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Kick-start Your Child’s Financial Journey with Roth IRAs

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Summer break is here, and many young people will be working at a summer job or internship. While earning a paycheck is exciting, it can also be an excellent time to consider opening a Roth IRA and contributing a portion of their summer earnings. Not only does this jump-start retirement savings from an early age, but it can also serve as a positive learning experience about the principles of saving, investing, and cultivating long-term wealth.

The Roth IRA offers a unique combination of tax advantages and flexibility, making it an excellent choice for young savers.

Here are a few key benefits:

  • Tax-free growth: Roth IRA contributions are made with after-tax dollars, so your child won’t pay taxes (and perhaps penalties) until they make withdrawals.
  • Penalty-free withdrawals of contributions at any time: Your child can withdraw up to the amount of their total contributions at any time, for any reason, without paying taxes or penalties.
  • Early withdrawals of earnings: If your child withdraws amounts that exceed their contributions before age 59½ or before the account has been open for five years, they may face taxes and a 10% early withdrawal penalty on the earnings portion of the withdrawal.
  • Exceptions to early withdrawal penalties: Your child can withdraw funds before age 59½ or before the account has been open for five years for several reasons (keep in mind that you may be able to avoid penalties but not taxes on any earnings), including:
    • Funds can be used for qualified higher education expenses. 🎓
    • First-time home purchase (up to a $ 10,000 lifetime limit.)
    • If your child becomes disabled. ♿
    • For certain emergency expenses. 🏥
    • If your child is unemployed, they can use a withdrawal to help pay for health insurance premiums. 🩺

The flexibility and withdrawal choices for a Roth IRA can make it an attractive choice for young savers who may need access to their money in the future while still providing a powerful tool for long-term wealth building.

Keep in mind that with a Roth IRA, to qualify for the tax and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawals can also be made under certain other circumstances, such as in the examples we listed above. The original Roth IRA owner is not required to take minimum annual withdrawals.

Eligibility requirements

To contribute to a Roth IRA, your child must have earned income from a job, and the maximum contribution for 2024 is $7,000 or the total of their earned income, whichever is less. You can open and manage the account until they reach the age of majority in your state.

One more thing: They may need help filling out their Form W-4

If your child makes less than $14,600 in 2024, they may want to claim an exemption from withholding on their W-4 form by writing “Exempt” on line 4(c) of the form.

Here’s why:

  • Standard deduction: For the 2024 tax year, the standard deduction for a single filer is $14,600. If your child’s total income for the year is less than this amount, they won’t owe any federal income tax.
  • Claiming exemption: If your child expects to owe no federal income tax for the year and wants to have no tax withheld from their paycheck, they can write “Exempt” on line 4(c) of Form W-4. This means their employer won’t withhold any federal income tax from their paychecks.
  • Remember that if your child claims exemption, Social Security and Medicare taxes may still be withheld from their paychecks. Also, if their situation changes and they owe federal income tax for the year, they may face underpayment penalties.
  • Our ideas in this letter are for informational purposes only and are not a replacement for real-life advice. Consider consulting your tax, legal, and accounting professionals if you have questions about completing Form W-4.

If you’d like to discuss opening a Roth IRA for your child or grandchild, feel free to contact us. And feel free to share this with anyone you think might be interested.

Wishing you and your family a wonderful start to the summer!

Bryan Cassick, MBA, CFP®

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents 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 document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

What to Do With a 529 Balance

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Watching your child earn a college diploma is a proud moment for any parent. It also marks another great moment: No more tuition bills. But after all the saving and planning you’ve done, what if there’s still money left over in your child’s 529 plan? Fortunately, you’ve got plenty of options. Here’s a list of strategies to make the most of those surplus education savings.

Keep Paying for School

If your newly minted graduate is pursuing a higher degree, that’s an easy way to spend down the balance in their 529 plan. These funds can be used to cover the same types of qualified educational expenses for graduate programs.

Name a New Beneficiary

If grad school isn’t in your child’s future, the most straightforward option for surplus funds is to assign the 529 account to a new beneficiary. You can change beneficiaries with no penalties or tax consequences, but the person must be related to the original beneficiary by blood, marriage, or adoption. That definition is broader than it sounds: For example, it includes in-laws, first cousins, first cousins’ spouses, and stepparents. You can even name yourself as the new beneficiary and spend the funds on your own continued education.

Repay Student Loans

If your graduate has taken on student loan debt, you can use 529 funds to help pay it down, subject to a lifetime limit of $10,000. You can also use up to $10,000 per sibling to repay their loans, which you can do without changing the beneficiary.

A few things to bear in mind: Most, but not all, student loans qualify. Private student loans must meet several criteria to be included in the program. For example, they must have been used solely for qualified education expenses for a degree or certificate program at an institution eligible for Title IV federal student aid. And they can’t be personal loans from a family member or a loan from a retirement plan. 

Also, 529 plans are run by states, and their rules don’t always align perfectly with federal legislation. We can help you check your 529 to see whether withdrawals for student loan payments will trigger any state tax penalties.

Roll Over Funds Into a Roth IRA

The SECURE 2.0 Act of 2022 added a brand-new option for unused 529 funds. If your 529 plan is at least 15 years old, you can transfer up to $35,000 into a Roth IRA in the beneficiary’s name with no taxes or penalties. 

The biggest limitation with this option is that rollovers are subject to the annual $7,000 Roth contribution limit. (If the beneficiary is 50 or older, that amount rises to $8,000.) You also can’t roll over more than the income earned by the beneficiary in that tax year. Any other contributions made to your beneficiary’s traditional or Roth IRA will reduce the amount you can roll over that year.   

Take the Money…and the Penalty

If you spend 529 funds on nonqualified expenses, you’ll be charged federal income tax and a 10% penalty on the earnings portion of your withdrawal. While doing so isn’t always ideal, it is an option—and sometimes, it may be the best one. For example, if you face a pressing financial need and your only other choice is to take on high-interest debt, paying the taxes and penalties on a nonqualified 529 withdrawal may be less expensive in the long run.

It’s also possible that the earnings portion is small enough to render the penalty insignificant. Let’s say you had $500 dollars left in the account, with contributions accounting for $420. In that case, only $80 would be subject to taxes and penalties. You might decide it’s worth taking the hit to be able to close the account and move on.

The bottom line is that 529 college savings plans have more flexibility than you might think. Reach out, and we will gladly help you weigh all the options for leftover funds. Congratulations to all the recent grads out there—and to the parents who helped foot their tuition bills.

Bryan Cassick, MBA, CFP®

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents 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 document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Secure Act 2.0: Tax Planning Tips

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Tax planning for your retirement savings is also important. To help with that, you can typically choose between two account types as you save for retirement: Traditional IRA or employer-sponsored plans, or Roth versions of the same. 

All Things Roth

Either way, your retirement savings grow tax-free while they’re in your accounts. The main difference is whether you pay income taxes at the beginning or end of the process. For Roth accounts, you typically pay taxes up front, funding the account with after-tax dollars. Traditional retirement accounts are typically funded with pre-tax dollars, and you pay taxes on withdrawals. 

That’s the intent, anyway. To fill in a few missing links, the SECURE 2.0 Act:

  • Eliminates Required Minimum Distributions for employer-sponsored Roth accounts, such as Roth 401(k)s and Roth 403(b)s, to align with individual Roth practices (2024)
  • Establishes Roth versions of SEP and SIMPLE IRAs (2023)
  • Lets employers make contributions to traditional and Roth retirement accounts (2023)
  • Lets families potentially move 529 plan assets into a Roth IRA (2024 – as described above)

There’s one thing that’s not changed, although there’s been talk that it might: There are still no restrictions on “backdoor Roth conversions” and similar strategies some families have been using to boost their tax-efficient retirement resources. 

Speaking of RMDs

Not surprisingly, the government would prefer you eventually start spending your tax-sheltered retirement savings, or at least pay taxes on the income. That’s why there are rules regarding when you must start taking Required Minimum Distributions (RMDs) out of your retirement accounts. That said, both SECURE Acts have relaxed and refined some of those RMD rules. 

  • Extended RMD Dates (2023): the original SECURE Act postponed when you must start taking taxable RMDs from your retirement account—from 70 ½ to 72. The SECURE 2.0 Act extends that deadline further. If you were born between 1951–1959, you can now wait until age 73. If you were born after that, it’s age 75. 
  • Reduced Penalties (2023): If you fail to take an RMD, the penalty is reduced from a whopping 50% of the distribution to a slightly more palatable 25%. Also, the penalty may be further reduced to 10% if you fix the error within a prescribed correction window. 
  • Aligned RMD Rules for Personal and Employer-based Roth Accounts (2024): As mentioned above, RMDs have been eliminated from employer-based Roth accounts. If you’ve already been taking them, you should be able to stop doing so in 2024. 
  • Enhanced RMDs for Surviving Spouses (2024): If you are a widow or widower inheriting your spouse’s retirement plan assets, you will be able to elect to determine your RMD date as if you were your spouse. This provision can work well if your spouse was younger than you. As described here: “RMDs for the [older] surviving spouse would be delayed until the deceased spouse would have reached the age at which RMDs begin.”

An Addendum For Charitable Donors

One good thing hasn’t changed with SECURE 2.0: Even though RMD dates have been extended as described, you can still make Qualified Charitable Distributions (QCDs) out of your retirement accounts beginning at age 70 ½, and the income is still excluded from your taxable adjusted gross income, as well as from Social Security tax and Medicare surcharge calculations. Plus, beginning in 2024, the maximum QCD you can make (currently $100,000) will increase with inflation. Also, with quite a few caveats, you will have a one-time opportunity to use a QCD to fund certain charitable trusts or annuities. 

Next Steps

How else can we help you incorporate SECURE 2.0 Act updates into your personal financial plans? The landscape is filled with rabbit holes down which we did not venture, with caveats and conditions to be explored. And there are a few provisions we didn’t touch on here. As such, before you proceed, we hope you’ll consult with us or others (such as your accountant or estate planning attorney) to discuss the details specific to you. 

Come what may in the years ahead, we look forward to serving as your guide through the ever-evolving field of retirement planning. Please don’t hesitate to reach out to us today with your questions and comments.

Justin D. Rucci, CFP®

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents 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 document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Reference Materials and Additional Reading:

What is a Roth Conversion?

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What is a Roth Conversion?

According to Investopedia, “a Roth IRA conversion is a reportable movement of assets from a Traditional IRA, SEP or SIMPLE IRA to a Roth IRA, which is a taxable event. A Roth conversion can be advantageous for individuals with large traditional IRA accounts who expect their future tax bills to stay at the same level or grow at the time they plan to start withdrawing from their tax-advantaged account, as a Roth IRA allows for tax-free withdrawals of qualified distributions.”

To simplify this down, you are taking assets from a qualified account, such as the traditional IRA,  paying the income taxes owed on the amount now, and moving them into a Roth IRA to capitalize on the tax-free income on eligible withdrawals.

Why would someone do this?

If someone feels that their tax liability is going to increase in the future, this provides a way for tax diversification. For example, if you are in a low tax bracket currently and have a large sum of your assets in qualified accounts, then it may make sense to convert the funds assuming you have the cash on hand to cover the tax liability.

Taking advantage of your low tax basis now (maybe even specific to the most recent tax reform) could allow you to control your RMDs (required minimum distributions) in the future or allow you to leave money more efficiently to your heirs, especially if your income tax rate is lower than theirs.

Who would be someone that would want to do this?

There are a couple different scenarios that this strategy might be useful in.

One is a retiree who is going to have no earned income and has plenty of assets for a successful retirement. If their asset base is large enough to not worry about income, chances are they may run into Required Minimum Distributions in the future. To control this, they could convert money now and limit their tax exposure during the RMD years. Additionally, if they plan to leave money to their heirs, this is an opportunity to leave it for them income tax-free.

A second scenario might include someone who is not in retirement, but perhaps they had a lower than normal income year, has a long time horizon until retirement, and has qualified assets they would rather have in a Roth. In our “younger than retirement age” scenario, their financial plan might dictate they would retire prior to the 59.5 age mark. This conversion would allow them to tap into their basis before 59.5.

In all instances, if someone has qualified assets, a lower than normal current tax environment, and the cash to complete the conversion, then it is something to be considered for financial planning purposes.

Additionally, there are some nuanced rules regarding how long someone must wait to access these funds known as the “5-year rule”. You can learn more about the finer details around that issue here: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

How does one convert their traditional IRA funds to Roth?

This can be a tricky process since timelines and amounts might need to be tracked for the “5-year rule”, so we recommend speaking with your personal financial planner and/or accountant to make sure that this might be a good fit for you and your plan.

Overall, the Roth conversion can be a good strategy assuming that all the important variables line up in regards to tax rates, timing, and cash on hand. However, a Roth conversion should be considered on a case-by-case basis and may not be right for everyone. With it being a tricky strategy to execute, make sure you consult your financial advisor or account for a smooth process.

Cary Warren Facer, Partner Emeritus

Warren Street Wealth Advisors

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. 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. Warren Street Wealth Advisors are not Certified Public Accountants and all tax-related matters should be vetted and acted on with your personal tax counsel.

The Solo 401k

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The Solo 401k

A retirement savings vehicle designed for the smallest businesses.

A solo 401(k) lets a self-employed individual set up a 401(k) plan combined with a profit-sharing plan. You can create one of these if you work for yourself or for you and your spouse.(1)

Reduce your tax bill while you ramp up your retirement savings. Imagine nearly tripling your retirement savings potential. With a solo 401(k), that is a possibility. Here is how it works:

*As an employee, you can defer up to $18,500 of your compensation into a solo 401(k). The yearly limit is $24,500 if you are 50 or older, for catch-up contributions are allowed for these plans.(1)

*As an employer, you can have your business make a tax-deductible, profit-sharing contribution of up to 25% of your compensation as defined by the plan. If your business isn’t incorporated, the annual employer contribution limit is 20% of your net earnings rather than 25%. If you are a self-employed individual, you must calculate the maximum amount of elective deferrals and non-elective contributions you can make using the methods in Internal Revenue Service Publication 560.(1,2)

*Total employer & employee contributions to a solo 401(k) are capped at $55,000 for 2018.(1)

Are you married? Add your spouse to the mix. If your spouse is a full-time employee of your business, then he or she can also make an employee contribution to the plan in 2018, and you can make another profit-sharing contribution on your spouse’s behalf. (For this to happen, your spouse must have net self-employment income from the business.)(2,3)

The profit-sharing contributions made by your business are tax-deductible. Annual contributions to a solo 401(k) are wholly discretionary. You determine how much goes in (or doesn’t) per year.(2,4)

You can even create a Roth component in your solo 401(k). You can direct up to $5,500 annually (or $6,500 annually, if you are 50 or older) into the Roth component of the plan. You cannot make employer contributions to the Roth component.(3)

Rollovers into the plan are sometimes permitted. Certain plan providers even allow hardship withdrawals (loans) from these plans prior to age 59½.(5)

There are some demerits to the solo 401(k). As you are setting up and administering a 401(k) plan for your business, you have to see that it stays current with ERISA and IRC regulations. Obviously, it is much easier to oversee a solo 401(k) plan than a 401(k) program for a company with 15 or 20 full-time employees, but you still have some plan administration on your plate. You may not want that, and if so, a solo 401(k) may have less merit than a SEP or traditional profit-sharing plan. The plan administration duties are relatively light, however. There are no compliance testing requirements, and you will only need to file a Form 5500 annually with the I.R.S. once the assets in your solo 401(k) exceed $250,000.(4)

If you want to hire more employees, your solo 401(k) will turn into a standard 401(k) plan per the Internal Revenue Code. The good news is that you can present your new hires with an established 401(k) plan.(2,3)

On the whole, solo 401(k)s give SBOs increased retirement savings potential. If that is what you need, then take a good look at this option. These plans are very easy to create, their annual contribution limits far surpass those of IRAs and stand-alone 401(k)s, and some custodians for solo 401(k)s even give you “checkbook control” – they let you serve as trustee for your plan and permit you to invest the funds across a variety of different asset classes.(5)

J Rucci

Justin D. Rucci, CFP®
Wealth Advisor
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.

Citations.

1 – irs.gov/retirement-plans/one-participant-401k-plans [10/25/17]
2 – mysolo401k.net/solo-401k/solo-401k-contribution-limits-and-types/ [2/13/18]
3 – doughroller.net/retirement-planning/solo-401k-best-retirement-plan-self-employed/ [5/21/17]
4 – tdameritrade.com/retirement-planning/small-business/individual-401k.page [2/13/18]
5 – thecollegeinvestor.com/18174/comparing-the-most-popular-solo-401k-options/ [12/11/17]