Life Events & Tax Planning – Part VII: Planning for Retirement
It’s no secret that retirement planning is important, though too often it’s not necessarily something we think about quite as early as we should. Aside from simply wanting to live comfortably later in life, there are a number of reasons why it’s important to plan and save for retirement. Unforeseen medical expenses, the uncertainty of social security benefits, the benefits of tax-deferred saving and better quality of life are some key reasons to put your resources into strategic retirement planning.
Whether you work at a corporation with a robust retirement plan for its employees, a small or mid-sized business with fewer bells and whistles—or are self-employed—there are a number of options available based on your specific needs to help you optimize your retirement planning process. As a starting point, it is important to understand the different types of retirement plans and accounts, as well as the benefits, limitations and requirements of each.
REQUIRED MINIMUM DISTRIBUTIONS & RETIREMENT PLANS
REQUIRED MINIMUM DISTRIBUTIONS (RMD’S)
A Required Minimum Distribution (RMD) refers to the amount that certain retirement plan owners and qualified plan contributors must begin withdrawing from their accounts after age 70 ½. It’s crucial to understand that RMD withdrawals are something that’s required of you after this age—whether you need the money or not. If you do not take your RMD, or if you take too little an amount, you might get hit with an excise tax equal to 50% of the amount not distributed.
If you do not need the money from your qualified retirement account at the beginning date of your RMD, there are a number of RMD options available for you to avoid the excise tax. These include investment in non-IRA/non-retirement accounts, contributing to a donor-advised fund account and contributing to an education savings plan.
TRADITIONAL INDIVIDUAL RETIREMENT ACCOUNTS (IRA’S)
Traditional Individual Retirement Accounts (“IRA’s”) allow you to invest pre-tax income toward investments that grow tax-deferred, meaning no investment income is taxed until the date it is withdrawn. The required beginning date for distributions from an IRA is April 1 of the year after the year in which you reach age 70 ½ (i.e. if you were to reach age 70 ½ on December 1, 2017, your required beginning distribution date would be April 1, 2018).
The 2018 required minimum distribution (“RMD”) must be made by April 1, 2019—but don’t wait until the last minute to take your first RMD! If you end up taking two RMD’s during the same calendar year, you might get stuck with more taxable income than you had planned for.
Annual distributions are calculated by taking the total value of the IRA as of December 31 for the previous year, and multiplying it by an “age-factor,” defined by the IRS in its RDA Uniform Lifetime Table. If you made any nondeductible contributions during your working years, you will have basis in your IRA, and a portion of the distributions will not be taxable.
Another way to satisfy the RMD from your traditional IRA is through a Qualified Charitable Distribution (“QCD”), a transfer directly from your IRA to a charitable organization. The QCD is not taxable to the IRA owner, nor is the owner entitled to the charitable contribution deduction. The current maximum annual QCD is $100,000; if you file a joint return, your spouse can also make a $100,000 QCD. With some taxpayers now unable to receive benefit for certain itemized deductions under the new tax legislation, the QCD is even more attractive than before.
A 401(k) is simply a retirement savings plan sponsored by an employer through which employees allocate a portion of their paychecks into the account pre-tax. Similar to IRA’s, taxes are not paid until withdrawals are made from the account. The required beginning date for distributions from a 401(k) account is similar to that for IRA’s, with two exceptions:
– If, in the year you reach age 70 ½, you are still employed by the employer who maintains your 401(k) plan, you are not required to take the annual RMD until the year after you retire.
– There is a special rule in place for business owners: individuals who own more than 5% of the business cannot defer their RMD until they retire. These individuals must begin taking their annual RMD by April 1 of the year after the year in which they reach age 70 ½.
SOCIAL SECURITY DISTRIBUTIONS
If the only type of income you receive during the year is social security, your benefits are generally not taxable and you probably do not have to file a return. For the majority of our clients, however, they receive other sources of income, including their social security, and this combined income triggers a tax effect whereby a portion of their social security benefits is taxable.
For individuals born after January 1, 1960, the typical retirement age is 67. Social security benefits can be requested at age 62, but the amount received will be 70% of the total amount you would have received had you waited until age 67. If you choose to defer benefits until age 70, the amount received will be 124% of the benefit amount you would receive at normal retirement age (67).
Roth IRA’s allow individuals to put post-tax income into an account up to a maximum specified annual amount. Earnings on and withdrawals from the account are tax-free after age 59 ½. There is no RMD for amounts saved in a Roth IRA.
As mentioned above, most people will be required to meet the RMD requirement after age 70 ½, so it is best to fully understand what your options are, depending on your individual circumstances, well before that time comes. We always recommend discussing such investment and planning decisions with your trusted tax advisors, wealth managers or other certified advisory professionals to ensure you’re allocating your resources in the most efficient and beneficial way.
This blog series is meant to provide an overview of the common implications you might face when you encounter various life events, but there are likely additional considerations dependent on your specific scenario. At FF&F our experienced staff will act as your advisors throughout each step of any event that might affect your tax planning. For more information on this topic, or to discuss tax planning strategies, please contact us at firstname.lastname@example.org or (212) 245-5900.