Tag: Retirement planning

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.

IRA Strategy #1

March 10, 2022
Uncategorized

The 50/50 Minimum Strategy: Maintain 50% of your 401(k) and IRA money in Roth accounts

Why pay taxes today when you can postpone them until years later? The obvious answer is to delay paying taxes as long as possible. But sometimes the obvious answer is not the best answer. Let’s consider several assumptions that support the 50/50 Minimum Strategy.

First, if one invests the money that would have gone to taxes, it should compound over time and the total investments, less the eventual taxes to be paid, would potentially be greater than the amount of the Roth conversion, plus earnings. The problem with this is most people will not diligently invest the money that would have gone to pay the tax. It is more easily spent in the normal household budget. And even if it were invested, the potential to keep it invested over a long period of time is dependent on many variables.

Second is the assumption that a person’s income will be lower in retirement. This is true for many taxpayers. However, many of our clients remain in a high tax bracket after retirement. This is especially true if one has large IRA balances that require minimum distributions combined with large investment accounts that create capital gains.

Third is the assumption that tax rates will remain relatively stable over time. This is the most dangerous assumption. Congress has the power to change the tax rates at any time and with the skyrocketing budget and related government debt, it appears likely that tax rates will be higher in the future. So, even if one’s income is lower, the tax rate could be higher.

How high could tax rates go? The following chart provides a history of the highest marginal tax rate for 1944 through 2022 for married couples filing jointly:

Years Highest Marginal Rate# Taxable Income Over#

1944 through 1951 91% $200,000 (1950)

1952 through 1953 92% $300,000 (1953)

1954 through 1963 91% $300,000 (1958)

1964 77% $200,000 (1964)

1965 through 1981 70% $180,000 (1974)

1982 through 1986 50% $108,300 (1984)

1987 38.5% $80,000 (1987)

1988 through 1990 28% (Bubble Rate 33%) $78,400 (1988)

1991 through 1992 31% $70,450 (1991)

1993 through 2000 39.6% $288,350 (2000)

2001 39.1% $297,350 (2001)

2002 38.6%$ $307,050(2002)

2003 through 2012 35% $388,350 (2012)

2013 through 2017 39.6% $444,550 (2017)

2018 through 2022 37.0% $647,850 (2022)

# Rate for Married Couples Filing Jointly

Information provided by The Tax Foundation, Washington, DC. 20005

The strategy that we have continued to recommend to most of our clients is to approach retirement with a minimum of 50% of their IRA and 401(k) assets held in Roth accounts. With this approach, an investor takes a balanced approach to the payment of taxes. Pay taxes at the rates in effect now on the Roth contributions and conversion amounts while delaying the taxes on the non-Roth portion of their deferrals or contributions. If we err on one side or the other, we prefer to convert more of the retirement assets and pay the taxes at today’s rates as opposed to leaving these assets subject to whatever future rate Congress enacts.

If a client is charitably minded, we do not recommend converting ALL your IRA assets. The preferred use of a portion of your IRA assets is to process Qualified Charitable Distributions (QCD) with the pre-tax IRA assets. After age 70.5, taxpayers may donate money directly from their IRA to qualified charities utilizing the QCD provisions. The annual limit on QCD donations is currently $100,000.

ACTION: Consider adopting the strategy of working towards a minimum Roth balance of 50% of your total retirement assets by your retirement date. Work with your financial advisor to determine if you should convert a higher percentage.

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.

By: Donald P. Bolden, CFP®, CLU & Lewis Robinson, CPA

Retirement Seen Through Your Eyes

August 5, 2021
Uncategorized

How do you picture your future? Some see retirement as a time to start a new career. Others see it as a time to travel. Still others plan to spend more time with family and friends. With that in mind, here are some things to consider.

What do you absolutely need to accomplish? If you could only get four or five things done in retirement, what would they be? Answering this question might lead you to compile a “short list” of life goals, and while they may have nothing to do with money, the financial decisions you make may be integral to pursuing them.

What would revitalize you? Some people retire with no particular goals at all. After weeks or months of respite, ambition may return. They start to think about what pursuits or adventures they could embark on to make these years special. Others have known for decades what dreams they will follow … and yet, when the time to follow them arrives, those dreams may unfold differently than anticipated and may even be supplanted by new ones.

In retirement, time is really your most valuable asset. With more free time and opportunity for reflection, you might find your old dreams giving way to new ones.

Who should you share your time with? Here is another profound choice you get to make in retirement. The quick answer to this question for many retirees would be “family.” Today, we have nuclear families, blended families, extended families; some people think of their friends or their employees as family.

How much do you anticipate spending? We can’t control all retirement expenses, but we can manage some of them. The thought of downsizing your home may have crossed your mind. One benefit of downsizing is that it can potentially lead to no mortgage or a more manageable mortgage payment.

Could you leave a legacy? Many of us would like to give our kids or grandkids a good start in life, but leaving an inheritance can be trickier than many realize. Tax laws are constantly changing, and the strategies that worked years ago may have more limited benefits today.

How are you preparing for retirement? This is the most important question of all. If you feel you need to prepare more for the future or reexamine your existing strategy in light of recent changes in your life, conferring with a financial professional experienced in retirement approaches may offer some guidance.

To learn more about CapSouth Wealth Management visit our website at www.capsouthwm.com or www.capsouthwm.com/services/financial-estate-planning/

Keep in mind this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax or legal professional before modifying any part of your overall estate strategy.

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. This material has been prepared for planning purposes only and is not intended as specific tax or legal advice. Tax and legal laws are often complex and frequently change. Please consult your tax or legal advisor to discuss your specific situation before making any decisions that may have tax or legal consequences.

This article contains external links to third party content (content hosted on sites unaffiliated with CapSouth Partners). The policies and procedures governing these third-party sites may differ from those effective on the CapSouth company website, as outlined in these Disclaimers. As such, CapSouth makes no representations whatsoever regarding any third-party content/sites that may be accessible directly or indirectly from the CapSouth website. Linking to these third-party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.