The IRA and the 401(k)/in Financial Planning, Investing, Retirement, Taxes /by Justin D. Rucci, CFP®
The IRA and the 401(k)
Comparing their features, merits, and demerits.
How do you save for retirement? Two options probably come to mind right away: the IRA and the 401(k). Both offer you relatively easy ways to build a retirement fund. Here is a look at the features, merits, and demerits of each account, starting with what they have in common.
Taxes are deferred on money held within IRAs and 401(k)s. That opens the door for tax-free compounding of those invested dollars – a major plus for any retirement saver. (1)
IRAs and 401(k)s also offer you another big tax break. It varies depending on whether the account is traditional or Roth in nature. When you have a traditional IRA or 401(k), your account contributions are tax deductible, but when you eventually withdraw the money for retirement, it will be taxed as regular income. When you have a Roth IRA or 401(k), your account contributions are not tax deductible, but if you follow Internal Revenue Service rules, your withdrawals from the account in retirement are tax-free. (1)
Generally, the I.R.S. penalizes withdrawals from these accounts before age 59½. Distributions from traditional IRAs and 401(k)s prior to that age usually trigger a 10% federal tax penalty, on top of income tax on the withdrawn amount. Roth IRAs and Roth 401(k)s allow you to withdraw a sum equivalent to your account contributions at any time without taxes or penalties, but early distributions of the account earnings are taxable and may also be hit with the 10% early withdrawal penalty.1
You must make annual withdrawals from 401(k)s and traditional IRAs after age 70½. Annual withdrawals from a Roth IRA are not required during the owner’s lifetime, only after his or her death. Even Roth 401(k)s require annual withdrawals after age 70½. (2)
Now, on to the major differences.
Annual contribution limits for IRAs and 401(k)s differ greatly. You may direct up to $18,500 into a 401(k) in 2018; $24,500, if you are 50 or older. In contrast, the maximum 2018 IRA contribution is $5,500; $6,500, if you are 50 or older. (1)
Your employer may provide you with matching 401(k) contributions. This is free money coming your way. The match is usually partial, but certainly, nothing to disregard – it might be a portion of the dollars you contribute up to 6% of your annual salary, for example. Do these employer contributions count toward your personal yearly 401(k) contribution limit? No, they do not. Contribute enough to get the match if your company offers you one. (1)
An IRA permits a wide variety of investments, in contrast to a 401(k). The typical 401(k) offers only about 20 investment options, and you have no control over what investments are chosen. With an IRA, you have a vast range of potential investment choices. (1,3)
You can contribute to a 401(k) no matter how much you earn. Your income may limit your eligibility to contribute to a Roth IRA; at certain income levels, you may be prohibited from contributing the full amount, or any amount. (1)
If you leave your job, you cannot take your 401(k) with you. It stays in the hands of the retirement plan administrator that your employer has selected. The money remains invested, but you may have less control over it than you once did. You do have choices: you can withdraw the money from the old 401(k), which will likely result in a tax penalty; you can leave it where it is; you can possibly transfer it to a 401(k) at your new job; or, you can roll it over into an IRA. (4,5)
You cannot control 401(k) fees. Some 401(k)s have high annual account and administrative fees that effectively eat into their annual investment returns. The plan administrator sets such costs. The annual fees on your IRA may not nearly be so expensive. (1)
All this said, contributing to an IRA or a 401(k) is an excellent idea. In fact, many pre-retirees contribute to both 401(k)s and IRAs at once. Today, investing in these accounts seems all but necessary to pursue retirement savings and income goals.
Justin D. Rucci, CFP®
Warren Street Wealth Advisors
Justin D. Rucci is an Investment Advisor Representative of Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented.
This material was prepared by Marketing Pro, Inc. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy, and results of your portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of the content, those securities held may change over time and trades may be contrary to outdated posts.
1 – nerdwallet.com/article/ira-vs-401k-retirement-accounts [4/30/18]
2 – irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions [5/30/18]
3 – tinyurl.com/y77cjtfz [10/31/17]
4 – finance.zacks.com/tax-penalty-moving-401k-ira-3585.html [9/6/18]
5 – cnbc.com/2018/04/26/what-to-do-with-your-401k-when-you-change-jobs.html [4/26/18]
72(t) Distributions/in Financial Planning, Investing, Retirement /by Justin D. Rucci, CFP®
Sometimes you can take penalty-free early withdrawals from retirement accounts.
Do you need to access your retirement money early? Maybe you just want to retire before you turn 60 and plan a lifelong income stream from the money you have saved and invested. You may be surprised to know that the Internal Revenue Service allows you a way to do this, provided you do it carefully.
Usually, anyone who takes money out of an IRA or a retirement plan prior to age 59½ faces a 10% early withdrawal penalty on the distribution. That isn’t always the case, however. You may be able to avoid the requisite penalty by taking distributions compliant with Internal Revenue Code Section 72(t)(2).(1)
While any money you take out of the plan will amount to taxable income, you can position yourself to avoid that extra 10% tax hit by breaking that early IRA or retirement plan distribution down into a series of substantially equal periodic payments (SEPPs). These periodic withdrawals must occur at least once a year, and they must continue for at least 5 full years or until you turn 59½, whichever period is longer. (Optionally, you can make SEPP withdrawals every six months or on a quarterly or monthly basis.)(1,2)
How do you figure out the SEPPs? They must be calculated before you can take them, using one of three I.R.S. methods. Some people assume they can just divide the balance of their IRA or 401(k) by five and withdraw that amount per year – but that is not the way to determine them.(2)
You should calculate your potential SEPPs by each of the three methods. When the math is complete, you can schedule your SEPPs in the way that makes the most sense for you.
The Required Minimum Distribution (RMD) method calculates the SEPP amount by dividing your IRA or retirement plan balance at the end of the previous year by the life expectancy factor from the I.R.S. Single Life Expectancy Table, the Joint Life and Last Survivor Expectancy Table, or the Uniform Lifetime Table.(1,2)
The Fixed Amortization method amortizes your retirement account balance into SEPPs based on your life expectancy. A variation on this, the Fixed Annuitization method, calculates SEPPs using your current age and the mortality table in Appendix B of Rev. Ruling 2002-62.(1,2)
If you use the Fixed Amortization or Fixed Annuitization method, you are also required to use a reasonable interest rate in calculating the withdrawals. That interest rate can’t exceed more than 120% of the federal midterm rate announced periodically by the I.R.S.(1,3)
A lot to absorb? It certainly is. The financial professional you know can help you figure all this out, and online calculators also come in handy (Bankrate.com has a good one).
There are some common blunders that can wreck a 72(t) distribution. You should be aware of them if you want to schedule SEPPs.
If you are taking SEPPs from a qualified workplace retirement plan instead of an IRA, you must separate from service (that is, quit working for that employer) before you take them. If you are 51 when you quit and start taking SEPPs from your retirement plan, and you change your mind at 53 and decide you want to keep working, you still have this retirement account that you are obligated to draw down through age 56 – not a good scenario.(1)
Once you start taking SEPPs, you are locked into them for five consecutive years or until you reach age 59½. If you break that commitment or deviate from the SEPP schedule or calculation method you have set, a 10% early withdrawal penalty could apply to all the SEPPs you have already made, with interest. (Some individuals can claim exceptions to this penalty under I.R.S. rules.)(3,4)
The I.R.S. does permit you to make a one-time change to your distribution method without penalty: if you start with the Fixed Amortization or Fixed Annuitization method, you can opt to switch to the RMD method. You can’t switch out of the RMD method to either the Fixed Amortization or Fixed Annuitization method, however.(2)
If you want or need to take 72(t) distributions, ask for help. A financial professional can help you plan to do it right.
Justin D. Rucci, CFP®
Warren Street Wealth Advisors
Justin D. Rucci is an Investment Advisor Representative of Warren Street Wealth Advisors, a Registered Investment Advisor. Information contained herein does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented.
This material was prepared by Marketing Pro, Inc. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy, and results of your portfolio.Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results.Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of content, those securities held may change over time and trades may be contrary to outdated posts.
1 – irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments [12/19/17]
2 – fool.com/retirement/2017/05/19/use-your-retirement-savings-early-with-substantial.aspx [5/19/17]
3 – thebalance.com/how-to-use-72-t-payments-for-early-ira-withdrawals-2388257 [9/20/17]
4 – military.com/money/retirement/second-retirement/early-retirement-options.html [5/7/18]
9 Year End Tax Tips for Investors/in Education, Taxes /by Blake Street
Chartered Financial Analyst
Certified Financial Planner®
Founding Partner & CIO
Warren Street Wealth Advisors
I know, I know, you’d rather be thinking about the holidays than taxes. Consider us The Grinch for even bringing this up, however, the timing is important. As the years draws to a close it is important that you consider year end tax planning before 2017 strikes our calendars.
Here are the some of the biggest items for consideration for an investor before year end:
1) Changes to the tax code?
There were no significant changes to tax law from 2015 to 2016, prepare for much of the same for your 2016 filing.
2) Don’t forget your RMDs (Required Minimum Distribution)
If you’re over age 70 ½, make sure you take your required minimum distribution (RMD) by December 31st. Investors who turned 70 ½ this year can defer their 2016 RMD until April 1st of next year, but that will mean taking two RMDs next year. Investors who turned 70 ½ last year and deferred their 2015 RMD to 2016 need to make sure they take their 2016 RMD by December 31st. Important to note: RMDs apply to most retirement accounts, not just IRAs; 401(k)s and even Roth 401(k)s are subject to RMDs.
3) Max out your IRAs
If you are eligible, be sure to max out your IRA when you can. An individual can contribute up to $5,500 per year, or $6,500 if over the age of 50. These contributions can be on a tax deferred basis or after-tax basis (ROTH IRA) depending on your personal goals and objectives.
The truth is you can cut these checks all the way up until the time you file your taxes, but as like I to say to myself, “save early, save often.”
4) Consider a ROTH conversion
If you think you’re in a lower tax bracket now then you will be in the future, and you’ve got most your assets in pre-tax buckets like a 401(k) or an IRA, it may pay to consider converting some of those assets to a ROTH IRA. The ROTH IRA grows and can be withdrawn from tax free after age 59 ½. Converting assets to a ROTH may create a tax bill today for future savings, so be aware.
One wonderful perk of a conversion is the fact that you can undo it should the terms or tax implications look unfavorable before you file. This is called recharacterization. You’re eligible to recharacterize the conversion all the way up until the time you file, including extensions.
Consider converting small portions over a long period of time when your tax scenario makes sense.
5) Make the Most of your Charitable Giving
Charitable contributions are usually deductible up to 50% of your adjusted gross income (AGI). If you have a habit of being charitable, might as well get credit for the deduction. If you plan to give, consider doing it in years when you need the tax break. Also, if you’re at the limit for giving, consider delaying gifts until your deduct limit clears out next year.
One other strategy we like to see considered is gifting highly appreciated securities. You can deduct the market value of the securities subject to your deduction limit, and avoid the capital gains taxes you would have been exposed to should have sold the securities in your name.
If you’re curious for a ballpark figure on what you can deduct, you can see your AGI on Page 1, Box 37 of your 1040, also known as your tax return.
6) Consider Qualified Charitable Distributions
Two bullet points for charity, we can’t be The Grinch! Qualified Charitable Distributions (QCDs) are a wonderful part of the tax code that allows you take distributions from your IRA and send directly to a charity of your choice, tax free.
The best part, QCDs don’t count as income, but do count against your RMDs. QCDs will also reduce your adjusted gross income and could reduce your Medicare Part B premiums, in addition to reducing the amount of your Social Security benefits that are taxable.
7) Gifts to Non-charitable Interests
I know, sometimes your loved ones feel like charity, but if you’ve got any large gifts planned to grandkids, children, or whomever, timing matters. You’re able to gift $14,000 to any individual each year without any gift tax implications. You and your spouse can gift that amount separately to the same person for a total of $28,000.
These gift amounts are a great way to reduce your taxable estate or even fund your wishes in your lifetime without getting into messy gift and estate tax issues. One additional creative idea, you’re able to gift five years worth of gift limits into a 529 plan in a single year, so in this case, $70,000. One asterisk, you can’t gift to this person again for five years. We see folks use this technique if they want to fund large portions of someone’s advanced education while reducing their taxable estate at a faster rate.
8) Tax Loss Harvest
This is something we do on behalf of our clients, but if you manage outside assets on your own, consider booking some of your losses. We all have some, don’t be shy. Losses can be used to offset capital gains generated within your portfolio, carried forward to future years, or even a small portion used to reduce taxable income. One great idea when harvesting losses is trying to replicate your exposure of what you sold, so that you’re not sitting in cash waiting for the IRS 30-day wash sale rule to pass to buy back the original security. If it sounds complicated, let us show you how we do it for our clients.
9) Take Your Gains
To add some intrigue after the last bullet point, it’s equally as important to harvest your gains at the appropriate time. Depending on your income level, you could pay as low as 0% in long term capital gains tax rates. It makes sense to know in what years you’ll fall below this income threshold so that you can pay as little taxes as possible.
RMD? IRA? What are these things exactly? If you need help navigating your financial picture, contact us and schedule a free consultation.
Blake Street is a Founding Partner and Chief Investment Officer of Warren Street Wealth Advisors. Blake graduated from California State University, Fullerton in 2009 with a Bachelor of Arts in Finance, and he is a CERTIFIED FINANCIAL PLANNER™ (CFP™) and a Chartered Financial Analyst (CFA).
Disclosure: Blake Street is an Investment Advisor Representative of Warren Street Wealth Advisors, a Registered Investment Advisor. The information posted here represents his opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of content, those securities held may change over time and trades may be contrary to outdated posts.
As a Registered Investment Advisor, Warren Street Wealth Advisors, LLC is required to file form ADV to report our business practices and conflicts of interest. Please call to request a copy at 714-876-6200.