7 Missed IRA Opportunities

Individual Retirement Account (IRA) is the cornerstone of retirement planning, yet so many people miss opportunities to fund an IRA because they don’t realize they are eligible. With the great tax benefits of IRAs, you might want to consider funding yours every year that you can. Here are seven situations where many people don’t realize they could fund an IRA.

1. Spousal IRA. Even if a spouse does not have any earned income, they are eligible to make a Traditional or Roth IRA contribution based on the household income. Generally, if one spouse is eligible for a Roth IRA, so is the non-working spouse. In some cases, the non-working spouse may be eligible for a Traditional IRA contribution even when their spouse is ineligible because they are covered by an employer plan and their income is too high.  

2. No employer sponsored retirement plan. If you are single and your employer does not offer a retirement plan (or if you are married and neither of you are covered by an employer plan), then there are NO income limits on a Traditional IRA. You are always eligible for the full contribution, regardless of your household income. Note that this eligibility is determined by your employer offering you a plan and your being eligible, and not your participation. If the plan is offered, but you choose not to participate, then you are considered covered by an employer plan, which is number 2:

3. Covered by a employer plan. Here’s where things get tricky. Anyone can make a Traditional IRA contribution regardless of your income, but there are rules about who can deduct their contribution. A tax-deductible contribution to your Traditional IRA is greatly preferred over a non-deductible contribution. If you cannot do the deductible contribution, but you can do a Roth IRA (number 4), never do a non-deductible contribution. Always choose the Roth over non-deductible. The limits listed below do not mean you cannot do a Traditional IRA, only that you cannot deduct the contributions.

If you are covered by your employer plan, including a 401(k), 403(b), SIMPLE IRA, pension, etc., you are still be eligible for a Traditional IRA if your Modified Adjusted Gross Income (MAGI) is below these levels for 2018:

  • Single: $63,000
  • Married filing jointly: $101,000 if you are covered by an employer plan
  • Married filing jointly: $189,000 if your spouse is covered at work but you are not (this second one is missed very frequently!)

Your Modified Adjusted Gross Income cannot be precisely determined until you are doing your taxes. Sometimes, there are taxpayers who assume they are not eligible based on their gross income, but would be eligible if they look at their MAGI.

4. Roth IRA. The Roth IRA has different income limits than the Traditional IRA, and these limits apply regardless of whether you are covered by an employer retirement plan or not. (2018 figures) 

  • Single: $120,000
  • Married filing jointly: $189,000

5. Back-door Roth IRA. If you make too much to contribute to a Roth IRA, and you do not have any Traditional IRAs, you might be able to do a “Back-Door Roth IRA”, which is a two step process of funding a non-deductible Traditional IRA and then doing a Roth Conversion. We’ve written about the Back Door Roth several times, including here.

6. Self-Employed. If you have any self-employment income, or receive a 1099 as an independent contractor, you may be eligible for a SEP-IRA on that income. This is on top of any 401(k) or other IRAs that you fund. It is possible for example, that you could put $18,500 into a 401(k) for Job A, But this is more like a series of popular online friv games than what is described above. contribute $5,500 into a Roth IRA, and still contribute to a SEP-IRA for self-employed Job B.

There are no income limits to a SEP contribution, but it is difficult to know how much you can contribute until you do your tax return. The basic formula is that you can contribute 20% of your net income, after you subtract your business expenses and one-half of the self-employment tax. The maximum contribution to a SEP is $55,000, and with such high limits, the SEP is essential for anyone who is looking to save more than the $5,500 limit to a Traditional or Roth IRA. 
Learn more about the SEP-IRA.

7. Tax Extension. For the Traditional and Roth IRA, you have to make your contribution by April 15 of the following year. If you do a tax extension, that’s fine, but the contributions are still due by April 15. However, the SEP IRA is the only IRA where you can make a contribution all the way until October 15, when you file an extension. 

Bonus #8: If you are over age 70 1/2, you generally cannot make Traditional IRA contributions any longer. However, if you continue to have earned income, you may still fund a Roth IRA after this age.

A few notes: For 2018, contribution limits for Roth and Traditional are $5,500 or $6,500 if over age 50. For 2019, this has been increased to $6,000 and $7,000. You become eligible for the catch-up contribution in the year you turn 50, so even if your birthday is December 31, you are considered 50 for the whole year. Most of these income limits have a phase-out, and I’ve listed the lowest level, so if your income is slightly above the limit, you may be eligible for a reduced contribution. 

Retirement Planning is our focus, so we welcome your IRA questions! We want to make sure you don’t miss an opportunity to fund an IRA each and every year that you are eligible. 

Do You Know Your Spouse’s Beneficiary Designations?

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Beneficiary designations are important. The people you list on your IRAs, retirement plans, and life insurance policies will receive those monies regardless of the instructions in your will. What happens when you don’t indicate a beneficiary or if the beneficiary has predeceased you? In that case, the estate is named as the beneficiary of the account.

It is usually much better if you have a person indicated as the beneficiary rather than the estate, for the following reasons:

  1. If a person is the beneficiary, they can receive the assets very quickly by completing a distribution form and providing a copy of the death certificate. When the estate is the beneficiary, you may tie up the assets in probate court for months, or even years.
  2. A person can roll an inherited IRA into a Stretch IRA and keep the account tax-deferred. The beneficiary is required to continue taking Required Minimum Distributions, but even doing so, the IRA can last for many years. When a spouse is the beneficiary of an IRA, he or she can roll the assets into their own IRA and treat it as their own. By spreading distributions over many years, taxes may be lower than if you took a large distribution all in one year and are pushed into a higher tax bracket.
  3. When the estate is the beneficiary, they do not have the option for a Stretch IRA. They can either distribute the IRA immediately or over 5 years. Either way, the estate will be paying taxes sooner than if the beneficiary was a person.
  4. The tax rate on estates can be much higher than for individuals. An estate or trust will pay the maximum rate of 39.6% on income over $12,400 whereas a married couple would hit this tax rate only on taxable income that exceeds $466,950 (2016 rates).

For many individuals, a substantial portion of their estate may be in IRAs, retirement plans, life insurance and annuities, where the beneficiary designation is vitally important. In the last two months, the IRS has issued two Private Letter Rulings (PLR) specifically on beneficiary designations and the rights of surviving spouses. A PLR is official guidance from the IRS on how they interpret and enforce tax law, based on specific cases which are brought to the IRS.

In PLR 201618011, a spouse did not indicate any beneficiaries on her IRA. When she passed away, the absence of a beneficiary designation meant that the estate would be the beneficiary of the IRA. The husband was the sole beneficiary and executor of the estate under her will. The IRS ruled that in this scenario, the surviving spouse has the right to rollover the inherited IRA and treat it as his own, even though the decedent failed to designate a beneficiary. This exception is granted only for surviving spouses and does not apply to other beneficiaries, such as children.

On June 3, the IRS issued PLR 201623001, which is of particular interest to Texas residents as it deals with community property issues for married couples. (Texas is one of nine states with Community Property laws.) A man listed his son as the sole beneficiary of his three IRAs. He passed away and his wife claimed that she should be entitled to one-half of the IRA assets because they were community property of the marriage. The IRS ruled that Federal Law takes precedence over state law and rejected her claim.

Both of these rulings show how important it is to know your spouse’s beneficiary designations on all of their accounts. Even if you have a will that is up to date and perfectly legal, it won’t help you if you don’t indicate a beneficiary, or indicate the wrong person. Review your beneficiary designations every couple of years and especially if you have gotten married, divorced, or had births or deaths in your family.

Beneficiary designations are not exciting or complicated. However, a big part of financial planning is getting organized and taking care of these small details. If your beneficiary designations are wrong, it could have a major impact on your heirs and cost thousands in additional, unnecessary taxes.

The Saver’s Tax Credit

Since most employers today no longer provide defined benefit pension plans for their employees, the burden of retirement saving has shifted to the employee. Not surprisingly, saving for retirement is a pretty low priority for the many Americans who are focused on how they are going to pay this month’s bills.

Self Employed? Discover the SEP-IRA.

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The SEP-IRA is a terrific accumulation tool for workers who are self-employed, have a family business, or who have earnings as a 1099 Independent Contractor. SEP stands for Simplified Employee Pension, but the account functions similar to a Traditional IRA. Money is contributed on a pre-tax basis, and then withdrawals in retirement are taxable. Distributions taken before age 59 1/2 may be subject to a 10% penalty.

Qualified Charitable Distributions From Your IRA

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For several years, taxpayers have had an opportunity to make Qualified Charitable Distributions, or QCDs, from their IRA. This was originally offered for just one year and then subsequently was renewed each December, an uncertainty which made it difficult and frustrating for planners like myself to advise clients. Luckily, this year Congress made the QCD permanent. Here is what it is, who it may benefit, and how to use it.

A QCD is a better way to give money to charity by allowing IRA owners to fulfill their Required Minimum Distribution with a charitable donation. To do a QCD, you must be over age 70 1/2 at the time of the distribution, and have the distribution made payable directly to the charity.

If you are over 70 1/2, you must take out a Required Minimum Distribution from your IRA each year, and this distribution is reported as taxable income. When you make a qualified charitable contribution, you can deduct that amount from your taxes, through an itemized deduction. The QCD takes those two steps – an IRA distribution and a charitable contribution – and combines them into one transaction which can fulfill your RMD requirement while not adding to your Adjusted Gross Income (AGI) for the year.

The maximum amount of a QCD is $100,000 per person. A married couple can do $100,000 each, but cannot combine or share these amounts. For most IRA owners, they will likely keep their QCD under the amount of their RMD. However, it is possible to donate more than your RMD, up to the $100,000 limit. So if your goal is to leave your IRA to charity, you can now transfer $100,000 to that charity, tax-free, every year.

The confusing thing about the QCD is that for some taxpayers, there may be no additional tax benefit. That is to say, taking their RMD and then making a deductible charitable contribution may lower their taxes by exactly the same amount as doing a QCD. Who will benefit from a QCD, then? Here are five situations where doing a QCD would produce lower taxes than taking your RMD and making a separate charitable contribution:

1) To deduct a charitable contribution, you have to itemize your deductions. If you take the standard deduction (or would take the standard deduction without charitable giving), you would benefit from doing a QCD instead. That’s because under the QCD, the transaction is never reported on your AGI. Then you can take your standard deduction ($6,300 single, or $12,600 married, for 2016) and not have to itemize.

2) If you have a high income and your itemized deductions are reduced or phased out under the Pease Restrictions, you would benefit from doing a QCD. The Pease Restriction reduces your deductions by 3% for every $1 of income over $259,400 single, or $311,300 married (2016), up to a maximum reduction of 80% of your itemized deductions.

3) If you are subject to the Alternative Minimum Tax (AMT). The AMT frequently hits those who have high itemized deductions. With the QCD, we move the charitable contributions from being an itemized deduction to a direct reduction of your AGI.

4) If you are subject to the 3.8% Medicare Surtax on investment income. While IRA distributions are not part of Net Investment Income, they are part of your AGI, which can push other income above the $200,000 threshold ($250,000, married) subject to this tax.

5) If your premiums for Medicare Parts B and D are increased due to your income, a QCD can reduce your AGI.

You can make a QCD from a SEP or SIMPLE IRA, provided you are no longer making contributions to the account. You can also make a QCD from a Roth IRA, but since this money could be withdrawn tax-free, it would be preferable to make the QCD from a Traditional IRA. 401(k), 403(b), and other employer sponsored plans are not eligible for the QCD. If you want to do the QCD, you would need to rollover the account to an IRA first.

Charitable giving is close to our heart here at Good Life Wealth Management. We believe that true wealth is having the abilit