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IRA

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.

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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New Year’s Resolutions You Can Keep

Gym

Gym (Photo credits: www.mydoorsign.com)

This time of year it’s cliché to make resolutions for the coming year.  Whether it’s to lose weight, stop a bad habit, or begin saving for retirement, many of us set these goals at the beginning of the new year.  And then three weeks into the new year, we’ve left that goal astern – having changed nothing at all.

The problem is in how we set goals for ourselves.  For example, we might make the bold statement that we want to lose weight.  Often, that’s all there is to our resolution – but there’s much more to setting a goal than making a statement about it.  There has to be a plan, and some specifics around the goal.

If the resolution is to lose weight, first of all you need to put some specifics around that goal:

I want to lose fifteen pounds in 2014.

Now, how are you going to do this? Is it going to happen all at once? One fine day you’ll wake up and you’re 15 pounds lighter?  Of course not.  But it’s that “presto” mentality that often derails us.  We dive into our 15-pound goal with much gusto, going to the gym and working out four days a week for the first week. (Have you ever tried to get a treadmill at the gym during the first week of January? Impossible!)

Then, when we don’t see the automatic result after the first couple of weeks, we get discouraged, and we start to fall back into our old routines.  Pretty soon we’ve given up on the goal altogether.  How can you stop this cycle? Incrementalism.

Incrementalism

Instead of focusing on the year-long goal of losing fifteen pounds, look at the goal incrementally – set yourself monthly goals of losing 1¼ pounds each month.  That’s a much more attainable goal, and not one that you have to spend hours on the treadmill each day to achieve.  You might be able to achieve this by taking a walk for 20 minutes, three days a week, and pushing back from the table a bit sooner at mealtime.  Before you know it, you’re incorporating the walks into your daily routine, and you’re not missing the extra helping of taters – and you’ve lost that month’s 1¼ pounds.  Keep up the incremental changes through the year, and voila! you’ve met your yearly goal.

The trick is in looking at shorter-term increments to meet the larger goal. When we look at the larger goal only, we think we’ve got to do something heroic in order to meet the goal.  By taking a short term view, we realize that smaller, incremental changes will help us to get to that short-term goal.

Let’s take saving for retirement as an example: In 2014 you have the goal of saving $5,500 to make a full IRA contribution toward your retirement.  If we focus on the full $5,500 – that can be a significant amount to come up with.  Instead, incrementalize the goal.  Look at it in terms of your regular payroll cycle – every two weeks.  That works out to $211 every paycheck.

That’s not insignificant, especially if you’re on a tight budget already, but it can be done.  There are many places where we’re short-changing ourselves, paying for more things than are necessary.  Most folks have more tax withheld from their pay than is necessary, which results in an over-large income tax refund.  Making a change to your W4 filed with your employer will help to free up some extra cash to make up the $211 each payday that you are looking to save.

Other areas can be reviewed as well – rarely-used gym memberships, rented storage lockers (full of stuff we haven’t thought of for years!), magazine subscriptions that we don’t take time to read, and lunches out while working – all represent places where we can free up cash for the by-weekly $211 contribution to the IRA.

Insurance premiums – for homeowner’s and auto insurance – can be reduced by upping the deductibles on these policies.  For example, a $1,000 deductible on your auto insurance policy (rather than $250) will result in a decrease in the cost of the policy.  Most of the time, if you have minor damage to a vehicle (less than $1,000) you’re better off to pay for it yourself rather than submit a claim, since your insurance company will make up the difference (plus!) by increasing your premium in the coming years.  The same is true for your homeowner’s policy.

Start going through your month-to-month expenses and finding those places to free up the cash on an incremental basis, and soon enough you’ll have that $211 per pay period freed up, and next thing you know you’ve saved that $5,500 for the year.  This is the magic of incrementalism.

Keep in mind that the net result of your $5,500 contribution to the IRA, if it’s a deductible IRA, will be less than the full $5,500 after you’ve prepared your tax return.  If you’re in the 25% marginal tax bracket, the net resulting cost is $4,125, since you are paying $1,375 less tax on your income by making the $5,500 contribution.

So – go forth and make your resolutions for 2014.  But put some more planning into the process, and incrementalize the goals.  You’ll have a much better chance of meeting them.  And if you follow this advice, leave word below about your plans and your successes.  We’d love to hear about them!

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