving spouses, full phase-out is achieved when their AGI is $20,000 over the threshold. Those using the married separate filing status who are active participants in their employer’s qualified plan generally are not allowed a deduction once their AGI reaches $10,000.

Generally, when funds are withdrawn from an IRA, the distribution is fully taxable, including the amount contributed and the earnings. An exception applies when a taxpayer elects not to take a deduction or when the deduction has been phased out. Contributions that were not deductible are recovered tax-free proportionally to each distribution. For example, if 8% of the overall contributions to a traditional IRA were nondeductible, 8% of each distribution will be tax-free and 92% will be taxable.

Traditional IRAs are recommended for those that may need a tax deduction in order to afford to make a contribution or those who are contributing later in life and cannot substantially benefit from a Roth IRA’s tax-free accumulation and whose income during retirement will be in a tax bracket substantially lower than it was when they were making the contributions.

Roth IRA – The tax benefit of a Roth IRA is quite different than that of a traditional IRA. With a Roth IRA, a taxpayer gets no tax deduction when contributions are made. However, the taxpayer gets tax-free accumulation, and at retirement, all distributions are tax-free, including the account’s earnings (if a five-year required holding period is met).

The annual contribution limits for a Roth IRA are the same as for a traditional IRA, including the need for earned income. However, for higher-income taxpayers, the amount they can contribute to a Roth IRA is reduced as their AGI increases above an inflation-adjusted threshold established for their filing status.

Selecting the IRA Type for You – If you are going to include an IRA in your retirement planning, a decision you will have to make is whether to choose a traditional IRA or a Roth IRA. A traditional IRA provides a tax deduction for contributions and tax-deferred growth, but any withdrawal from the account is fully taxable except for non-deductible contributions. On the other hand, Roth IRA contributions are not deductible, but distributions after retirement are tax-free. A Roth IRA offers tax-free accumulation, meaning the earnings build up over the life of the IRA tax-free. Making the decision involves a number of factors, and the decision may change as finances dictate.

For those currently with low income and on a limited budget with little extra income to spare for IRA contributions, the traditional IRA offers a tax deduction, which will allow them to make a larger contribution and is better than having no retirement funds at all. In addition, lower-income individuals may qualify for (and benefit from) the Saver’s Credit, which provides a tax credit that may help them afford a contribution.

For those who can afford to make a non-deductible IRA contribution without financial stress, the Roth is the go-to IRA because of its tax-free accumulation.

Even younger individuals should strongly consider investing in a Roth IRA—the longer one has a Roth IRA, the more tax-free income it can provide.

Other Issues to Consider – Unfortunately, like everything involving taxes, there are a number of complications and special considerations.
Penalties – There is a 6% penalty on amounts contributed to an IRA in excess of the allowable contribution amount. This penalty continues to apply annually until the excess is corrected. There is also a 10% early distribution penalty on the taxable amount withdrawn from an IRA before reaching age 59½. However, some or all of the 10% penalty is waived under certain circumstances. While distributions from Roth IRAs are generally tax-free, some portion of the distribution could be taxed and subject to penalty if funds are withdrawn prior to completing the 5-year aging period. Please call this office for additional details.
Conversions – To take advantage of the tax-free benefits of a Roth IRA, an IRA owner can convert a traditional IRA to a Roth IRA any time, but taxes must be paid on the amount of the taxable traditional IRA funds converted to a Roth IRA. Timing is key when making a conversion; many taxpayers overlook some great opportunities to make conversions, such as years when their income is abnormally low or a year when their income might even be negative due to atypical deductions or business losses. Even the new higher standard deductions may offer a taxpayer the opportunity to convert some or all of their traditional IRA to a Roth IRA without any conversion tax.

Conversion is also a way to get around the AGI limitation on making Roth IRA contributions. Often referred to as a back-door Roth IRA, non-deductible contributions are made to a traditional IRA and then converted to a Roth IRA. This procedure has some tax traps, so be sure to consult with this office before attempting a back-door Roth IRA.
Spousal IRAs – Spouses with no or a small amount of compensation for the year may contribute to their own IRA based upon their spouse’s compensation. If the unemployed spouse chooses a traditional IRA and the working spouse participates in an employer’s plan, the contribution’s deductibility phases out between $196,000 and $206,(508) 376-8811 inflation adjusted amounts). If a Roth IRA is chosen, the contribution limit also phases out between $196,000 and $206,000, even if the working spouse isn’t covered by an employer’s plan.
Retirement Distributions – For both traditional and Roth IRAs, distributions can begin once a taxpayer reaches age 59½ without penalty. For traditional IRA owners, once they reach age 72 (up from 70½ for those who turned 70½ before 2020), they must begin taking what is referred to as a minimum required distribution (RMD) each year. The minimum amount is based upon current age and the value of the IRA account. Failing to take a distribution of the required minimum amount may result in a 50% penalty of the amount that should have been withdrawn; however, the IRS will waive the penalty under certain conditions.

TIP: In any post-retirement year when your income is below the taxable threshold, you have an opportunity to withdraw from the IRA tax-free. You should consider doing so even if you don’t need the income. You can put it away in a savings account until you do need it.

Roth IRAs are not subject to the RMD requirement so long as the Roth account owner is alive.

Saving for retirement is extremely important, even if it means cutting back on discretionary spending. Choosing the right IRA or retirement plan can become complicated and can have a big impact on your current tax situation as well as in your retirement years.

Our MOK professional team is here to help you with any questions or concerns.

The views expressed herein represent the opinions of MOK Financial Planning & Tax Inc., and are not intended as a forecast or guarantee of future results. This information should not be considered a solicitation or an offer to provide any MOK Financial Planning & Tax Inc. service in any jurisdiction where it would be unlawful to do so under the laws of that jurisdiction. The information contained in this presentation is obtained from sources believed to be accurate, reliable and current as of the presentation date. MOK Financial Planning & Tax Inc. will not undertake to supplement, update or revise such information at a later date. The information contained herein is for informational purposes only and is not intended to be a recommendation, investment advice, forecast or guarantee of future results.

MOK Financial Planning & Tax, Inc. is a registered investment adviser based in Millis, Massachusetts. We are organized as a corporation under the laws of the State of Massachusetts and have been providing investment advisory services since September 2017.

Watch Out for Tax Penalties

Wed, 01 Jan 2020 16:02:07 GMT

Underpayment of Estimated Taxes and Withholding Penalty – The United States income tax system is a pay-as-you-earn tax system, which means that taxpayers are required to pay their tax liability as they receive income during the year through withholding or by making estimated tax payments. If a taxpayer owes more than $1,000 when filing their return for the year, the IRS will assess the underpayment of estimated tax penalty, which is currently 3% of the underpayment. There are “safe harbor” payments that can protect you from this penalty, which include payments in the following amounts: 90% of the current year’s tax liability or 100% (110% for high-income taxpayers) of the prior year’s tax liability. Farmers and fishermen need only prepay (508) 376-8811% of the current liability or 100% of the prior year’s liability.

Required Minimum Distribution (RMD) Penalty - To prevent an individual from investing in tax-deferred retirement plans, including traditional IRAs, but never withdrawing funds from the plans (which would mean the government wouldn’t ever collect taxes on the distribution), retirees must take an RMD each year after reaching the mandatory RMD age. The mandatory distribution age has recently changed from 70½ for years before 2020 to 72 in 2020 and later years. Failing to take the correct minimum distribution (also known as excess accumulation) results in a penalty of 50% of the difference of what should have been withdrawn and what was actually withdrawn.

However, the IRS is very liberal in general and will abate the penalty in most situations.

Late Filing Penalty – If a return is filed after the due date, including extensions, a late filing penalty of 4.5% per month (maximum 22.5%) applies. The normal due date for returns is April 15 of the subsequent year. Because of COVID-19, the due date for 2019 returns was extended to July 15, 2020, and the penalty for filing a late (508) 376-8811 return does not begin until after July 15, 2020. If you have not filed your 2019 return and did not file an extension by July 15, 2020, you are encouraged to do so as soon as possible to minimize penalties.

If a return is over 60 days late, the minimum penalty for failure to file is the lesser of $435 or 100% of the tax shown on the return. While the obvious way to avoid a late filing penalty is to file in a timely fashion, the IRS will consider abating the penalty if it can be proven that there was reasonable cause and no willful neglect.

Late Paying Penalty – When the tax owed on a return is paid after the unextended due date of the tax return (July 15 for 2019 returns filed in 2020), the taxpayer is subject to a penalty of 1/2% per month (maximum 25%) on the unpaid balance. Taxpayers are frequently caught by this penalty when they need an extension to file their tax return; many fail to realize that the extension does not include an extension to pay. The only way to avoid or minimize this penalty is to have no or little balance due on the return when it is finally filed. The extension form includes a provision to pay the projected balance owed when filing the extension.

Negligence – When underpayment is due to negligence on the part of the taxpayer or there are errors in tax valuations, a penalty of 20% of the tax underpayment is charged. This penalty is frequently encountered when the IRS adjusts a filed return due to unreported income or overstated deductions.

Fraud – This penalty is 75% of the tax unpaid due to fraud.

Dishonored Check – The penalty for dishonored checks of over $1,250 is 2% of the check amount. If the amount is $1,250 or less, the penalty is the amount of the check or $25, whichever is less. If you don’t have sufficient funds to pay your tax when you file your return, rather than writing a check that you know will bounce, you may be able to arrange an installment payment plan with the IRS. You may still incur late payment charges, but the penalty rate is lower if you are on a payment plan.

Missing ID Number – A penalty of $50 for each missing number applies when a taxpayer doesn’t provide a required Social Security number (SSN) for themselves, a dependent or another person on their tax return. It is also charged when the taxpayer doesn’t provide their SSN to another person or entity when required.

Early Withdrawal Penalty – If a taxpayer is under age (508) 376-8811 and withdraws assets (money or other property) from a qualified retirement plan, including traditional IRAs, the taxpayer must pay a 10% additional tax, commonly referred to as the early withdrawal penalty. This tax is 10% of the part of the distribution that the taxpayer was required to include in gross income for the year of the distribution.

Failure to Report Tips - A penalty is charged if a taxpayer didn’t report tips to their employer. It equals 50% of the Social Security tax on the unreported tips.

Reporting Foreign Accounts and Assets – There are numerous and substantial penalties for failure to report a variety of foreign accounts and assets, and some of the penalties are even draconian. Please contact this office if you have a foreign financial account, foreign trusts, ownership in a foreign corporation, received foreign gifts, etc.

Excessive Claim Penalty - If a claim for refund or credit for income tax is made for an excessive amount, the person making the claim is liable for a penalty equal to 20% of the excessive amount. The excessive amount is the amount by which the claim for any tax year exceeds the amount of the claim allowable for that tax year.

The penalty doesn’t apply if it is shown that the claim for the excessive amount is made with reasonable cause. The penalty also does not apply if any portion of the excessive amount or credit is subject to an accuracy-related penalty.

Frivolous Return - In addition to any other penalties, the law imposes a penalty of $5,000 for filing a frivolous return—one that does not contain information needed to establish the correct tax or shows a substantially incorrect tax because the taxpayer takes a frivolous position or displays a desire to delay or interfere with the tax laws. This includes altering or striking out the preprinted language above the space where the taxpayer signs. Under limited circumstances, the IRS may reduce the penalty from $5,000 to $500.

Failure to File Information Returns – A taxpayer who, without reasonable cause, fails to file required information return in the manner the law specifies or by the proper deadline, fails to include all of the information required or includes incorrect information is subject to a penalty of $280 for each return required to be filed during 2020. The penalty is reduced to $50 if the failure is corrected within 30 days of the due date and $110 if corrected by August 1.

Our MOK professional team is here to help you with any questions or concerns.

Financial Strategies

Wed, 01 Jan 2020 15:56:57 GMT

Strategy #1: Update your beneficiary designations on your IRA accounts.

Why this matters:

The SECURE (Setting Every Community Up for Retirement Enhancement) Act became law on December 20, 2019, and it alters several rules related to tax-advantaged retirement accounts.

Two notable changes: It moves back the age at which retirement plan participants need to take required minimum distributions from age 70 ½ to age 72. In addition, it mandates that most non-spouses who are inheriting IRAs must fully liquidate the accounts within 10 years, rather than over a lifetime. This has a serious, sweeping impact on taxes that must be paid by the beneficiary.

Action steps you should consider:

We believe that people should reassess their beneficiaries in terms of age and tax bracket. It’s also important to be aware of the fact that the SECURE Act effectively obliterates trust planning with IRAs.

Be sure to talk with your financial advisor to review any existing trust or tax-advantaged retirement accounts to ensure they’re set up in a way that your wishes will be carried out.

Strategy #2: Stick to your plan, regardless of the stock market.

Why this matters:

The stock market has been hitting all-time highs as of late, triggering emotionally charged changes to financial planning for some, who seek a quick return based on strong market performance. In our industry, this is referred to as “recency bias,” when people allow recent events to influence their investing decisions.

What you should do:

In our view, it’s important to stay committed to a prudent asset allocation and to not let your emotions or rationale based on recent events dictate changes, no matter what the market is doing.

Likewise, stick to your plan despite rumors of downturns coming later in the year. There’s sentiment among economists and asset managers that we will see volatility in this presidential election year (and due to other factors), but it’s our belief that those who stay the course will emerge in an optimum financial position.

Strategy #3: Aim for a holistic financial planning + tax solution

Why this matters:

Sometimes financial advisors — even those acting in good conscience — can be guilty of tunnel vision when it comes to your money, recommending changes that are wise from an asset allocation standpoint, but inadvertently ignore the impact of those changes on you come tax return time.

What you should do:

Strive for a unified front in terms of matching up your financial advisor with your CPA. When the two professionals are in a position to coordinate together, and are on the same page when it comes to tax-efficient strategies relative to your wealth, we believe it can make your financial picture stronger overall.

We can help you protect your assets and assist you to create financial structures that are funded with tax-deductible dollars to minimize your taxes and maximize your wealth.