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roth conversion

Taxing Times

By | 2021, Money Matters, Newsletter | No Comments

It is that time of the year! Tax season is upon us. As you gather your tax documents together, you may be wondering how you are taxed on investments. This is a good time to review how taxes apply to different account types.

Tax-deferred

Most everyone has some type of tax-deferred account, generally thought of as a retirement account(s). Money is invested in these accounts before taxes are paid. It grows over the years and is taxed when you take it out of the account through withdrawals and distributions. These accounts include Individual Retirement Account (IRA), 401(k), 403(b), SIMPLE IRA, SEP IRA, etc. It can also include non-qualified tax-deferred annuities where the initial investment has been taxed, but the tax on the growth is deferred until you take a withdrawal from the account.

Money taken from tax-deferred accounts is taxed as ordinary income. That means it is taxed at your marginal-income tax rate.

Restrictions apply to these accounts. For instance, the amount of money you can invest each year is limited based on the account type and your age. If you take money out before you are age 59 ½, you will pay an early withdrawal penalty of 10%. Furthermore, you must begin taking money out of these accounts by age 72. This is known as a Required Minimum Distribution (RMD), and you will be subject to a penalty if you miss the deadline.

Taxable

Taxable investment accounts can be accessed at any time without restriction. They are often used to reach a specific goal or increase savings that will be used to supplement income during retirement. The initial investment has already been taxed, and you will only pay tax on the growth.

The tax rate is determined by the length of time you hold the investment. If you hold a specific investment within a taxable account for more than one year and one day, you will be taxed at lower capital gains rates. If you sell an investment in less than one year, taxes are calculated at your ordinary income-tax rate. Dividends received are generally taxed as ordinary income as well.

You can manage taxes within the account by offsetting gains and losses. This strategy can be helpful in reducing taxes.

You are free to add as much money as you want to a taxable account, and there are no requirements to take money out of this type of account regardless of your age.

Tax-free

Growing money without taxes is a wonderful way to plan for retirement. This can be done in a Roth IRA or Roth 401(k). Money is invested in the account after taxes have been paid. Any growth earned over the years is tax-free. It does not get better than that!

There are differences between the two types of Roth accounts. The amount of money you can contribute is limited by the type of account and your age. A Roth IRA has no required distribution date. You can leave the money in the account until you are ready to use it or pass it to your heirs tax-free. Unfortunately, the Roth 401(k) is subject to Required Minimum Distributions at age 72. This can be avoided by rolling the Roth 401(k) to a Roth IRA before the year you will turn 72.

For details on marginal tax rates, capital gains rates, and contribution limits, visit us at SmedleyFinancial.com and browse the updated 2021 tax information. You can also call us at 800-748-4788. Happy tax season!

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Supersized Retirement Savings

By | 2020, Money Moxie, Newsletter | No Comments

If you want to supersize your retirement savings for early retirement or help you make up for lost time, consider a mega backdoor Roth. It can allow you to stash up to another $37,500 into retirement savings, which will grow tax-free. In an environment where taxes may go up because of government debt, this can be a very worthwhile proposition. It is especially beneficial for earners that make too much to contribute to a regular Roth or have too much in IRA assets to do a regular backdoor Roth. Of course, there are hurdles and restrictions.

The first hurdle is maxing out your 401(k) or Roth 401(k) contributions. In 2020, the limit is $19,500, or $26,000 if over age 50. If you aren’t contributing enough to hit these thresholds, then a mega backdoor Roth doesn’t apply. If you are hitting these thresholds, then your normal contributions should probably be pre-tax, and the backdoor Roth can serve as your after-tax savings. (It may not make sense to put all of your contributions into the Roth bucket if you are taxed at 37% federally.)

If you earn less than $124,000 or $196,000 filing jointly, then you are still eligible to contribute to your normal Roth IRA. Make that contribution first, which can be $6,000 or $7,000 if over age 50. If you earn more than the limits, then a mega backdoor Roth is your only retirement savings option.

The next big hurdle is your 401(k) plan. Only 43% of companies allow for after-tax contributions. In addition, the company 401(k) plan needs to allow for in-service distributions into the Roth. If the plan checks both of these boxes, then the contributions go into the after-tax portion, and the plan administrator can convert those assets into a Roth.

If the plan doesn’t allow for in-service distributions, then you can still put money in after-tax, but the earnings will only be tax-deferred. Usually at age 59½ or at retirement, you can place the after-tax portion into a Roth IRA, and the tax-deferred portion can go into a traditional IRA. This somewhat defeats the purpose as the goal is to get as much as possible into a Roth as soon as possible to allow for tax-free growth.

If you have jumped over these hurdles, then you are ready to stash money away. In 2020, you can put a maximum of $57,000 into a retirement plan, including your contributions and the company’s match. So, if you put in $19,500, and the company matches $5,500, then you can put in up to $32,000 more in the mega backdoor Roth. Talk about supersizing your retirement savings!

The major benefit of a mega backdoor Roth over a regular backdoor Roth conversion is not having to deal with the pro-rata rule. In a normal backdoor Roth, whatever you convert is proportionate across all of your IRAs. So, if you have any sizable amount in pre-tax IRA (i.e., traditional IRA), then you have to convert and pay taxes on the proportional amount converted from the IRA. Depending on the size of your IRA, and if you are under age 59½, this can really hurt. Since the mega backdoor Roth takes place in a 401(k), that pro-rata rule doesn’t apply.

While there are hurdles and restrictions, the mega backdoor Roth can be a great way to supersize your retirement savings. If you have any questions on how this can help you reach your goals, please contact our Private Wealth Managers.

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Year-End Tax Tips

By | 2015, Money Moxie, Newsletter | No Comments

As the end of 2015 approaches, here are some year-end tax tips that may help you save some of your hard-earned money.

Piggy Bank

• Tax harvesting – This is one way to turn a curse into a blessing. If you have an investment with large capital gains that you haven’t wanted to sell for tax reasons, just look to see if you have another non-retirement investment that is underwater. If you sell both investments, you can use the losses in the poor-performing investment to offset the gains of the good performer.

• Lost a job or retired early – You may consider a Roth conversion if your taxable income is low. Low-income years can result in more deductions than taxable income, which means that you may be able to convert part or all of an IRA into a Roth without much tax consequence.

• Roth conversions – If you have been contemplating converting money from an IRA into a Roth for 2015, just remember that the conversion has to take place before the end of the year.

• Watch for approval of Qualified Charitable Distributions (QCD’s) – Congress hasn’t approved QCD’s yet, and they may not this year. They have a history of waiting until the last minute. If congress does approve QCD’s and you are over age 70.5, you can donate part or all of your Required Minimum Distribution to a charity. This donation reduces your taxable income and may mean that less of your Social Security is subject to tax.

 

Smedley Financial and its advisors do not provide personal tax advice. It is important to coordinate with your tax advisor regarding your situation.

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