Category: IRA

Understanding IRAs

May 11, 2022
Investing, IRA

An individual retirement arrangement (IRA) is a personal savings plan that offers specific tax benefits. IRAs are one of the most powerful retirement savings tools available to you. Even if you’re contributing to a 401(k) or other plan at work, you might also consider investing in an IRA.

What types of IRAs are available?

The two major types of IRAs are traditional IRAs and Roth IRAs. Both allow you to contribute as much as $6,000 in 2022 (unchanged from 2021). You must have at least as much taxable compensation as the amount of your IRA contribution. But if you are married filing jointly, your spouse can also contribute to an IRA, even if he or she has little or no taxable compensation, as long as your combined compensation is at least equal to your total contributions. The law also allows taxpayers age 50 and older to make additional “catch-up” contributions. These folks can contribute up to $7,000 in 2022.

Both traditional and Roth IRAs feature tax-sheltered growth of earnings. And both give you a wide range of investment choices. However, there are important differences between these two types of IRAs. You must understand these differences before you can choose the type of IRA that’s best for you.

Note: Special rules apply to certain reservists and national guardsmen called to active duty after September 11, 2001.

Learn the rules for traditional IRAs

Practically anyone can open and contribute to a traditional IRA. You can contribute the maximum allowed each year as long as your taxable compensation for the year is at least that amount. If your taxable compensation for the year is below the maximum contribution allowed, you can contribute only up to the amount that you earned.

Your contributions to a traditional IRA may be tax deductible on your federal income tax return. This is important because tax-deductible (pre-tax) contributions lower your taxable income for the year, saving you money in taxes. If neither you nor your spouse is covered by a 401(k) or other employer-sponsored plan, you can generally deduct the full amount of your annual contribution. If one of you is covered by such a plan, your ability to deduct your contributions depends on your annual income (modified adjusted gross income, or MAGI) and your income tax filing status:

For 2022, if you are covered by a retirement plan at work, and:

Your filing status is single or head of household, and your MAGI is $68,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $68,000 and less than $78,000, and you can’t deduct your contribution at all if your MAGI is $78,000 or more.
Your filing status is married filing jointly or qualifying widow(er), and your MAGI is $109,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $109,000 and less than $129,000, and you can’t deduct your contribution at all if your MAGI is $129,000 or more.
Your filing status is married filing separately, your traditional IRA deduction is reduced if your MAGI is less than $10,000, and you can’t deduct your contribution at all if your MAGI is $10,000 or more.

For 2022, if you are not covered by a retirement plan at work, but your spouse is, and you file a joint tax return, your traditional IRA contribution is fully deductible if your MAGI is $204,000 or less. Your deduction is reduced if your MAGI is more than $204,000 and less than $214,000, and you can’t deduct your contribution at all if your MAGI is $214,000 or more.

What happens when you start taking money from your traditional IRA? Any portion of a distribution that represents deductible contributions is subject to income tax because those contributions were not taxed when you made them. Any portion that represents investment earnings is also subject to income tax because those earnings were not previously taxed either. Only the portion that represents nondeductible, after-tax contributions (if any) is not subject to income tax. In addition to income tax, you may have to pay a 10% early withdrawal penalty if you’re under age 59½, unless you meet one of the exceptions. You must aggregate all of your traditional IRAs — other than inherited IRAs — when calculating the tax consequences of a distribution.

If you wish to defer taxes, you can leave your funds in the traditional IRA, but only until April 1 of the year following the year you reach age 72. That’s when you have to take your first required minimum distribution (RMD) from the IRA.¹ After that, you must take an RMD by the end of every calendar year until you die or your funds are exhausted. The annual distribution amounts are based on a standard life expectancy table. You can always withdraw more than you’re required to in any year. However, if you withdraw less, you’ll be hit with a 50% penalty on the difference between the required minimum and the amount you actually withdraw.

Learn the rules for Roth IRAs

Not everyone can set up a Roth IRA. Even if you can, you may not qualify to take full advantage of it. The first requirement is that you must have taxable compensation. If your taxable compensation in 2022 is at least $6,000, you may be able to contribute the full amount. But it gets more complicated. Your ability to contribute to a Roth IRA in any year depends on your MAGI and your income tax filing status:

If your filing status is single or head of household, and your MAGI for 2022 is $129,000 or less, you can make a full contribution to your Roth IRA. Your Roth IRA contribution is reduced if your MAGI is more than $129,000 and less than $144,000, and you can’t contribute to a Roth IRA at all if your MAGI is $144,000 or more.
If your filing status is married filing jointly or qualifying widow(er), and your MAGI for 2022 is $204,000 or less, you can make a full contribution to your Roth IRA. Your Roth IRA contribution is reduced if your MAGI is more than $204,000 and less than $214,000, and you can’t contribute to a Roth IRA at all if your MAGI is $214,000 or more.
If your filing status is married filing separately, your Roth IRA contribution is reduced if your MAGI is less than $10,000, and you can’t contribute to a Roth IRA at all if your MAGI is $10,000 or more.

Your contributions to a Roth IRA are not tax deductible. You can invest only after-tax dollars in a Roth IRA. The good news is that if you meet certain conditions, your withdrawals from a Roth IRA will be completely income tax free, including both contributions and investment earnings. To be eligible for these qualifying distributions, you must meet a five-year holding period requirement. In addition, one of the following must apply:

You have reached age 59½ by the time of the withdrawal
The withdrawal is made because of disability
The withdrawal is made to pay first-time home-buyer expenses ($10,000 lifetime limit)
The withdrawal is made by your beneficiary or estate after your death

Qualified distributions will also avoid the 10% early withdrawal penalty. This ability to withdraw your funds with no taxes or penalties is a key strength of the Roth IRA. And remember, even nonqualified distributions will be taxed (and possibly penalized) only on the investment earnings portion of the distribution, and then only to the extent that your distribution exceeds the total amount of all contributions that you have made. You must aggregate all of your Roth IRAs — other than inherited Roth IRAs — when calculating the tax consequences of a distribution.

Another advantage of the Roth IRA is that there are no required distributions. You can put off taking distributions until you really need the income. Or, you can leave the entire balance to your beneficiary without ever taking a single distribution.

Choose the right IRA for you

Assuming you qualify to use both, which type of IRA is best for you? Sometimes the choice is easy. The Roth IRA will probably be a more effective tool if you don’t qualify for tax-deductible contributions to a traditional IRA. However, if you can deduct your traditional IRA contributions, the choice is more difficult. The Roth IRA may very well make more sense if you want to minimize taxes during retirement and preserve assets for your beneficiaries. But a traditional deductible IRA may be a better tool if you want to lower your yearly tax bill while you’re still working (and probably in a higher tax bracket than you’ll be in after you retire). A financial professional or tax advisor can help you pick the right type of IRA for you.

Note: You can have both a traditional IRA and a Roth IRA, but your total annual contribution to all of the IRAs that you own cannot be more than $6,000 for 2022 ($7,000 if you’re age 50 or older).

Know your options for transferring your funds

You can move funds from an IRA to the same type of IRA with a different institution (e.g., traditional to traditional, Roth to Roth). No taxes or penalty will be imposed if you arrange for the old IRA trustee to transfer your funds directly to the new IRA trustee. The other option is to have your funds distributed to you first and then roll them over to the new IRA trustee yourself. You’ll still avoid taxes and the penalty as long as you complete the rollover within 60 days from the date you receive the funds.

You may also be able to convert funds from a traditional IRA to a Roth IRA. This decision is complicated, however, so be sure to consult a tax advisor. He or she can help you weigh the benefits of shifting funds against the tax consequences and other drawbacks.

Note: The IRS has the authority to waive the 60-day rule for rollovers under certain limited circumstances, such as proven hardship.

¹If you reached age 72 before July 1, 2021, you will need to take an RMD by December 31, 2021.

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

RMDs are Back on Track for 2021

January 14, 2021
IRA, IRS, Retirement, Taxes, Uncategorized

The year 2020 was one of the most eventful in recent times, and the changes to the rules that govern retirement accounts were no exception. One of those changes was the waiver of required minimum distributions (RMDs) for 2020. As a result of the waiver, you were not required to take RMDs from your IRA for 2020. But if you are of RMD age in 2021, you must resume RMDs for 2021 and continue for every year after. RMDs were waived for beneficiary IRAs as well and will need to resume in 2021 for certain beneficiaries.

Reminder: RMDs do not apply to Roth IRA owners.

RMDs- A Mild Refresher An RMD is a minimum amount that you must distribute (or withdraw) from your retirement account for any RMD year. You can always distribute more if you want to; however, a distribution of less than your RMD amount will result in you owing the IRS an excess accumulation penalty of 50% of the RMD shortfall. For example, if your RMD for 2021 is $20,000 and your 2021 IRA distributions total only $12,000, you will owe the IRS an excess accumulation penalty of $4,000 [($20,000 – $12,000) x 50%]. If you are required to take an RMD for 2021, your IRA custodian will send you an RMD notice by January 31, 2021. This will include your calculated RMD amount or an offer to calculate the amount upon request. This requirement does not apply to Beneficiary IRAs.

New RMD Age- A Reminder: The Setting Every Community Up for Retirement Enhancement (SECURE) Act, a new law passed in 2019, increased the RMD beginning age for IRA owners from age 70 ½ to age 72. As a result of this change, any IRA owner who reached age 70 ½ by December 31, 2019 – those born June 30, 1949, or earlier – must begin taking RMDs for the year he or she reaches age 70 ½ and continue for every year thereafter (except for 2020- where RMDs are waived). IRA owners who reach age 70 ½ after December 31, 2019, must begin RMDs for the year they reach age 72.

Who Must Take RMDs for 2021 Whether you must take an RMD from your IRA for 2021 depends on factors that include whether it is your own IRA and your age in 2021, or if it is a beneficiary IRA, and if so, when the IRA was inherited.

RMDs for Your own IRAs For 2021, For 2021, you must take an RMD from your own (non-beneficiary) IRA if you were 70 ½ or older on December 31, 2019, as you would have already started your RMDs and are required to continue. You would also be required to take an RMD for 2021 if you were born at any time in 1949 or earlier, as this means that you would be at least age 72 on December 31, 2021. If you were born in 1950 and after, you would not be subject to RMDs for 2021 because you would not have reached age 70 ½ by December 31, 2019 and you would be under age 72 as of December 31, 2021.

RMDs For Your Beneficiary IRAs – Including Beneficiary Roth IRAs

For beneficiary IRAs, whether you must take an RMD for 2021 depends on several factors, which starts with when you inherited the IRA.

If you inherited the IRA before 2020: If you inherited the IRA before 2020- including a Roth IRA, you must take an RMD for 2021 if:

Your beneficiary IRA must be distributed within five years (the 5-year rule), and the IRA was inherited in 2015. This is because 2020 was not counted due to the RMD waiver, making 2021 year 5 of the 5-year period.

2016

2017

2018

2019

2021

Under the 5-year rule, distributions are optional until the end of the 5^th year that follows the year the IRA owner died, at which time the entire account must be distributed.

Your distributions are taken under the life-expectancy rule. Under this option, you must take a beneficiary RMD for every year that follows the year in which the IRA owner died (except for 2020).

Please note: If you are the surviving spouse of the IRA owner, exceptions could apply. For example, if the IRA owner would have reached age 70 ½ after 2021, you would not need to start RMDs until the year your spouse would have reached age 70 ½. Also, the owner rules above would apply if the spouse beneficiary elects to move the assets to his or her own IRA.

If you inherited the IRA in 2020: If you inherited the IRA in 2020- including a Roth IRA, you must take an RMD for 2021 if you are an eligible designated beneficiary, and you are taking distributions over your life expectancy. You are an eligible designated beneficiary if:

You are the surviving spouse of the IRA owner. But, the owner rules above apply if you elect to treat the IRA as your own, instead of electing the beneficiary IRA option.

You are disabled

You are chronically ill

You are a minor, as defined under state law

You are none of the above, but you are not more than 10-years younger than the IRA owner.

In other cases, distributions for 2021 are optional.

Spouse beneficiary caveat: If you are the surviving spouse of the IRA owner and you elect to keep the funds in a beneficiary IRA, you would not need to take RMDs for 2021, if your spouse would reach age 72 in a later year.

Professional Assistance Helps To Avoid Penalties

The rules explained above are complicated and professional assistance is often needed to ensure that any caveats are properly applied, thus avoiding the risk of IRS penalties. For instance, consider that your IRA custodian is permitted to make assumptions that could cause your RMD calculations to be incorrect. Therefore, even though your IRA custodian will calculate RMDs for your IRAs, it is still practical to have a professional review those calculations.

Additionally, you might need to take RMDs from accounts under employer plans such as 401(k) and 403(b) plans. If you have assets under an employer plan, contact the plan administrator or your HR department regarding their RMD policies to determine if they will automatically distribute your RMDs or if you are required to submit RMD instructions. If you plan to roll over amounts from these accounts, contact us for help with ensuring that RMD amounts are not included in any rollover.

Please do not hesitate to contact us with questions about this and any other matters related to your IRAs and employer plan accounts. To learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com

CapSouth Partners, Inc., dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences.

6 Key Areas of a Financial Strategy

October 20, 2020
IRA, Taxes

When training to become a financial professional, much of the course work centers on the six critical areas of creating a financial strategy. Some recognize October as Financial Planning Month, so it’s an excellent time to review those six personal finance areas of a financial strategy.¹

Cash Management:
This an important part of a financial strategy and is a broad topic that can address many issues. One area is creating an emergency fund, which is money that’s set aside for unplanned expenses. Cash management also can include looking at your “sources and uses” of money. Financial Planning Month focuses mainly on cash management and spending habits.¹
Investment Approaches:
Concerns about investment approaches are among the key reasons people start a relationship with a financial professional. When reviewing investment approaches, it’s critical to consider a person’s goals, time horizon, and risk tolerance.
Retirement Preparation:
This is another crucial reason why a person approaches a financial professional. The chief concern for 49 percent of Americans is running out of money in retirement. The retirement preparation process reviews your current situation and helps you better understand your choices.²
Protection Strategies:
This area looks at how well you are prepared for life’s potential financial risks such as premature death or permanent disability. Protection strategies also can include health-care considerations. By the way, did you know that 44 percent of Americans cite “declining health” as their second biggest retirement concern?²
Tax Management:
Do you feel comfortable with current tax laws? Are you confident about your approach to tax management? Tax rules are constantly changing, and there is no guarantee that the tax landscape will remain the same in years ahead. Financial professionals often work with tax, legal, or accounting professionals when creating an overall tax management strategy.
Estate Strategies:
How well you prepare today may help determine how your assets are distributed after you’re gone. Much like tax rules, estate rules are continually changing, and today’s landscape may change in a few years. Financial professionals often work with legal professionals when creating an estate approach. It can be a challenge to feel confident in all six key areas of creating a financial strategy. If you think you may need help, contact CapSouth Wealth Management at 800.929.1001 or visit our website at www.capsouthwm.com or https://capsouthwm.com/services/financial-estate-planning/ We’d welcome the chance to review your approach.

^{1. NationalDayCalendar.com, October 2020} ^{2. AARP.com, May 21, 2019}

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG, LLC, is not affiliated with CapSouth Wealth Management. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Copyright 2020 FMG Suite.