facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast blog search brokercheck brokercheck
%POST_TITLE% Thumbnail

IRS Missteps to Avoid

If you have an IRA account or are considering one, there are a number of potential missteps you will want to avoid. Some of them can lead to unwanted taxes and penalties, and of course, we are talking about your retirement funding, so it is an important issue. Here are a number of issues to keep in mind:

Selecting a Type of IRA Account – Roth or Traditional?– The first decision you will have to make is whether to choose a traditional IRA or a Roth IRA. A traditional IRA provides a tax deduction for the contribution and tax-deferred growth, but any withdrawal from the account is fully taxable. On the other hand, Roth IRA contributions are not deductible, but distributions after retirement are tax-free. A Roth IRA offers tax-free accumulation, meaning the earnings build up over the life of the IRA tax-free. The 2018 contribution limits to IRAs and Roth IRAs are $5,500 and for people over 50, $6,500. There are limitations to Roth IRAs, if your Modified Adjusted Gross Income (MAGI) for the year is above a certain level, your contributions to Roth IRAs become limited and eventually phased out completely and you are no longer eligible. The phase out for an individual starts at $120,000 and phased out completely at $135,000, and for couples filing jointly, starts at $189,000 and phased out completely at $199,000.  

For those currently with low income and on a limited budget with little extra income to spare for IRA contributions, the traditional IRA offers a tax deduction, which will allow them to make a larger contribution and is better than having no retirement funds at all. In addition, lower-income individuals may qualify for the Saver’s Credit, discussed later, which provides a tax credit that might help them to afford a contribution.

For younger individuals, a Roth IRA provides tax-free accumulation, meaning the earnings will be tax-free when distributed at retirement. Thus, the longer one has a Roth IRA, the more tax-free income it can provide.

Taking Distributions before Retirement Age – If a distribution is taken from a traditional IRA before reaching the age of 59½, that distribution will not only be taxable but will also be subject to a 10% early withdrawal penalty. Therefore, careful consideration should be taken while contemplating an early distribution. Assuming you are in the 22% tax bracket, every $100 of an early distribution will result in you owing $32 of tax, including the penalty. Only take an early distribution if you are desperate. There are exceptions to the 10% early withdrawal penalty, but not for the tax on the early distributions. The common penalty exceptions include limited withdrawals for a home purchase, medical expenses, disability and higher education expenses.

Overlooking the Spousal IRA – You may not be aware, but a non-working spouse can also make an IRA contribution based upon the working spouse’s income. The amount that can be contributed is the smaller of the annual IRA contribution limit or the working spouse’s compensation less any IRA contribution made by the working spouse. Contributions to spousal IRAs do not need to be divided equally between spouses, but neither spouse may make a contribution of more than the annual limit. The deduction for contributions to both spouses’ IRAs may be further limited if either spouse is covered by an employer’s retirement plan.

Social Security Income and Traditional IRA Distributions – If you are retired and drawing Social Security, remember that Social Security income does not become taxable until one-half of the Social Security income plus your other income exceeds $32,000 for a married couple, or $25,000 for most other filing statuses. Even if you don’t need the funds from an IRA distribution, it may be appropriate for you to withdraw enough from your IRA (or other qualified plans) so that your overall income closely matches the taxable Social Security threshold. Then, you can put those withdrawals away for a future major expense item or unexpected financial liability and avoid a large distribution in one year that would cause the Social Security to be taxed.

Rollover Errors – You are allowed to take a distribution from your IRA accounts, and the distribution won’t be taxable if the same amount is returned to your IRA within 60 days. However, you are allowed only one tax-free rollover in a 12-month period.

Failing to Take a Required Minimum Distribution – If you have a traditional IRA, you must begin taking required minimum distributions (RMDs) from your IRA once you reach age 70½. Failure to do so can result in a penalty equal to 50% of the amount that should have been distributed. Luckily, at least so far, the IRS has been very liberal about waiving that penalty for almost any reasonable excuse when a request is made.

You can take out as much as you would like each year, but it cannot be less than the RMD. If you withdraw more than the RMD, the excess can’t be applied to the following year’s RMD. The RMD amount for any year is the balance of your non-Roth IRA accounts on December 31 of the prior year divided by your remaining life expectancy. The remaining life expectancy is based upon the Uniform Lifetime Table, which appears in IRS Publication 590-B.

There is no requirement for the owner of a Roth IRA to take distributions, but the distribution requirements apply to the beneficiary of a Roth account after the owner passes away.

Understanding the Beneficiary Options – Beneficiaries of a traditional IRA where the decedent had already begun taking RMDs will also be subject to an RMD requirement, even if the beneficiary’s age is less than 70½ years. They must begin taking RMDs over the longer of the deceased owner’s life expectancy or the beneficiary’s remaining life expectancy. If there are multiple beneficiaries, the age of the oldest is used in the determination (but see the section on dividing an inherited IRA later). As an option, a beneficiary may elect to take the entire account at any time before the end of the fifth year following the year of the owner’s death.

If the decedent had not yet begun taking RMDs, the beneficiary can choose either to take the five-year payout or begin taking distributions over their lifetime. For lifetime payouts, the distributions must begin no later than Dec. 31 of the calendar year immediately following the calendar year during which the IRA owner died.

Understanding the Special Spousal Beneficiary Option – Spouse beneficiaries not only have the same options as other beneficiaries but also have the irrevocable option to treat the inherited IRA as their own, which is accomplished by re-titling the deceased spouse’s IRA or simply transferring the IRA balance to the surviving spouse’s own IRA. A surviving spouse may also be deemed as having elected to treat the IRA as his or her own if he or she fails to take RMDs as a beneficiary within the applicable deadline or if the surviving spouse makes contributions to the IRA.

Disclaiming an Inherited IRA – If you, as a beneficiary, do not want to inherit an IRA for some reason, the law allows a designated beneficiary to disclaim an inherited IRA and permits the naming of a new beneficiary by the executor of the estate.

Taking Advantage of IRA-to-Charity Distributions – Taxpayers age 70.5 and older can directly transfer up to $100,000 a year from their IRA to a qualified charity. They won’t get a charitable deduction, but instead – and even better – they will not have to pay taxes on the distribution, and because their AGI will be lower, they will benefit from other tax provisions that are pegged to AGI, such as the amount of Social Security income that’s taxable and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward their annual required minimum distribution. If you want to take advantage of this tax benefit, be sure the transfer from your IRA to the qualified charity is a direct transfer from the IRA trustee to the charitable organization and that you get the required acknowledgment from the organization to substantiate the deduction.


Please check with your tax advisor, your Curran Wealth Management Relationship Manager, or contact Curran Wealth Management if you have any questions.  
518.391.4200 •
info@curranllc.com

The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness. No one connected with CIM, LLC or CIMAS, LLC can ensure tax consequences of any transaction.