Do You Qualify For A Penalty-Free Distribution From Your IRA?

Many people possess an Individual Retirement Account (IRA) or employer plan that holds assets for their future financial security. Due to the substantial economic impact caused by the coronavirus, the IRS provided relief to individuals in the form of more liberalized distribution options for these types of accounts.

However, the misunderstanding of many citizens is that anyone under the age 59½ can take a distribution from their IRA without incurring the typical 10% additional tax (or penalty) for premature withdrawals. This misunderstanding could cost you a significant amount of money, including additional penalty and interest, if you fail to pay the correct amount of tax on the distribution.

To qualify for relief from the premature distribution penalty, you must be a “qualified” individual as defined in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted on March 27, 2020. A qualified individual is one that has met one of the following criteria:

  • You have been diagnosed with COVID-19 or SARS-CoV-2 by a test approved by the Centers for Disease Control and Prevention (CDC);
  • Your spouse or dependent is diagnosed with one of the above viruses;
  • You suffered adverse financial consequences as a result of being quarantined, furloughed, laid off or had work hours substantially reduced due to the pandemic;
  • You have been unable to work caused by a lack of childcare due to the pandemic; or
  • You suffered adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to the pandemic.

As an individual with evidence of one of the criteria applying to your situation, and the proof would be required of you, the 10% additional tax on early distribution would not apply. However, federal and state income taxes would apply in this instance. Relief is provided by the IRS in the payment of the income tax due on the distribution by reporting one-third of the income on your individual return over a three-year period beginning with 2020 or the year you receive your distribution. For example, if you requested and received a $12,000 distribution from your IRA, you may include $4,000 of the distribution in each of the next three tax returns filed beginning with your 2020 return. Of course, if you wish to report the entire distribution in the year of receipt, you may do so and pay the total amount of tax due.

Lastly, what happens if you decide to return or repay the distribution to your account? Additional relief is provided in this instance. If you have reported one-third of the distribution on your tax return for 2020 and 2021 but decide to return the funds to your IRA in 2022, you may file an amended income tax return for 2020 and 2021 to receive your refund of taxes paid in these years associated with the pandemic relief. The repayment of the funds would be treated as if they were repaid in a direct trustee-to-trustee transfer and no federal income tax would be due on the distribution.

In most cases, the perception of relief is far different than its actual purpose. Too many people hoped that a carte blanche relief approach would be offered and anyone, for any reason, could take a penalty-free distribution and that would be the end of the matter. Our tax code is not an area of law that is easily amended or comprehensive enough in its nature that revenue generation may be left out of the analysis.

Tax law is not simple to understand. To help your family and you make sense of these complex laws and regulations, seek out the advice of a CERTIFIED FINANCIAL PLANNER™ professional for an analysis and planning meeting to reduce your tax burden. Judge Learned Hand remarked, “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that platform which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Now, that alone should help you enjoy a Happy Thanksgiving! 

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IRA Law Changes That Affect You Now!

If you are receiving required minimum distributions from an IRA, you may have an opportunity to lower your tax burden for 2020! The Coronavirus Aid, Relief and Economic Security (CARES) Act includes a waiver for required minimum distributions for 2020. This provides immediate relief to taxpayers who were being forced to pay tax on the distribution but had no economic need. Another reasoning for this provision of the Act was to allow investors to retain their investments within their IRAs during a time our economy was contracting. Further, the required minimum distribution is based on the balance of the account at December 31, 2019. The markets were much higher than they are currently. The waiver applies to traditional and Roth inherited IRAs, too.

To provide immediate tax reduction, individuals under the age of 59½, who need funds to continue their lifestyle, may receive up to $100,000 of IRA premature distributions in 2020 and the 10% penalty for early distribution will be waived. However, the distribution is taxable. Good news for these individuals is that the tax due on the distributions may be evenly spread over three (3) tax years to be repaid.

If you are in the process of preparing and filing your 2019 individual income tax returns, you may contribute to your 2019 IRA up to July 15, 2020. This contribution would normally be allowed only to the date of April 15. By providing taxpayers the opportunity to build additional cash flow for their households, the extension of time to fund an IRA may allow investors to open or fund an IRA that otherwise would not be feasible.

Limits for IRA contributions for 2019 remain at $6,000 for Roth and Traditional IRAs. For those age 50 or older, an additional “catch-up” contribution of $1,000 is allowed. If you or your spouse, as married filing joint tax filers, wish to contribute to an IRA for 2019, your modified adjusted gross income must be $103,000 or less. If you are a single filer, your modified adjusted gross income must be $63,000 or less to contribute the full amount allowed in a Traditional or Roth IRA. The limit for IRA contributions for the 2020 tax year are the same as those in 2019.

Earnings limits for contributions to an IRA, while participating in an employer plan, are increased to $65,000 for single filers and $104,000 for married filing joint filers. The preceding amounts of modified adjusted gross income allow the taxpayer(s) to fully deduct their IRA contributions.

Lastly, one of the better changes to the IRA rules, for 2020, is the allowance of contributions to an IRA by individuals older than 70½. There is no age limit to make contributions to a Traditional or Roth IRA in 2020. This is a big bonus for many individuals who are savers. A tax deduction that you get to keep in your own account!?!? Welcome to the crazy world of taxation in the United States. See you on the golf course! 

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Big Changes Affecting Your Retirement

A couple of bills containing significant changes to retirement planning were signed into law by President Trump on December 20, 2019. We will provide just a few of the sweeping changes that affect most of us planning or currently in retirement. The Setting Every Community Up for Retirement Enhancement Act of 2019 (commonly referred to as, “The SECURE Act of 2019) is effective for tax years beginning January 1, 2020.

If you are reaching the age of 70-1/2 and anticipated taking a distribution from your IRA, or suffer a penalty, the Act extends the date of required minimum distributions to age 72. When the present age of 70-1/2 was applied to IRA distributions, U.S. citizens were living fewer years, on average, than they are now. By increasing the age of required minimum distributions to age 72, the federal government has deferred revenue for another one and a half years which allows continued growth of the retirement funds. Many of our clients do not need or desire the distributions required under previous law. However, the penalty for failing to withdraw the IRA funds was more costly than the effective tax rate applied to the distribution. In other words, it was far cheaper to simply take the distribution and pay the tax bill.

The Act has closed a very effective generational planning strategy used by many people. No longer can your IRA be utilized for multi-generational planning (i.e., your grandchildren could have benefited from a “stretch” IRA strategy in the past). Under the provisions of the Act, the non-spouse beneficiary, or any beneficiary more than 10 years younger than the IRA owner, must take the full IRA value by the end of the tenth year after the death of the IRA owner. Of course, taxation will occur at a much sooner date than previously recognized due to the distribution occurring within ten years of death of the IRA owner. 

Congress and President Trump have expressly acknowledged that children require families to spend money for housing, clothing, food, etc. Another relief item for individuals adopting or birthing children is the use of $10,000 of your employer-provided retirement plan assets without penalty. Although the participant will be required to pay income tax on the distribution, the 10% penalty for early withdrawal will not subject the family to additional burden.

IRAs can be confusing for individuals. To assist you with helpful information, please go to Compass Capital’s Resource Center and watch one of our instructional videos. If you have any questions regarding your particular retirement plan facts, seek out a Certified Financial Planner practitioner and CPA that specializes in families just like yours.

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How To Avoid Common IRA Mistakes

Most retirees have heard the word “IRA” and may not fully understand this retirement savings plan. An IRA, or Individual Retirement Account, is merely a type of account that allows for the owner to grow, tax-deferred, the underlying investments within the account. I often hear people say that “I have an IRA for each year to diversify my investments.” It is often misunderstood that the IRA owner can own one IRA and maintain many different investments within the account. This article will help you avoid some of the common mistakes made by IRA owners.

Mistake Number 1: Avoid ineligible rollovers.

Under the current federal tax code, owners of IRA may rollover the IRA once-per-year. The confusion, and resulting taxable event, occurs when the owner interprets, incorrectly, the “once-per-year” requirement. This descriptor of time means literally one year from the date of the last rollover, not the calendar year. For example, if you performed a rollover on March 1, 2018, and performed another rollover on February 28, 2019, you would be subject to a penalty. 

Mistake Number 2: Missing the 60-day deadline.

A gentleman came to our office recently with a concern about his IRA. After much discussion, we provided him several alternatives to resolve his issue. His concern was due to advice he received from a friend that he could withdraw money from his IRA to purchase a piece of property and then seek financing from his bank to return the withdrawn funds. However, the friend, not a licensed financial adviser, failed to mention the strict timeline for such transactions. The Internal Revenue Code allows 60 days to accomplish the rollover to prevent taxation of the event. In this instance, the man was informed by his bank the process of underwriting the loan would take longer than 60 days. To illustrate the tax cost of this transaction, the man had withdrawn $200,000. The penalty of 10% assessed to the distribution, the man was under 59½ years of age, and the income taxes due now cost the man approximately $80,000! We quickly worked with his local bank to structure a lending arrangement that would allow him to return the withdrawn funds to his IRA within the 60-day mandatory deadline. We solved the problem but the stress it created was unbearable for the gentleman.

There is no IRS relief for missing the 60-day rollover deadline unless you file for a Private Letter Ruling with the IRS which will cost thousands in filing fees and you may not receive relief if your facts do not warrant such. The simple mitigation strategy is to not use your IRA as a lending source. Congress meant for these accounts to be long-term in nature and for retirement purposes.

Mistake Number 3: Failing to Meet a Hardship Exception.

One of the greatest contentions of angst to individuals is when hardship is being experienced by the family and funds in the IRA can’t be utilized for the particular relief needed. Unless the IRA owner experienced a natural disaster that is described in the Internal Revenue Code, the hardship distribution received from the IRA will be taxable and subject to a possible penalty for early withdrawal if the owner is less than 59½ years of age.

The confusion that causes this mistake to occur is that employer plans generally provide for a hardship distribution. IRAs do not. By statutory language, few exceptions to the penalty application to the distribution apply. Two of the primary exceptions we have seen are higher education expenses for a dependent and a first-time home purchase by the IRA owner.

This area of the U.S. tax laws is very complex. It is vital you seek appropriate guidance before potentially committing the mistake. If you are concerned about your investments and/or your IRA account, you may qualify for a Complimentary Stress-Test. Seek out a Certified Financial Planner™ practitioner and CPA to give you the confidence you are in compliance and meeting your retirement objectives.

For additional, free information about investing and tax planning, go to compasscapitalmgt.com where you will find a wealth of information to help you navigate life!

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Simplify Your Life, Consolidate Your IRAs

Diversification is a common term heard by most investors. However, its true meaning is sometimes lost. Recently, we were meeting with a new client of ours that is retired. When the woman brought her giant, purple, three-ring binder to the first meeting, we were somewhat puzzled. Near the end of our first meeting, she opened up the binder to reveal that she owned six, yes six, different IRAs with a total of three advisors!

She must have noticed the look of shock on my face and responded with a phrase we hear, although erroneously, that this is a form of diversifying her portfolio. We examined her statements for the different custodians and asked if we could provide her a “second opinion” as to the state of her investments according to her goals. She quickly responded affirmatively and we set the next meeting.

After much review of the statements, we noticed a trend among the various advisors. Each advisor had taken a similar strategy to helping the client meet her lifetime income goals! Further analysis explained what we previously thought about her approach to diversification – the client had not truly diversified her portfolio but had concentrated her portfolio, inadvertently, by never informing the advisors of her use of multiple advisors. In other words, she was highly concentrated in certain assets classes within her total holdings that exposed her to significant risk. We use the term “overlap” to describe the result of using several advisors that essentially invest in the same assets classes.

During the second meeting we verified her goals, risk tolerance and cash flow needs to confirm our understanding. We provided her a consolidated report of all six IRA statements and she was alarmed at the problem she created with so many accounts. After explaining our recommendation of diversification in many different forms – asset classes, geographically, market sectors, etc. – she was ready to simplify her life. 

By combining all of her IRAs into one account, she reduced the amount of paperwork necessary to be maintained for tax purposes and monitoring of her investment positions. Additional diversification was achieved by including asset classes not previously in the portfolio that would reduce her exposure to risk while maintaining her need for immediate cash flow each month. Her smile was all we needed to see to know that we had provided her the highest level of response and service as well as a resolution to a worry she had been carrying for some time. She also through away the giant, purple binder!

If you have multiple accounts with multiple advisors, you should consider a simpler approach to achieve your desired result with a consolidated account of truly diversified investments. We have a saying in our company, “To make things complex is simple. To make things simple is complex.” In other words, let us help you make life simple that you can enjoy retirement on your own terms. Stress? We don’t think it’s necessary when you work with a retirement planning specialist. 

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It’s That Time of Year for IRA Owners

For many years you saved taxes by contributing to your Individual Retirement Account (IRA) or employer-provided retirement plan. Now, it is time to retire and the IRS says, “Do you remember all of the tax savings you realized for the past 35 years? We want it back!” Perhaps this is a bit extreme but there is an Internal Revenue Code section that requires you take required minimum distributions (RMD) from your IRA or pay a 50% penalty. Ouch!

To mitigate or eliminate this penalty it is critical that you aggregate all of your IRAs to calculate the total RMD that must be distributed by December 31, 2019. Over my 32-year career as a CPA and wealth advisor I have seen many instances where this simple task was erroneously performed and clients paid significant penalties. For example, Bill (not his actual name) was approached early in his retirement years to establish several IRAs to “diversify” his portfolio. This is not a form of diversification but merely a way to create more paperwork.

After he established six IRAs, he sat back and relaxed thinking retirement is a pretty good time of life. Time passed and the year came that Bill was required to take a RMD from his IRAs. The CPA for Bill thought he had accounted for all of Bill’s IRAs when, in fact, he had overlooked two of the accounts. The total funds in the two omitted accounts were $300,000! Imagine the impact this amount of funds would have made to the RMD calculation. Bill actually owned a total of $1,000,000 in IRAs and claimed a RMD on only $700,000. Bill failed to claim $10,949 of RMD and suffered a penalty in the amount of $5,474 for simply failing to account for all of his IRAs.

How can you avoid this negative impact? When we meet with new clients we perform a review of their income tax returns as well as all of their investment statements. Many people don’t understand the types of investment accounts they own. 

To mitigate all of this confusion, we look for ways to eliminate or minimize paperwork to make your record keeping much simpler. As stated earlier, more accounts does not equate to diversification. 

Required Minimum Distributions are required from IRAs the year after the owner turns 70½ years of age. To reduce the RMD amount you may wish to consider Qualified Charitable Deductions. This is a strategy in which the trustee of the IRA will distribute the RMD, or a portion thereof, to a qualified charity. To meet the criteria for this type of distribution, the taxpayer must meet the age criteria for RMDs. The limit for the charitable deduction is not the RMD limit for the year but a statutory limit of $100,000 per taxpayer.

IRAs can be confusing. Don’t take chances with your financial future. Seek out a CPA and Certified Financial Planner practitioner that specializes in retirement and tax planning. If you own an IRA, don’t give your money to the government. You worked for it, we can help you keep it! 

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