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

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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.

October 16, 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 16, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Required Minimum Distributions in Retirement – Monthly, Quarterly, or Annually?

Listen in to learn the advantages and disadvantages of taking required minimum distributions monthly, quarterly, or annually. You will also learn how the three-bucket strategy income safety and growth buckets can work together to your advantage.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Required Minimum Distributions – Monthly, Quarterly, or Annually?

US tax law requires you to take a certain amount out of your traditional retirement accounts or employer-sponsored retirement plans each year, called a required minimum distribution. If you transferred money into these qualified plans and didn’t pay taxes on it, guess what? The IRS will eventually want you to pay your taxes, which is where RMDs come into the equation…

CLICK HERE TO READ THE BLOG

Required Minimum Distributions – Monthly, Quarterly or Annually?

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Required minimum distributions (RMDs) become a very important point of discussion before the end of the year, and there is a lot that you need to consider. You can take your RMDs monthly, quarterly, and annually. 

However, which one is the right choice for you? That’s what we’re going to cover in this post. If you would rather listen to this post, we do have a podcast on this very topic.

 

What are RMDs?

US tax law requires you to take a certain amount out of your traditional retirement accounts or employer-sponsored retirement plans each year, called a required minimum distribution.

A traditional account is a tax-deferred account, such as your:

  • IRA
  • SEP IRA
  • 401(k)
  • 403(b)
  • 457

If you transferred money into these qualified plans and didn’t pay taxes on it, guess what? The IRS will eventually want you to pay your taxes, which is where RMDs come into the equation.

Basically, you need to take out “roughly” 3.5% of your money each year, but there is a more complex calculation involved that we won’t go into with this post. The most important thing is that you’re required to take these distributions even if you don’t need the money.

Whether you’re in your 50s or 65, it’s important to educate yourself on RMDs and what you are required to do. Developing a plan for your RMD is important because you can incorporate a few strategies to lower your distribution requirements, too.

If you reach a certain age, you must take distributions.

In 2020, once you had reached age 70.5, in the calendar year, you would have needed to take distributions. After the Secure Act, this age has changed to age 73 – 75, depending on your birth year. The year you were born dictates this age:

  • Born in 1951 – 1959, your RMD age is 73
  • Born 1960 and later, your RMD age is 75

In the first year, you can defer your distribution to the next year and take it by April 1st. However, if you do this deferral, you will need to take two distributions, which is uncommon because it will push your tax bracket up.

On a Roth IRA, you have a tax-free bucket that you can use with no RMD requirement during the life of the original owner. Roth accounts are something that we often recommend as a strategy for eliminating or reducing RMDs, but this is something we’ll dive into more shortly.

Quick Note: Inherited IRA accounts work a bit differently. You used to be able to take distributions over a lifetime. Now, the new rule requires you to deplete the entire account over 10 years. There are a few caveats to this rule, but you’ll want to sit down with a financial advisor to discuss these in greater detail. Exceptions do exist for disabled individuals, minor or chronically ill beneficiaries and those who are less than 10 years younger than the original account owner.

Penalty for Not Taking an RMD

We do want to mention that when researching RMDs, you’ll learn that there is a penalty for not taking your distribution once required. The penalty can be 50% of the distribution, which is a lot, but we have never actually seen this applied.

Often, the government will give you a reprieve, but they do want you to take your RMD.

Is It Better to Take Your Required Minimum Distributions Monthly, Quarterly or Annually?

You know what RMDs are and that you can be penalized for not taking them, but one question still remains: at what frequency should you take your RMDs? We’re going to walk you through each of these distribution options.

Everyone has their own line of thinking when it comes to taking their RMDs, and it’s ultimately up to you. Each option has its advantages and disadvantages.

Monthly RMDs: Advantages and Disadvantages

Monthly distributions offer consistent cash flow – just like a paycheck. For example, if you need to take $12,000 per year in distributions, you can rely on $1,000 a month coming into your account.

You also benefit from market volatility.

For example, you are withdrawing the $1,000 when the account is up or down for the month, which can be an advantage or disadvantage. If you have a consistently down market when you’re withdrawing, that can become an issue.

The main advantages are:

  • Monthly cash
  • Less concern about the market
  • Easier to maintain a budget

However, the disadvantages are almost the exact opposite of the advantages. You’re taking money out of the account and missing growth opportunities.

Note on RMD Calculations and Growth Buckets

The IRS calculates your required minimum distribution on the balance of the account at the end of December 31st. If the IRS states that you need to withdraw $12,000 per year, it doesn’t matter if the markets are up or down 100% that year – you still need to take the full distribution.

When offering retirement planning, we often use a bucket strategy. 

In this article, we’ll discuss the:

  1. Income/Safety bucket
  2. Growth bucket

Why? They offer advantages in a down or up market, helping you mitigate some of the risks your accounts have in retirement.

The income safety bucket often isn’t correlated with the market so:

  • It provides income
  • Protects against stock market volatility

The growth bucket is, in all essence, money in the stock market. Last year, the market was down 20% or more.

When both buckets work together, it helps safeguard against the market. Money comes from the income bucket and the growth bucket is allowed to grow long-term and mitigate retirement accounts being down.

Income buckets buy us time so that we don’t remove money when an account is down.

During a year like 2022, the growth bucket was allowed to recuperate while still having a steady income from the income bucket. If you have all your money in a growth bucket, it leaves you very little room to mitigate losses.

Note on RMDs and Multiple Accounts

For the sake of simplicity, let’s assume that you have 3 IRA accounts and the government states that you need to take a $12,000 RMD annually. Your distribution can come out of one account, a combination of accounts or all your accounts.

You may have $1 million in an IRA and decide to put 50% in an income bucket and 50% in the growth bucket. You can take all the distribution from the income bucket and let the growth bucket grow.

However, if your money is in a 401(k), there are stricter rules. Money in the 401(k) must come out first if multiple other non-401(k) accounts exist.

You can also put money from a 401(k) into an IRA with different strategies, which may be a better option for you.

Quarterly RMDs: Advantages and Disadvantages

Quarterly distributions are middle-of-the-road. You’re between the monthly and annual distributions, and the advantages and disadvantages are very similar to monthly.

For our clients, it’s always a monthly or annual distribution because many people don’t prefer the quarterly option.

Annual RMDs: Advantages and Disadvantages

Annual distributions are ideal for clients who want to keep their money in the market and let it grow as much as possible. Since the account balance may be higher, you’ll benefit from higher returns.

You can also have a down year where you’ve lost money and now need to take it out of the account when you’re in the negative for the year.

  • During up years, you benefit from greater returns
  • During down years, you lose some money

What’s best for you? Consider your personal preference and needs. If you need a monthly paycheck, then the monthly RMD is best. However, if you plan to reinvest your RMDs because you don’t need the extra cash flow, it may be better to go with the annual RMDs.

A retirement-focused financial plan is what we recommend to our clients. The rules of RMDs are general, but your case is always going to be unique. Analyzing financial plans in retirement allows us to optimize income and RMD planning.

We can walk you through how this looks, even if you’re not currently a client of ours. You can schedule a 15-minute complimentary call with us that will allow you to discuss your options with us to have a more personal discussion about your RMDs and retirement plan.

Click here to schedule a 15-minute call with us to discuss your retirement plan and required minimum distributions.

October 9, 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 9, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Social Security Taxation – How it Works in Retirement

Learn the importance of understanding your sources of income, social security benefits, and how they’ll be taxed, and have a long-term perspective. You will also learn why some people with low income in other areas can have their social security untaxed.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Social Security Taxation – How it Works

Social Security taxation is complex. You may need to pay taxes on your benefits, or you may not have to pay taxes. Ultimately, your combined income will determine if you pay taxes and will include the sum of….https://pomwealth.net/social-security-taxation-how-it-works/

CLICK HERE TO READ THE BLOG

Social Security Taxation – How it Works

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Social Security taxation is complex. You may need to pay taxes on your benefits, or you may not have to pay taxes. Ultimately, your combined income will determine if you pay taxes and will include the sum of:

  • Adjusted gross income
  • Non-taxable interest
  • Half of your Social Security benefits

Often, clients of ours are taken aback because they paid into Social Security their entire lives, and then they find out that they may be taxed on their benefits. For many of our clients, the benefits that they receive are not enough to live the lifestyle they want in retirement, so they’ll need other sources of income, such as distributions from their IRA.

We brought Taylor Wolverton, a member of our team, to our podcast to discuss how your Social Security is taxed because there are a lot of moving parts to consider. Taylor is our lead tax strategist and an Enrolled Agent, so she’s hyper-focused on individual taxation.

P.S. We are going to go through a lot of numbers, so take your time and reread this post a few times. However, if you do have questions about your specific situation, feel free to schedule a free 15-minute call with us.

Breaking Down the Figures

We have three main factors in determining how much of your benefits are taxable, but what do these really encompass?

What is Adjusted Gross Income?

Adjusted gross income (AGI) includes:

  • Interest from savings accounts
  • Dividends
  • IRA or other distributions

Your AGI includes any type of income that you’ll be taxed on in a given year.

What is Non-taxable Interest?

Your non-taxable interest comes from things like municipal bonds. Now, you must combine all this income plus half of your Social Security benefits. It’s a lot to consider.

Example of Taxation on Social Security

Someone has other sources of income of $75,000. Bob and Jane each receive $3,000 per month from Social Security ($6,000 total). Based on this example, there is:

  • $75,000 AGI
  • $0 tax-exempt interest
  • 50% of Social Security benefits, or $36,000 annually

Other sources of income are now $75,000 + $36,000 or $111,000. Now, it gets a little more complicated because of your tax filing status and the various thresholds that this may include.

Married Filing Jointly

If your income is between $32,000 and $40,000, up to 50% of your benefits may be taxable. However, if the couple’s income is more than $44,000, up to 85% of benefits will be taxable.

In the example above, the couple has $72,000 in Social Security benefits, so $61,200 will be reported on the couple’s tax return and will be taxable.

Going over these figures again, based on these calculations, the couple would have:

  • $75,000 AGI
  • $61,200 (85% of $72,000) from Social Security

Total taxable income is $136,200.

Note: For people who have income less than $32,000, you might not pay any taxes at all on your Social Security. However, taxation is on a sliding scale. At the most, 85% of your benefits are taxable.

Thresholds for Single, Head of Household, Qualifying Widow(er), or Married Filing Separately (and you did not live with your spouse during the year) 

A single person will have a different threshold for Social Security. You’ll be taxed up to 50% if you have income of $25,000 – $34,000. You may be taxed up to 85% if you have income of more than $34,000.

You’ll want to keep in mind that taxes are a bit more complicated than the examples above. We used approximations for these figures, but you’ll also need to consider credits, deductions, and special financial situations, which can lower your tax bill, too.

Variations Based on States

All the taxation above this point is based on the federal level. Every state has different rules that you must consider when retirement planning because some may follow federal rules, while others may not tax Social Security.

In North Carolina, where our office is located, there is no tax on Social Security, and this can be advantageous when trying to secure your retirement. 

How Social Security Taxation Impacts Retirement Planning

When looking at Social Security taxation, it’s important to know:

  • Sources of income
  • Taxes

Often, one of the largest expenses people have is the taxes that they need to pay in retirement. You’re not saving money for retirement any longer – you’re living off what you saved.

You need to understand how Social Security benefits will impact your taxes this coming year.

It’s possible to withhold taxes in some areas to lower the pending tax burden, but this is something that you need to consider well ahead of time. You never want to have a surprise when filing a tax return because you didn’t realize that Social Security is taxed.

Example of the Impact Social Security Had On One Client

One client of ours has the goal of leaving a tax-free legacy behind when she retires. She turned on Social Security, but she didn’t realize that she would be taxed on her benefits. 

What did she do?

  • Turned off Social Security
  • Paid it back
  • Leveraged Roth conversions for a few years
  • Turned benefits back on

She wants to leave a tax-free legacy behind, so it was crucial to make the most out of tax-free Roth conversions.

While she did have to pay back the benefits she received, she does benefit from higher Social Security benefits when she does decide to take them in the future.

Working with an advisor allows you to take the long-term approach to your Social Security and maybe avoid 85% of your benefits being taxable. A long-term perspective, based on your goals, needs to be considered.

Our goal is to limit the amount of taxation over a lifetime rather than a short period of time.

You may find that paying more taxes this year allows you to lower your burden over your lifetime. If you pay a bit more in taxes today but save 10% every year, it’s often in your favor to take the tax hit immediately.

Where to Learn How Much of Your Benefits Were Taxable

Pull out your most recent tax return and find your 1040 form. Often, this is the first page of your return. You’ll want to go to line 6a. This will show you how much of your benefits were for that year. If you look to the right to 6b, you’ll see how much of your benefits were taxable.

IRS officials do like to update income tax brackets and change percentages around for inflation. You’ll need to consult with us or a tax professional to learn the current year’s guidelines for income ranges and maximum taxation percentages.

The IRS does have an online calculator (here) where you can plug in data and learn how much of your benefits are taxable.

Do you want to talk to us about your tax situation?Schedule a free 15-minute call today.

September 25, 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 September 25, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Practical Tips for a Successful RV Lifestyle when you Retire

In this Episode of the Secure Your Retirement Podcast, Radon speaks with Jenelle Jones about the perks of the RV lifestyle in retirement. Jenelle is the owner of the oldest RV club for anyone traveling on their own, The Wandering Individuals Network. She refers to herself as an RV travel enabler who has been living the RV lifestyle full-time for four years.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Practical Tips for a Successful RV Lifestyle

Have you always dreamed of a successful RV lifestyle in retirement? You’re not alone. Jenell Jones was our special guest on the Secure Your Retirement podcast this week, and she was more than happy to exclaim, “I live everywhere.”

CLICK HERE TO READ THE BLOG

Practical Tips for a Successful RV Lifestyle

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Have you always dreamed of a successful RV lifestyle in retirement? You’re not alone. Jenell Jones was our special guest on the Secure Your Retirement podcast this week, and she was more than happy to exclaim, “I live everywhere.”

If you’re in the midst of retirement planning and think, “I would love to live in an RV and travel the US,” you definitely want to grab a cup of coffee and keep reading. You can also listen to this episode right on our podcast: click here to get started.

About Janell and Her Insight into the RV Lifestyle

Janell started living full-time in her RV in 2019, but she has been on and off in this lifestyle since 2015/2016. Living in an RV allows her to travel across the country. Why did she want to live this lifestyle?

In her government job, her office window faced an RV dealership.

She would sit there, watching out her window, as people purchased RVs and drove off. The seed was planted in her mind that the RV life may be for her, but when she retired in 2015, she thought, “No, this is crazy.”

She didn’t want a large RV or to be without a house. So, she bought a small RV. The more she traveled in the RV, the more she realized that she didn’t want a house anymore. She only returned to her home to check on it, so she decided that she would do what she wanted to do: travel full-time.

Tips on Seeing the Places You Want to See

If you want to spend the summer in Florida, don’t. Janell did, and she says it was hot. Instead, she chases the weather and claims that she hasn’t been really hot or cold for a long time. 

How does she see the places she wants? She starts by grabbing a map, and making some calls.

RVing around and visiting the places you want is a travel experience that includes planning your trips. You’ll need to get comfortable with rolling with the punches, missing friends and family, and dealing with constant change.

One thing that has helped Janell a lot in her RV lifestyle is RV clubs. She actually loved the club she joined so much that she purchased it.

Why join an RV Club?

If you are anxious about going RVing alone, join a club where you can travel with your friends. You can go to Mexico together for the month, or some can go to Canada and others to Washington.

Clubs are one of the best ways to transition into the RV lifestyle because you have the opportunity to travel with other people following the same lifestyle as you. Traveling in a group will help you remain calm and have less worry if you break down or have issues on the road.

Travel buddies can also help push you outside of your comfort zone to visit places and do things that you wouldn’t be able to do alone. For example, she went on a 5-mile hike to a gorgeous location with her group that she would not have attempted alone.

Maintaining Your RV

Your RV is your home, so you need to maintain it and keep it up. Before buying her RV, she had never even entered one. You’ll learn the ropes of maintenance, but you need to have a positive attitude.

Like your car, RVers need to maintain the vehicle by:

  • Changing water filters
  • Putting air in the tires
  • Fixing things as they break

These items are even more important to be aware of on your RV, as it is also your home.

Challenges of the RV Lifestyle

Owning an RV does come with its challenges. You may have an occasional blowout, but the one challenge that never seems to get better is getting lost. Doing a U-turn or backing up is difficult when your RV is 30 feet long and you’re towing a car. You’re always on the go, traversing different roads, so you need to plan for a situation where you may end up blocking traffic and need to call the cops for non-emergency help.

Janell has three GPS systems running just so she doesn’t get lost.

The first year of RV ownership was a challenge. She went to a McDonald’s, went under trees that were lower than she thought and knocked everything off her roof. Learning to back up was also a challenge.

With this in mind, she rolled with the punches, and everything started getting better as she learned the ins and outs of the lifestyle.

Important Items to Keep in Your RV

Probably the most important item to keep in your RV is actually two different types of GPS. She means an in-dash GPS, phone, paper map, or other type of GPS. 

You also want to have a:

  • Water pump (an extra)
  • Air compressor
  • Jumper cable
  • Internet 
  • Square #2 screwdriver
  • Spare screws

Towing an RV is different from a car. Tow companies will charge $6,000 to come out, so you want to avoid calling them when you can. Simply being able to fill your tire so that you can get it changed can save you thousands of dollars.

Top Experiences in an RV

Janell noted that we don’t have three hours to do a podcast, but since exiting the corporate world and living in an RV, she has learned one thing: patience. She was fast-paced, and RV living taught her to slow down and smell the roses.

She visited the Grand Canyon, biked 13 miles in it and hiked. She has been to Maine, Utah, and Colorado and places where there are no people for miles. She values being able to experience the joys of life without needing to sacrifice anything. Some of the adventures that she’s been on could never have happened if she wasn’t living an RV lifestyle.

Purchasing the RV Club

Janell retired at 54, so she was looking for something that she could buy and do “here and there.” Going back into an office is certainly not something that she aspires to do because it’s not up to her alley anymore.

She joined the RV club in 2015 and over time, she thought – I could take this business to the next level.

The club started in 1988 and the founders thought, “There must be other people like us.” However, with Janell’s background, she knew that she could market the club in new ways. Owning it also allows her to travel and write off expenses, which is certainly a great way to keep taxes low in retirement.

She has achieved 12% growth each month since March.

If you’ve never been part of an RV club, it offers you a lot:

  • Company to go with you 
  • A community of like-minded people
  • Safety in numbers
  • Year-round traveling

The club offers traveling together with trips already planned out for you. The club handles all the planning. You will book your reservations and can come and go as you please if you’ve already been to a location.

As a member of the club, you’re free to travel when you want, which is the beauty of joining.

You can join the club for a few weeks and then go back to your sister’s house and hop back into the club’s route. All the itineraries and plans are given to you, so you can have someone else handle the planning for you.

If you want to learn more about the club, you can go directly to her website, Wandering Individuals Network.

September 18, 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 September 18, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Mastering Medicare Planning in Retirement

Learn how to evaluate your prescription drug needs and choose the right Medicare plan that caters to those needs. You will also learn about Medicare supplements and Medicare Advantage plans, plus how to join our Free Webinar to learn more about Medicare planning from experts.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Mastering Medicare Planning

Open enrollment for Medicare is right around the corner, and people on all points of the spectrum should begin planning for it. If you’re in one of the categories below, you’ll especially want to continue reading…

CLICK HERE TO READ THE BLOG

Mastering Medicare Planning

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Open enrollment for Medicare is right around the corner, and people on all points of the spectrum should begin planning for it. If you’re in one of the categories below, you’ll especially want to continue reading:

  1. You’re already enrolled in Medicare and want to make sure that you’re in the right plan
  2. You’re eligible for Medicare and need to select your providers

We’re going to create a checklist of sorts for folks who are already enrolled in Medicare or need to sign up for a plan.

Note: We also have a webinar on this topic coming up, where we’ll go into all these points in far greater detail.

Prescription Drug Plans

Prescription drug plans are crucial for retirement planning because you may need very costly medicine in retirement. Each drug plan has different drugs that they cover, so you need to:

  • Review your individual medication needs
  • Find a list of prescription drugs that the plan covers
  • Have an idea of when you need to have prescriptions filled

If you’re not on any medication, your choice may be easier than someone who is on a few medications. You’ll want to read through the prescription drug plan to ensure that the medicine you’re taking now is all covered under the plan.

Anyone who is planning on switching plans must be extremely diligent to ensure that the desired plan covers the drugs you’re taking.

Comparing Part D Plans

Part D is the prescription portion of Medicare. You’ll have one plan that covers hospital visits, one for doctor’s visits and another for prescriptions. If you worked through our first point, then you’ll need to compare drug coverage and the costs you will cover.

Imagine one person with high blood pressure and cholesterol. Their medicine may be covered on one plan. However, what happens if you also have arthritis and are on blood thinners? You’ll need to consider all these factors when making a choice on which Part D plan to join.

But what if you’re not on any medication?

If you’re not on medication, you need to really look at your risk factors when choosing a plan. Perhaps there’s a history of high blood pressure in your family, so you’ll want to find a plan that covers related medications.

Evaluating Your Pharmacy Network

Next, you need to consider each plan’s pharmacy network. If you go to your local Walgreens to have your prescriptions filled, you may not be able to fill them at Walgreens if they’re not a part of the Walgreens pharmacy network.

You should consider cost and convenience.

Is the plan that you plan on entering ideal for your location? Most people don’t want to drive 30+ minutes away once or twice a month for their prescriptions. Online prescriptions are becoming more popular; however, you do have to wait for the medicine to arrive, which can be inconvenient or completely impractical for certain illnesses.

Everyone should evaluate what they’re comfortable with in terms of the pharmacy network each plan offers.

Cost Analysis

Medicare plans are not free. In most cases, you’ll still pay premium cost and out-of-pocket cost.

If you want to have 100% of everything covered, you’ll pay more in premiums. Instead, you need to consider your medications and what the cost is for each of them. What if you have a very simple scenario where your prescription drug cost is very low? In this case, you may not need the most expensive plan.

What we are really looking at here is the “coverage gap” or “donut hole.”

These two terms mean that you need to analyze:

  • Premium costs
  • Prescription costs
  • Income

If you do not have a lot of taxable income, this can work to your benefit and help you get into a more comprehensive prescription drug plan.

Annual Reviews

Annually, we recommend that you review your plan. One of the biggest Medicare mistakes we see is that people do not review their plans annually.

You might have been on the same plan for a decade, but switching plans can save you a lot of money. Some of the Medicare professionals that we work with have saved clients that we’ve worked with $2,000+ a year by simply reviewing and switching plans.

Dental, Vision and Hearing

Our second point revolves around parts of Medicare that are easy to overlook:

  • Dental
  • Vision
  • Hearing

In fact, a lot of health insurance providers are severely lacking in these three areas of coverage, which can cause you to pay out of pocket for any related expenses.

Medicare requires you to think about the dental coverage you need and find a plan that will better meet your needs. Dental issues can spill over into your overall health issues, and you certainly want to maintain your eyesight and hearing, too.

Each of these elements deteriorates faster as we age, so this is an area that you need to focus on heavily.

Vision Coverage

Do you want your:

  • Eye exams covered
  • Lenses or contacts covered

You may want to cover these costs and forget about a plan that offers them. Why? You may compare plans and find that your premiums for vision coverage are much higher, and it’s more cost effective to cover these expenses on your own.

Hearing Coverage

If you think there’s a chance that you’ll need a hearing aid or screening in the future, then you’ll want to consider coverage for hearing. Otherwise, you may be fine without having hearing coverage as a part of your plan.

Integrative Plans

Finally, an integrative plan is when you look at all these items and come across Medicare Advantage plans. There’s a lot to look at with an Advantage plan. You may even find that a Gap plan is better for you.

Unfortunately, there are a lot of things to consider with integrative plans, but it’s something we’ll discuss in greater detail in our upcoming webinar.

Individual Needs Assessment

An individual needs assessment is an integral part of Medicare planning because what works for your neighbor may not work for you. Medicare is very individualized and will help you better understand your needs, true coverage needs, and potential future needs.

Medicare Supplement and Advantage Plans

We do want you to attend the webinar because these plans are so important for you to secure your retirement. Medical expenses can rise rapidly, and you need to be prepared to cover these costs.

In the webinar, we plan to cover:

  • Medicare basics, such as supplements vs advantage plans
  • State-specific coverages and differences
  • Cost considerations
  • Out-of-pocket costs
  • Value of one plan to another
  • Restrictions of each type of plan
  • In-network and out-of-network differences
  • Additional benefits of Advantage plans and if they offer the most coverage
  • Getting access to personalized advice

We work with specialists who can help you make the best decision for your annual plan based on current and future medical needs.

During the webinar, we’ll be working with a Medicare expert who will answer all your questions and those that others have sent to us.

Want to learn more about Medicare planning? 

Click Here to register for our “Medicare Webinar” on October 9th at 12:00pm EST. The webinar is 100% free, so feel free to invite your friends to listen to it, too

September 5, 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 September 5, 2023

CLICK HERE TO WATCH THE UPDATE

This Week’s Podcast – Integrated Wealth Management Experience in Retirement

Learn more about the elements of an integrated wealth management experience: a retirement financial plan, specific-to-the-client investment process, and tax planning. You will also learn how we’re involved in every step of the wealth management process, in-house or with a partner.

CLICK HERE TO LISTEN TO THE PODCAST

 

CLICK HERE TO WATCH ON YOUTUBE

This Week’s Blog – Integrated Wealth Management

Integrated wealth management experiences are our way to help clients have the type of retirement planning assistance that is provided in a “family office.” If you don’t know what this term means or who it applies to, we’re going to cover that in great detail before explaining the concept of integrated wealth management to you.

CLICK HERE TO READ THE BLOG

Integrated Wealth Management Experience

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Integrated wealth management experiences are our way to help clients have the type of retirement planning assistance that is provided in a “family office.” If you don’t know what this term means or who it applies to, we’re going to cover that in great detail before explaining the concept of integrated wealth management to you.

Note: Click here to listen to the podcast that this article was based on using Spotify, Apple Podcasts, Google Podcasts and Amazon Music. 

What is a “Family Office?”

A “family office” caters to what can be considered ultra-high net worth. You have enough assets that you require an entire team to help manage your assets. These offices will help you with:

  • Family businesses
  • Taking care of budgets
  • Paying bills
  • Managing cash flow, credit cards, real estate

Individuals in a family office have assets of $50+ million. Anyone who falls into this category can be their “own client,” meaning that the entire team works for you to manage your wealth. Extensive assistance is offered, including tax and estate planning, to the degree that 99% of people will never require. You’ll also work with attorneys and CPAs.

All these employees work for you, they’re registered with the SEC, and they assist with managing your “family.” If a person has this high of a net worth, they may need to have a chief financial officer (CFO) who will handle hiring or working with certain experts to meet their family’s needs.

Often, with a family office, they have a CPA working with them full-time.

The family office works solely for the family and will handle all their financial and wealth management needs. If a lawyer needs to be hired to work on estate plans, that’s all handled for you behind the scenes.

Integrated Wealth Management Experience

In our office, our average client doesn’t have $100 – $200 million or a billion dollars. We can’t create a family office for these individuals, but we wanted to create a system that offered the same experience as a family office for all our clients.

What we devised is known as our integrated wealth management experience.

What Does an Integrated Wealth Management Experience Look Like?

Instead of working with one individual, we work with many and take on the role similar to a “CFO.” We look at the person’s entire financial picture and beyond to help you secure your retirement. We partner with multiple professionals on a range of services, in addition to in-house wealth management.

For simplicity, we’ll break this down into a few of our in-house and partnered services.

In-House Wealth Management

In-house, we specialize in wealth management. We are financial advisors, and fiduciaries- which means we’re required to put your best interests first. The majority of our clients are people close to or retirement, and we’re big on the retirement-focused financial plan.

In a few words, the retirement-focused financial plan:

  • Analyzes where you are today
  • Outlines retirement goals
  • Identifies changes that need to be made to reach your goals

Reaching your financial goals will often mean investing in some sort of return. We may invest in the market, bonds, annuities, or a wide range of other financial vehicles. We invest for a return that is comfortable for the client and is based on individual risk tolerance.

Next, we offer tax planning. Some of the tax planning is in-house and some of it is done by working with outside experts. We have checks and balances in place to understand:

  • What your taxes look like today
  • What strategies we can implement before the end of the year to lower the tax burden
  • What to do to save you money next year

We can also handle the tax return for you, and we have partnered with CPAs to lead this process. CPAs will also provide a stamp of approval for all the tax planning strategies that we prepare to ensure that everything moves along smoothly.

Our team helps clients understand where their income is coming from and ensures that their retirement-focused financial plan is operating to reach their goals.

Estate Planning

Estate planning is a crucial part of retirement planning that folks really struggle to talk and think about. However, we incorporate this planning into the experience because it provides you with peace of mind that your estate matters are all handled in a legal manner.

Without an up-to-date estate plan, it can be difficult for you to leave assets in your desired way for heirs and beneficiaries. If you’ve had a major life change since you’ve created or looked at your estate plan, it is a good idea to have your estate plan professionally reviewed and updated. 

For our clients, we have a system in place for the state they live in to create a:

  1. Trust
  2. Will
  3. Power of Attorney
  4. Healthcare Power of Attorney
  5. HIPAA form

We believe this aspect of your retirement-focused financial plan is urgent, and strongly encourage our clients to review and update these documents on a regular basis.

Social Security

We work with a Social Security consultant, so our clients have an expert look at avoiding mistakes when filing for Social Security. Some clients have an easy process for Social Security, and we can help them apply for their benefits. However, other clients do not have as easy of a time.

Our consultant is on retainer and will help consider:

  • Complex decisions
  • Divorce
  • Optimizing for certain forms of income
  • Survivorship

She assists us when running the numbers for Social Security to help you make the best decision on when to take your benefits and how to reach your financial goals.

Insurances

Insurance includes many different options, but one of the major ones is health insurance. When you retire, you’re responsible for your own health insurance, which will be Medicare.

Medicare can be overwhelming when it comes to options, plans, and thresholds. We work with our clients and partners to help them find the best Medicare options for their health scenario and budget. We may be able to structure things to avoid IRMAA surcharges on Medicare, too.

Additionally, we help clients during open enrollment to find plans that may be more affordable or a better overall option for them. 

Long-term Care Planning

Speaking of healthcare planning, we also dive into long-term care planning. Hopefully, you’ll never need this level of care, but you just never know what the future will hold for you. We recently had a podcast on long-term care planning.

We’ll analyze your long-term care options and even help you secure the insurance you need to pay for a nursing home or assisted living facility.

Life Insurance

We’ll work through the question of life insurance and how to structure it for you and your family. 

These are just some of the insurance options that we can use to help build our clients retirement-focused financial plan. As we’ve outlined, we do our best to mimic the “family office” so that it works in your best interests.

What Getting Started with Our Integrated Wealth Management Experience Looks Like

If you call us to discuss your options, we already have:

  • Ongoing, up-to-date research to aid in building plan for your goals
  • Multiple estate planning methods in place
  • Many in-house Insurance and Wealth Management strategy options

We’re involved the entire time, working to have all your questions answered. We will do the research with the estate planner or Social Security expert to have your questions answered.

Since we work with the outside experts, you bypass the extra step to make sure your financial, tax, and estate planning professionals are all on the same page when it comes to your retirement-focused financial plan. We’re very much involved with every aspect of your plan to help you make sound financial decisions.

Want to learn more about our Integrated Wealth Management Experience? Schedule a free call with us today.