October 30, 2023 Weekly Update

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We do love it when someone refers a family member or friend to us.  Sometimes the question is, “How can we introduce them to you?”   Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.

Here are this week’s items:

Portfolio Update:  Murs and I have recorded our portfolio update for October 30, 2023

CLICK HERE TO WATCH THE UPDATE

Roth IRA – 5-Year Rule – Your Retirement – Part 2 with Denise Appleby

Denise Appleby explains the nuances around two separate Roth IRA 5-year rules and what you need to take distributions from a Roth IRA if you’re aged 59 and a half or below. Listen in to learn the importance of starting your Roth IRA 5-year clock earlier and protecting your records to avoid paying taxes you don’t owe.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

Roth IRA – 5-Year Rule – Part 2 with Denise Appleby

In our last podcast (read the blog here), we dove right into one of the most common questions our clients and listeners have: Roth IRAs and the 5-year rule. Well, we decided that we need to cover this topic even more in-depth and brought Denise Appleby on the show to clear up any confusion that you may have.

CLICK HERE TO READ THE BLOG

Roth IRA – 5-Year Rule – Part 2 with Denise Appleby

Written by

In our last podcast (read the blog here), we dove right into one of the most common questions our clients and listeners have: Roth IRAs and the 5-year rule. Well, we decided that we need to cover this topic even more in-depth and brought Denise Appleby on the show to clear up any confusion that you may have.

Denise is an expert in all things IRAs and an excellent consultant for these types of questions.

What are the 5-Year Rules?

Denise was quick to point out that it’s not the 5-year rule but the 5-year rules. Two main rules are in place and the challenge is determining which rule applies to you.

First 5-Year Rule

This rule is used to determine if a Roth IRA distribution is qualified. This rule starts January 1 on the first year that you fund your Roth IRA, and it never starts over.

For example:

  • 2010, you contribute to a Roth IRA
  • 2023, you start a new Roth IRA because you cleared out the original
  • When did the 5-year period start? January 1, 2010.

Second 5-Year Rule

The second 5-year rule only pertains to you if you’re not eligible for a qualified distribution. Under this rule, we’re looking at Roth conversions and their distributions. If you withdraw the money that you put in within the first 5 years, you’re subject to a 10% distribution penalty.

However, the rule is very complex because it starts over with each conversion.

For example:

  • In 2020, you perform a Roth conversion
  • You take a distribution in 2023

The distribution would come from the 2020 conversion first before any conversion you do at a later date, if that applies.

This rule can be very hard to wrap your head around without an example.

Whose Responsibility Is It to Track Distributions and the 5-Year Rule?

Each conversion you make has a 5-year rule attached to it. Unfortunately, it’s your responsibility to track these conversions and how long ago they were made. For example, let’s assume that you convert $10,000 over the next 5 years.

The IRA custodian will not track these conversions. The IRS says that if a distribution is made and the IRA custodian doesn’t know the following, the custodian will report it as a non-qualified distribution without an exception:

  • If the person is eligible for an exception, or
  • If the person is eligible for a qualified distribution

It’s your burden to provide your tax preparer with the documentation necessary to show that the distributions are penalty-free. You can do this by keeping documents handy, such as your Form 5498.

You must protect yourself by keeping clear documentation of conversions. If you don’t keep proper records, you’ll pay penalties because there’s no proof that the distributions are non-qualified.

As you can see, there are a few nuances around the 5-year rule that can be complex and a bit tricky. Part of the reason why we’re diving deep into this rule for retirement planning is that you can leverage conversions now for tax planning purposes.

We know that unless there are significant legislative changes made before 2026, tax rates are going to go up.

Converting traditional IRAs to Roth accounts now may be beneficial for you and allow your money to grow tax-free. Most of our clients are doing conversions for future potential use way down the road or they’re doing it for their legacy. In these cases, the 5-year rule won’t matter to them.

With this in mind, let’s consider the following example:

Example 1: 60 Year Old with a Roth Balance of $100,000 that is Well Past the 5-Year Rule

If this person did a conversion last year of $100,000, do they have to wait five years to take distributions on this conversion? No. Because they are over the age 59 and a half, the second 5-year rule does not apply, and they can take a distribution without additional tax or penalty.

Anyone over age 59 and a half doesn’t need to track anything aside from having had a Roth account open for at least 5 years. You’re in a very nice place to be at age 60.

Because of this, we recommend that you establish a Roth account, even with a small contribution, as soon as possible. Why? Your five-year period starts ticking down the moment that the account opens. You could potentially not contribute to the account for years, but that five-year period will be ticking down, allowing you the freedom to do conversions in the future and still take distributions from the account without penalties.

Example 2: 50 Year Old, No Roth Account and Has Opportunity to Do a Roth Conversion

Imagine that this individual begins converting their accounts and assumes that they’ll wait until they’re at least 59 and a half to begin distributions. Life happens, and suddenly, the person does need to take money out of the account before then.

If they haven’t had the Roth IRA for 5 years and aren’t eligible for a distribution, then we need to look next at the ordering rules.

What are Ordering Rules?

Ordering rules pertain to your Roth IRA and distributions. Your distribution is taken from your account in the following levels:

  1. Regular Roth IRA contributions or money rolled over from Roth 401(k), 403(b), 457(b). These contributions come out first and are always tax- and penalty-free.
  2. Conversions from traditional SEPs and SIMPLEs and rollovers from the pre-tax side of 401(k) plans. Unless you qualify for an exception, these distributions will have a 10% penalty because of your age and not meeting the 5-year rule. What are the exceptions? If you converted the account at least 5 years prior, you could take distributions without penalty.
  3. Earnings, which are taxable and subject to the 10% penalty.

If you must take distributions early, you want to avoid taking money from levels 2 and 3. Level 2 money still has the 10% penalty unless you fall under very specific circumstances, and level 3 money is both taxable and comes with a penalty.

Example 3: 50 Year Old with Plans to Convert $10,000 Each Year Until 60, Never Had a Roth Before

Over the 10 years, the person has $100,000 in conversions in the account. The account has been open for five years, so one rule is checked off. The person is also 60, so they can start taking qualified distributions if they wish. Any distribution going forward is both tax-free and penalty-free. They can tap into growth without penalty as well. 

Legislatively, everything is always up in the air. Ages can change for these rules. A few years ago, the government did try to make changes to some Roth provisions, but they haven’t tried to do so recently.

Even the Secure Act 2.0 was very Roth-friendly.

Denise does not believe that Roth accounts are going anywhere any time soon because the IRS wants to be paid upfront. The IRS always wants to be paid as soon as possible, so it’s not likely that Roth accounts will be a major legislative target at this time.

Of course, things can change and new rules can be added, but we’ll keep you up to date on these occurrences.

Does a Roth 401(k) Start the 5-Year Clock?

No. A Roth 401(k) does not start the Roth IRA clock. The time that you’ve had the 401(k) open doesn’t apply to your IRA, which is very unfortunate.

What Should People Think About When It Comes to the 5-Year Rule?

Final points from Denise:

  • Having and contributing to Roth 401(k) is not the same as opening and contributing to a Roth IRA.
  • If a spouse beneficiary inherits a Roth IRA and the spouse treats it as their own, the 5-year period is considered to have begun at the earlier of the two spouse’s first Roth IRA contributions. However, if the funds are transferred to a beneficiary IRA, the accounts inherit the decedent’s period. Do you have documentation on these accounts?
  • Beneficiary IRA accounts allow for $10,000 to be used for a first-time home purchase without penalties.

Clearly, there is quite a lot to think about with Roth IRAs, conversions and the 5-year rule. Having an expert like Denise at your side is extremely beneficial when working on these accounts.

If you have any questions, you can schedule a free 15 minute call with us and we’ll be more than happy to have a conversation with you. We can even consult Denise on any complex questions.

October 23, 2023 Weekly Update

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We do love it when someone refers a family member or friend to us.  Sometimes the question is, “How can we introduce them to you?”   Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.

Here are this week’s items:

Portfolio Update:  Murs and I have recorded our portfolio update for October 23, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Roth IRAs – 5-Year Rule and Conversions in Retirement

Listen in to learn the difference between Roth IRAs’ contributions and conversions and how the 5-year rule applies to each. You will also learn about the five advantages of a Roth IRA: tax-free growth, not subject to RMDs, tax diversification, estate planning benefits, and hedge against future tax increases.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Roth IRAs – 5-Year Rule and Conversions

Roth IRAs are on the minds of many of our clients and listeners. If you’re concerned that taxes may be higher in the future, you may want to learn more about Roth Accounts. In a Roth account, you pay taxes on the money today and can then allow it to grow tax-free. However, you also need to be aware of the 5-year rule for Roth IRA conversions. The rule is a small caveat that is easy to overlook…

CLICK HERE TO READ THE BLOG

Roth IRAs – 5-Year Rule and Conversions

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Roth IRAs are on the minds of many of our clients and listeners. If you’re concerned that taxes may be higher in the future, you may want to learn more about Roth Accounts. In a Roth account, you pay taxes on the money today and can then allow it to grow tax-free.

However, you also need to be aware of the 5-year rule for Roth IRA conversions. The rule is a small caveat that is easy to overlook, but it impacts your ability to withdraw your earnings without penalties or taxes.

5-Year Rule for Roth IRA Contribution: Limits and Requirements

You can contribute to a Roth, but there is an income level that you need to be concerned about. We won’t go into these levels in great detail, but a lot of companies are offering Roth 401(k) options to circumvent these income limits – just a contribution limit.

If you contribute money into a traditional Roth IRA, it’s 100% liquid. You can put $10,000 in and take it right back out of the account.

However, the 5-year rule pertains to the interest earned on the account.

Example 1: the 59 ½ Rule

For example, let’s say that I’m 40 years old and I put $10,000 into a Roth IRA. Fast-forward 10 years. Now I’m 50 years old, and the $10,000 I put into the account has swelled to $20,000. You’re past the 5-year rule, but you’re not 59 1/2 yet.

You can take out the $10,000 that you put into the account without penalties, but you cannot touch the interest until you reach the 59 1/2 threshold.

Example 2: the 5-year Rule

Since many of our listeners and clients are past the 59 1/2 age requirement, let’s look at another example of someone who is 60 and contributes to a new Roth IRA. In four years, they gain $3,000 – $4,000 in interest, but since it’s a new Roth, they cannot take the interest out with a penalty based on the 5-year rule.

So, the 5-year rule for a new Roth IRA account has two main components:

  1. 59 1/2 years of age to touch the interest
  2. 5 years to take out the interest without 10% tax penalty and paying taxes on the interest

Even if you’re 65 and just opened the account, you still need to wait five years before you can touch the interest without being concerned about penalties or taxes.

Note: Contributions into Roth IRAs are always penalty-free, as you’ve already paid taxes on the money.

5-Year Rule for Roth IRA Conversions

Conversions and contributions are different. A Roth conversion is not subject to limits, so if you have pre-taxed assets, you can convert $1 million (or whatever amount you like). Let’s say that you have a traditional IRA. You can convert 100% of the account if you like.

However, you will need to pay taxes today on the money that you’re converting into the Roth IRA to leverage this tax-free bucket.

How Does the 5-Year Rule Impact Roth IRA Conversions?

Roth conversions are very powerful and beneficial because your money can grow tax-free. The rules on these conversions are different, so let’s look at an example:

  • This person is 60 years of age
  • $1 million in pre-tax IRA
  • $100,000 converted into a Roth IRA
  • **This is the first time the person opened a Roth IRA

The person is above the age of 59 1/2, so they meet this threshold for taking money out of the account without penalties. However, since this is the first time the person has had a Roth IRA account, they must wait five years before being able to withdraw on the tax-free growth.

Let’s say that if the person comes back in two years and wants to take out $30,000 for a new roof, they can do so because they’re not touching the tax-free growth on the account.

If you’re under the age of 59 1/2 or fall into one of the following categories, there are some exceptions:

  • Disability
  • First-time homebuyer
  • Deceased 

Pro Tips: The clock starts ticking from the moment you open the account. Let’s say that you did a conversion at 55 and a conversion at 60. You don’t need to worry about the 5-year rule. We recommend converting even a small amount into a Roth IRA to get the clock started so that the account is open for 5 years.

Note: Always be sure to consult with a financial advisor before making any distributions to ensure that you follow all the rules and regulations.

Click here to schedule a call with us to discuss your Roth conversions, contributions, or distributions.

Example of the Power of Roth IRA Conversions

In this example, let’s say you’re 60 years old and opening a brand-new Roth account to start doing $50,000 into conversions per year for 5 years. We’re not worried about the 59 1/2 age rule, and we estimate that the account will earn 5% compound interest annually.

Year 1: Conversion of $50,000 + 5% interest ($2,500) = $52,500 total
Year 2: Conversion of $50,000 + 5% interest on ($52,500 + 50,000 = $5,125 = $107,625 total
Year 3: Conversion of $50,000 + 5% interest on ($107,625 + 50,000) = $7,881.25 = $165,506.25 total
Year 4: Conversion of $50,000 + 5% interest on ($165,506.25 + 50,000) = $10,775.31 = $226,281.56 total
Year 5: Conversion of $50,000 + 5% interest on ($226,281.56 + 50,000 = $13,814.08 = $290,095.64 total

Cumulative growth on your money is very powerful. You’ve contributed $250,000 in conversions and earned over $40,000 in interest in just five years.

What happens if, in year four, you need to take a withdrawal?

At year 4, you have an account total of $226,281.56. How much can you take out of the account? You can take out $200,000 because those are your contributions. At the end of year 5, you have 100% access to the money because you hit all thresholds.

Walking you through some math, let’s assume that you don’t need the money and let the $290,095.64 sit for 15 years without any further conversions or contributions. 

Based on 5% interest per year, your $250,000 put into the account would now be $602,998.22.

You’ve earned over $350,000 in interest alone.

Now, you want to take out $350,000 and pay taxes on it. You would need to pay a huge chunk of money if you didn’t pay taxes already. However, since you did a conversion of $50,000 a year, you paid 22% in taxes or $11,000 in taxes per conversion.

You paid:

  • $55,000 in taxes total for all contributions
  • Gained $350,000 in interest that is 100% tax-free

You achieved great tax-free growth and can now withdraw the $350,000 in its entirety.

With that said, Roth IRAs have their advantages and disadvantages.

Advantages of a Roth Conversion

Roth accounts are one of our favorites and we like them so much because of how advantageous they are. You benefit from:

  1. Tax-free growth that grows over time.
  2. Not subject to required minimum distributions. Unlike a 401(k) or other pre-tax accounts, you don’t need to take a required minimum distribution (RMD) on the account. You can keep the money in the Roth for as long as you wish, allowing you to be in more control.
  3. Tax diversification because you have a sizeable tax-free asset. You can blend withdrawal strategies using taxable and non-taxable accounts to minimize taxes.
  4. Estate planning benefits also exist. You can pass the account to your heirs, who can take tax-free distributions over their lifetime. Beneficiaries must withdraw the entire account over 10 years and can allow it to remain in the account for 10 years and still don’t need to pay taxes on the growth.
  5. Hedge against future tax rates because this tax-free bucket will not be subject to higher taxes, which we’re very likely to see in 2026 unless major legislation is otherwise passed.

Disadvantages of a Roth Conversion

While we’re major fans of Roth IRAs for retirement planning, Roth conversions are not ideal for everyone. These disadvantages are things you should keep in mind.

  1. Immediate tax burden. You will need to pay taxes on the conversion, which no one likes. But you benefit from the money growing tax-free.
  2. Potential of lost tax benefit. If you’re at a higher tax bracket today but in the future taxes are lower, you lose the benefit of lower taxes. We don’t know what the tax rate will be in 10, 15, or 20 years from now.
  3. Loss of liquidity. You lose some liquidity with your money because, in many cases, you’ll use outside funds to fund the account, such as cash.
  4. 5-year rule. Of course, you do have to wait 5 years to touch any of the interest in the account.
  5. Potential impact on other benefits. If you’re about to convert at Medicare age, you may have to pay an IRMAA surcharge for a single year of the conversion. 

If you’re looking at this and have questions, it is very overwhelming. However, you can always schedule a call with us right on our website to go over this information in greater detail.

Click here to schedule your call.

Why Review Beneficiary Designations Annually

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Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.

Backtracking a little bit, we decided to discuss this topic in-depth with you after reading an article on MarketWatch.

The story begins with a man who has a market account worth around $80,000. Suddenly, this man passes away, and the beneficiary of his account is his prior wife. However, his prior wife was deceased.

What Happens if the Beneficiary of an Account is Deceased?

In the scenario above, the man’s prior wife is deceased already. When he passes on, the account then goes to his estate. His account must then go through probate and into the estate, too.

However, in this man’s case, he had a daughter who was meant to inherit the account. Her stepmother even sent the daughter a text message stating that her father wanted her to have the money in the account.

Fast forward a bit, the stepmother becomes the executor of the estate after the account goes through probate and says, “She thinks the girl’s father changed his mind and that the money is meant to go to her, the stepmother.”

The daughter feels like the stepmother betrayed her father.

Unfortunately, a text message isn’t enough legal grounds for the daughter to fight back against her stepmom.

This is an example of someone who didn’t review beneficiary designations annually. Instead of the father’s wishes being upheld, someone else decided what they thought was best for the funds in the account.

Key Takeaways from this Example

Beneficiary designations are very important. We don’t know what the father wanted to happen to the funds in his account, nor do we know what may have been written in his estate plan. What we do know is that the daughter does have a message from her stepmother stating that the funds were meant for her, but something changed along the way.

We can speculate that perhaps the stepmom found estate documents mentioning that she received the estate, or maybe she fell on hard times financially and wanted to keep the funds.

In all cases, this could have been avoided by:

  • Reviewing beneficiaries annually
  • Updating beneficiaries when major life changes occur

Many accounts that you have often allow you to add beneficiaries, even if you don’t know that you can. For example, you can add beneficiaries to IRA, 401(k) and life insurance. You can even add beneficiaries to checking accounts.

We recommend that you:

  • Gather all of the accounts that have money in them
  • Inquire with all of these accounts if you can add a beneficiary

Probate and state law can vary from state to state dramatically. The daughter in the case above wanted to know if she could use the text message as evidence and file a lawsuit.

Contesting Probate 101

We don’t know the logistics of the case the daughter has or if a text message will mean anything in her scenario. Likely, the text will not hold up in court. What we are certain of is that contesting probate is:

  1. Lengthy and can be very difficult to do
  2. Costly

Avoiding any probate contestation is always in your best interest. The father in the example above may have been able to add a contingent beneficiary to his account. What this does is say, “If the first person is no longer living, the next beneficiary should be this person.”

Contingent designations would have helped this family avoid probate court and animosity between the daughter and stepmom.

7 Steps to Manage Your Beneficiaries Throughout Your Life

1. Review Your Beneficiaries Annually

For our clients, we do a beneficiary review each year. We show them who is listed on their accounts as a beneficiary, including:

  • Beneficiary name
  • Percentage to each beneficiary
  • Contingents
  • Etc.

If you’re not a client of ours, you can easily do this review on your own. Reach out to all of your account holders and ask them who you have listed on your account as a beneficiary. It is possible that you sent in a form to change a beneficiary and it was never filed.

It’s so important to verify your beneficiaries annually, even if you have a form sitting in front of you naming the beneficiary, because you just want that peace of mind that everything has been filed properly.

2. Consider Tax Implications

When you leave accounts behind, they may have certain tax implications that you need to worry about. For example, an IRA is taxed one way and a Roth IRA is taxed another way. It’s important to know the implication of each account to make it easier to understand who best to leave the account to when you pass.

If you leave an account to a high-income earner, they may take the money out of the account and pay the tax burden. Then, they may decide to give the money to your grandkids.

However, there are ways that you can set up these accounts to avoid this high tax burden and leave the funds to your grandkids directly. You can do what is known as “disclaiming,” which would allow your son or daughter to divide the money how they see fit with fewer potential taxes.

3. Understand the Impact on Your Overall Estate Plan

Let’s assume that you’re leaving $1 million behind with most of it in an IRA or 401(k) and have beneficiaries attached to it. The remaining part will go through the estate plan. In this case, you may be disinheriting a child if:

  • In one area, you split the funds 50/50
  • Another area you split the funds 80/20

When going through a beneficiary review, it’s important to look at the dollar amounts that are given to each child. You may decide to leave $500,000 to one child and $1 million to another child.

In this scenario, one child would need to receive the house and an additional $250,000 and the other $750,000 to split the inheritance evenly. Of course, you can divide your estate up however you see fit, even if that means one child receives far less than the other.

4. Consider Beneficiary Needs

Beneficiaries may have different needs. If one beneficiary is a high-income earner and the other is not, the high-income earner may not need as much money. You may even want to allow the high-income earner to disclaim the inheritance to give to their kids without the high tax burden.

If you have a special needs child, you also need to consider how the inheritance may impact their benefits. In this case, you may want to consider a trust account so that the child still receives their benefits and the help they need.

Another common scenario is that:

  • Your child is not good with money
  • The child may spend all of their money at once

In this case, a trust and a discussion with an attorney can empower you to leave money behind and dictate how it is used with greater control.

5. Be Specific 

For example, your intent is to leave 25% of the money to your grandchildren. It’s better to name the grandkids as primary beneficiaries. The reason for this is that people may forget how you want the money divided, and being very specific in your documentation can help clear any potential confusion.

6. Consult with an Attorney

An attorney is a second set of eyes who will look through all of your beneficiaries and estate plans with you. We know quite a few attorneys who are highly skilled and still hire others to review their documents with them in case they overlook something.

If you need a trust, the attorney can also assist with that.

Legally drafted documents will hold up far better in court than you writing a will on a piece of paper.

7. Consider Contingencies

In our story of the daughter and stepmother above, a contingent would have been immensely helpful. The reason why adding a contingent is so important is that if, for some reason, you get sick and do not check your beneficiaries, you already have a contingency in place.

The father could have listed the mom as the primary and the daughter as a contingent, which would have helped those he left behind avoid arguments and disagreements along the way.

What if the father set the contingent so long ago that both the primary and contingent are no longer living at the time of his death?

He could have left the funds to his grandkids if the institution allowed him to mention “per stirpes,” which means if the primary is not alive, the funds will go down the line to the person’s descendants equally.

Per stirpes is a powerful designation because you don’t even need to know the names of the person(s) to whom you’re leaving the funds. 

Annual beneficiary reviews and putting contingencies in place are powerful tools that we firmly believe are worth using. You can help your family avoid grief and any potential arguments if you spend the time going through your accounts and putting all these measures in place.

Are you curious about retirement and want to gain more insight into the process? Click here to browse through books we’ve authored on the topic.

April 10, 2023 Weekly Update

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We do love it when someone refers a family member or friend to us.  Sometimes the question is, “How can we introduce them to you?”   Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.

Here are this week’s items:

Portfolio Update:  Murs and I have recorded our portfolio update for April 10, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast -Why Review Beneficiary Designations Annually?

Listen in to learn the importance of naming contingent beneficiaries after your primary beneficiaries to ensure everything is clear. You will also learn why you need to consider the tax implications of each account, the needs of your beneficiaries, and its impact on your overall estate plan.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Why Review Beneficiary Designations Annually?

Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.

CLICK HERE TO READ THE BLOG

401k Versus IRA: Which is Better for Your Retirement?

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If you’re saving for retirement, you’ll need to know the difference between a 401k versus IRA. You may even have both types of accounts. While trying to secure your retirement, it’s crucial to know what each account type offers you.

We’re going to discuss a few important details of each:

  • What is a 401k?
  • How does a 401k work?
  • What is an IRA?
  • Should I transfer to an IRA?

What is a 401k?

A 401k is an employer-sponsored plan. It’s set up by a business, and you can contribute money to it for your retirement.

What is an IRA?

An IRA is an individual retirement account. Virtually anyone can open this type of account and contribute to it.

Both a 401k and IRA are meant for anyone planning for retirement.

401k Versus IRA

A 401k and IRA have two main types:

  1. Pre-tax, or “traditional” 401k/IRA
  2. Tax-free, or “Roth” 401k/IRA

The main difference between pre-tax and tax-free is that contributing pre-tax has tax benefits. However, when you take a withdrawal in the future, you’ll pay taxes on these withdrawals.

With a Roth account, you pay taxes now and don’t have to pay taxes on withdrawals. Roth accounts allow your money to grow tax-free. Many companies are beginning to offer these types of accounts because they’re advantageous, as their money grows without further tax liability.

Let’s say that you have tax-free investments at 20. You can grow your money for 45+ years tax-free.

Funding a 401k vs IRA

When it comes to a 401k or IRA account, a 401k allows you to fund the account a little more than an IRA. An IRA allows you to contribute $6,000 – $7,000 per year. However, a 401k will enable you to put up around $19,500 per year.

Additionally, a 401k may have an employer contribution or an employer match.

If an employer puts money into your account, you may reach $50,000 a year in contributions in a single year.

Rules for a 401k

A 401k is started by an employer, and they choose:

  • Which brokerage the account is handled in
  • What types of investments are available

Employers make the rules for 401k accounts. It’s crucial to understand that these rules may change or be a bit more specific to the employer. However, the general rules that are followed by most employers include:

  • As long as you’re an employee of the company, you cannot move the money from the 401k to an IRA until you’re 59 and a half. At this point, you can do an in-service rollover. You can choose this option to take full control of your investments.
  • In-service rollovers keep the 401k account open to allow your employer to keep making contributions on your behalf.
  • You do not have to pay taxes when rolling over funds in these accounts because you’re not withdrawing the funds yet.
  • If you’re under 59 and a half and you have a 401k from another employer, you can move the money into an IRA.

One thing we hear a lot is that many people think that their employer negotiates better rates for them for their investment accounts. However, this is not the case. Mutual funds, which most people are investing in with their 401k, charge the fees and don’t lower them for employers.

Your employer may have fees, and the company can absorb these fees, but you wouldn’t have these fees with an IRA.

Quick Note on In-Service Rollovers

An in-service rollover is a simple process and not something that you need to be overly concerned about. The rollover is a basic decision that requires:

  • Advisor calling the 401k
  • Ask the rep for an in-service rollover
  • Walk through steps with the rep
  • Funds are sent to you directly
  • Funds are then deposited into your IRA

You may need to sign a paper every once in a while, and that’s really it. A rollover is straightforward and something that we do all the time.

Rules for an IRA

An IRA is an individual retirement arrangement, which means that as an individual, you’re 100% in control of the account. You can choose what brokerage to open an account with and where you want to invest your money to help it grow.

When you have an IRA, you can invest in:

You don’t lose any benefits when going to an IRA. Most of our clients opt for an IRA because we’re able to direct their investments.

How an Advisor Can Help You with Your Retirement Plan, Even If You’re Younger than 59 and a Half

For a long time, advisors couldn’t really help people who were younger than 59 and a half with their retirement accounts, aside from taking an advisory role. There are a lot of rules and regulations in place that make this process very difficult, specifically with sharing account usernames and passwords. 

Here’s a concept that we’ve been using as an advisor to manage a 401k:

  • You set us up with a login
  • We monitor and make trade allocations for you

We’re able to take a peek at your 401k and the options available to make allocation changes. We’re not granted the power to change contribution amounts or anything of that sort. These accounts are an overlay of your account that allows financial advisors to make trades on your behalf.

Our clients love the 401k option that allows us to manage a 401k on your behalf.

Moving from a 401k to an IRA is often ideal for clients, but you may find the tax advantages of a 401k to be the better option for you. The tax advantages include being able to deduct contributions from your current year’s taxes, but when your money grows, it will be taxed, which is something to consider.

If you’re trying to secure your retirement and aren’t an expert in retirement planning, we can help. We have a wealth of information available for free on our podcast (sign up here), or you can feel free to schedule a call with us.

IRAs – Required Minimum Distributions

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Many of our readers are planning to retire, and they want to know about required minimum distributions (RMDs). If you have a tax-deferred vehicle, RMDs are something that you should learn more about.

Tax-deferred vehicles are:

  • 401(k)
  • 403(b)
  • 457
  • IRAs (traditional)

When you’ve deferred taxes, you’re making an agreement with the IRS that you’re not going to pay taxes on this money now. But in the future, when you’re able to access the funds, the IRS will come knocking on your door because they want their cut of the money.

Under today’s requirements, you must start taking your required minimum distributions at age 72 – it was 70 and a half not too long ago.

RMDs are not a bad thing, and these are retirement accounts that you’ve been paying into for 30 or 40 years. However, since you’ll have to pay taxes on the distributions, some people get concerned.

Don’t be. This is money you saved and will be using for your retirement.

Understanding When You Must Take RMDs

RMDs are part of your retirement planning, and while you start taking them at age 72, this definition is a bit misleading. According to the IRS, you must begin taking distributions in the year you turn 72.

If you don’t turn 72 until December 31, guess what? You can take distributions from January 1st (you’re still 71) since it’s in the year that you turn 72, or you can wait until December. So, you can strategize to some degree on when is best for you to take your RMDs.

You must take the distribution by the calendar year end (with one exception listed below).

How RMDs are Calculated

The IRS will try and estimate your life expectancy, based on several factors, and then calculate your RMD. The required distribution can vary from year to year, so the RMD isn’t a fixed rate.

For example, let’s say that you have $500,000 in all of your IRA accounts.

If you have this much in your account on December 31st of the previous year, you would divide this amount by a factor that the IRS has created. The factor, at the time of writing this, is 25.6 for someone that is age 72.

The IRS figures that at age 72, you still have 25.6 years left to live. Your health isn’t personally calculated as these factors are across the board for everyone. So, you’ll be required to take the following RMD:

  • $19,531.25 ($500,000 / 25.6)

You can take a larger distribution if you want. However, you must take the minimum amount and it’s added to your income for the year.

In your first year, you can defer the distribution until April. You may want to defer the distribution to avoid taxes, but you’ll still need to take the distribution the second year.

In fact, if you defer the first distribution, you’ll be required to take the first and second distribution in the second year, adding significantly to your yearly income.

What to Do If You Have Multiple Tax-deferred Accounts

If you have 5 different tax-deferred accounts that require RMDs, you can take money from one or all of them. The IRS doesn’t care which accounts the distribution comes from. However, they do care that you’re taking the RMD (based on the combined value of all accounts) and paying tax on it.

What Happens If You Miss an RMD?

You’re penalized. You can be penalized by as much as 50% for missing your RMD.

3 RMD Strategies If You Need to Take RMDs in the Near Future

For anyone that is not retired yet but will be in the near future and has these tax-deferred accounts, there are a few strategies that can help you:

1. Roth Conversions

If you have an RMD, you cannot convert it into a Roth account. However, what you can do is a Roth conversion before you hit age 72. If you convert today, there are no RMDs, but you do pay taxes today.

You’re still paying taxes, but you know today’s taxes and not what your tax burden may be in 10 years.

When you use this strategy, you’re controlling your tax burden because you decide to convert the account at a time of your choosing and at a favorable tax bracket. For example, if your Roth account grows at 7.2% per year, you’ll double your money in 10 years and won’t have to pay taxes on your RMDs.

Of course, this doesn’t make sense for everyone.

We run simulations to see if this is a good strategy for our clients.

2. RMDs are Required, But You Don’t Have to Spend the Money

Many times, we’ll advise people to take money out of the IRA and then put it in another investment account. You don’t have to spend the money that you take out of your account, but you do need to pay your taxes on it.

3. Qualified Charitable Distribution

We have many people who don’t need the entirety of their RMD, so they’ll leverage what is known as a qualified charitable distribution, or QCD for short. A QCD allows those who want to donate to charity to do so with tax benefits.

Let’s assume that you have a $20,000 RMD and want to donate $5,000, you can.

When you do this, you’ll pay taxes on $15,000 instead of $20,000. You will need to go through your IRA to make this distribution, but you need to ensure that the distribution is in the charity’s name, address, and Tax ID.

You want the custodian to do the transfer for you so that the money never enters your account.

If you’re planning on giving to charity any way, the option of making a qualified charitable distribution makes a lot of sense for anyone that has an RMD that they must take.

The earlier you plan to reduce your RMD tax burden, the better. But, even if you plan on using our last strategy to lower your taxes, you want to start as early as possible to make sure it gets done in time for tax season.

Click here to join our course: 4 Steps to Secure Your Retirement.

How to Convert an IRA to a Roth IRA

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Is a Roth conversion right for you?

Moving your money from a traditional IRA or 401k and into a Roth IRA can be a smart choice for your future finances. But, while the mechanics of a Roth conversion are simple, it’s important to get the full picture to find out if it will benefit you in the long term.

In this post, we share everything you need to know about doing a Roth conversion, including what a Roth conversion is, why you may choose to do one, and the process of moving your money between these two different types of accounts.

You can watch the video on this topic above. To listen to the podcast episode, hit play below, or read on for more…

The differences between a traditional IRA and a Roth IRA

A traditional IRA or 401k is considered pre-tax money. It gives you an immediate tax benefit. So, for example, you may be using salary deferrals to contribute to a 401k which automatically comes off your income for the year. When you withdraw from a traditional IRA, then the money becomes taxable, similar to a paycheck.

A Roth IRA contains after-tax dollars, but it grows tax-free, and you won’t be taxed when you withdraw it. Say you contribute $50,000 to a Roth IRA that’s invested in the market, and it grows to $100,000 or even $200,000. You can withdraw this without being taxed.

So, these are the two key differences:

  • Traditional IRAs and 401ks are pre-tax (but you’ll pay tax on withdrawal)
  • Roth IRAs use after-tax money (but you get a tax benefit later)

One thing that is the same between the two accounts is how you invest. You can invest both a traditional IRA and Roth IRA exactly the same.

How much of a traditional IRA can you convert to a Roth IRA?

Broadly speaking, you can convert 100% of your traditional IRA or 401k into a Roth IRA. There are no conversion limits. So, if you have $1 million in your traditional IRA, you can convert the entire $1 million into a Roth IRA.

But don’t get conversion and contributions mixed up. There are contribution limitations. However, these depend on your age and income.

How to convert your traditional IRA into a Roth IRA

Converting your traditional IRA into a Roth IRA is a simple process, similar to switching any account. The easiest way to do a Roth conversion is when both IRAs are held at the same institution.

For example, if you had a traditional IRA at Charles Schwab and wanted to do a Roth conversion, the easiest option is to open a Roth IRA also at Charles Schwab. Then it’s a straightforward transfer to move your money from your traditional account into your Roth account. You just have to know how much you want to convert, then sign the document and the custodian (in this case Charles Schwab) will take care of the rest.

If your traditional IRA and Roth IRA accounts aren’t held at the same institution, the process is almost the same, but with a few extra steps. It’s best to check with your traditional IRA or 401k account holder to find out what their exact process is, and they’ll help you through it.

Taxes: what to look out for when converting

When you do a Roth conversion, you have to pay taxes as you’re moving money out of a pre-tax account and into an account for after-tax dollars only.

You might consider holding back some money to cover these taxes. However, we believe this isn’t the best option. You may not be able to make contributions to your Roth IRA, so a conversion is the only way to put as much money as you can in this tax-free account. So, we advise converting 100% of your traditional IRA into a Roth IRA and paying the taxes from another account, such as savings or a brokerage account.

Say you want to convert $30,000 from your traditional IRA into a Roth IRA. First, you should make sure you have enough money outside of your traditional IRA to cover the taxes. On $30,000, these taxes may equate to around $6,000. If you decide to take that $6,000 from your IRA money, you’re putting yourself at a long-term disadvantage. The tax-free growth of a Roth IRA means you should put as much money in as possible to reap the future benefits.

Depending on your tax situation, you may need to think strategically about how much you can convert. You don’t want to end up in a higher tax bracket because you converted too many extra dollars. If you’re unsure about how much you can convert without changing your tax bracket, speak to your financial planner or advisor who can help you play with the numbers.

Why you need to consider future tax

The number one reason to do a Roth conversion is to protect against higher tax rates in future. The idea is to pay lower tax rates now and avoid rising ones later down the line. So, if you believe that your taxes will be lower in future, a Roth IRA will not make sense for you.

If you currently have a high-income rate, say $250,000, but are expecting this to drop to $60,000 in 15-20 years, then you could be paying less tax in future. However, if tax rates rise, you may pay a higher percentage, even though you’re earning a lower amount. So, the question is, would you still convert?

In this situation, one solution is to do smaller conversions and split your money into both pre-tax and after-tax assets. Ultimately, we don’t know what might happen in the future, so you will need to think carefully about whether a conversion is really right for you and put a strategy in place.

How to avoid required minimum distributions with a Roth conversion

Any pre-tax account, including traditional IRAs, 401ks, and 403bs, are subject to required minimum distributions (RMDs). These are to make sure that you do eventually pay tax on this money. At age 72, you’ll be required to take withdrawals from your pre-tax account based on your life expectancy.

Another reason many people choose to do a Roth conversion is to avoid these RMDs. You may prefer to pay your taxes now rather than on RMDs at age 72. If you’re already at this age, it becomes more challenging to do a Roth conversion as the IRS requires you to take the RMDs every year.

Say you have $1 million in a traditional IRA and your RMD for that year is $50,000. If you want to do a Roth conversion, you have to take the $50,000, put it in your bank, pay the taxes on it, and only then can you proceed with the Roth conversion. So, if you wanted to convert $20,000 from your traditional IRA into a Roth IRA, you could do this after you’ve taken and paid tax on your RMD. It’s important to note that this means you’ll have to pay tax on both amounts, so $70,000 in total that’s been added to your income for the year.

Our advice is, if you’re planning to do a Roth conversion, don’t wait until you’re RMD age.

It’s important to look at the whole picture when deciding whether to do a Roth conversion. Tax numbers can be confusing, so it’s best to find out what solution suits your specific situation. If you want to get more insight on converting your traditional IRA into a Roth IRA, you can book a complimentary 15-minute call with us and we’ll discuss what option is right for you.

How to Prepare For Retirement

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Your retirement years are considered the golden years of your life, giving you the chance to relax and spend time with your loved ones. However, in order to maximize your experiences, you need to start preparing for retirement today.

 

If you are in your 60s, developing a thorough plan for your retirement is essential. That is why we have put together our top five tips to help you prepare.

 

 

  1. Identify your retirement starting point
    • The first thing that you need to do is to identify your starting point. To do this, you need to collect as much information as possible such as bank accounts, income, and outgoings. With this information, you can then break this down into three key categories:
      • Essential Needs (such as rent, food, etc.)
      • Wants (such as those dream trips with your family)
      • Legacy (the money you want to leave behind or donate)
    • By breaking this information down into these categories, you will be able to have a clear idea of the amount required for your retirement. When developing this information, you should also take into consideration your social security, the age you would be looking to retire, and when you want to start taking your pension.

 

  1. Know your destination
    • Once you have your starting point, you should then think about the destination and everything you want to achieve during your retirement. Think about the goals that you want to achieve and how you want to live. Do you want a new car every few years? Do you want to become a member of a golf club? An annual holiday with the family, perhaps?
    • Whatever it might be, make sure you know what you want to ensure you can fulfill this golden period of your life.

 

  1. Build a retirement roadmap
    • With your start point and destination created, you now need to build your retirement roadmap. This is the plan that you will follow as you save towards, and live through, your retirement.
    • When building your retirement roadmap, it is really important that you know your income and outgoings. One thing that many people forget to do when building their roadmap is to factor in taxes and the rate of inflation. Without doing this, you can quickly find your savings erode faster than you were expecting.

 

  1. Plan for retirement roadblocks
    • Even the best-laid roadmap can experience a roadblock, so it is crucial that you factor unexpected costs and issues into your plan. For example, another market crash such as that experienced in 2008 or a sudden deterioration in your health can see your savings depleted.
    • That is why it is vital that you constantly monitor your roadmap, making those small adjustments to keep you on track. When it comes to healthcare, you should also consider carefully whether you will be able to self-insure or whether you will need an insurance policy in place.

 

  1. Retirement cruise control
    • While for the most part, careful planning and preparation can mean your retirement can effectively run on cruise control. However, just like you would in real-life when driving a car, you still need to be ready to take over as the road ahead changes.
    • From a potentially volatile market and inflation to economic and political impacts, keep your eyes on the road ahead and adjust accordingly.

 

 

Are you ready to prepare for retirement?

If you are thinking about your retirement and want to start taking steps today to ensure you are in the best possible position, then we are here to help you. Our ‘4 Steps to Secure Your Retirement’ mini-series has been designed to take you through the preparation stages step-by-step, ensuring you are able to be in the best possible place.

 

Want to find out more? Get started today!

How to Rollover Your IRA and 401k

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How do IRA and 401k rollovers work?

Retirement accounts are a great way of saving for the future, but they’re not preferable for everyone. If you want to move your money out of your 401k, 403b, 457, or IRA, the best way is to do a rollover.

If done correctly, rollovers are tax-free and a straightforward solution to moving money between retirement accounts. But there can be rules, limitations, and risks involved. In this post, we explain the process of doing a 401k or IRA rollover, when you’ll be eligible, and the reasons why you should consider one.

[You can watch the video on this topic above or, to listen to the podcast episode, hit play below, or read on for more…]

 

 

How to rollover your IRA and 401k

A rollover is a term meaning the action of moving money from one account into another account.

You’ve likely accumulated money in several retirement vehicles throughout your career. You might have 401ks, 403bs, 457s, IRAs. If you decide to move your money from where it is currently to a new institution, this is a rollover.

You can do a rollover between any employer plan, even if they’re the same. For example, you can move your money from one 401k into another 401k, or you can go from a 401k to an IRA account.

There are two main types of rollover. One is a direct rollover, which is a straightforward, trustee-to-trustee transfer. The other is a 60-day rollover, which can be riskier.

 

How to rollover your IRA and 401k using a trustee-to-trustee transfer

A trustee-to-trustee transfer moves your money from one institution directly to another institution. To do this, your existing account holder has to make out a check to your new account holder, with your name listed as “FBO” (for the benefit of).

Let’s use an example. If you have a 401k or an IRA held with Fidelity, but you want to move it to Charles Schwab, Fidelity has to write a check addressed to Charles Schwab followed by FBO and your name.

 

Key things to know about a trustee-to-trustee transfer:

  • The check is not made out to you, so you cannot put it into your account
  • The government have not put a limit on how many trustee-to-trustee transfers you can do so you can do this as many times as you like
  • This is a simple, straightforward, and risk-free way to do a rollover
  • If you are moving money into an IRA, you should set this up before you instruct your institution ­– you do not have to put money into an IRA to open one

 

How to do a 60-rollover for your IRA and 401k 

With a 60-day rollover, your institution writes the check directly out to your name. From this date, you have just 60 days to put it into an IRA, otherwise, it will be taxable. If you’re under the age of 59 and a half and you go over the 60-day limit, you’ll owe a 10% penalty as well as tax.

For 401ks, there is one additional caveat. 401ks are required by law to withhold 20% of your money, even if you get them to write a check out to you. This can be an issue.

If you have $100,000 in your 401k, for example, and the institution withholds $20,000 in taxes, you only have $80,000. You will get that $20,000 back, but only when you next file your taxes. To complete the rollover in the meantime, you’ll need to find an additional $20,000 to roll over the full amount.

 

Key things to know about a 60-day rollover:

  • You have to complete your rollover within 60 days, or you will be taxed
  • If you’re under the age requirement, you will also face a penalty
  • You can only do one 60-day rollover in a calendar year

We prefer using a trustee-to-trustee transfer. This way, you do not run the risk of having to pay income tax on your money, and it’s a more straightforward solution.

 

Why you shouldn’t use a 60-day rollover as a personal loan

Some people choose to use a 60-day rollover as a personal loan, but we advise against it. You may do this to loan yourself money in an interest-free way.

This is a high-risk strategy as you’re bound by the 60-day rule to get your money back into that account. This is a fixed rule and if you miss your 60-day deadline for any reason, whether you didn’t manage your time well, or you didn’t have enough money to put it back in to your account in time, then you’re faced with an irreversible problem, and bigger tax bill, and potentially a penalty too.

It’s a very risky strategy and not one that the IRS likes, so we urge you to be cautious if this is something you’ve heard or read about.

 

What makes you eligible to rollover your IRA and 401k

If you’re under age 59 and a half and you try to take money out of any retirement account, such as 401ks and IRAs, you will be penalized for it.

However, if you’re over age 59 and a half, the government now considers you eligible to use that money. Most 401k, 403b, and 457 plans allow you to do rollovers whenever you want. So, if you meet the age requirement, you can do a rollover without any penalties or tax concerns, providing you do it correctly.

One other way you become eligible for a 401k rollover is following a separation of service. This is when you leave your company for one of the following reasons:

  • Transitioning into a new company
  • If you get laid off
  • If you retire before 59 and a half

If you’re leaving your company, you may want to consider doing a rollover as you may not be eligible again for some time.

 

Why should you rollover your IRA and 401k

Your company might match your 401k contributions and offer you investment choices, so why would you choose to rollover your 401k into an IRA?

Firstly, 401ks have lots of hidden fees. You may not be aware of just how much you’re losing in fees for your 401k. Sometimes your employer will pay these, but they can also be passed along to you, the participant, without you knowing.

With an IRA, there’s a far higher level of transparency. You own every aspect of your IRA, so you can know each fee that gets charged to your account – if any. There are no admin fees with an IRA, so the only possible charges will be mutual fund or ETF fees if you use your IRA to buy those.

Secondly, it’s a myth that you get better rates if you have a 401k with a big company. It is not true that you get better rates based on what company you’re with. It’s also worth noting that your investment options are very limited in a 401k. An IRA has far more investment opportunities available.

Thirdly, 401k plans limit how much activity your account can have within a given year. Some plans may only allow you to make a change once every quarter or biannually. If you like to manage your money actively, then an IRA might be more suited to you.

It’s also challenging to manage your funds in a 401k. If you want a financial planner to help you handle your 401k, there’s very little that they can do. With an IRA, a financial planner can manage and monitor your money much more closely.

Finally, if you have multiple retirement accounts, you may want to make them easier to manage by consolidating them all into a singular, traditional IRA.

So, those are the reasons why you might want to rollover your 401k into an IRA. But why might you not want to?

There’s one time when you might not want to do a rollover, and that’s if you’re aged between 55 and 59 and a half and you’re no longer employed with the company your 401k is with. The IRS allows people above the age of 55 to take distributions of their 401k without penalties. If it’s in an IRA, you have to be 59 and a half to avoid the penalty. If you’re within this window and want access to your 401k money, we advise you to take distributions instead of doing a rollover.

 

How to execute a rollover

To do a trustee-to-trustee transfer or 60-day rollover, call your institution directly. They will have specialists available to help you do a transfer, but they are not there to give you advice, so make sure you’ve researched your options beforehand.

If you’re continuing to work at your company, this is called an in-service rollover. In this case, you stay in-service at your company, keep the 401k account, but roll out the balance into a traditional or Roth IRA account. Your 401k will stay the same, you will still make contributions and get the match, but your previous balance will now be in an IRA.

When you speak to your institution, they’ll ask you to verify your identity and address and then ask where you’re sending the money. Make sure you already have your IRA in place so that you can send the money over smoothly.

Your institution will then write the check out to the new institution if it’s a trustee-to-trustee transfer or directly to you if it’s a 60-day rollover.

You will rarely need to do any paperwork, and if you do, your institution can walk you through any documents that they need. Your institution may also ask you to review a tax notice, which explains the tax-risk of a 60-day rollover, much like we have in this post.

Ultimately, a rollover should be a simple, smooth process, resulting in putting your money in an account that you’re happy with.

If you’re considering doing a rollover or have any questions about IRAs, 401ks, 403bs, or 457s, our team can answer them. We work with these accounts every day and can offer you tailored advice and information based on your situation. Do consider booking a complimentary 15-minute call with us to find out how we can help you.

How Are You Going to Stay on Top of Your Finances in 2021?

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How are you going to stay on top of your finances in 2021?

Financially planning for retirement can feel like a lot of work, especially if you have multiple moving parts to your money. Dealing with 401Ks, IRAs, Social Security, and RMDs can become overwhelming as the year gets busier, so we recommend taking stock of your finances early and planning ahead.

The beginning of the year is a great time to review your finances but knowing where to start is challenging. So, we’ve created our retirement and financial planning checklist.

Read on to discover the nine key areas you should consider for the upcoming year. We also point out some key changes and information for 2021, so you can start this year as securely as possible.

1. Review your 401K, traditional IRA, Roth IRA, and HSA contributions

If you’re earning income, you should review your accounts and plan how much you want to contribute to each one this year. Do you have a goal for each? How much will you need to contribute to get you there?

Bear in mind that contributions may be limited, so you might need to adjust your plans and payroll accordingly. For example, the contribution limit for 401Ks in 2021 is $19,500. However, if you’re over 50 years of age, you can qualify for the ‘catch-up contribution’, increasing the $19,500 limit by an additional $6,500. This also applies to 403Bs and 457 plans.

Roth IRA accounts have a much lower contribution limit of $6,000, with an additional $1,000 for those over 50.

We’ve detailed the difference between Roth IRAs and traditional IRAs before, but to recap, the main differences are:

  • A Roth IRA is tax-free assets: contributed to after you’ve paid tax on the money – these have income limitations, so if you earn over a certain amount, you will not be able to contribute
  • A traditional IRA is pre-tax assets: contributed to before you’ve paid tax on the money – no income limitations

To learn more about the pros and cons of Roth IRAs vs traditional IRAs, read this post.

Once you are aware of your accounts’ limitations, we advise you plan your contributions for the year. This way, you can ensure you’re on track to achieving your long-term money goals without having to continually review your accounts’ statuses.

2. Update your beneficiaries

Life sometimes moves so fast that it can be hard to keep up. New grandchildren, marriages, or other life changes may affect who you want as a beneficiary.

It’s important to stay on top of your different accounts and which beneficiaries are associated with them. Your accounts and associated beneficiaries should align with your overall estate plan and life insurance to avoid confusion.

Updating beneficiaries can be easily done online or with a signature on a form. It should only take a few minutes and is something we highly recommend putting in order while you have the time.

3. Consolidate your accounts

If you’ve previously changed employment, you may well have more than one 401K plan open. We often speak to clients who have two, three, or four 401Ks with past employers, that they’ve completely forgotten about – and that have substantial balances in them!

Moving existing 401Ks into a traditional IRA is a fantastic way to consolidate your accounts. It’s completely tax-free, with no risk, penalties, and typically no fees. If you hold multiple traditional IRAs, we also advise consolidating these into just one account.

By reducing the number of unnecessary accounts, managing your money will become more straightforward and less stressful.

4. Assess your mortgage rate

It’s very unlikely that mortgage rates will reduce further, so we recommend taking advantage of them while you can. Now is a great time to refinance your house or any investment properties you have a loan on. An advantageous rate could lower your payments, giving you greater monthly cash flow, or help you pay off the loan faster.

We spoke to a Loan Officer with 15 years’ experience about the benefits of refinancing in our podcast episode ‘Tammi Rowe – Planning Your Mortgage and Retirement’. To find out more about what refinancing could do for you, listen to the episode.

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5. Plan for emergencies

You might be faced with a financial opportunity, for example, paying off your mortgage, but it’ll leave you with less cash in the bank than you’d like. Should you do it? Or should you build up your ‘emergency fund’ first?

Having cash reserves in case of emergencies is necessary. But you don’t always have to choose between keeping lots of cash in the bank or paying off a substantial loan.

One tip we give our clients is to open an equity line of credit. There can be a minimal fee to open it, but there’s no interest if you don’t have any balance. This means that if you spend your cash reserves on something like paying off a mortgage, you have easy access to cash, as an equity line of credit comes with either a debit card, a checkbook, or both.

An equity line of credit is only available to those still working, so if you want an emergency fund for the future, we urge you to set one up while you still qualify. You won’t need to make any payments, and it won’t gain any interest, so long as the balance is zero.

6. Consider how and when you’ll take your RMDs

If you’re turning 72 in 2021, pay close attention. RMDs or Required Minimum Distributions were optional in 2020, however, the rules are changing for 2021, and if you turn 72 this year, you will have to take your RMDs this year and every year going forward.

Your individual RMDs are based on your IRAs’ combined balance, so there isn’t one set figure for everyone. You can spend your RMDs, or you can reinvest them into another brokerage account, but they must leave your IRA and cannot go into another IRA.

Bear in mind that money in a traditional IRA is pre-tax. So, when it leaves the IRA as an RMD, it’s treated as income and will be taxed.

There is no rule when you should take your RMDs, but you must start taking them before December 31st from the year you turn 72. Some people choose to take it monthly, like a paycheck, and others take it as a lump sum at the beginning or end of the year.

If you don’t need to take your RMD and don’t want to pay tax on the money you don’t need, you can make a qualified charitable deduction once you’re aged 70 and a half. This is where you direct your RMD straight from your IRA to a charity of your choice. This way, your RMD leaves the IRA but isn’t claimed as income, making it tax-free.

You can also do this with a portion of your RMD. For example, if your RMD is $10,000, and you want to instruct $5,000 to a charity and keep $5,000 for yourself, you only have to pay tax on the $5,000 you keep.

7. Apply for Social Security

If you’re planning on taking Social Security in 2021, it can be a long process. Right now, there are thousands of people applying every single day, so we advise applying two to three months ahead of when you want to start receiving your Social Security benefits.

You can apply as early as three months before the date that you want to start receiving them, so if you’ve already decided it’s part of your financial plan for 2021, don’t wait. Plan ahead, make the phone calls, and fill out the paperwork as soon as you can so that you can receive your benefits when you need them.

8. Research your Medicare options

Health insurance has never been more vital, so putting a plan in place as soon as possible is recommended. There’s a lot to think about with Medicare, from how your income affects your premiums to when the open enrollment periods are. If you’re turning 65 or going to be receiving Medicare, we encourage you to research your options.

We spoke to Medicare Specialist, Lorraine Bowen, on our podcast, and she answered all of our Medicare questions, including what it covers and how to find out if you’re entitled to it. To learn more about Medicare, listen to this episode.

9. Understand your income plan

When you stop working, you might find it more challenging to keep track of your income. There can be many moving parts in retirement with different income streams and RMDs, and it could leave you with an unnecessarily high tax bill or with fewer cash reserves than you’d like.

Now is the perfect time to adjust your income to ensure that you’re not taking too much or too little. We use a couple of different software programs that help us automatically track income on a month-by-month basis to find a monthly income figure that’s best suited to you. If you want to learn more about how we do this, reach out to us.

Those are our nine key points for preparing your finances for retirement in 2021. By completing this checklist, you’ll be giving yourself peace of mind that you’re on track to achieving your financial goals throughout the year.

We’re going to delve deeper into more of these topics as the year progresses, but if you have any urgent questions about any of the subjects we discussed in this post, please get in touch. You can contact us, or if you want to discuss your retirement goals with a member of our team, we invite you to schedule a 15-minute complimentary call with us.

The Stretch IRA is Gone: What Next for Your Inheritance?

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The stretch IRA is dead, so what options do you have when it comes to inheritance planning?

At the start of 2020, new rules were introduced on how individual retirement account (IRA) holders can use the “stretch” IRA to manage their inheritance. With changes to the way beneficiaries access inheritance assets, you may have questions about what the rules mean for you and your loved ones.

In this post, we look at what happened to the stretch IRA and how it could affect your inheritance planning. We also cover some of the alternatives to stretch IRAs, including life insurance and Roth conversions.

What happened to the stretch IRA?

On January 1, 2020, the Secure Act was passed and with it came to the end of the stretch IRA. For years, this estate planning strategy was a tax-advantageous way to leave an IRA to a non-spouse beneficiary, but now it’s no longer an option.

So, which new rules were introduced under the Secure Act 2020? And what effect have they had on how IRAs work?

The biggest change concerns how a beneficiary can access an IRA after they’ve inherited it. Previously, a stretch IRA allowed non-spouse beneficiaries unlimited time to withdraw funds from their inheritance. Now, the money must be out of the IRA within 10 years after the date of death, so beneficiaries can no longer access them over their lifetime.

Say, for example, you want to leave $40,000 to your grandchild, who is 30 years old. The Secure Act now means they must withdraw all of the assets within 10 years, either as a lump sum or as annual distribution payments. If they don’t, they’ll have to pay tax all at once, which could significantly reduce their inheritance pot.

Thankfully, the introduction of the Secure Act isn’t all bad news for those with an IRA. There are two other rule changes which many will see as a benefit:

  • The age at which you must withdraw required minimum distributions (RMDs) from your IRA has risen from 70 to 72. This means you’ll have two more years to pay into your retirement account before you need to start drawing money from it.
  • The Secure Act has removed the upper age limit of paying into an IRA. Now, so long as you’re still earning income, you can continue paying into your retirement account indefinitely.

What to consider when withdrawing from an IRA inheritance fund

Now that beneficiaries have just 10 years to withdraw assets from an IRA, they must think about how and when to access their inheritance. Remember, a beneficiary can withdraw funds either as a lump sum or as regular distributions, affecting how much they pay in tax.

If a beneficiary is 60-65 and within 10 years of retirement, it could be worth waiting until they retire before withdrawing money from the IRA. That’s because retirement means a smaller income, so they’ll be in a lower tax bracket and pay less tax on the total inheritance amount.

For younger beneficiaries, withdrawing from an IRA over the 10-year period may be more advantageous – especially if they expect their income to increase as they get older.

Through these examples, you can see why it’s important for beneficiaries to think about the best time to withdraw funds from an IRA. We’d always recommend discussing these options with your beneficiaries so that they can make the most of their inheritance after you’ve gone.

How to manage your inheritance now that the stretch IRA is gone

Now that the stretch IRA is a thing of the past, what other options can help you make the most of your inheritance?

With advanced IRA planning, you can make sure your beneficiaries don’t face a heavy tax burden on their inheritance. There are a few different options that provide good alternatives to the stretch IRA, including Roth conversions and life insurance.

Roth conversions

A Roth conversion is the process of switching your pre-tax IRA assets into tax-free ‘Roth’ assets. This means that you pay the tax on your beneficiary’s inheritance so that all the money they receive is tax-free.

The beauty of Roth assets is that, while the 10-year Secure Act rule still applies, there’s no tax to worry about for both lump sum and annual withdrawals. What’s more, as Roth assets earn interest, it’s well worth letting the inheritance grow over the 10-year period.

A Roth conversion does mean you’ll have to settle the tax bill yourself, passing this benefit to your beneficiary. If that’s important to you, it could be a great option.

Life insurance

The second option we’d recommend as an alternative to the stretch IRA is life insurance. Although slightly more complicated than a Roth conversion, taking out life insurance guarantees tax-free inheritance for your beneficiaries after you’ve gone.

A key thing to note about the life insurance option is that you have to go through underwriting, meaning you first have to qualify. Some people may be concerned that their age will bar them from taking out life insurance, but you may be surprised at the rates and options available.

Life insurance is a great way to ensure your non-spousal beneficiaries can enjoy their inheritance without worrying about tax. What’s more, there’s no 10-year rule on when an inheritor has to withdraw the funds from a life insurance plan, making it a beneficial long-term inheritance option.

So, if you have money set aside as inheritance, life insurance could be the best way to guarantee a tax-free benefit for your loved ones.

Do you need help with your inheritance planning?

We understand that planning your inheritance can be complicated, especially given the recent rule changes introduced by the Secure Act. So, if you need help understanding the different options available, our experts can provide impartial advice on the best way to pass your retirement assets on to your loved ones.

Whatever you’re planning for your inheritance and however big the sum you’ve set aside for your beneficiaries, we can help make the process simpler to manage. Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.

Roth Conversion – When and How to Plan

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If you have a traditional IRA, you may be considering a Roth conversion. There are many reasons why a Roth might suit your money better than a traditional IRA, however, knowing the differences between the two and the long-term results of moving your money can help you decide which IRA to choose.

Roth IRAs and conversions are a popular topic for those approaching retirement, so in this post, we explain why a Roth IRA might be beneficial to you, when to do a Roth conversion, and what’s involved in the process. 

The differences between a Roth IRA and a traditional IRA

An IRA, or Individual Retirement Account, allows you to save for your retirement through tax-free growth or on a tax-deferred basis. There are several different types of IRA, but the two most common we see compared are Roth and traditional accounts.

If you have a traditional IRA, you typically receive an immediate tax benefit after you’ve contributed. You put your money in pre-tax, and it will grow tax-deferred. This means that when you begin withdrawing money from the IRA, it’s treated as income and is taxable.

If you have a Roth IRA, you don’t get any immediate tax benefits after contributing. You put your money in after-tax, however, it grows tax-free within the Roth account and remains tax-free after you withdraw it.

So, if you’re looking at making substantial or long-term contributions to an IRA, a Roth account could be a better option for you. This way, you’ll pay less tax in the long run, as you won’t have to pay any tax on your savings growth.

But if you’d prefer immediate tax benefits, then a traditional IRA could be the better choice. So which IRA is best for you depends on whether you’d like your tax benefits now or in the future.

How RMDs affect traditional IRAs 

One thing to bear in mind with traditional IRAs is that you have to take an RMD (required minimum distribution) from the age of 72 and every year after.

This is the deal you make with traditional IRAs. While you receive immediate tax benefits when you make contributions, RMDs are the government’s way of ensuring that they still receive tax revenue. RMDs are not optional, and you have to take them every year even if you don’t need the money.

RMDs are also taxed at future tax rates. If you believe that tax rates will be lower in the future, then a traditional IRA may make more sense for you. However, if you think that they will be higher, you might want to consider a Roth IRA.

A Roth IRA has no RMDs. You can withdraw as much or as little as you like, and you won’t be taxed on any withdrawals. 

Why contribution limitations can lead to conversions

There are contribution limits to both Roth and traditional IRAs, but for Roth IRAs there are also income limitations. If you earn too much, then you cannot make a direct contribution to your Roth IRA.

This is where a Roth conversion can help.

A Roth conversion is where you transfer money from your traditional IRA into your Roth IRA. One important thing to remember when you do this is that you have to pay tax on that asset. As the money will have gone into your traditional IRA pre-tax, you must pay tax on it before you can put it into your Roth IRA.

Once your money is in the Roth account, it can continue to grow tax-free for however long it’s in there. There are no requirements for when you should start taking money out or how much you should take out annually.

If you are taking RMDs from your traditional IRA, it’s important to know that you cannot convert them into a Roth account. The only way to move your RMDs into a Roth account is to combine it with an additional amount first. For example, if your RMD is $15,000 and you want to move this into your Roth account, you’ll have to take out more from your traditional IRA, say an extra $15,000, and move both amounts into the Roth account.

You can contribute to your IRA account when you file your taxes. For most people this is usually around April. But conversions must be done by the end of the year. The deadline for Roth conversions is December 31st.

Why should you do a Roth conversion

Roth conversions make a lot of financial sense when you’re temporarily in a low tax bracket or receiving very little taxable income. If you’re in a situation where you’re expecting your tax bracket to rise or your taxable income to increase, then it’s best to do a Roth conversion as soon as possible.

Converting at a time when you pay less tax has the best long-term benefits for your money as it will continue to grow tax-free and you’ll never have to pay tax on it again. This is the number one reason that many people do a Roth conversion.

The second reason is that you want to avoid RMDs. If you’re planning long term, then you could aim to convert all of your money from your traditional IRA before you turn 72. This way you won’t have to take RMDs and pay tax on them. Even if it’s not possible to convert all of your money before then, by moving some money into a Roth account, your RMDs could decrease and you’ll pay less tax overall.

The step-by-step process of a Roth conversion

If you’re thinking about doing a Roth conversion, the first step is to speak to a financial advisor. We can help you look at the whole picture and gauge whether it makes sense for your money.

We take a look at your current tax bracket, what future tax brackets we can expect, and if it’s the best year to make this type of conversion. We also involve CPAs who can help us decide how much to convert and navigate tax brackets.

Speaking to a financial advisor will also help you determine what your goals are for your money. We’ll help you understand why a Roth conversion may or may not help you reach those goals, and then once you’re happy, the process is as simple as moving money from one account to another.

So, if you’re considering a Roth conversion or have any questions about IRAs and what they can do for you, then reach out to us. You can book a complimentary 15-minute call with a member of our team to discuss which avenue is right for you. Book your call today to get started!