Accounting Blog

Why You Should Convert Your Roth IRA in a Low-Income Year

Do you anticipate your income being lower this year? If you have a traditional individual retirement account (IRA), this might be a good time to consider a conversion to a Roth IRA, especially if the income from the conversion would be taxed in a low bracket.

 

Why Have a Roth?

 

Roth IRAs offer the opportunity for tax-free earnings — and those earnings can potentially accumulate for a long time since a Roth IRA owner has no obligation to take annual minimum distributions. Any withdrawals you choose to make from your Roth IRA after you have had it for five tax years would be both tax and penalty free after you reach age 59½.

 

Weighing the Tax Consequences

 

Projecting how much of your IRA you could convert before entering a higher tax bracket may be helpful. For example, single taxpayers in 2015 will see their 15% marginal rate jump to a 25% rate after their taxable income exceeds $37,450. Therefore, an individual with $30,000 in taxable income would have room for an additional $7,450 of taxable income from a Roth conversion before the marginal rate would change.

 

Call us for help with a Roth conversion analysis today.

 

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Will You have to Pay Taxes on Your Annuities?

Typically, at least a portion of an annuity payment is taxable.* Taxpayers should be careful to distinguish between the portion that represents a nontaxable return of the amount paid for the annuity and the taxable portion.

 

General Rule

 

To do this, the taxpayer generally divides the original, after-tax contribution by the expected return on the date the annuity begins. The cost/payout ratio, or “exclusion ratio,” is then multiplied by each installment payment to determine the nontaxable amount.

 

Example. Mary paid $10,800 for an annuity that will pay her $100 per month for 20 years. Mary’s expected return is $24,000. The exclusion ratio is 45% ($10,800/$24,000). For each $100 installment, $45 will be nontaxable, and the remaining $55 will be taxable.

 

Note that the expected returns on annuities may vary with the amount and the measuring term. Where the measuring term is someone’s lifetime or joint lifetimes, the IRS has tables for determining the expected return.

 

With variable annuities, the payout may vary based on such things as investment performance or changes in a particular index. Generally, the exclusion ratio is calculated by dividing the cost of the annuity contract by the total number of anticipated payments. However, if the nontaxable portion exceeds the actual payment, the taxpayer may elect to recompute the exclusion ratio for later years.

 

“Qualified” Annuities

 

Individuals sometimes receive all or a portion of the money in their qualified retirement plan accounts as an annuity. Such annuities are referred to as “qualified” annuities, and the method for calculating the exclusion ratio is similar to those described above. Note, however, that if the account assets consist entirely of pretax salary contributions (and earnings on those contributions), the exclusion ratio will be zero, and each installment will be fully taxable.

 

For more information about investments and taxes, give our tax professional a call today.

 

* Different rules apply to withdrawals, dividends, and loans from annuity contracts.

 

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Are Tax-Exempt Municipal Bonds Right for You?

For investors in the higher income-tax brackets, tax-exempt municipal bonds (munis) can represent an attractive investment. Municipal bond interest is generally exempt from federal income tax and often is exempt from state (and possibly local) income tax in the state of issuance.

 

Taxable Equivalent Yield

 

If you are looking at potential bond investments, you’ll want to figure out whether you will do better after taxes with a muni or a taxable security. Calculating the taxable equivalent yield — the interest rate in your tax bracket that is equivalent to the rate being paid on the tax-exempt bond you are considering — will help you make a useful comparison.

 

Example. Jay is in the 35% federal income-tax bracket. He wants to know how much a corporate bond would have to yield someone in his tax bracket to match the 1.8% yield on a tax-exempt muni investment he is considering. He subtracts .35 from one and divides the result (.65) into 1.8%. The answer: 2.77%. On an after-tax basis, a taxable bond yield of 2.77% is equivalent to a 1.8% tax-exempt yield. (Only federal taxes are considered in this example.)

 

Is AMT a Factor?

 

State and local governments and their agencies issue the majority of municipal bonds. However, nonprofit organizations, airports, certain housing agencies, and other “private activity” issuers also issue munis. Although exempt from regular income tax, the interest on most private activity bonds is taxable for alternative minimum tax (AMT) purposes. You’ll want to assess your potential exposure to AMT before investing in private activity bonds.

 

For more information about investments and taxes, give our tax professionals a call today.

 

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Cash or Lump Sum Payment – What is Best for You

Picture this: You’re leaving your current employer to start a new job or pursue other interests, and you’re about to receive a payout of the money in your retirement plan. What will you do with it? Keep the money invested and working full-time on your behalf in a tax-deferred retirement savings account? Or take the cash?

An Expensive Decision

While there may be circumstances that make taking the cash a necessity, it is generally not a smart move. First and foremost, you shortchange your financial future by cashing out and spending the money. Second, you’ll have to pay tax on the distribution, which means you may end up with less money than you had planned.*

Here’s how it works. Your distribution will be taxable to you at your ordinary income-tax rate. In fact, your employer is required to withhold 20% of your distribution as a “down payment” on your federal income-tax bill for the year. There could also be a 10% early withdrawal penalty on the distribution. (Some exceptions apply.)

If you don’t want to cash out the savings in your retirement plan when you leave, you have other options.

Let It Be

Instead of taking a distribution, you may be able to leave your money in your plan until you retire. Choosing this option lets you avoid a current tax bill and a possible penalty and it keeps your money invested tax deferred. Your plan administrator can tell you whether this option is available to you.

Roll It Over

Moving your money to an individual retirement account (IRA) or another employer’s plan that accepts rollovers is another option. In either case, it’s usually best to ask the administrator of your current plan to transfer your balance directly to the administrator of your new plan or the rollover IRA. You’ll avoid the automatic 20% withholding tax and any penalty that way. And your retirement savings can continue to grow uninterrupted.

Be smart. Keep your money working full-time for your future. To learn more about tax rules and regulations, give us a call today. Our knowledgeable and trained staff is here to help.

 

* Some plans allow participants to make after-tax Roth contributions. Distributions of Roth contributions and related earnings will not be subject to federal income tax when certain tax law requirements are met.

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Are Annuity Payments Taxable?

Typically, at least a portion of an annuity payment is taxable.* Taxpayers should be careful to distinguish between the portion that represents a nontaxable return of the amount paid for the annuity and the taxable portion.

 

General Rule

To do this, the taxpayer generally divides the original, after-tax contribution by the expected return on the date the annuity begins. The cost/payout ratio, or “exclusion ratio,” is then multiplied by each installment payment to determine the nontaxable amount.

Example. Mary paid $10,800 for an annuity that will pay her $100 per month for 20 years. Mary’s expected return is $24,000. The exclusion ratio is 45% ($10,800/$24,000). For each $100 installment, $45 will be nontaxable, and the remaining $55 will be taxable.

Note that the expected returns on annuities may vary with the amount and the measuring term. Where the measuring term is someone’s lifetime or joint lifetimes, the IRS has tables for determining the expected return.

With variable annuities, the payout may vary based on such things as investment performance or changes in a particular index. Generally, the exclusion ratio is calculated by dividing the cost of the annuity contract by the total number of anticipated payments. However, if the nontaxable portion exceeds the actual payment, the taxpayer may elect to recompute the exclusion ratio for later years.

 

“Qualified” Annuities

Individuals sometimes receive all or a portion of the money in their qualified retirement plan accounts as an annuity. Such annuities are referred to as “qualified” annuities, and the method for calculating the exclusion ratio is similar to those described above. Note, however, that if the account assets consist entirely of pretax salary contributions (and earnings on those contributions), the exclusion ratio will be zero, and each installment will be fully taxable.

For more information about investments and taxes, give our tax professional a call today.

* Different rules apply to withdrawals, dividends, and loans from annuity contracts.

 

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Two Types of College Savings Funds You Should Consider

It’s no secret that college costs have risen dramatically in recent years. Setting up an education savings program as early as possible can help you manage the ever-rising costs of post-secondary education for your children or grandchildren. Two types of college savings vehicles — qualified tuition programs, also called Section 529 plans, and Coverdell education savings accounts (ESAs) — offer income-tax benefits.

529 Plans

Most states offer some form of 529 plan. There are two types of programs — prepaid tuition programs and college savings plans.

Prepaid tuition programs let you lock in today’s tuition rates by purchasing credits or units of tuition in “today’s dollars” for your children’s use when they actually attend college at some future date. Typically, the units purchased are based on the average public school tuition rate in the state offering the plan. Generally, you may purchase amounts of tuition through a one-time, lump-sum purchase or monthly installments.

College savings plans, however, are the more common type of 529 plan. Minimum contribution requirements are generally very low. Once an account is set up, you typically may choose among several investment options.

For federal tax purposes, earnings on 529 plan investments accumulate on a tax-deferred basis. Distributions used to pay qualified education expenses* are excluded from taxation. Many states also exempt earnings and distributions from income taxes, and some even allow a deduction for contributions. Certain state benefits may not be available unless specific requirements (e.g., residency) are met.

Coverdell ESAs

You can establish an ESA at a bank, brokerage firm, insurance company, or other financial institution. ESAs are self-directed and must be funded with cash.

Subject to income limitations, you can make nondeductible contributions of up to $2,000 per year to ESAs for each child younger than 18 years old (and for special needs beneficiaries of any age). Your eligibility to contribute to an ESA is phased out with adjusted gross income (AGI) from $95,000 to $110,000 if you are an individual taxpayer or from $190,000 to $220,000 if you are a married taxpayer filing a joint return.

ESA distributions that are used to pay qualified education expenses are not subject to federal income taxes. Qualified education expenses include not only tuition and fees, but also books and supplies and, for students enrolled at least half-time, certain room and board charges. In addition to undergraduate and graduate-level education, ESAs can cover elementary and secondary public, private, or religious school tuition and qualified expenses.

Give us a call today, so we can help you determine the right course of action for you.

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

Using Stocks that Have Lost Their Value to Offset Stock Gains

With year-end just around the corner, you may be thinking of ways to reduce your taxes. If you own stocks (or mutual funds) that have declined in value, selling shares could produce a capital loss that you can use to offset gains on stock sales earlier this year.

However, suppose you still believe a particular stock has potential for future growth. Couldn’t you sell the stock and then immediately repurchase shares in the same company while the price is still low? That way, you could claim the capital loss on your tax return and still own the stock.

Unfortunately, the IRS limits the use of this strategy. The tax law’s “wash-sale rule” prevents you from claiming a capital loss on a securities sale if you buy “substantially identical” securities within 30 days before or after the sale. To claim the loss, you’d have to wait more than 30 days after your sale to repurchase stock in the company.

To learn more about stock strategies and how they affects your taxes, give us a call today. Our staff of professionals are always happy to help.

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

What is Cost Basis and How does it Affect Your Investments

When you sell securities in a taxable investment account, you have to know your “basis” in the securities to determine whether you have a gain or a loss on the sale — and the amount. Generally, your basis is the price you paid for your shares of stock or a mutual fund, adjusted for any reinvested dividends or capital gain distributions, as well as for any costs of the purchase.

Although the cost basis calculation sounds straightforward enough, there’s more to the story.

Inherited and Gifted Securities

Though basis is usually derived from cost, inheritances are treated differently. Generally, the basis of inherited securities is reset at their date-of-death value.

With gifted securities, the person receiving the securities generally takes the basis of the person who gave them. However, if gift tax was paid, a basis adjustment may be necessary. And, if the securities’ fair market value on the date of the gift is less than their original cost, you use that lower value to determine any loss on a subsequent sale.

Stock Dividends and Splits

Instead of distributing cash dividends, companies sometimes distribute stock dividends. Stock dividends are generally not taxable. However, a basis adjustment needs to be made. If the new stock you receive is identical to the old stock — for example, you receive two new shares of XYZ common stock for each share of XYZ common stock you own — you simply divide the basis of your old stock by the total number of shares held after the distribution to arrive at your new basis for each share.

Stock splits also result in basis adjustments. For example, if a company has a “two-for-one split” of its stock, the original basis must be divided between the two new shares. Conversely, companies sometimes have “reverse splits,” such as when three shares are exchanged for one, in which case the basis in the original three shares is now the basis of the new share.

Keeping track of share basis through a series of mergers, spinoffs, etc., can be very complicated. Often, taxpayers must research the terms of the relevant transactions by contacting the company directly or logging on to the company’s website.

Selling Less Than Your Entire Holding

If you sell less than your entire holding in a particular stock and can adequately identify the shares you sold (“specific identification”), you may use their basis to determine your gain or loss. Adequate identification involves delivering the stock certificates to your broker or, if your broker holds the stock, telling your broker the particular stock to be sold and getting a written confirmation. If you can’t adequately identify the shares you sell, you may use the FIFO —“first in, first out” — method to determine your basis.

With mutual funds, you are also allowed to elect to use the “average basis” method of accounting for shares sold. With this method, the total cost of all the shares owned is divided by the total number of shares owned.

Tax-deferred and Tax-exempt Investments

Cost basis is generally not an issue with securities held in tax-deferred investment accounts, such as individual retirement accounts (IRAs) or employee retirement accounts. With these accounts, you are not taxed on capital gains but will be taxed at ordinary income-tax rates on distributions you receive. (Qualified Roth distributions are an exception.) Also note that though interest on municipal bonds may be tax exempt, any gain realized from selling such bonds is taxable, so it’s important to keep the information you’ll need to determine your basis.

Connect with our team today for all the latest and most current tax rules and regulations.

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).

How to Withdraw from Your IRA Without a Penalty

You didn’t think you’d have a problem keeping your savings in your traditional IRA until you reached age 59½. Unfortunately, though, you need to take money out of your account now. You’ll have to pay income taxes on your early withdrawal, but what about the additional 10% penalty tax? Can it be avoided?

 

The federal tax law does let taxpayers off the 10% penalty hook in certain situations.

  • Higher education. You may withdraw money from your IRA without penalty for the payment of tuition and other eligible higher education expenses. The student can be you, your spouse, your child, or your grandchild.
  • Withdrawals for the payment of medical expenses in excess of 10% of your adjusted gross income* may be penalty free (other restrictions apply), as may withdrawals for the payment of medical insurance premiums after you’ve received unemployment compensation for at least 12 weeks.
  • Withdrawals on account of your disability (inability to engage in anysubstantial gainful activity) are penalty free.
  • “First-time” home buyer. You may withdraw up to $10,000 (lifetime cap) for the acquisition of a first home. The buyer can be you, your spouse, your child, or your grandchild, and the term “first” is interpreted loosely — as long as two years have elapsed since the buyer (and spouse) last owned a principal residence, the new home is considered a first home.
  • If you are a reservist ordered or called to active duty after September 11, 2001, withdrawals during the period beginning on the date of the order or call to active duty and ending at the close of your active duty period may be penalty free.
  • IRS levy. The penalty doesn’t apply to withdrawals on account of an IRS tax levy on your IRA.
  • Periodic payments. Taking a series of substantially equal periodic (at least annual) payments based on life expectancy will avoid the penalty.

 

Give us a call today, so we can help you determine the right course of action for you.

 

* 7.5% of adjusted gross income if age 65 or over.

Plan Ahead to Make the Most of Your Retirement Savings

You’ve worked, you’ve saved, and now you’re ready to start enjoying some of the money you’ve set aside for your retirement years. Planning ahead can help you make the most of your savings.

Weigh Your Options

If you participate in a traditional pension plan, you’ll generally have at least two payment choices: to collect benefits over your lifetime only or to collect a reduced monthly “joint and survivor” benefit for your life and the life of your spouse. Make this choice carefully.

While the simple lifetime benefit pays a larger sum each month, benefits stop at your death, potentially leaving your surviving spouse with insufficient income. With either option, the pension benefits you receive generally will have to be included in your income for tax purposes, so you will want to base your planning on projections of your income net of taxes.

401(k) plans and most other retirement savings plans sponsored by employers typically allow participants to withdraw their vested account balances in a lump sum at retirement. Your plan may provide additional payout options as well. As with a traditional pension, the money distributed from the plan is taxable to you in the year you receive it, except to the extent the distribution is attributable to after-tax contributions or is a qualified distribution from a designated Roth 401(k), 403(b), or 457 account.

Consider a Rollover

You can continue to defer taxes on an eligible distribution from a tax-deferred retirement savings plan by rolling the distribution over into an individual retirement account (IRA). A properly executed IRA rollover delays taxes on your savings and on IRA investment earnings until you take money out of the IRA.

Usually, the longer you can defer taxes, the better. In certain situations, however, it can make more sense to receive a plan distribution, even though you’ll have to pay taxes on the distribution that year.

For example, if a lump sum distribution will include appreciated company stock, taking the distribution may be your best alternative because you’ll be taxed only on the stock’s cost, not its appreciated value. Then, if you realize a gain on a subsequent sale of the stock, you’ll pay taxes on the gain at a favorable capital gains tax rate. Rolling the stock into an IRA means you’ll lose the benefit of the lower capital gains rate because allIRA distributions are taxed at your ordinary tax rate.

Take All Required Distributions

After you reach age 70½, you will have to begin taking annual required minimum distributions (RMDs) from your IRA. (This rule does not apply to a Roth IRA.) If you are retired and still have money in an employer-sponsored qualified plan when you reach age 70½, you’ll also have to start taking annual minimum distributions from that plan. If you continue to work for the plan sponsor after age 70½, minimum distributions do not have to be taken while you are still employed unless you are a 5% owner.

Failure to take a required minimum distribution can be costly. The IRS can assess a 50% excise tax on the amount of the shortfall. So, for example, a missed distribution of $10,000 could cost a forgetful taxpayer a $5,000 penalty.

Taxes may play a significant role in your retirement income planning. Give us a call. We’d be happy to review your situation with you.

…from the Team of Professional at RE-MMAP We are just a click or call away. www.re-mmap.com and phone # (561-623-0241).