Retirement & Taxes – Financial Focus : Income Tax Planning, Chapter 6


Making golden decisions about your golden years

Planning for your retirement means making a series of financial decisions that will have an impact on your golden years: Should you invest in a traditional tax-deferred plan, a Roth plan that offers tax-free distributions, or both? If you opt for a Roth plan, which of the several options available is right for you? Also, when should you start withdrawing from your retirement savings, and in what amounts? Whether you’re just starting to think about retirement planning, are retired already or are somewhere in between, addressing the questions relevant to your current situation will help ensure your golden years are truly golden.

401(k)s and other employer plans
Contributing to a traditional employer- sponsored defined contribution plan is usually a good first step:
* Contributions are typically pre tax,
reducing your taxable income.
* Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.
* Your employer may match some or all of your contributions pre tax.

Chart 4  below shows the 2014 employee contribution limits. Because of tax-deferred compounding, increasing your contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement. If, however, you’re age 50 or older and didn’t contribute much when you were younger, you may be able to partially make up for lost time with “catch-up” contributions.

If your employer offers a match, at minimum contribute the amount necessary to get the maximum match so you don’t miss out on that “free” money.

More tax-deferred options

In certain situations, other tax-deferred savings options may be available:
You’re a business owner or self- employed. You may be able to set up a plan that allows you to make much
larger contributions than you could make to an employer-sponsored plan as an employee. You might not have to make 2014 contributions, or even set up the plan, before year end.
Your employer doesn’t offer a retirement plan. Consider a traditional IRA. You can likely deduct your contributions, though your deduction may be limited if your spouse participates in an employer- sponsored plan. You can make 2014 contributions as late as April 15, 2015. Your annual contribution limit (see Chart 4) is reduced by any Roth IRA contributions you make for the year.

4 Roth options
A potential downside of tax-deferred saving is that you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, however, allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current-year taxable income:

1. Roth IRAs. An income-based phaseout may reduce or eliminate your ability to contribute. But estate planning advantages are an added benefit: Unlike other retirement plans, Roth IRAs don’t require you to take distributions during your life, so you can let the entire balance grow tax-free over your lifetime for the benefit of your heirs.

2. Roth conversions. If you have a traditional IRA, consider whether you might benefit from converting some or all of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into tax-free growth and take advantage of a Roth IRA’s estate planning benefits. There’s no income-based limit on who can convert to a Roth IRA. But the converted amount is taxable in the year of the conversion.

Whether a conversion makes sense depends on factors such as:
* Your age,
* Whether the conversion would push you into a higher income tax bracket or trigger the NIIT (see page 6),
* Whether you can afford to pay the
tax on the conversion,
* Your tax bracket now and expected
tax bracket in retirement, and
* Whether you’ll need the IRA funds in retirement.
Your tax advisor can run the numbers and help you decide if a conversion is right for you this year.

3. “Back door” Roth IRAs. If the income- based phase out prevents you from making Roth IRA contributions and you don’t have a traditional IRA, consider setting up a traditional account and making a nondeductible contribution to it. You can then convert the traditional account to a Roth account with minimal tax impact.

4. Roth 401(k), Roth 403(b), and Roth 457 plans. Employers may offer one of these in addition to the traditional, tax-deferred version. You may make some or all of your contributions to the Roth plan, but any employer match will be made to the traditional plan. No income-based phaseout applies, so even high-income taxpayers can contribute. Plans can now more broadly permit employees to convert some or all of their existing traditional plan to a Roth plan.

Early withdrawals
Early withdrawals from retirement plans should be a last resort. With a few exceptions, distributions before age 591 are subject to a 10% penalty on top of any income tax that ordinarily would be due on a withdrawal. Additionally, you’ll lose the potential tax-deferred future growth on the withdrawn amount.
If you must make an early withdrawal and you have a Roth account, consider withdrawing from that. You can with- draw up to your contribution amount free of tax and penalty. Another option, if your employer-sponsored plan allows it, is to take a plan loan. You’ll have to pay it back with interest and make regular principal payments, but you won’t be subject to current taxes or penalties.
Early distribution rules also become important if you change jobs or retire and receive a lump-sum retirement plan distribution. You should request a direct rollover from your old plan to your new plan or IRA. Otherwise, you’ll need to make an indirect roll- over within 60 days to avoid tax and potential penalties.

Warning: The check you receive from your old plan may be net of 20% federal income tax withholding. If you don’t roll over the gross amount (making up for the withheld amount with other funds), you’ll be subject to income tax — and potentially the 10% penalty — on the difference.

Required minimum distributions
After you reach age 701, you must take annual required minimum distributions (RMDs) from your IRAs (except Roth IRAs) and, generally, from your defined contribution plans. The noncompliance penalty equals 50% of the amount you should have withdrawn but didn’t. You can avoid the RMD rule for a non-IRA Roth plan by rolling the funds into a Roth IRA.
Waiting to take distributions until age 701 generally is advantageous. But a distribution (or larger distribution) in a year your tax bracket is low may save tax. Be sure, however, to consider the lost future tax-deferred growth and, if applicable, whether the distribution could: 1) cause Social Security payments to become taxable, 2) increase income-based Medicare premiums and prescription drug charges, or 3) affect tax breaks with income-based limits.
If you’ve inherited a retirement plan, consult your tax advisor about the distribution rules that apply to you

Retirement plan contribution limits for 2014
Regular contribution  Catch-up contribution1

Traditional and Roth IRAs                                                                                           $ 5,500                            $ 1,000

401(k)s, 403(b)s,
457s and SARSEPs2                                                                                                       $ 17,500                          $ 5,500

SIMPLEs                                                                                                                          $ 12,000                          $ 2,500
1 For taxpayers age 50 or older by the end of the tax year.

2 Includes Roth versions where applicable.
Note: Other factors may further limit your maximum contribution.


For the next several weeks, join us in educating you to the world of Tax Planning, 2014, but please , contact your tax advisor to learn exactly which strategies can benefit you the most.

Chapter 4 INVESTING 
Chapter 5 BUSINESS  
Chapter 6 RETIREMENT (you are reading)
Chapter 8 TAX RATES


Anthony Rivieccio is the founder & The CEO of The Financial Advisors Group, celebrating their 18th year as a fee only financial planning firm specializing in solving one’s financial problems. Anthony has been a recognized financial expert since 1986. He has been seen, heard or read by many national and local media outlets including: Klipingers Personal Finance Magazine, The New York Post, News12 The Bronx, Bloomberg News Radio, Bronxnet Channel 67 TV, The Norwood News, The West Side Manhattan Gazette, Labor Press Magazine, Financial Planning Magazine, WINS1010 Radio, The Bronx News newspaper and The Bronx Chronicle. Anthony can be reached at 347.575.5045

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