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IRA Cross Loans – Don’t Even Think About It

Jan 5th, 2011
by jblankenship.
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fluff it up by Axel BührmannOnce again in the category of terrible things you can attempt to do with your IRA, there is the concept of a “cross loan” from your IRA to another, unrelated party.

You know from previous articles that it’s not allowable to transact business with disqualified persons.  Therefore, you can not take a loan from your IRA to finance your business.  But what if you came to an agreement with someone else not related to you in any way, who is not a disqualified person, to loan money from your IRA to finance her business, while she loans money from her IRA to finance yours?  Whatever could go wrong with this?

While the technical provision of transacting business with a disqualified person has been avoided, there’s a small problem with the plan.  There is another test that prohibits the IRA owner from receiving an indirect benefit from a transaction.  In the case of the cross loans, there is an indirect benefit in that one loan facilitates the other – and the IRS would figger this out before you could say “Bob’s your uncle”.

Entering into such a series of loans would most likely result in both IRAs being disqualified and taxable immediately.  It should be noted that this would likely be considered a prohibited transaction if the second loan was from another source besides an IRA, since the indirect benefit would still have come into play.

Photo by Axel Bührmann
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2011 IRA MAGI Limits – Married Filing Separately

Jan 1st, 2011
by jblankenship.
2 comments

cryptic clothing label by Wm JasNote: 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 50% for every dollar (or 60% 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 2011.  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 50% for every dollar over the lower limit (or 60% 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 2011.  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.

Photo by Wm Jas

2011 MAGI Limits for IRAs – Married Filing Jointly or Qualifying Widow(er)

Jan 1st, 2011
by jblankenship.
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450px-Wooden_Joints_and_Beams_-_Folk_Theme_Park_-_Suzdal_-_RussiaNote: 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 $90,000 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 $90,000 but less than $110,000, you are entitled to a partial deduction, reduced by 25% for every dollar over the lower limit (or 30% 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 $110,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2011.  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 $169,000, 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 $169,000 but less than $179,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% 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 $179,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2011.  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 $169,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $169,000 and $179,000, 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 $179,000 or more, you cannot contribute to a Roth IRA.

Photo by Wikimedia

2011 MAGI Limits – Single or Head of Household

Jan 1st, 2011
by jblankenship.
2 comments

single firework by One Tree Hill StudiosNote: 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 $56,000 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 $56,000 but less than $66,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% 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 $66,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2011.  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 $107,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $107,000 and $122,000, 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 $122,000 or more, you can not contribute to a Roth IRA.

Photo by One Tree Hill Studios

Your 2% Opportunity in 2011

Dec 31st, 2010
by jblankenship.
1 comment

opportunity center by {Guerrilla Futures Jason Tester}By now you’ve heard the news from the 2010 Tax Act – one of the provisions is that during calendar year 2011, the Social Security withholding tax is reduced from 6.2% to 4.2%.  This means that you have an additional 2% of your income, up to the $106,800 limit, available to you to do with as you wish.  This is your opportunity to make a splash!

I think it would be a very good idea to bump up your 401(k) deferral by 2% if you aren’t already maxed out.  If you have maxed out your 401(k), you could use the extra money to contribute to your Roth IRA, or put some money into your taxable investment account.  No matter what, since this money was originally intended to be for retirement (if it had been withheld for Social Security, it would have gone to *someone’s* retirement), you should put it toward some variety of savings or debt paydown.

It’s not often that you get the opportunity to take control of your Social Security withholding, and many folks are chomping at the bit to do just that.

Don’t waste your opportunity – this is the chance you’ve been waiting for!

Photo by {Guerrilla Futures | Jason Tester}

More On the One-Rollover-Per-Year Rule

Dec 24th, 2010
by jblankenship.
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Beethoven,_Ludwig_van_3This particular rule is one that can really cause you a lot of problems – and there’s no reason to run into problems with it, if you plan ahead and do things right.

One of the big reasons why this rule can cause so much heartache is because there is no way, procedurally, for the IRS to grant an exception, no matter what the circumstances are.  For example, in the 60-day-rollover rule, often the IRS may be in a position to grant an exception, especially if something awful happened to make you miss the deadline.  This sort of exception is not even a consideration for the One-Rollover-Per-Year rule. It just can’t be done.

Key Features of the One-Rollover-Per-Year Rule

You are allowed to roll over funds from one IRA or Qualified Retirement Plan to another, that’s a given… but you’re limited in how often you can do this, if you use the 60-day-rollover.  A 60-day or indirect rollover is when you take distribution from an IRA in the form of a check (or a deposit into a non-IRA account), and then within 60 days you deposit the funds into another IRA (or back into the same IRA).

The other way to rollover funds between IRAs, the preferred method, is called a trustee-to-trustee or direct transfer, where you don’t actually receive a check – the transfer is done between the first IRA and the second IRA, with no one else handling the money in between.  There is no limit to how many trustee-to-trustee rollovers you can do per year.

FYI, the IRS doesn’t even refer to these direct transfers as rollovers, generally speaking – they call them trustee-to-trustee transfers.  The “R” word is generally reserved for the indirect, 60-day type.

So – if you use an indirect rollover to move funds from one IRA to another, you now have limited yourself, with regard to those two IRAs.  You cannot rollover money from either IRA to any other IRA for 12 months – actually 365 days, 366 in leap years.

How about an example to ‘splain this a little better?

Examples

Situation 1: You have 3 IRAs: IRA A, IRA B, and IRA C.  There is $100,000 in each account. You wish to move half of the money from IRA A into IRA B.  If you take a withdrawal from IRA A of $50,000 and receive a check for it, you can then deposit the check into IRA B within 60 days, and the rollover is complete.

At this point, you cannot rollover any the remaining $50,000 in IRA A into IRA B or IRA C for 12 months.  You furthermore cannot rollover any of the current $150,000 that is now in IRA B into IRA A or IRA C for 12 months.  What you could do is rollover any amount you wish from IRA C into either IRA A or IRA B -  as long as IRA C hasn’t been involved in an indirect rollover within 12 months.

Situation 2: Same situation as above, except that you do a direct, trustee-to-trustee rollover of $50,000 from IRA A to IRA B.  You are not limited at this point for making any other move with the funds in any of your IRAs.  You could rollover the same $50,000 back into IRA A from IRA B if you wanted using either method, but the indirect rollover would put you back into the limit mode described above.  You are free to make any rollovers you wish at this stage, since you used the trustee-to-trustee transfer.

Situation 3: Same facts as in Situation 1 above, except that you change your mind about the rollover a week after you requested the check from IRA A, and you deposit it back into IRA A (without ever depositing into IRA B).  Regardless of the fact that you’re back where you started, this action is considered a rollover.  This has now limited your ability to successfully rollover any amount from IRA A for a period of 12 months.  The other IRAs are unaffected.

Situation 4: This one will be more complex, showing what might happen if you aren’t paying attention.  Same starting facts as the others. You do an indirect rollover of $50,000 from IRA A to IRA B on September 1, 2010.  So far so good.  But then, you decide you want to rollover the remaining $50,000 from IRA A into IRA C, and you do this on December 1, 2010.  Then in January of 2011, you figure out that what you’d really like is to rollover all of the funds from IRA C into IRA A instead, so you take the distribution of $150,000 from IRA C and deposit into your IRA A account within 60 days.

What is going to happen?  Well, if all of those things happened and none of the custodians stopped you, you would have to pay tax on a distribution of $50,000 (plus any growth on that amount) from IRA A in 2010.

Since the rollover of $50,000 from IRA A to IRA C was within the 12 month period, this would be considered a disallowed rollover and therefore a taxable distribution.  Since you pulled the money out before taxes were due, there is no additional consequence for your 2010 actions.  If you had waited until after April 18, 2011 you might have had to pay an additional 6% excess contribution tax on the $50,000 disallowed rollover, since this would be considered a regular contribution to IRA C.

But part of the rollover from IRA C to IRA A, the amount less than the disallowed excess contribution and any associated growth, would be allowed as a completed rollover.  Remember the prohibition is on rollovers from the involved accounts, and since IRA C had not been involved in a valid rollover within 12 months (since the rollover from IRA A had been disallowed), this amount is a valid rollover.  You’d still have to pull out the $50,000 (plus growth) from IRA A to avoid excess contribution tax.

In all of the situations above where the distribution became taxable, there could also be the 10% early distribution penalty applied unless one of the exceptions is met.

Admonition

So – what’s the lesson here?  Never, ever, ever do a 60-day rollover unless there is some mitigating circumstance that requires it.  And if you have to do the indirect 60-day rollover, make sure that you mind your p’s and q’s with the accounts involved, so that you don’t get hung up on the one-rollover-per-year rule.  Often, the IRA custodian will step in and explain the prohibition to you, but not always, and they’re not responsible for your actions.  If you do this and they let you get away with it, the entire tax bill is yours and yours alone.

Photo by Wikimedia

IRA Charitable Distributions – If You’re Less Than Age 70½

Dec 22nd, 2010
by jblankenship.
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sea otter by mikebairdWe discussed the IRA Charitable Contribution option for folks age 70½ or better, and it’s possible from that article that you got the impression that if you are younger than 70½, you are not able to make charitable contributions with money from your IRA. Nothing could be further from the truth! You can always make charitable contributions of any money you wish… the question is, what will such a move do for you tax-wise?

If you’re under age 70½

You can make charitable contributions from your IRA account – the only problem is that you must first count the distribution from your IRA as income, and then you account for the charitable contribution among your Schedule A Itemized Deductions. The end result is the same, right? O contrare, Mona Me*.

The problem is that, by having to count your IRA distribution as income, you will increase your Adjusted Gross Income (and therefore your Modified AGI), both of which can have a significant impact on other items on your tax return.

Example

Let’s run through an example: you’re retired, age 72, have an IRA worth $50,000, and you want to contribute the entire amount to your favorite charity. Your other income, along with your spouse’s income, totals $70,000. Included among your tax return items is $10,000 in medical expenses, along with other deductions (real estate tax, home mortgage interest, etc.) amounting to $15,000. You had no other charitable contributions for the year.

Under the QCD rules, your AGI is $70,000. Your itemized deductions amount to $19,750 – because your medical expense deduction is limited to the amount over 7.5% of your AGI. Since 7.5% of $70,000 is $5,250; we subtract that amount from $10,000 and come up with $4,750, which we then add to the rest of your itemized deductions for a total of $19,750 in deductions.

Subtracting the itemized deductions from your AGI ($70,000 minus $19,750) equals $50,250. Then subtract your personal exemptions of $7,300 from that and you get $42,950 in taxable income. Tax on this amount is $5,607.50.

If you were younger than age 70½, your AGI is $120,000. (The IRA distribution of $50,000 is added to the rest of your income.) So if you were age 65 for example, itemized deductions are now $66,000, because your medical expense deduction was reduced to $1,000 – $120,000 times 7.5% equals $9,000, subtracted from $10,000 equals $1,000. We add the rest of your itemized deductions (including the $50,000 charitable contribution deduction) and come up with $66,000 ($15,000 plus $1,000 plus $50,000).

Subtracting the itemized deductions from your AGI equals $54,000, and then we subtract the personal exemptions of $7,300 (it didn’t change for 2010) to come up with taxable income of $46,700. Tax on this amount is $6,167.50.

Under these rules, you just lost $560. Or rather, you paid 10% more in taxes than you would have if you were 70½ or older, with the same circumstances as before. So, while it’s possible to make a charitable contribution from your IRA account when you’re younger, it’s more costly to do so.

Other items affected by AGI

There is a significant number of items on your tax return that are impacted by the amount of your AGI – listed below are some of the more common ones:

  • taxable amount of Social Security (or Railroad Retirement) benefits
  • allowable losses from rental real estate activity with active participation
  • deductible traditional IRA and spousal IRA contributions
  • ability to contribute to a Roth IRA
  • miscellaneous itemized deductions, including non-reimbursed employee job expenses
  • and a number of miscellaneous credits

These and many other components of your tax return can be impacted by an increase in your AGI.

Photo by mikebaird

Charitable Contributions From Your IRA in 2010 and 2011

Dec 19th, 2010
by jblankenship.
9 comments

293px-Weston-super-Mare_station_Dandy_memorialWith the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (Tax Act 2010 or 2010 Tax Act), Congress retroactively reinstated the ability to make direct qualified charitable distributions (QCDs) from your IRA, in amounts up to $100,000 by IRA owners who are at least age 70½ years of age.

This provision expired at the end of 2009, but is once again available, retroactive to January 1, 2010, through December 31, 2011.

The provision allows the individual, age 70½ and thus subject to Required Minimum Distributions (RMDs), to make contributions directly from an IRA to a Qualified Charity, in an amount of up to $100,000 per year.  Since the 2010 Tax Act was passed so late in the year, there is a special provision for 2010 only, which allows the IRA owner to make such a QCD for the 2010 tax year as late as January 31, 2011.

QCDs can be used to satisfy the RMD requirement for the IRA owner, and the special provision allows the IRA owner to make such a distribution during January 2011 and elect to count this distribution toward his or her 2010 RMD.

This means that the IRA owner who doesn’t need his or her RMD for income can direct the distribution to the charity of his or her choice.  In addition, he or she will not have to recognize the distribution as income for determining Adjusted Gross Income (AGI) or any modified AGI calculations.

fyi – you can find the technical explanation at jct.gov – in the document JCX-55-10.

Photo by Wikimedia

IRA Investment Planning for Taxation

Dec 15th, 2010
by jblankenship.
2 comments

The question often comes up – what types of investments are best for my IRA?

Of course, any investment that you make in a tax-deferred fashion is a good one, at least in theory.  But there are other investments that make the most sense for your IRA versus other vehicles… and some investments that make more sense in other kinds of investment accounts, where possible.

Listed below are a couple of considerations to take into account when considering taxation of your IRA and non-IRA investments.

Bonds and other interest-bearing vehicles

Given the nature of the IRA – deferring taxation on current income and growth, investments that would otherwise be taxed at ordinary income tax rates would be best for your IRA.

This includes the likes of interest-bearing investments, such as CDs or bonds.  Since, presumably, your tax rate when you begin taking distributions will be either the same or less than your rate before retirement, the deferral will provide for the interest to be taxed at either the same rate or lower, just later in your life.

Growth-oriented and dividend-paying investments

Growth-oriented stocks and investments that pay current dividends make more sense to be held in taxable accounts than in deferred accounts.  This is due to the fact that dividends and capital gains are (at least for now) taxed at much lower rates than ordinary income – which is the rate your distributions from the IRA will be taxed at.

The same would be true of other growth- and dividend-oriented investments such as real estate and commodities, for example.

Bottom Line

So in other words, if you have the ability, you should split your interest earning investments into your IRA, and growth- and dividend-oriented investments into taxable accounts.  This way, you won’t be subjecting lower-taxed items to a higher tax rate – if possible.

This doesn’t mean that you should ONLY invest in items that would be taxed at ordinary rates within your IRA.  This is known as letting the tax-tail wag the investment dog.  Tax planning should always be considered as you plan your investments, but appropriate diversification should always be your first consideration.

In addition, the deductibility of IRA (and 401(k)) contributions provides a benefit that should be weighed against the taxation concepts we’ve talked about above as well.  Again, the tax-tail shouldn’t wag the investment dog…

Photo by Wikimedia

New Book: “Can I Retire?”

Dec 6th, 2010
by jblankenship.
4 comments

Can I Retire CoverMy friend Mike Piper at Oblivious Investor recently published a new book Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less. The book is available for sale on Amazon.

As the latest addition to Mike’s “…in 100 Pages or Less” series, this book answers two questions:

  1. How much money will you need to retire?
  2. How should you manage your retirement portfolio to minimize the risk of outliving your money?
What Makes This Book Unique?

How does this book hope to be better than, for example, The Bogleheads’ Guide to Retirement Planning or Jim Otar’s Unveiling the Retirement Myth?

It doesn’t. It’s not better. It’s shorter.

Can I Retire? is written for the person who might not be able to find the time to read Otar’s entire 525-page book or the 370-page Bogleheads’ Guide.

If you’re considering reading a more in-depth guide to retirement planning, I wholeheartedly encourage you to do so. (Both of the above-mentioned books are excellent!) But if there’s a good chance that, if you were to buy one of those other books, it would sit unread on your coffee table or bookshelf, then this book is written for you.

What Topics Does the Book Address?

Some of the topics addressed in the book include:

  • How to calculate how much you’ll need saved before you can retire,
  • How to use annuities to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • When it makes sense to use a Roth IRA conversion to save on taxes,
  • How to choose an appropriate asset allocation for your retirement portfolio, and
  • How to minimize taxes by proper use of an asset location strategy.
Retiring Soon? Pick Up a Copy of Mike’s New Book:

Can I Retire CoverCan I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Click here to see it on Amazon.

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