Don't Get Sent to the 529 Penalty Box

The rules regarding what happens if you withdraw 529 assets for outlays other than qualified college expenses, such as tuition, fees, and room and board, don't get a lot of attention. Most investors who put money in 529s worry about being unable to save enough for college, not about saving more than they'll need. But for parents unsure whether their child will attend college--perhaps because of poor academic performance or special-needs challenges--the question of whether to put money into a dedicated college-savings vehicle, such as a 529, is very real.

The first thing to consider if you're unsure the beneficiary will attend college is whether the assets could be transferred to another family member. 529 assets may be transferred from the account of one family member to the account of another without penalty, and the list of potential exchange partners is rather broad. Not only can assets be transferred within the immediate family--from one sibling to another, for example--but families with unneeded 529 assets may transfer them to other relatives, such as cousins, aunts, uncles, and even in-laws.

However, not all families will want to or be able to take advantage of this provision. For example, not everyone wants to hand over the hard-earned money they've saved in a 529 account to an extended family member just to avoid paying taxes. And in some cases, families simply do not have any other relatives who can use the money for college. In cases like these, knowing the rules regarding withdrawals for unqualified expenses--which is accounting talk for taking money out of the account and not using it for anything college-related--is essential. 

Expect to Pay a Federal Tax Penalty
Let's start by looking at the main reason investors use 529 plans to save for college in the first place: the tax advantages. Contributions to a 529 are not deductible on federal income taxes. But earnings on that money grow tax-free, and there's no tax on distributions as long as they're used for eligible college expenses. Plus, many states offer income tax deductions on contributions made to in-state 529 plans.

So what happens if the money is not needed or must be withdrawn early for some reason? In that case the earnings portion of the account is subject to federal income tax plus a 10% penalty as well as any applicable state and local income taxes. Withdrawals of the contributions are not subject to federal income tax because the contributions were made with aftertax dollars in the first place (in other words, no federal tax deduction was given on the contributions). For example, if you contributed $5,000 to a 529 plan--and over time it grew to $7,000--but then you had to use the money for nonqualified expenses, you would owe federal income tax on the $2,000 plus a 10% penalty on top of that amount. The 10% penalty is waived, however, if the beneficiary dies or becomes disabled, or if he receives a scholarship. (Most scholarships don't cover all college expenses, however, so there may well be other opportunities to use funds left in the account). The taxes are to be paid by whomever gets the distribution, which could be the account holder or, in some cases, the beneficiary.

Plans make distributions on a pro rata basis, which means that you can't simply request they pay you back your contributions and leave the earnings in the account as a way to avoid paying taxes and a penalty. (By contrast, you can withdraw your contributions from a Roth IRA at any time without taxes or penalty, while leaving the investment earnings alone.) Rather, if the account consists of two thirds contributions and one third earnings, two thirds of the distribution is taken from contributions and one third from earnings. Some plans do, however, allow account holders to take distributions from a specific investment option within the account, according to a spokeswoman from the College Savings Plans Network, a nonprofit organization that provides information on state-sponsored 529 plans. For example, an account holder who splits 529 assets for one beneficiary into two different investment options within the plan could request a distribution from just one of those options and pay taxes accordingly.

State Tax Break Could Be Jeopardized
The other important tax wrinkle to keep in mind if taking nonqualified 529 distributions involves any state income tax deductions you may have received for contributing to the plan. Many states offer residents such tax breaks for contributions made to an in-state plan, but they may also apply a clawback provision to recapture those unpaid taxes if the contributions aren't used as intended. That means for a nonqualified 529 distribution, you could be required to pay state income taxes on the contribution portion and not just on earnings.  

Whether to fund a 529 account for a beneficiary who may not go to college is a very personal decision, and not necessarily one with a clear-cut answer. On the one hand, you'd hate to pay even more in taxes than you would by saving in a taxable account; this is because of the 10% penalty on 529 earnings for nonqualified distributions, not to mention the fact that those earnings would be taxed as ordinary income rather than at lower long-term capital gains rates. On the other hand, the federal and state tax breaks that could be worth thousands of dollars if the beneficiary does go to college are hard to ignore. Ultimately, only you can decide which risk is the one worth taking.

Beware of late year tax changes

Planning for changes in the tax laws — even when no one is sure what they will be as Congress drags its feet ahead of November’s midterm elections — is the most important piece of advice local accountants and tax professionals recommend for small-business owners.

“Small-business owners need to be aware that tax planning is by far the most essential fact this year,said Rice, who specializes in tax deal structuring planning and consulting, business advisory services, tax preparation, tax review and representation before the Internal Revenue Service. “The reason being is many tax provisions have expired and/or not being reenacted. They need to stay in tune with what is going to happen closer to the end of the fourth quarter. After the election, Congress may extend some of those provisions. I’d say the biggest thing is start tax planning and staying up on what is going on in (Washington) D.C.”

One tax law that could change drastically after the election would be the revival of the Section 179 bonus depreciation for 2014. Before 2013, small-business owners and others using the deduction could take a maximum deduction of $500,000 for qualifying business purchases, such as computers, printers and office furniture, among others. Now, the maximum deduction is only $25,000.

In the past, small-business owners would make those large purchases at the end of the year, But all three accountants said that might decision might be unwise this year.

“With business deductions, it’s hard to say,” said Rice, who specializes in tax return preparation and consulting services for businesses, individuals, and not-for-profit entities. “A lot of the tax credits and deductions expired at the end of 2013, and as of yet, have not been extended, modified or really anything done for 2014. I don’t anticipate seeing anything until after the elections. Bonus depreciation has also expired, which allowed a 50 percent deduction for all brand new assets purchased during the year.

“Typically, the case is we don’t hear about it until after it passes until Dec. 31 at midnight. There are a few bills floating around the House to extend the tax provisions, but right now, it’s the roll of the dice. We are not changing the White House this year, but who knows what might happen in the Senate or House.”

Despite the political uncertainty of an election year, creating or contributing to an existing retirement is always sage advice, whether business owners are looking for tax deductions or just ensuring they’ll be comfortable when it comes time to retire.

“The No. 1 thing I recommend to clients is to create or contribute to an existing retirement plan,” said Rice, who specializes in business and management consulting; corporate partnership and individual tax return preparation and planning; estate, retirement and business succession planning; and estate and trust tax return preparation.

“It depends on whether you are self-employed or incorporated. In general terms, a simple IRA could be created by the small business on behalf of employees or themselves, and employees can contribute up to $12,000 per year into the plan,” he said. “On the employer side, you can add up to a 3 percent match. If over 50, employees or owners can add an additional $2,500 to the plan.

“A 401(k) is a little more complicated. It is costly to implement and it requires an annual return where the simple does not. With a 401(k), employees can defer up to $17,500 with an additional $5,500 if over 50. On the employer side, you can match up to 3 percent.”

Tax planning will also help small businesses be prepared for unnecessary penalties and be ready in case the business ends up owing a lot of money to the IRS. This way, the small-business owners can start paying down their debt and not be surprised with a big payment due on April 15.

“One of my big pointers is to encourage business owners to meet with their accountants and discuss their options,” Rice said. “One of the biggest benefits of doing that is to figure out what I can do before the year ends to cut down on my tax bill. It also gives you an idea of what your tax bill will look like. If I’m going to owe $10,000, I don’t want it to be a surprise, plus I have six months or longer to pay it.”

Small-business owners also need to plan for marginal tax rates — the percentage taken from your next dollar of taxable income above a predefined income threshold — and managing their alternative minimum tax — a tax imposed by the federal government on individuals, corporations, estates and trusts.

Taylor said it is especially important to plan for marginal tax rates as those flow through to individual tax returns. He also recommended speaking with a tax adviser to help with planning for the alternative minimum tax.

“A lot of that phases out at $200,000 to $250,000 income with higher rates kicking in at $400,000,” he said. “If small-business owners are not managing this, they won’t know when to pay. A lot of people are trying to figure out when they need to pick up income and manage expenses because they are paying higher tax rates.”

▶ Rice recommends having a good bookkeeping system and making sure records are in order, with receipts to back up disbursements to vendors. This will help make life easier in case of an IRS audit. He also encouraged cash businesses to pay all vendors before the end of the year to get all deductions.

▶ Rice said small-business owners also might consider donating noncash items, such as office equipment, to local nonprofit agencies such as Goodwill or The Salvation Army. He encourages business owners to get receipts for all donations. If an item is valued at $5,000 or more, it must be appraised.

10 Year-End Tax Tips

Here are 10 of the most important 2014 tax planning considerations for individuals, executives and business owners:

1. Accelerate deductions and defer income. Deferring tax is a cornerstone of tax planning. Generally, this means accelerating deductions into the current year and deferring income into next year. There are plenty of income items and expenses you may be able to control. Consider deferring bonuses, consulting income or self- employment income. On the deduction side, you may be able to accelerate state and local income taxes, interest payments and real estate taxes.

2. Bunch itemized deductions. Many expenses can be deducted only if they exceed a certain percentage of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you exceed these AGI floors. Consider scheduling your costly non- urgent medical procedures in a single year to exceed the 10 percent AGI floor for medical expenses (7.5 percent for taxpayers age 65 and older). This may mean moving up a procedure into this year or postponing it until next year, when you'll have more medical expenses. To exceed the 2 percent AGI floor for miscellaneous expenses, bunch professional fees like legal advice and tax planning, as well as unreimbursed business expenses such as travel and vehicle costs.

3. Make up a tax shortfall with increased withholding. Don't forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you're in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year.

4. Leverage retirement account tax savings. It's not too late to increase contributions to a retirement account. Traditional retirement accounts like a 401(k) or individual retirement account (IRA) still offer some of the best tax savings. Contributions reduce taxable income at the time that you make them, and you don't pay taxes until you take the money out at retirement. The 2014 contribution limits are $17,500 for a 401(k) and $5,500 for an IRA (not including catch-up contributions for those 50 years of age and older).

5. Reconsider a Roth IRA rollover. It has become very popular in recent years to convert a traditional IRA into a Roth IRA. This type of rollover allows you to pay tax on the conversion in exchange for no taxes in the future (if withdrawals are made properly). If you converted your account this year, reexamine the rollover. If the value went down, you have until your extended filing deadline to reverse the conversion. That way, you may be able to perform a conversion later and pay less tax.

6. Leverage state and local sales tax deduction. If you itemize deductions, you can elect to deduct state and local sales tax instead of state income taxes. This is valuable if you live in a state without an income tax, but can also provide a bigger deduction in other states if you made big purchases subject to sales tax (like a car, boat, home or all three). The Internal Revenue Service (IRS) has a table allowing you to claim a standard sales tax deduction so you don't have to save all your receipts during the year. This table is based on your income, family size and the local sales tax rate, and you can add the tax from large purchases on top of the standard amount. If you've already paid enough sales tax that you'll make this election for 2014, consider making any planned large purchases before the end of the year. If you wait to make the purchase in 2015 and won't be electing to deduct sales tax that year, you won't get any tax benefit.

7. Don't squander your gift tax exclusion. You can give up to $14,000 to as many people as you wish in 2014, free of gift or estate tax. You get a new annual gift tax exclusion every year, so don't let it go to waste. If you combine gifts with a spouse, you can give up to $28,000 per beneficiary, per year. For example, a couple with three grown children who are married could give each couple $56,000 each and remove a total of $168,000 gift tax free in a single year. Even more could be given tax free if grandchildren are included.

8. Understand the new home office deduction safe harbor. You can deduct some of the cost of your home if you use your home as your principal place of business, use it to meet clients and customers in the normal course of business, or your office is a separate structure not attached to your home. The amount of this deduction has long been a source of controversy, but the IRS has a new safe harbor this year that allows you to deduct up to $5 per square foot of home office space up to $1,500 per year.

9. Maximize "above-the-line" deductions. Above-the-line deductions are valuable because you deduct them before you calculate your AGI. They are allowed in full and make it less likely that your other tax benefits will be limited. Common above-the-line deductions include traditional IRA and health savings account (HSA) contributions, moving expenses, self-employed health insurance costs and alimony payments.

10. Perform an overall financial checkup. The end of the year is always a good time to assess your current financial situation and plan for the future. You should think about cash flow, health care, retirement, investment and estate planning. Check wills, powers of attorney and health care proxies for changes that may have occurred during the year. Use the open enrollment period to reconsider employer-sponsored programs that could reduce next year's taxable income. HSAs and flexible spending accounts for dependent care or medical expenses allow you to use pre-tax dollars.

10 Year-End Tax Moves to Make Now

April 15 is the target date for taxes, but to ensure that you pay the Internal Revenue Service the least possible amount on that date, you need to make some tax moves before the tax year ends.

Congress is not making that easy. Once again, U.S. representatives and senators have delayed action on tax extenders, more than 50 business and individual tax breaks that expired on Dec. 31, 2013. Lawmakers are expected to consider, or extend (hence the laws' collective name) after the Nov. 4 election.

The bad news is that there is no guarantee that all the extenders -- including popular things such as the higher education tuition and fees deduction, and itemized claims for state and local sales taxes and private mortgage insurance payments -- will be renewed.

The good news is that there still are some tax breaks on the books that you can use to your advantage before the end of 2014.

Some tax moves will take a little planning. Others are very easy to accomplish. But all are worth checking out to see if they can reduce your tax bill.

Following are 10 year-end tax moves to make before New Year's Day.

1. Defer your income
The top tax rate is 39.6 percent on taxable income of more than $406,750 for single taxpayers; $457,600 for married couples filing joint returns ($228,800 if filing separately); and $432,200 for head-of-household taxpayers. If your remaining pay will push you into the top tax bracket, defer receipt of money where you can.

Ask your boss to hold your bonus until January. Put more money into your tax-deferred workplace retirement plan. Hold off on selling assets that will produce a capital gain. If you're self-employed, don't send out invoices for year-end jobs until early 2015.

This strategy works even if you're not in the top tax bracket, but just about to cross into the next higher one.

2. Add to your 401(k)
Even if you're nowhere near the top tax bracket, putting as much money as you can into your company's 401(k) or similar workplace retirement savings plan is a good idea. Since most plan contributions are made before taxes are taken out, you'll have a bit less income that the Internal Revenue Service can touch. (Exceptions are contributions to Roth 401(k) plans, where you put away after-tax money and get tax-free growth.) Plus, the sooner you put the money into the account, the longer the earnings will grow tax-deferred.

Few of us will reach the maximum $17,500 that employees can stash in a 401(k), but any amount you can contribute is good. If you are age 50 or older, you can put in an extra $5,500.

In most cases, you can modify your 401(k) contributions at any time, but double-check with your benefits office to be sure of your plan's rules.

3. Review your FSA amounts
Another workplace benefit, the medical flexible spending account, or FSA, also requires year-end attention so you don't waste it. You can contribute up to $2,500 to an FSA via paycheck withdrawals. If that limit seems lower, you're right. As part of the Affordable Care Act the maximum contribution amount was set at $2,500; before the health care law change there was no statutory limit.

As with 401(k) plans, money goes into an FSA before your taxes are calculated, saving you some tax dollars. But if you leave any money in your FSA, you lose it. Some companies allow a grace period into the next year to use the untouched FSA funds, but not all. And though the U.S. Treasury recently announced a change in the use-it-or-lose-it rule, allowing account holders to carry over up to $500 in excess money into the next benefit year, your company has to take steps to adopt it.

Be sure to check with your employer, and if you must use your FSA money by Dec. 31, make sure you do.

4. Harvest tax losses
If you have assets in your portfolio that have lost value, they could be a valuable tax tool. Capital losses can be used to offset any capital gains. If you have more losses than gains, you can use up to $3,000 to reduce your ordinary income amount. More than $3,000 can be carried forward to future tax years.

Capital losses could be especially helpful to higher income taxpayers facing the 3.8 percent Net Investment Income Tax. This surtax, part of the Affordable Care Act, applies to the unearned income of taxpayers with modified adjusted gross incomes of more than $200,000 if they are single or head of the household; $250,000 if married and filing jointly; and $125,000 if married and filing separately. High earners with investment income can reduce this new tax burden by using capital losses to reduce their taxable amount.

If you do face the 3.8 percent surtax, consult with your financial adviser and tax professional. In addition to figuring your modified adjusted gross income, you must take into account the different types of investment earnings that are subject to the tax and how to appropriately calculate losses within each category.

5. Make the most of your home
 Homeownership provides a variety of tax breaks, some of which you can use by year-end to reduce your current year's tax bill. Make your January mortgage payment by Dec. 31 and deduct the mortgage interest on your coming tax return. The same is true for early property tax payments.

6. Bunch your deductible expenses
 Taxpayers who itemize know there are many ways on Schedule A to reduce adjusted gross income, or AGI, to a lower taxable income level. But in several instances, deductions must be more than a certain threshold amount.

Medical and dental expenses, for example, cannot be deducted unless they exceed 10 percent of AGI. Miscellaneous expenses, which include business expense claims, must be more than 2 percent of AGI.

To get over these deduction hurdles, start consolidating eligible expenses now. This strategy, known as bunching deductions, will push them into one tax year where you can make maximum tax use of them. The sooner you start this process, the better. It's much easier to plan your costs now than scramble to come up with eligible expenditures as December days fade.

7. Add to or open an IRA
 Remember that added money you put in your 401(k) to lower your taxable income? Bulk up your retirement planning even more by contributing to an individual retirement account.

If you have an IRA account or open a traditional IRA, you might be able to deduct at least some of your contributions on your tax return. If you don't make a lot of money, your contribution also could be used to claim the retirement savings contributions credit.

Even if you won't get a deduction, you'll be adding to your nest egg so that you can retire on your terms. And while it's true you can wait until the April 15 filing deadline to contribute for the previous tax year, the sooner you put money into an IRA, traditional or Roth, the sooner it can start earning more for your golden years.

Self-employed workers also get an added retirement saving benefit. There are a variety of plans -- SEP-IRAs, Keoghs, solo 401(k) plans -- into which you can put some of your self-employment earnings. If you're a sole proprietor, your contribution to a self-employed retirement plan also is deductible on your tax return.

8. Be generous to charities
 As you're putting together your holiday shopping list, be sure to include charitable gifts that could help reduce your tax bill. In addition to the usual dollar donations or household goods and clothing, consider some less traditional ways to give to charities.

Many groups will accept vehicles, with some even making arrangements to pick up the jalopies.

Donate stock or mutual funds that you've held for more than a year but that no longer fit your investment goals. The charity gets the asset to hold or sell, and your portfolio rebalancing nets you a deduction for the asset's value at the time of gifting. Even better, you don't have to worry about capital gains taxes on the appreciation of your gift.

9. Pay college costs early
 The spring semester's bill isn't due until January, but it might be worthwhile to pay it before year's end. By doing so, you can claim the American Opportunity Tax Credit on this year's tax return.

The American Opportunity credit replaced the Hope tax credit in 2009 and is in effect through the 2017 tax year. It's worth up to $2,500 with up to 40 percent of the new credit refundable. That means you could get as much as $1,000 back as a tax refund even if you don't owe any taxes.

Tuition, fees and course materials for four years of undergraduate studies are eligible expenses under the American Opportunity credit. This includes education expenses made during the current tax year, as well as expenses paid toward classes that begin in the first three months of the next year.

10. Adjust your withholding
Did you write the U.S. Treasury a big check in April? Or did you get a large refund from Uncle Sam instead? Neither is a particularly good financial or tax plan.

Most of us cover our eventual tax bills through payroll withholding. Ideally, you want the amount coming out of your paychecks throughout the year to be as close as possible to your final tax bill. If you have too much withheld, you'll get a refund; too little withheld will mean you'll owe taxes when you file.

You can correct the imbalance by adjusting your payroll withholding now. The correct amount taken out of your final 2014 paychecks will help ensure that you don't over- or underpay the tax collector too much next filing season.

How to Max Out On Itemized Income Tax Deductions in 2014

In the usual case, the tried-and-true tax strategy at the end of the year is to pull deductions into the current year and push income into the following year. And, for the most part, it still makes sense. But now there’s a few extra tax wrinkles to contend with.

Case in point: Itemized deductions claimed by high-income taxpayers may be reduced by the so-called “Pease rule.” This special tax law provision, which was gradually phased out prior to 2010, was revived in 2013 and will continue to be a thorn in the side of some clients.

Let’s start with this basic premise. Normally, you can use the full amount of your itemized deductions to offset the taxable income on your tax return, thereby lowering your overall tax liability. However, under the Pease rule (named after the Ohio Congressman who sponsored the legislative provision on its initial go-round), certain itemized deductions are reduced by 3% of the amount above an annual threshold. For 2014, the threshold is $254,200 of AGI for single filers and $305,050 for joint filers.

Suppose a joint filer in 2014 has an excess AGI of $200,000 with $50,000 of itemized deductions that are covered by the Pease rule. The couple’s itemized deductions are thus reduced by $6,000 (3% of the $200,000 excess AGI), so they can deduct only $44,000, instead of $50,000. Note that the 80% limit comes into play for only the wealthiest of taxpayers.

Generally, the Pease rule applies to those itemized deductions not affected by some other built-in tax return limit or floor, including several big-ticket items like deductions for charitable contributions, state and local tax deductions and mortgage interest. Conversely, the limit doesn’t apply to medical and dental expenses, investment interest expenses and casualty and theft losses. Key exception: Although a 2%-of-AGI floor applies to miscellaneous expenses, this deduction is still covered by the Pease rule.

The Pease rule may force taxpayers to rethink their tax planning strategies at the end of the year. For instance, say that a taxpayer is contemplating a large gift of property to charity. If the deduction will be reduced by the Pease rule, the taxpayer might postpone the gift until 2015, especially if it appears that he or she won’t be affected by the Pease rule next year.

Similarly, an increase in AGI at the end of the year may have an adverse tax impact on itemized deductions. If a taxpayer has already made substantial charitable gifts in 2014, he or she might seek to postpone taxable income items to keep AGI at a manageable level. One possibility is to defer year-end bonuses to 2015 if the taxpayer is able to time such payouts.

Bottom line: Every situation is different. When upper-income clients are in danger of triggering the Pease rule, schedule a meeting to determine the optimal approach for maximizing deductions.

Fall brings 4th quarter and a chance for tax planning

As we're enjoying the fall colors, we're also heading into the last financial quarter of the year. There's plenty of time to look at where you are financially and make some changes before the new year.

- Assess your tax situation. Whether you're self-employed or you get a W-2, you don't have to be surprised each year when you file your tax return about to learn whether you owe, get a refund or broke even on taxes. Contact your tax preparer and ask for a tax planning appointment. You'll need to bring the documents the preparer asks for, and you can adjust your tax withholding or quarterly estimates accordingly. Remember, no one likes to pay lots of taxes in April, but a big tax refund is just an interest-free investment you made with the IRS, so don't see it as a great idea for you.

- Be sure you've contributed to your favorite charities. Nonprofits are accustomed to getting a surge in contributions toward the end of the year. Many people use the last few months of the year to contribute because it allows them to assess their ability to give. If the charities you prefer help those in need around the holidays, the sooner they get your cash contributions, the better they can assess their ability to help at that time. So feel free to get out your checkbook now.

- Clean up your wardrobe. What does that have to do with finance? If you give the clothes you don't wear to a nonprofit's thrift shop, you can get a tax receipt, which will give you a little extra money and allow you to update your wardrobe. Be realistic. If you haven't worn something for a year, give it away. Once you've gone through your closet, turn all the clothes so the hangers face the wrong way, with the open part of the hook out. If you get to the fall of next year and those hangers are still facing the wrong way, you haven't worn that outfit in a year and can put it directly into your thrift store pile.

- Maximize your retirement plan contributions. There are some retirement contributions - IRAs, Roth IRAs, SEPs and some others if you're self-employed - that you can make for this year after Dec. 31 and before you file your taxes for this year. But if you work for a company with some of the more popular plans - 401ks, 403bs, 457s - you can only contribute to the plan through paycheck withholdings and must do it for this year before Dec. 31. So take this opportunity to contribute as much as you can. If your employer matches some of your contributions, make sure you put in that much.

You can reassess your finances any time of year, and now is always a good time.

MAKING CENTS: Planning for 2014 taxes

Every year taxpayers look for ways to reduce the burden of federal and state income taxes. Yet most taxpayers do little during the tax year to make that happen.

Just a year or two ago, as most knew that higher rates were coming, the direction was to accelerate income and hold off on deductions to the largest extent possible. With the changes to the tax code now in full force, high income taxpayers are again looking to maximize deductions and deferring income.

Let’s review the changes that high wage earners will see on 2014 returns.

The first change is in the top tax rates. Married taxpayers who file jointly will now pay an income tax rate of 39.6% on earnings above $450,000. That’s 10 percent more in income taxes on your top layer of earnings. For families earning over $250,000, there will be an additional 0.9% Medicare tax on earnings –– a top rate on ordinary income of 40.8% in federal taxes alone.

For families earning over $300,000, your itemized deductions such as mortgage interest and property taxes begin to phase out.

Next is the change in capital gains rates. What was a 15% rate on long term capital gains is now a 20% rate. This 33% increase in capital gains taxes is painful enough, but there’s more. For those families again earning over $250,000, you’ll be assessed with an additional 3.8% rate on your net investment income. Net investment income includes capital gains, interest and dividends minus any expenses such as management fees or administrative fees.

With income tax planning you are somewhat guessing about future rates. Sentiment at this time does not favor a tax cut, so most planners today assume that tax rates will remain constant or go higher in the near term. With that in mind, high earning taxpayers would look to keep their earned income as low as possible by maximizing deferrals such as contributions to retirement or deferred compensation plans.

Accelerating deductions can be a slippery slope, as many of these get phased out as your income climbs. But you may look to some non-traditional deductions or credits such as those available for energy saving improvements to your home, investments in oil and gas, or the contribution of appreciated property to a favorite charity.

As for investment income and the capital gains rates, there may still be time to minimize the tax bite for 2014.

Using a qualified income tax planning professional, prepare a pro-forma of what your tax return may look like if today were the end of the year. Next discuss strategies to minimize capital gains and reduce net investment income from now until the end of the year and re-cast your forecast the possible tax savings.

Tax Season Will Be Here Before You Know It. Will You Be Ready?

It's October, and we're more than five months away from the IRS' official tax deadline, so it's understandable that taxes likely haven't consumed your thoughts lately.

However, doing some tax planning in advance can make your life much easier when tax season rolls around after New Year's Day. Think back to when you filed your return this past year. How much of a hassle was it to get all of your paperwork together? Did you lose out on any possible deductions because you lost receipts or simply forgot about some purchases? Or worse, did you find your taxes so overwhelming that you paid someone else to do them for you?

Here are three things you can do right now that will make the upcoming tax season much easier for you.

Figure out what deductions you'll qualify for
Surprisingly, many taxpayers don't take all the deductions to which they are legally entitled. Either they don't think they'll qualify for them, or they don't know about the deductions in the first place.

According to a list of the most overlooked tax deductions published by Turbo Tax, many people who take the standard deduction are short-changing themselves. For example, you can write off the greater of your state income tax or the state sales taxes you pay throughout the year. And many people, especially in states with no income taxes, forget about this one.

Or, if your parents paid your student loans, you can still write off the interest paid on your tax return. And even if you took just one class to further your education, you may still qualify for a tuition deduction.

There are hundreds of potential deductions that may apply to you, so here are lists from U.S. News, Turbo Tax, and Bankrate to help get you started. Or better yet, invest in a good reference book like this one. If you even find one extra deduction, it'll be well worth the $20 or so it costs and the time you spend flipping through the book.

Spend a rainy day getting your paperwork in order
If you spend some time and organize your tax documentation, you'll definitely be thankful you did.

First, receipts can be difficult to find when tax time finally rolls around. Instead of scrambling to find a receipt from August when the deadline approaches next April, make sure you have your paperwork together now. It is usually easier to have a business reprint a receipt before too much time has passed, and worse yet, you might forget about the deductible expense entirely when tax time rolls around.

And if your tax documentation isn't well-organized, there's no time like the present to get started. Make sure you have a decent system for keeping your paperwork in order. When tax time rolls around, answering a question like "How many charitable deductions do I have?" should be a simple matter of grabbing a short stack of receipts -- not an hour-long process of sorting through a filing cabinet.

Finally, if you're like me and find it easier to keep electronic records, scanning your paperwork and creating a filing system on your computer is an efficient (and possibly safer) option.

Become familiar with the changes in the tax law and plan accordingly. Many people first learn about changes in the tax law when they start preparing their returns. The problem with this is that if there is a significant change affecting you, it may be too late to document your eligibility or do anything about it.

For example, the tax penalties for not having health insurance will change significantly over the next few tax years, increasing from $95 or 1% of income in 2014 to $695 or 2.5% of income in 2016. Further, the threshold for medical expenses has risen from 7.5% of your income to 10%, unless you or your spouse is over 65.

Several other tax breaks expired at the end of 2013, such as the deduction for mortgage insurance premiums, so it may be worth looking into now. TaxAct maintains a pretty up-to-date list of recent tax law changes, both good and bad. And it's likely that some more changes will come over the next few months, so you should take a look regularly.

Don't wait until the last minute
The main point here is that tax planning should be a continual process throughout the year, not just something you do on the first weekend of April. A little advance planning can make your life much easier when tax season rolls around, so spending a couple of hours on your tax planning every month or so is a very good idea.

Year-end retirement planning strategies

October marks the start of the fourth quarter: the perfect time to think about year-end planning strategies and tactics that can help save or make a buck or two. Though not an exhaustive list, here’s what experts say you should consider or do now.

Put your financial house in order

The last quarter of the year is a great time to review how much money you’ve spent during the past 12 months or to otherwise create a plan to track your annual expenses for the coming year, said Randy Bruns, a certified financial planner with HighPoint Planning Partners. “Understanding your annual expenses is crucial for calculating how much should be set aside in savings in the case of a job loss, how much term life is needed to protect your family should you die, and ... to help calculate a target nest egg.”

Consider purchasing Quicken or using free online tools such as Mint.com.

Project your tax bill

Once you get a handle on your income and expenses, now would be a good time to estimate your 2014 tax bill, especially if there have been or will be large differences from previous years. Items to look for, according to Joseph Clemens, a certified financial planner and owner of Wisdom Wealth Strategies, include:

Increased medical expenses. “Since medical mileage/travel is potentially deductible, did you travel a lot for medical purposes?” he asked “This can be especially important since those 65 and over have through 2016 before their threshold jumps up to the rest of the population from 7.5% to 10%.”

Have you made large purchases such as a vehicle and the funding came from a taxable account? If so, this could increase tax liability, said Clemens.

Are you making enough in estimated payments? “If you think you won’t be, one trick is to do a withdrawal from an IRA to cover the difference and withhold 100%,” Clemens said. “Since IRA withholdings are treated as being contributed to throughout the year, this trick can help avoid the underpayment of tax penalty.” FYI: If you don’t want the income from the IRA that is required to do this, you could replace the moneys into the IRA account from their bank as a “once per year 60-day replacement” or take the funds from a Roth, Clemens said.

“Once you get a tax projection, then a retiree will be in a better position to analyze the usual year-end strategies, such as charitable stock gifting and tax harvesting,” said Clemens.

Consider a Roth IRA conversion

Part of getting a handle on your potential tax bill means getting a sense of what your taxable income will be for 2014, said Scot Hanson, a certified financial planner with EFS Advisors. That would be line 43 on Form 1040.

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One possible tactic. Taxpayers who expect to land in the 15% tax bracket or less (married couples filing jointly in 2014 with taxable income of $73,800 or less, for example) might consider converting part (or all) of their traditional IRA into a Roth IRA, but not so much that they move into the 25% tax bracket.

“It is no fun to report income and pay the extra taxes, but at 15%, you are most likely never to be in a lower tax bracket for the rest of your life,” said Hanson.

One benefit: “Any amount you convert now and move to Roth IRA will not have required minimum distributions (RMDs) that start at age 70½ with most other retirement accounts, so you are blunting that future impact,” Hanson said.

And the worst of it is this: You’re prepaying taxes so that children inheriting your Roth IRA will not have to pay any taxes, Hanson said.

Also, consider asking your children to help pay whatever tax you might owe on the Roth IRA conversion. “If I am your son or daughter and can expect the future IRA at death, I would be willing to help with those taxes at 15%, because I would not want to pay those same taxes at a much higher tax bracket if in a higher tax bracket,” Hanson said.

Another benefit: By converting to a Roth IRA before reaching age 70½ you might be reduce how much your Social Security benefit is taxed. “RMDs (from your traditional IRA) often cause more of your Social Security to be taxed,” said Hanson.

How so? If you’re married and filing a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits and if you have combined income more than $44,000, up to 85% of your benefits may be taxable. Of note, combined income equals your adjusted gross income, plus nontaxable interest, plus one-half of your Social Security benefits. RMDs would be included in your adjusted gross income.

By contrast, you won’t ever have to take an RMD from your Roth IRA. And if you do take a distribution from a Roth IRA, it won’t be included in your adjusted gross income.

Mark Luscombe, a principal analyst with Wolters Kluwer, CCH, said Roth conversions can also be a good strategy, especially if IRA distributions might push the taxpayer into a higher tax bracket or push adjusted gross income (AGI) up sufficiently to make the taxpayer subject to the 3.8% tax on net investment income. “The taxpayer might want to spread out the conversions over several years, again to keep AGI as low as possible,” he said.

And, Luscombe said, “Roth conversions also make more sense for taxpayers who do not anticipate needing the converted funds in retirement, at least not right away, and if the taxpayer has other funds to pay the tax on conversion.”

Speaking of what planners often refer to as tax-bracket planning, consider this tactic too. Long-term capital gains are taxed at 0% if you are in the 10% or 15% federal income tax brackets. So, if you fall into those tax brackets, Ryan Pace, a certified financial planner with D3 Financial Counselors, recommends realizing enough long-term capital gains to take you to the top of the 15% tax bracket.

Maximize, maximize, maximize

Another way to trim you tax bill? Make sure you’re on pace to contribute as much as possible, even the maximum allowed, to your retirement accounts, such as your 401(k) and the like, as well as, if you have one, your health saving account (HSA), said Pace.

You can contribute up to $17,500 in your 401(k) plus an additional $5,500 if you are age 50 or older.

As part of this exercise, Bruns recommends reviewing your financial plan to determine whether you’re saving enough for retirement, and then making the appropriate changes to your contribution rates for this and next year.

Pace also recommends: contributing to a 529 college savings plan if your state offers an income tax deduction for contributions and enrolling in a flexible spending account (FSA) if your employer offers one. FYI: The government changed modified the “use-it-or-lose-it” rule for health flexible spending arrangements. Participants now can carry over up to $500 of their unused balances remaining at the end of a plan year. So make sure to spend as much as you need to bring your balance down to $500. Otherwise, you’ll lose any amount over $500.

What’s the benefit of maximizing your contributions to 401(k)s, HSAs and the like? You’ll lower your income tax bill.

Deductions and credits anyone?
You might be able to reduce your tax bill by increasing your charitable contributions. Pace recommends the following: cleaning out your garage and closets to make noncash donations to charity; donating your most appreciated assets to charity (by doing so you avoid realizing capital gains); and front-loading charitable contributions by gifting cash or stock into a donor-advised fund.

Also, if a family member has higher education expenses, Pace recommends taking advantage – if possible – of the American Opportunity Credit (it’s a tax credit of up to $2,500 of the cost of tuition, fees and course materials paid during the taxable year) or the Lifetime Learning Credit (it’s a tax credit of up to $2,000). Read American Opportunity Tax Credit: Questions and Answers. Also read Lifetime Learning Credit.

Tax-loss harvesting
For some, tax-loss harvesting might be another way to keep your tax bill in check. “Tax-loss harvesting is a way to reduce your taxes by selling an investment that is trading a significant loss and replacing it with a comparable investment,” said Dustin Obhas, a certified financial planner with CLA Financial Advisors.

Two caveats: One, the IRS will disallow the loss if the same or substantially identical asset is purchased within 30 days. That’s called the “wash-sale rule.” And two, only up to $3,000 of loss can be used to reduce your taxable income ($1500 each if married filing separately). Given this caveats, consider talking with a qualified tax professional who can determine in advance whether tax-loss harvesting makes sense for you.

Rebalance your portfolio
Consider the pros and cons of tax-loss harvesting in the context of your overall portfolio. You might be able to accomplish two goals — rebalance your portfolio to its intended target and tax-loss harvest — at the same time.

“If the stock market is booming and the bond market is flat, chances are you’ve now got more exposure to stocks than you did when the year began, which adds risk to your portfolio,” Bruns said. “A disciplined rebalancing strategy is a simple and easy way to remove emotion from your investment decisions by forcing you to sell high and buy low.”

Examine too the fees you’re paying for your investments. “Review your mutual fund expenses at year-end and dump those with unnecessarily high fees,” said Bruns. “Decades of academic research has shown that high mutual fund expenses are a major headwind to future performance.”

What to do: Own mutual funds with expense ratios well below 1%. “Low-cost providers such as Vanguard offer mutual funds with expense ratios below 0.10%,” said Bruns.

Also, as part of this process, update your investment policy statement, your blueprint for your investments. “You want to make sure your investment match your risk tolerance and goals,” said Obhas. “Ask yourself if you’re taking on too much risk or being too conservative.”

Take your RMD
If you’re over age 70½ and you own traditional IRAs and/or 401(k)s don’t forget to take your required minimum distributions (RMDs). “Miss the Dec. 31 deadline and you’ll face a steep penalty of 50% of the amount that you should have taken,” said Bruns.

Remember too that taking your RMD is taxable income, said Obhas.

Update your estate plan
Use the final three months of the year to update your estate plan, including your will, trusts, and powers of attorney. Make sure they reflect any material changes such as divorce, or children leaving your home, or a sibling who was listed as your executor or trustee dying.

“Also make sure the beneficiaries are up-to-date on your various financial accounts,” Bruns said. “A lot can change after you open an account.”

Others agree with the need to review your estate documents. “Chances are it’s been years since you updated your estate planning documents,” said Obhas. “Life happens, things change.”

Watch Congress
Taxpayers already in retirement, Luscombe said, should watch whether Congress extends expired provisions, particularly the provision that permits taxpayers over age 70½ to make IRA distributions directly to a charity without taking the distributions into income.

“This keeps AGI lower which could help reduce tax on Social Security benefits and perhaps also help the taxpayer qualify for other tax breaks that phase-out as AGI increases,” said Luscombe.

Of note: Luscombe said the last time Congress waited until the end of the year to extend this provision, they let required minimum distributions made in December be treated as if they were made directly to a charity and allowed distributions to charity made in January of the following year to be treated as if made on Dec. 31. “It is not certain what Congress might do this time around,” he said.

How to avoid the IRS by planning ahead for tax-free inherited IRA rollovers

In a pair of recently decided private letter rulings, the IRS unexpectedly blessed tax-free rollover treatment in situations where spouses inherited IRAs that did not actually designate them as beneficiaries. The rulings were surprising because, in completing the rollovers, these IRA funds passed through trusts that did not technically allow for the tax-free rollover treatment. While favorable rulings preserved the valuable IRA tax deferral for these surviving spouses, the results were by no means guaranteed, and the inconvenience of obtaining IRS rulings could have been avoided entirely had the taxpayers in these cases planned properly in the first place.


Private letter rulings 201430026 and 201430029: The facts

Both of these recent private letter rulings (PLRs) involved cases where a deceased spouse named the surviving spouse’s trust — rather than the surviving spouse herself — as designated beneficiary of the IRA. When each IRA owner died before reaching age 70½, the IRA funds were distributed into each of the surviving spouse’s trusts. The surviving spouses then attempted to roll those funds into their own IRAs, a technique that would have been easily accomplished had the surviving spouses themselves been designated IRA beneficiaries.


The general rule governing inherited IRA funds that are paid into a trust provides that the surviving spouse is no longer eligible to roll those funds into an IRA in his or her own name once the trustee actually distributes the proceeds to that trust. In such a case, the surviving spouse is treated as though he or she received the proceeds from the trust, rather than from the deceased spouse’s IRA.


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However, the IRS found that this general rule does not apply when the funds are considered to have been distributed to the surviving spouse only because he or she is named as sole trustee of the trust that received the IRA proceeds. In each of these PLRs, the surviving spouse was sole trustee and had the power to control trust payments, add trust property, or amend or revoke the trust. Therefore, the IRS exempted them from the general rule and allowed them to roll the IRA proceeds from the trust into their own IRAs within sixty days without incurring income tax liability.

The surprise ruling

The results in these cases were surprising because neither of the trusts would qualify as see-through trusts that could be looked through to use the trust’s beneficiary as the IRA designated beneficiary. Therefore, the rules governing nondesignated beneficiaries could have applied to prevent tax-free rollover treatment.

Generally, if IRA proceeds pass to a designated beneficiary, the life expectancy of that designated beneficiary can be used to stretch withdrawals from the inherited IRA over the beneficiary’s lifetime. Similarly, if IRA proceeds pass to a nondesignated beneficiary after the original account owner has begun taking required minimum distributions (RMDs), the remainder of the account proceeds can be distributed based on the life expectancy of the original owner. However, if the proceeds pass to a nondesignated beneficiary before RMDs have begun, the IRS can require that the entire account balance be distributed within five years of the original owner’s death.

In this case, because the original account owner’s RMDs had yet to begin and the designated beneficiaries were trusts (which have no life expectancies), but not see-through trusts where the trust beneficiary’s life expectancy can be used, the IRS could have prohibited the rollover treatment that allowed the IRA proceeds to be distributed over the lives of the surviving spouses.

Proper planning strategy

The time and expense of obtaining a favorable IRS ruling could have been avoided if the deceased spouses had simply designated their spouses directly as beneficiaries under the IRAs. In the alternative, the designated beneficiaries could have been trusts that qualified as see-through trusts.

In order to qualify as a see-through trust, four requirements generally apply: the trust must be valid under state law, the trust must be irrevocable (or must become irrevocable upon the death of the IRA owner), the trust beneficiaries must be identifiable, and a copy of the trust must be provided to the IRA custodian by October 31 of the year after the IRA owner’s year of death.

The trusts here were revocable by the surviving spouses, so failed to meet the second requirement, which forced the surviving spouses to turn to the IRS to approve the tax-free rollover treatment.

Conclusion

The surviving taxpayers in these cases stood to lose thousands in immediate income tax liability had the IRS decided that tax-free rollover treatment was impermissible. While the IRS eventually ruled in their favor, advisors should note that simple advance planning could have prevented the question entirely had the designated beneficiary forms been properly prepared.

Four Tips for Year End Tax Planning

April 15 is still a ways off and taxes are probably pretty far from your mind. Now, however, is a great time to take advantage of tax-saving opportunities that will be lost once the year is over.
The following are some often overlooked tax-planning areas to consider while there is still time to act and pay less in taxes in this tax year and beyond.

1. Contribute to a Roth

Most folks know that saving in a workplace retirement plan such as a 401k is a great way to shield income from taxes while building up a nest egg for retirement.

Many of us forget, however, that these pre-tax savings will someday be taxed as income when we begin making withdrawals in retirement. Ideally, the rates at which these withdrawals are taxed will be lower than the tax bracket we were in when making contributions. This is the ideal arbitrage scenario and is often true for mid-career and senior employees.

Younger workers just starting the climb up the career ladder, however, are typically in a lower tax bracket than they will be later in their careers and in retirement. For these folks, another retirement savings vehicle, the Roth IRA, may be a better option.

While contributions to a Roth are made with after-tax dollars, both these contributions and their earnings can be withdrawn free of income tax in the future. Younger workers can come out ahead by investing in a Roth with after-tax money when in a lower tax bracket in exchange for not paying income taxes in the future on withdrawals when they have entered a higher tax bracket.

One caveat is that if an employer matches 401k contributions, it is a good idea to save enough to qualify for the match before directing after-tax savings to a Roth.  The match is, in effect, a guaranteed return and should not be passed up. Note that while contributions to an employer Roth 401K must be made by 12/31, you actually have until April 15 of the following year to make an individual Roth IRA contribution for the current tax year.

2.  Spend Your Flexible Spending Account (FSA) Money

Many employers offer their employees a way to set aside a portion of their salary on a pre-tax basis to pay for out-of-pocket medical expenses and for child and dependent care. Given that the IRS does not allow a deduction for medical expenses that do not exceed 10 percent of adjusted gross income, an FSA is usually the only way to save taxes on these expenses.

FSAs are particularly valuable for taxpayers who are impacted by the AMT tax as a way to lower their taxes via pre-tax savings, thereby offsetting some of the deductions lost due to the AMT.

You need to spend unused savings before year end or risk losing them if your company’s plan is the “use it or lose it” kind. IRS rules allow employers to offer the option of rolling over as much as $500 of unused savings to the following year, but this is not mandatory.

3. Check Your Income and Withholdings to Date

We need to pay taxes throughout the year on our income to avoid a large tax bill and penalties for under withholding.  We do this via payroll withholdings and estimated tax payments. The rule for avoiding an underpayment penalty, known as the “safe harbor,” is to withhold 100 percent (110 percent for higher earners) of the tax due in the previous year or 90 percent of the tax due in the current year.

An additional complication is the 0.9 percent Medicare surtax for higher earners. This is due on earned income over $250,000 for married couples ($200,000 for singles). Couples earning more than $250,000 may be at risk of under withholding because employers only begin withholding for this surtax once individual wages reach $200,000. If each spouse earns $200,000, as a couple they will earn $400,000 and will owe additional tax on $150,000, the excess over $250,000.

Since none of the Medicare surtax would have been withheld from their salary, additional estimated taxes are needed to avoid a possible underpayment penalty.

4. Perform a Roth Conversion in a Low Income Year

Despite improvements, our economy is still recovering. While unemployment has fallen, many of us remain out of work and it is taking longer for the unemployed to find a new job. Unemployed workers can experience a significant income decline and drop down one or more tax brackets as a result.

While upsetting and stressful, a significant temporary drop in income opens up the opportunity to convert an IRA to a Roth at a low tax rate and convert taxable income to tax-free income for a relatively low cost. Folks whose income has fallen low enough that their deductions exceed their tax can even perform a partial Roth conversion for no tax at all.

The above are just some of the tax-planning issues often overlooked by taxpayers. A little time spent planning for these before Dec. 31 can help you reap large rewards in the form of tax savings and future growth of wealth.

Speak to a tax professional to review your situation and put the tax code to work for you to help you save money and avoid surprises next April.

Retirement-Planning Tips for Singles

FROM WSJ.COM


Preparing for retirement is hard enough when two people are in it together. When you are on your own, it can be even harder.

Many Americans will head into retirement solo for different reasons, of course, including the death of a spouse, divorce and changing lifestyles. In the 2013 U.S. Census, some 54% of women 65 or over were unmarried, and 27% of men.

That is a lot of people, and their situations vary widely. But something senior singles tend to have in common, financial advisers say, is that their retirement-planning needs can be very different from those of married peers—and that many of them are unprepared.

In fact, a study by Rand Corp. says that single people are at much greater risk of not saving enough for retirement than married couples. The study, by researchers Michael Hurd and Susann Rohwedder, found that 20% of married couples won’t save enough for retirement, but that some 35% of single men and 49% of single women will enter retirement financially unprepared.

The reasons run the gamut. For one, there are more forces nipping away at their income and investible resources. For the newly widowed or divorced, advisers say that housing costs may jump as a proportion of income and that some income streams may become less predictable. A single person’s cost of living isn’t, as some might think, 50% of a couple’s. It may be 60% to 80% of a couple’s—or even the same—unless the single person reduces housing expenses significantly, perhaps by downsizing or living with a roommate—something AARP research indicates 40% of adults will consider.

Fewer Tax Breaks
In addition, singles often miss out on tax breaks (filing jointly, for instance) that are available to married peers. As they look ahead, advisers say, singles may also perceive a greater need to pay for pricey long-term care insurance in the absence of a spouse-as-caretaker, which can come at the opportunity cost of investment.

Fear of outliving their retirement savings is a common denominator for single women, who tend to outlive single men. It’s a concern frequently heard by Colin Drake, a fee-only certified financial planner with Drake Wealth in San Francisco.

Standard financial-planning models suggest that retirees can typically withdraw 4% of their portfolios starting at 65, adjusting the withdrawal upward over time for inflation, and not outlive their means, Mr. Drake says. For single women in retirement, he says, it may make more sense to start with a lower withdrawal—maybe 3.5%.

Tax experts add that single adults often face steeper tax challenges than their married peers, especially as they near retirement age. Without child tax credits, a spouse exemption, and no one with whom to realize the benefits of filing jointly, singles can take a pretty big tax punch during peak earning years.

“To lessen the tax bite, I advise my single adult clients who own their own businesses or have side businesses and freelance income to set up a solo 401(k),” says Dean Ferraro, an enrolled agent with Authoritax, a Mission View, Calif., company that prepares tax returns and represents taxpayers in IRS audits. Mr. Ferraro notes that 2014 contribution limits to solo 401(k)s are $52,000, and $57,500 for those over age 50. The contributions consist of a salary deferral (a maximum of $17,500) and a profit-sharing distribution (until the $52,000 or $57,500 limit is reached).

Singles have to be smart about planning for withdrawals from their retirement accounts once they’ve stopped working, experts say. While withdrawals from traditional individual retirement accounts are taxed as ordinary income, withdrawals from Roth IRAs aren’t taxed. For this reason, it can be wise for a single person to move a portion of funds into Roth products before age 70½. Because traditional IRAs require that adults begin withdrawing a minimum distribution (based on a percentage of total assets) at age 70½, retirees with substantial assets in a traditional IRA may be surprised at the high tax brackets.

Glenda Moehlenpah, a certified financial planner for Financial Bridges in Poway, Calif., tells of a couple that had socked away $3 million and assumed the wife would outlive her older husband. But when the man’s wife died first, his mandatory minimum IRA distributions and Social Security payments totaled more than $200,000 annually—more than he needed to live on—and incurred a bigger tax bill than they would for a couple. If he had converted a portion of those assets to a Roth 401(k) before 70½, Ms. Moehlenpah says, he might have owed less in taxes. It’s worth discussing with a tax adviser the possible benefits of a rollover and what the tax impact would be.

Dan Sudit, a Seattle-based financial adviser and regional market manager at BMO Private Bank, describes a similar situation in which a client with about $3 million in assets made a $500,000 Roth conversion before turning 70. Doing so lowered his required minimum distribution from the $100,000-to-$120,000 range into the $80,000-to-$100,00 range, and lowered his tax burden substantially.

Everyone’s situation is different, of course. Cindy Pestka, a 54-year-old regulatory-affairs manager at a Seattle-area medical-device company, has been single all her life and has saved consistently in employer 401(k) plans. She rents out a portion of her century-old Craftsman home for additional income, and isn’t planning to rely heavily on Social Security, which she estimates will account for 30% or less of her retirement income.

But despite her efforts, a financial adviser recently told her she might need to work longer than she’d planned—maybe to 72, versus her late 60s—to sufficiently fund her retirement years. She is now considering whether portfolio moves or downsizing could shorten her working years.

“I was very surprised,” she says. “I’d like to retire while I still have energy to enjoy my life.”

More Surprises
For retirees who are recently divorced, planners say, there can be other surprises as well. Assets like alimony and life-insurance policies become less reliable sources of income. Alimony designed to cover a former spouse for life, for example, may dry up upon the death of the former spouse who was paying. In addition, the owners of life-insurance policies determine who the beneficiaries are; thus, singles who don’t become owners on a shared policy may find themselves without benefits if an ex changes the beneficiaries.

There can be overlooked benefits for divorcées, however. Many don’t realize they may be eligible to receive an ex-spouse’s Social Security benefits, for example, provided the marriage lasted a decade. The divorced spouse can do this even if the ex has remarried, and with no impact to the ex’s benefits.

Ms. Moehlenpah says such a strategy can provide bridge income that can help defer collection of Social Security benefits, and thus increase the benefits that one receives. Indeed, some people choose to delay collecting their benefits until age 70.