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Everything You Need to Know About RMD’s

Everything You Need to Know About RMD’s

As Ben Franklin said, “… [n]othing is certain but death and taxes.” Required Minimum Distributions (RMDs) are the method the IRS uses to ensure that you pay some taxes on your pretax retirement savings. They’re pretty straightforward, but there is a catch here and there.

 

What accounts are subject to RMDs?

To paraphrase George Carlin, Uncle Sam loves you and he needs money! Required withdrawals are generally only taken from retirement accounts that have pretax funds in them, with one exception. Because you haven’t yet paid any taxes on that money, you need to start taking money out to provide the government with some income tax revenue.

Traditional IRA, SEP and SIMPLE IRAs, and 401(k)-like accounts, such as TSP and 403(b)s, are subject to required minimum withdrawals. However, if you reach RMD age while you’re still working at the company whose 401(k) you currently contribute to, you don’t need to start taking them as long as you own less than 5% of the company. If you have 401(k)s from previous companies, however, you’ll need to take RMDs from them.

Since you paid taxes on your Roth contributions, you won’t have to take any money out of your Roth IRA. That’s for both contributions and conversions, because either way you already paid your taxes. Roth conversions often make sense in certain years with lower tax brackets, and to “fill up” your tax bracket. You get the added benefit of reducing the size of your Traditional account and thereby reducing required income in addition to accumulating more tax-free money.

The one exception for Roth accounts is for 401(k)s and similar employer retirement accounts (though not SEPs and SIMPLEs). Roth 401(k)s are subject to the same rules as the Traditional 401(k). Even though it’s after-tax money, RMDs are still the rule. Unless you’re still working for the company whose 401(k) you’ve been contributing to, in which case you don’t have to begin at age 72.

It’s easy to avoid this particular complication. Just roll your Roth 401(k) money into a Roth IRA instead. A direct rollover has no tax consequences, and you’ll eliminate the RMD from that account.

 

How much am I required to take out?

Fortunately, you’re not the one who has to calculate the amount! The financial institution that holds your retirement account will tell you how much you need to withdraw. If you have multiple accounts, the institution calculates the amount for each account.

The requirement is based on the account balance as of the previous December 31 and your life expectancy factor taken from IRS tables. The beginning requirement is usually around 4% of the balance, and the percentage increases as you age.

 

Which accounts can I use to satisfy the RMD requirement?

The money must come from a pretax retirement account in your name. The IRS doesn’t keep track of the individual amount that you owe, just the aggregate amount.

For example, suppose you have three IRAs at different brokerage firms. The RMDs are $2,000 on one, $3500 on another, and $1500 on the third so the total withdrawal is $7,000. You can take the entire amount from one account or split it up between them all, whichever makes sense for your financial plan.

We recommend consolidating accounts, especially retirement accounts. Fewer accounts makes keeping track of your RMDs much easier. If you miss a withdrawal, the penalty is pretty steep.

 

When do I have to start my RMD’s?

For many years, the starting age was 70 ½. That was changed during the last administration to age 72, and RMDs were waived for the 2020 tax year in the CARES Act, due to the coronavirus.

If you are age 72 or older you need to start your distributions (subject to the caveats noted in question 1). For the first year of RMDs, you can delay your distribution until April 1 of the following year. For every other year, you’ll need to make the withdrawal by December 31 of that year.

It’s usually not a good idea to delay your first withdrawal. If you don’t take it in the year you turn 72, then you’ll have two required withdrawals the next year: the one you were supposed to take at age 72 plus your RMD for age 73. The option is available to you in case there is some reason that it makes sense.

 

Is there any way I can avoid RMDs?

There’s no legitimate way to avoid the required withdrawals once you’re age 72 and no longer working for the company you were contributing to. However, you can avoid paying taxes on up to $100,000 of your RMD by using the Qualified Charitable Deduction or QCD.

Sending a withdrawal from your retirement account directly to the qualified charity of your choice satisfies your distribution requirement, but you don’t owe taxes since it’s a charitable donation.

The QCD strategy only works if the money comes from an IRA, because it doesn’t count from an employer retirement plan. In addition, the funds must leave the IRA institution and be sent immediately to the charity (a nonstop transfer). Any donation that makes a stop at your bank account loses QCD eligibility.

 

What if I don’t take my RMDs for the year?

The IRS levies a pretty hefty penalty of 50% of the RMD if you elect not to take it out, or on the portion that you didn’t withdraw if you did take some out.

Unless you can prove that you didn’t know you had to take it and you never received the notification from your financial institution, you’ll owe that penalty.

 

What happens if I die in the year I start my RMDs?

Your beneficiaries are required to take the required withdrawals by the end of the year (December 31), even if it’s the year you turned 72. Each of the beneficiaries has to take their proportional share, no matter if another beneficiary takes more than their share.

For example, suppose your RMD is $1,200 and you have four beneficiaries. Each one must take $300 before December 31, even if another beneficiary already took out the full $1200.

If your beneficiary is a trust or the estate, the trust (or estate) must make the withdrawal before December 31.

If you have questions about consolidating your accounts or potentially reducing your RMD exposure, please give us a call at 619.255.9554 or send us an email to set up an appointment.

 

 

Are you on track for retirement?

Making sure you will be ready for retirement can be overwhelming. Funding your retirement accounts over the years is a critical part of your journey to the retirement of your dreams. An experienced Financial Advisor can help you navigate the complexities of investment management. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Vacation Homes and Taxes: 4 Things You Need to Know Before You Buy

Vacation Homes and Taxes: 4 Things You Need to Know Before You Buy

Your vacation home may be taxed differently than your primary residence, depending on how you use it. Will you be using it as a second residence, a rental property or an investment property? There are advantages and disadvantages to each with different rules from lenders and the IRS. It’s important to know the rules for vacation homes and taxes before you buy, to see if the costs make sense.

While the IRS draws a firm line between a residence and an investment property, lenders have a looser definition of what “second home” really means. You could have more than one “second” home. Each lender has its own rules about whether it will finance a property used at least partially for rental income. In general, they prefer to lend money for personal residences as opposed to investment properties.

Here’s a guide to making sure you know what kinds of financial issues, including taxes, you may encounter on your second home that might not have appeared with your first.

 

1. If your vacation house is not rented out but remains a residence for you and your family, taxes are levied like they are for your primary residence.

 

Mortgage interest may be tax-deductible

 

As long as you bought your house before 12/15/2017, you can deduct mortgage interest up to $750,000 of mortgage debt. You can do the same for a certain amount of home equity loan interest when you use the money to improve the property. 

You can only take the mortgage interest deduction if you’re itemizing. Therefore, if you’re married filing jointly, you’ll need to get over the $24,000 standard deduction hurdle to take it.

 

Local and state real estate (property) taxes may be tax-deductible

 

In theory, state and local taxes (SALT) are deductible from your federal return. However, the Tax Cuts and Jobs Act of 2017 limited SALT deductions to $10,000. 

 

If you’ve already reached this limit on your primary home, then you have no more room for deductions on your second home. But if you haven’t, you might get some tax relief from your vacation home.

 

2. If your vacation house is used for rental property and not entirely personal use, the taxation will likely change.

 

In the IRS parlance, a “second home” is different from an “investment property” and likewise is taxed differently. If you claim a property as a second home, you must live in it at least some of the time (during the taxable year. An investment property is one you don’t live in. 

 

Second homes qualify for mortgage interest and real estate tax relief, whereas investment properties don’t. On the other hand, maintenance and other expenses can be deducted for investment properties but not for personal residences. That includes the entire property tax bill, not the $10,000 SALT limit on a second home.

 

 

3. A second home used for personal and rental use can change characterization according to how many days you use it for each purpose during the calendar year.

 

If you rent your vacation home for 14 days or fewer during the tax year, you do not owe taxes on the rental income.

 

Otherwise, the income is characterized as taxable. Expenses related to a rental property, including property management, are deductible against the revenue. You can deduct the expense of utilities and any maintenance that’s performed. You can even deduct the cost of a new roof from your taxes. 

 

You can also take a depreciation deduction, but be aware it may later be recaptured when you sell. The deduction is limited to the percentage of time during the year that you rented the home out.

 

Although you can’t take a loss on a second home, you can take losses on an investment property to offset income.

 

Tax considerations of using your vacation home as a residence and a rental

 

If the home is used both as a personal residence and as a rental property, the costs must be divided between the two. One of two conditions must be met to be considered personal property and qualify for the mortgage interest/property tax deductions. And it has to be the one that would require a greater number of days you lived in the house.

 

The conditions are either you live in the house for at least 14 days during the year, or you use it at least 10% of the time you rent it out. 

 

For example, suppose you rent your house out for 150 days during the year. If you don’t spend at least 15 days living in it, the house will be considered investment property and taxed accordingly. If you lived there for 14 days, you would meet the first condition, but not the second with its higher residency requirement.

 

None of these periods have to be consecutive; you could have a two-week stay plus a few three-day weekends here and there in between rentals if you like. The aggregate number of days you live in it during the year is what counts. 

 

While this expense division is technically true for all types of residences, it’s more common with second homes than primary ones.

 

4. Whether you use the property as a second home or at least partially as an investment property also affects taxes when you sell it.

 

Depending on when you bought your second home, you may qualify for the residential capital gains exclusion when you sell an appreciated property. There’s no exclusion when it’s used as an investment property, and you might be subject to depreciation recapture as well.

If you bought it before 2008, you’re able to use the capital gains exclusion as long as it’s a second home and not an investment property. You may recall that you’re allowed to exclude a certain amount of the capital gain from your taxes on the sale of your residence. The exclusion is $250,000 when filing singly and $500,000 when you file jointly. In expensive real estate locations like San Diego, the exclusion can save you a lot of money on your taxes if you’re eligible.

But it’s your second home, not your primary. (Or you may have been treating it as an investment property until now.) The way to get around the residency requirement is to move into the home for at least two of the five years preceding the sale. That will allow you to characterize the property as a residence and take the exclusion.

 

 How tax depreciations work on a vacation home

 

Investment properties are eligible for a tax deduction for depreciation every year to offset rental income. When you sell it, the deductions are subject to recapture. You can avoid it in the year of sale by performing a 1031 exchange with another property, which delays recapture.

 

Depending on your tax situation, one form of tax relief (taxable interest and SALT deductions, capital gains exclusion) might be more attractive than the other (expense deductions, property taxes). The characterization isn’t set in stone, so you may find that one is more advantageous now and elect to make a different choice later.

 

If you’d like to talk about how a second home might affect your financial situation, please give us a call at 619.255.9554 or send us an email to set up an appointment.

 

 

 

Are you on track for retirement?

Making sure you will be ready for retirement can be overwhelming. Funding your retirement accounts over the years is a critical part of your journey to the retirement of your dreams. An experienced Financial Advisor can help you navigate the complexities of investment management. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Estate Exemption Expiration

Estate Exemption Expiration

Today, it’s hard to believe that in 1997 you could only exempt $600,000 from estate taxes. When a person died, heirs would pay tax on anything above $600,000 at the (then) maximum 55% tax rate. The estate situation is very different today. The Internal Revenue Service just announced that for anyone dying in 2021, the inflation-indexed exemption would be $11,700,000 per person. Any unused amount from the first spouse to die can be used later by the surviving spouse. Also, the maximum estate tax on amounts above that threshold has dropped to a 40% rate.

 

The Tax Policy Center estimates that only about 0.1% of the estimated 2.7 million people expected to die in the coming year will have to pay any estate taxes at all. There has never been a year when the government has reduced the estate tax exemption in the history of estate taxes.

 

 

Changes to the estate exemption

 

All of that could end in four years unless Congress passes an extension. The current exemption sunsets at the end of 2025, at which point the exemption would automatically drop back to what it was before 2018—back to $5 million indexed to inflation. We may not have to wait that long. President-elect Joe Biden’s tax plan calls for reducing the estate tax exemption amount to $3.5 million. The plan would also increase the top rate for the estate tax to 45%.

 

 

How the Biden plan would change the estate exemption

 

The Biden plan would dramatically reduce the exemption. This change would pull a lot more people into estate tax territory. It is uncertain the measure would pass in its current form, and it seems unlikely that it would affect the 2021 tax year. But the prospect of a change has set people talking to their financial advisors about gifting to heirs under today’s very generous exemption, under the (reasonable) assumption that there would be no walk-back for any actions taken under current tax law. Besides, families can put several relatively complicated estate tax strategies into place, which allow them to keep control of their assets if needed in retirement. At the same time, heirs receive increases in value tax-free. Tax experts are quietly telling their clients to plan now rather than later.

 

 

Planning for the estate exemption or possible changes

 

 

Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route.

 

Discover. Where are you and where do you want to be?

During our meeting, we discuss your goals and concerns before we start gathering data. The financial facts and figures are important, but it’s not the whole story. We learn about your values and dreams, as well as what keeps you up at night, so that we can serve you better.

 

Create. How can you get to where you want to be?

We develop a customized financial plan that shows where you are in relation to where you want to be. We present different scenarios that show the impact of your options so you can choose how to accomplish your goals in a way that is meaningful to you and how you want to live your life. We also stress test the scenarios to see how your plan will hold up to challenges like lower returns or higher inflation.

 

Execution. What are you willing to do to get there?

A plan has no value if it’s not implemented. You choose the scenarios and options that are right for you, and we act as your accountability partner to ensure the plan is implemented. We break the actions into manageable steps and help you prioritize so you’re not overwhelmed.  We also work with your attorneys, accountants, and other professionals as needed.

 

Monitor. What happens when life happens to your plan?

We stay engaged with you because life happens, both good and bad. Fluctuating markets, career changes, liquidity events, changes in the laws, and health concerns can impact your plans. Ongoing proactive planning can keep you on track toward your

 

If you’d like to see some financial plan scenarios for your retirement or estate planning, please give us a call at 619-255-9554.

We would love to explore your possibilities with you.

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