Tuesday, July 5, 2016

What are the tax-advantage incentives of retirement plans?

FROM http://www.readingeagle.com/

Whether you've saved enough money for retirement is a question best answered by a financial adviser.

But for anyone considering retirement, having your investments in accounts that will keep your post-retirement taxes low is the best policy.
If you don't have a 401(k) plan with your employer, or if you want to take advantage of more investment options, opening an individual retirement account is a sound policy.

According to Kevin J. Miller, an accredited asset management specialist at Berkshire Investment Group, Wyomissing, traditional IRAs allow for an upfront tax deduction on your income tax return for the year of contribution. The maximum in 2016 is $5,500, and $6,500 for an individual over the age of 50.

"The money grows tax-deferred and is taxed on the withdrawals once the IRA owner reaches age 59½," said Miller. "There are some exceptions for early withdrawals without penalty."
Individuals must pay an additional 10 percent early-withdrawal tax unless an exception applies. Some of the exceptions include qualified higher education expenses, qualified first-time home buyer costs and unreimbursed medical expenses.

Miller said Roth IRA contributions are made with after-tax money, but the earnings and growth are tax deferred along with tax-free withdrawals after age 59½ and a five-year holding period. The same maximum contribution limits apply as with a traditional IRA.
"In addition, there is no requirement to withdraw assets after age 70½ as compared to the traditional IRA that has required minimum distributions after age 70½," he said.

Paul L. Marrella, a financial adviser with Marrella Financial Group LLC, Spring Township, said, "These distributions begin at just under 4 percent of the IRA's value, with the percentage increasing over time."

A Roth IRA does not mandate minimum distributions.
"Roth IRAs may be more suitable for longer-term intergenerational wealth planning, where the money can be invested for many years on a tax-free basis," Marrella said. "In addition, spending your Roth IRA during retirement may keep your income lower, potentially reducing the percentage of your Social Security being taxed."

Given the flexibility of the Roth IRA, investors may want to consider converting their traditional IRA accounts into Roth IRA accounts.

"There are normally no fees involved when converting a traditional IRA to a Roth IRA," Miller said. "However, you may be liable for a large tax consequence when converting from a traditional to a Roth because of the transition from a pretax account of a traditional to a post-tax account of a Roth. One way to combat the large tax liability is to transition a traditional IRA to a Roth IRA over a period of years."

Planning strategy
The best way to lower taxes in retirement years is by planning your income tax strategy while you are still working, according to Marrella.

"For some Americans, you are better off having higher taxable income every other year, with lower years in between," he said. "This may help lower your Social Security taxation. For others, it may make sense to begin taking IRA distributions from the year following retirement up to the time they must take required minimum distributions. This can be done by either withdrawing money from the IRA account or converting to a Roth IRA. In some cases, tax-free municipal bonds may make sense."
Miller noted that municipal bonds distribute tax-free income but are subject to capital gains and losses when the bonds are sold at a gain or loss. The holding period of assets also plays a role.
"When assets are held for longer than one year and sold, they are considered long-term capital gains and losses and are taxed at a favorable tax rate," he said, "as compared to assets held and sold in one year or less, considered short-term capital gains and losses, and can be taxed as ordinary income."
Pensions are taxed at ordinary income rates. "That means you include the taxable pension along with any other wages, interest, dividends, etc.," Marrella said. "In addition, if your income is high enough, up to 85 percent of your Social Security could be taxed. The formula used is somewhat complex, but essentially begins taxing $1 of your Social Security for every $2 of income you have over a certain threshold."

Reduce tax liability
Miller said that tax loss harvesting, the practice of selling stocks and securities that are now worth less than an investor paid for them, can provide investors with the opportunity to reduce their tax liability because realized losses on investments can be used to first offset taxable gains and then to reduce ordinary income up to $3,000 per year.

"Starting in 2006, Congress allowed for Roth 401(k) contributions into employer-sponsored retirement plans to allow employees to take advantage of the Roth taxation benefits," Miller said. "This is further evidence that the federal government is encouraging people to save even more through tax-advantage incentives."