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Further Guidance on the One-Rollover-Per-Year Rule for IRAs


As a follow-up to the recent post on this blog The One-Rollover-Per-Year Rule: Revised, the IRS has recently released some additional guidance on the subject, via Announcement 2014-15.

As previously mentioned, the IRS has determined to begin using the one-rollover-per-year rule applied to ALL IRAs that the taxpayer owns, rather than only the affected IRAs that have been involved in a rollover.

According to the Announcement, the IRS fully acknowledges that the previous understanding of the rule was that it applied on an IRA-by-IRA basis.  In fact, there was a Proposed Regulation § 1.408-4(b)(4)(ii) on the books that was to further define the rule as applied only to the involved IRAs.  Ever since the Tax Court decided otherwise in the case Bobrow v. Commissioner (TC Memo 2014-21), the rule has been changed.

According to the recent announcement though, this will not take affect across the board until January 1, 2015.  Prior to that date, presumably, the old interpretation will be used, except, apparently, for Mr. Bobrow’s case (and any further cases that might be tried by the Tax Court).

How Does an Early Withdrawal from a Retirement Plan Affect My Taxes?

Image courtesy of adamr at FreeDigitalPhotos.net

Image courtesy of adamr at FreeDigitalPhotos.net

Oftentimes we are faced with difficult situations in life – where we need extra money to pay for a major car repair, a new roof for the house, or just day-to-day living expenses – and our emergency funds are all tapped out.  Now your options become poor: should I go to a payday loan place, put more on my credit card?  My mortgage is upside-down so there’s no home equity loan in my future, and I can’t ask my folks for a loan, I’ve asked them for too much.  Hey, what about my retirement plan?  I’ve got some money socked away in an IRA that’s just sitting there, why don’t I take that money?

It’s really tough to be in a situation like this, but you need to understand the impacts that you’ll face if you decide to go the route of the IRA withdrawal, especially if you’re under age 59½.

Any money that you take out of a retirement plan as a withdrawal will be taxed as ordinary income – just like wages, salaries, and tips.  So if you’re in the 25% marginal tax bracket, every dollar that you withdraw from your IRA or 401(k) plan (if allowed) will cost you 25 cents right off the top.

In addition to the ordinary income tax, if you’re less than 59½ years of age you’ll also be hit with an additional 10% penalty for an early withdrawal (unless your withdrawal meets one of these 19 exceptions). So now every dollar that you withdraw costs an extra 10 cents on top of the ordinary income tax.  If you’re in the 25% bracket, that $10,000 withdrawal from your IRA can cost you as much as $3,500 in extra taxes and penalties.

Bear in mind that you may be able to take a temporary loan from your 401(k) or other qualified retirement plan (QRP) if you’re still employed by that employer.  Naturally you’ll need to repay the loan, but it might be a better option cost-wise than the other choices.  Plus, if you have an outstanding loan from your QRP and you leave the employer you’ll be required to either recognize the balance of the loan as a withdrawal or pay it back to the plan immediately.

Armed with this information makes your decision points much more clear: review all of the available options mentioned above (loans from family and friends, home equity loans, payday loans, and the like) against the cost of the taxes for taking an early withdrawal from your retirement plan.  The best option may be to see about a formal loan from family, paying them a reasonable rate of interest.  But of course, your circumstances are going to dictate the best option for you.  Just go into it with your eyes wide open.

Market Returns Aren’t Savings

Golden Egg

In 2013 the market and those invested in it experienced a nice return on their investments. The S&P 500 rose an amazing 29.6% while the Dow rose 26.5%. Needless to say 2013 was an amazing year for investors – but try not to make the following mistake:

Don’t confuse investment returns with savings.

While it is true that the more of a return an investor receives on his or her investments the less they have to save it still does not mean that your returns should take the place of systematic saving for retirement, college or the proverbial rainy day. And by no means should you reduce the amount you’re saving thinking that the returns from 2013 and other bull years will repeat and continue their upward bounty.

Investment returns are the returns that an investor receives in a particular time frame. For 2013, if an investor was invested in the S&P 500 or an S&P 500 index fund they received almost 30% returns for the year. Not bad. But this is deceiving. Not to burst anyone’s bubble, but we are only looking at one year. If an investor was saving for retirement for over 30 years, to expect 30% returns each year for 30 years is  like expecting my chickens to lay golden eggs – it ain’t gonna happen!

But what if an investor stops systematically saving, thinking that a 30% increase in their portfolio for 2013 can offset any additional money they intended to put in? The result would be disastrous to their retirement plan. Perhaps some numbers can help explain.

Let’s assume that we have two investors, Alex and Neil. Both are age 30, both will retire at age 65 and both start with $10,000 in their IRAs at the beginning of 2013 and both are invested 100% in the S&P 500. At the end of 2013, both investors have $13,000 in their IRAs. Up until the end of 2013, both Alex and Neil had systematically contributed the maximum to their IRAs annually – about $5,000 annually. Now they can contribute $5,500 annually.

Alex decides that since 2013 rocked, he will not contribute to his IRA for 2014 thinking that 2013’s numbers will last forever. Neil decides to keep drumming away and putting in his annual amount ($5,500 for 2014) at a steady rhythm.

Neil is handsomely rewarded for his commitment and over the next 35 years, at a 6% average annual return he amasses close to $690,000 ($698,752 for those of you with your financial calculators).

Alex is sporadic. After up years in the market he doesn’t invest and after down years he thinks he needs to contribute. It turns out that there were 20 years of downs and 15 years of ups – so Alex invested his annual IRA maximum 20 times, instead of Neil’s 35.

Keeping the math simple, let’s say that the market was down for the next 20 years causing Alex to save and then up the last 15 years causing him to relax his savings commitment. In 20 years, since there were no gains Alex has $123,000 (we assume no losses in this down market).

In the next 15 years, Alex averages 6% return and contributes nothing since they are up years. At the end of 35 years Alex has roughly $295,000 ($294,777 for those of you still calculating) – or about $400,000 less than Neil.

Admittedly my examples are very simplistic and a bit unrealistic. But the point is to not confuse your investment returns with savings. They are not the same. An investor still needs to stick to their savings plan regardless of what the market does.

In up years and I would argue more importantly in down years you need to stick to your plan of saving regularly – along with the ups and downs to take advantage of compounding returns and  buying less when the market is overpriced and more when it’s under-priced.

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2014 IRA MAGI Limits – Married Filing Separately

Separated Strawberry

Separated Strawberry (Photo credit: bthomso)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Separately):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at your job and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 55% for every dollar (or 65% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan but your spouse is, and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Separately):

If your MAGI is less than $10,000, your contribution to a Roth IRA is reduced ratably by every dollar, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $10,000 or more, you can not contribute to a Roth IRA.

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2014 MAGI Limits for IRAs – Married Filing Jointly or Qualifying Widow(er)

rendered universal joint animation. Español: M...

rendered universal joint animation. (Photo credit: Wikipedia)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Jointly or Qualifying Widow(er)):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, and your MAGI is $96,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $96,000 but less than $116,000, you are entitled to a partial deduction, reduced by 27.5% for every dollar over the lower limit (or 32.5% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $116,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan at your job, but your spouse IS covered by a retirement plan, and your MAGI is less than $181,000, you can deduct the full amount of your IRA contributions.

If you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $181,000 but less than $191,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $191,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Jointly or Qualifying Widow(er)):

If your MAGI is less than $181,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $181,000 and $191,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $191,000 or more, you cannot contribute to a Roth IRA.

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2014 MAGI Limits – Single or Head of Household

David Lee Roth IRA ruins my perfect shot

David Lee Roth IRA ruins my perfect shot (Photo credit: nickfarr)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately who did not live with his or her spouse during the tax year, is considered Single and will use the information on this page to determine eligibility.

For a Traditional IRA (Filing Status Single or Head of Household):

If you are not covered by a retirement plan at your job, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, if your MAGI is $60,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $60,000 but less than $70,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $70,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status Single or Head of Household):

If your MAGI is less than $114,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $114,000 and $129,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200. If your MAGI is $129,000 or more, you cannot contribute to a Roth IRA.

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