Borrowing Money from Your 401(k) – Good idea? …not so much
Borrowing Money from Your 401(k) – Good idea? …not so much
Too many are dipping into their employer sponsored retirement plans 401(k) using the lending feature. Unfortunately, many are later faced with a tax dilemma.
Borrowing Money from Your 401(k)
For years you have put away 6% of your pay into your employer provided 401(k) retirement savings account. Your employer may have even matched 50% of your contribution. Now you want to take some of this money out in the form of a loan to help pay your bills or to buy a car. Before you take action, here are some things to consider.
Loan versus withdrawal
If you withdraw funds from a 401(k) prior to age 59 ½ you may be in for a surprise at tax time. Withdrawals are subject to income tax and often are subject to a 10% early withdrawal penalty. A better option is to consider loaning yourself the money. 401(k) loans are available for up to 50% of your account balance.
The advantages
There are many advantages of borrowing money from your own retirement account.
No immediate tax. You do not pay income taxes on the funds lent to you. If you withdraw the funds, you must pay ordinary income taxes and a potential penalty on the withdrawal.
You repay the loan. This re-establishes your original retirement account contributions for use during retirement.
Your interest payment is to yourself. Your 401(k) loan payment includes interest. This interest provides you a return on your original contributions. It is better to pay yourself interest than to pay this interest to a bank.
The disadvantages
Repay or else. If you leave your current employer you will need to repay all outstanding 401(k) loans immediately. If you do not, your remaining loan balance turns into a withdrawal subject to income tax and a potential early withdrawal penalty.
Opportunity lost. Your 401(k) loan amount is no longer invested. While your interest payments provide a small return, it usually is much lower than those available through retirement account investment options.
Less take home pay? If you wish to contribute to your retirement savings at the same level as before you took out the loan, you must make sure your retirement loan repayment does not impact your previous contribution levels.
When making the tough decision to borrow your retirement savings, remember to first consider all your alternatives. The risk of job loss and then immediately needing to repay this retirement plan loan often leads to financial hardship and an unwanted surprise at tax time.
Understanding Tax Terms: Structuring – IRS has broad authority to seize bank accounts
Understanding Tax Terms: Structuring
IRS has broad authority to seize bank accounts
The IRS has broad powers to seize bank accounts if it believes there is criminal activity and you are actively trying to avoid their financial transaction reporting requirements. Here is what you should know.
Understanding Tax Terms: Structuring
If someone manipulates cash transactions to avoid required bank reporting to the Treasury Department, they are using the technique of structuring their transactions. Knowing what is reported and the power given to the IRS to seize related assets can be important.
Background
In an effort to identify questionable illegal transactions, financial institutions are required to report any monetary amounts over $10,000 to the Treasury Department. If someone knowingly structures their transactions to avoid this reporting, the Bank Secrecy Act allows the IRS to legally seize these assets. The old rules provide fairly broad discretion in this area and many innocent taxpayers not only had assets frozen, but found it virtually impossible to get their funds returned to them.
Example
Vocatura’s Bakery in Norwich, CT did most of their bakery trade in cash. To help their local banker not have to fill out required federal forms when they deposited $10,000 or more, they tried to make lower deposits. One day in 2013 the IRS showed up at their business and seized over $65,000 of their deposits suspecting illegal activity through use of this structuring activity. Using civil forfeiture rules, the IRS permanently seized this small business’ assets. Three years and lots of legal fighting later, the business finally got their money back. Here is a link to their story; IRS Returns Bakery’s Money After 3 Years. Now It Wants To Put The Owners In Prison.
What you should know
Be aware of the rule. As more small businesses try to avoid the high charges associated with credit cards, they must also be aware of the Bank Secrecy Act rules. Establish a good relationship with your banker and have them understand your business to help create a potential ally if needed. Do not knowingly try to avoid the $10,000 reporting rule.
Consistent numbers. Create a regular routine of sales deposits. Do not save up deposits and then deposit similar amounts. This could raise red flags.
The rules are changing. In a recent change, the IRS will still pursue structuring violations, but will try to more closely align action taken with knowledge of criminal activity. The government must show that the taxpayer knows of the rules and knowingly structures their transactions to avoid the reporting.
There are bad guys. Money laundering is a big problem. Whether it be drug money, terrorist fund raising, bootlegging or other illegal activity, excess cash deposits will raise suspicions. So while the IRS uses their tools to catch these crooks, they are making an active attempt to keep innocent taxpayers out of their net.
Leveraging Gift Rules During Retirement
Leveraging Gift Rules During Retirement
Wish to transfer some of your assets to your children or grandchildren tax-free? Understanding the annual gift limits is a good place to start
Leveraging Gift Rules During Retirement
As you or family members approach retirement years, it is important to have a basic understanding of the IRS gift giving rules. With this understanding, there are opportunities to leverage this tax law without creating a tax problem.
The rule
You may give up to $14,000 to any individual (donee) in 2016 and avoid any gift tax filing requirements. If married you and your spouse may transfer up to $28,000 per donee. If you provide a gift to your spouse who is not a U.S. citizen, the annual exclusion amount is $148,000. Gifts in excess of this annual amount trigger the need to file a gift tax form with your individual tax return. The excess gift amounts are then added to your estate for potential estate taxation. The estate tax currently has a maximum rate of 40% and the donor of the gift (or their estate) is responsible for paying the associated tax.
Using the rule to your advantage
The unsaid gem within this tax law is this: You can transfer up to $14,000 ($28,000 if married) to anyone you wish each year tax-free. Additionally, most states also adhere to this federal law. So if you wish to move assets to loved ones without the burden of future taxation, consider the following ideas.
Make periodic gifts. Remember the gift-giving limit is per calendar year. To take full advantage of this tax-free transfer, consider starting now and make periodic payments. Every year you miss out on this annual limit reduces the amount a couple can transfer tax-free to each individual donee by up to $28,000 per year.
Fund college saving. Consider donating money into 529 College Saving plans for children and grandchildren. This can be done with automated deposits into the account. The account could be established by you or your grandchild’s parent.
Pay direct. If you are concerned about exceeding the annual limit for gifts to a single person, consider paying bills directly. Examples of this strategy might be paying medical bills directly to a hospital or directly paying college bills for a loved one.
Leave a cushion. Remember the annual limit. If you provide a gift for the maximum allowable to an individual, you may not provide any other gifts to this person during the year or the event would be deemed excess gift giving and require filing a gift tax form.
Property too. Gifts can include property as well as cash. You can donate investments or other physical property. If you do this, document the fair market value of the property when you transfer it. The IRS is requiring this documentation to ensure the value of the property transferred is consistently valued by you and the person receiving the gift.
Building a down payment. Often children burdened with college debt cannot afford to save the down payment required to own their first home. You can aid in this by helping build a down payment through gift transfers.
Keep it in perspective
Understanding and leveraging the annual gift tax rules can create tremendous tax savings. But this strategy should be done in conjunction with understanding your personal financial needs. Providing gifts of funds that you might later need for your own retirement can be problematic. It is best to review your gift plans prior to taking action.
Retirement Basics: Understanding Tax Efficiency
Retirement Basics: Understanding Tax Efficiency
Managing your taxable income during retirement can be complicated. Social Security Retirement benefits, retirement plan distributions and supplemental income can quickly impact the amount of tax you must pay. Here is something to consider.
One of the basics in retirement is to be as tax efficient with your income as possible. In 2016, income tax rates range from 0 – 39.6% plus a potential 3.8% net investment tax. Understanding how these progressive tax rates apply to ordinary income creates a tremendous retirement planning opportunity.
Many retirees can control their taxable income each year by the amount they work and how much they withdraw from retirement savings accounts like IRAs and 401(k)s. When your income drives you into a higher income tax rate, you will need to decide if you want to maximize the tax rate applied to this range of income.
Example: Assume you are a single taxpayer with $10,000 in retirement income from a part-time job. You also have $150,000 savings in a 401(k) retirement account. Also assume you are old enough to not have taxable Social Security Retirement benefits. The income range and applicable tax rate for a single taxpayer in 2016 is…
| TAX RATE | TAXABLE INCOME* |
| 10% | $1 – 9,275 |
| 15% | 9,276 – 37,650 |
| 25% | 37,651 – 91,150 |
| 28% | 91,151 – 190,150 |
| 33% | 190,151 – 413,350 |
| 35% | 413,351 – 415,050 |
| 39.6% | Over $415,050 |
In this example, excluding other variables, you have the opportunity to withdraw an additional $27,650 from the 401(k) at an income tax rate of 15%. Income beyond this amount will be taxed at 25% or higher.
*Note: Taxable income typically includes wages, interest, non-qualified dividends, short-term capital gains (assets owned for one year or less), and withdrawals from most 401(k), 403(b), and non-Roth IRAs.
It is never simple.
Unfortunately, planning for tax efficient retirement is never simple. There are other things to consider.
- Your age
- The taxability of your Social Security Benefits
- Income phase-outs of other tax benefits
- Required Minimum Distributions from retirement accounts at age 70 1/2 or older
- Your state tax situation
- Other taxes. Unfortunately, the tax code is not only based on income taxes. It also includes estate taxes, inheritance taxes, qualified dividend taxes and long-term capital gain taxes to name a few.
What to do?
Making tax efficiency an integral part of your retirement plan can be complicated. But for those willing to start early, spend the time and ask for assistance, the rewards are tremendous.
Prepare Now for Future Refund Delays – IRS now required to delay refunds to many taxpayers
Prepare Now for Future Refund Delays – IRS now required to delay refunds to many taxpayers
As part of recent tax legislation, the IRS is now mandated to delay sending out some refunds to taxpayers beginning with 2016 tax returns. If impacted, you will need to plan for this delay.
Topline: If next year’s tax return claims an Earned Income Tax Credit or the Additional Child Tax Credit your refund will be held by the IRS until February 15th.
The delay in sending out tax refunds is mandated by recent tax law legislation because of the proliferation of identity theft and tax fraud. This extra time will be used by the IRS to help prevent revenue loss from early tax return filings claiming invalid tax refunds. Those most impacted by this change are early tax return filers. While the IRS plans future correspondence to alert taxpayers to this change, here are some things to note.
- Entire refund. If your tax return claims either of these credits, your entire refund will be held until February 15th.
- Do not delay. If you typically file early, do not delay filing your tax return because of this rule change. Tax returns can still be processed. Only the refund payment is being delayed.
- The bottleneck. Filing early can help you avoid the bottleneck of tax refund processing. On February 15thyou will want to be at the front of the line to receive your money.
- Plan accordingly. If you historically plan on receiving and using an early refund, you will now need to plan for this delay.
The Documentation Must Haves – Guilty until proven innocent
The Documentation Must Haves – Guilty until proven innocent
Taking valid deductions on your tax return is your right. Defending your deductions is becoming harder and harder to do. Read this to make sure your deductions rule the day.
When faced with questions on your tax return deductions, it is getting all too common for tax authorities to deny everything and then make you prove that your deductions are valid. Do not let this happen to you. Here are some suggestions.
The one-two punch. To prove your deduction most auditors are looking for two key documents. Miss one of the two and your deduction will evaporate like smoke at a campfire.
- Receipts. This is the first of the sure-fire two things you must have to validate a deduction. The receipt should clearly show the company or entity, the date, the value of the activity and a clear description of the activity. In the case of donations, the receipt should also have a statement that confirms you received no benefit in return for your donation. It should also state that you are not retaining part ownership of the donation.
- Proof of payment. This is the second of two sure-fire things you must have to validate a deduction. You will need a canceled check, a bank statement or a credit card receipt and related statement.
Contemporaneous. Any proof of payment and receipts should generally match the date of the activity. The IRS and state agencies are quick to dismiss receipts that are obtained after the fact. A good rule of thumb is to ensure receipts and proof of payment are received at the time of the activity. If not, at least make sure you have receipts and payment proof within the tax year the deduction is taken.
Other proof. In addition to the above, there are certain deductions that require additional documentation. Here are the most common;
Mileage logs. You will need to show properly maintained mileage logs for business miles, charitable miles and any medical mile deductions.
Business records. You will need financial statements for any business related activity with supporting documentation.
Residency. If you live in multiple states or multiple countries, you may have to prove where you lived during the year. Keep records that show your physical presence to support your tax filings.
Proof of non-reimbursement. If you claim any unreimbursed business expenses, many states are asking you to prove that you were not able to get these expenses reimbursed from your employer. The easiest ways to do this are to show a denied expense report or to get your employer to write a letter that confirms your expenses are not reimbursed. Those most impacted by this are musicians, barbers/hairstylists, construction workers and anyone who uses their own tools to do their job for their employer.
IRS Gets Transcript Service Back On-line – Be prepared for more security hurdles
IRS Gets Transcript Service Back On-line – Be prepared for more security hurdles
After being off-line for over a year, the IRS recently announced the reactivation of their popular ”Get Transcript” service. Here is what you need to know.
A year ago the IRS closed down their popular “Get Transcript” online service after a severe security breach. With new security protocols now in place, this IRS service is available once again. Here is what you need to know.
Background. Last spring the IRS announced their “Get Transcript” online system had been compromised. The nature of the break-in suggested that thieves did not “hack” the system. They were able to get past security with identity information stolen from other sources. The IRS closed the service until the system could be better protected.
How used. Use this online system to obtain summary information of your tax records. Many use the service to verify current and prior year income for student loans, mortgages, and e-file verification.
The new 2-step. The new security will now entail a 2-step authentication process to log into the “Get Transcript” service. When you wish to log-in, the IRS will use email and/or text messaging to send you a one-time use code to enter the system. Without this additional code you will be denied access.
The MUST HAVES. To access the new online feature you must have:
- An email address
- A text-enabled mobile phone
- Confirming financial account information (credit card number or loan numbers)
Give up more identity to get more security? While this extra security measure will make the system harder to breach, it is requiring you to give up more of your private information to the government. This means the IRS will now have your cell phone number, email address, and specific financial information. Given the track record of IRS systems, some may hesitate to provide this additional information.
Other options are available. Unfortunately, everyone must re-register to use the system. This includes those who have used the old system successfully. If you have problems using the newly enhanced security features you can still request your information via mail or online ordering. The IRS anticipates response time for these requests to be approximately 10 days so please plan accordingly.
Tips to Organize Your Tax Records
Tips to Organize Your Tax Records
If your tax records are a bit of a mess, here are some ideas to help to get better organized.
The time to organize your tax records is now. Waiting until the end of the year or, even worse, waiting until you are audited can lead to headaches. Here are some tips to get on top of your tax records.
Storage Hints
Organize your records by tax year. At the start of each year create the current year’s files. Here are some filing suggestions.
- Tax return and support. Create a file with copies of your signed tax return(s) for the year. Include any support documents provided with your filed tax return.
- Files in tax return order. Create your annual files to match the flow of your 1040 tax return. Here are some suggestions.
- Income. Copies of W-2s, 1099s, Social Security statements, interest income, K-1s, and investment activity go in this file.
- Charitable Donations. Create a separate file for cash donations and one for non-cash donations. Include a copy of your charitable mileage log in this file.
- Medical and Dental. Create a file for all your medical related expenses. Include a copy of your medical related mileage log in this file.
- Other itemized deduction file. In this file include all other proof of itemized deductions. This includes tax statements, mortgage interest, state income tax documentation, casualty and theft loss information and unreimbursed business expenses.
- Business activity. Have a file for each hobby and business activity. Include a copy of your business mileage log in this file.
- Education. Create a file for all documents related to educational expenses. Include in it copies of invoices, tuition and fees. Include invoices for music lessons, instruments and any materials required to purchase for your student.
- Other. Put all your miscellaneous receipts into this file. This includes receipts you are unsure about. Include receipts for daycare, educational expenses, dues, unreimbursed business expenses and any other tax related items.
- Statement file. Sort all your statements by vendor, then by month. Create a separate file for these statements. This can include bank statements, credit card statements, and investment account statements. Consider creating a digital back up copy of these statements and store them on a CD or USB drive.
The Digital Alternative
If more of your records are in digital format, consider creating a tax folder for each year on your computer and then place your digital records into sub-folders using the same sort as noted above. Create password protection for each folder.
Rotation idea
Finally, at the end of each tax year place a note on the tax return to confirm the date your tax return was sent into the federal and/or state government. Note on the outside of this file when you can toss the support documentation. Go back to old tax years and shred the old documents that are no longer needed. Do not take this action unless you know the length of time you will need to save these records.
Avoid These Five Retirement Planning Mistakes
Avoid These Five Retirement Planning Mistakes
Retirement planning and tax planning go hand in hand. Here are five common retirement planning mistakes and ideas on how to ensure they do not happen to you.
Here are five common retirement planning mistakes and steps you can take to avoid them.
1. Not having a plan
Surprisingly most of us do not know how much money is needed for our retirement years. A retirement plan should consider how long you expect to live, create an estimate of the amount of money you will need, and consider your desired lifestyle during retirement. Your plan should have measurable goals that can then be broken down into a reasonable way to reach them. Thankfully there are many tools and advisors to help you figure this out.
Action item. If you have a plan, review it for possible revisions. If you do not, consider getting one put together as soon as possible.
2. Not starting early enough
One of the most powerful tools for a well-funded retirement is to start saving for your retirement at an early age. The sooner you start saving the better off you will be.
Action item. Open a retirement account and start saving. Increase the percent of your pay that you place in tax-advantaged retirement saving accounts. This includes IRAs, 401(k)s, and other plans.
3. Not maximizing employer contributions
Many employers have plans available to help their employees save for retirement. If your company has a pension plan, understand how it works and how much you can expect to receive upon retirement. If your company has a retirement plan contribution-matching program, take full advantage of this free money by making minimum contributions to avail yourself to this employer funding.
Action item. Review your employer provided retirement saving options. Maximize the benefits they are providing.
4. Taking the all or nothing approach
Do you plan on working during retirement or avoiding work at all costs? Do you plan on having a pension or Social Security covering all your retirement needs or none of it? Too often retirees plan the extremes, but reality is something in between. For example, if you are someone who plans to have your pension plan fail and Social Security go broke, you may be taking too conservative an approach. Realistically these fund sources will be contribute something to your retirement.
Action item. Create a range of retirement funding scenarios, not just the worst case or best-case scenario. Consider no work or part-time work. Consider some contribution from Social Security and potential pension income if your employer has a program.
5. Not understanding the true nature of your retirement
Are you being realistic in your future retirement plans? Have you correctly estimated the cost of health insurance? Have you really thought about the impact of relocating to a warmer climate? How important is living close to family and friends? Will you really downsize your home after the kids leave?
Action item. If you have a retirement plan that includes relocating or traveling to far off places, consider test-driving this change before you implement it. You may be surprised at the result.
Retirement should be something to look forward to, and with a little planning it can be a reality for most of us.
Double Check Your Documentation – Better to be surprised now than during an audit
Double Check Your Documentation – Better to be surprised now than during an audit
After filing a tax return, most of us are simply relieved another tax year is done. Before moving on to next year, please spend a moment organizing your records. It will help tremendously should you need to refer to them at a later time.
Your tax return is completed and you can exhale a big sigh of relief. Not so fast. Do you have adequate support documentation if the federal or state authorities decide to review your tax return?
The checklist
Here is a check-list to help your recordkeeping. At minimum, make sure your records include the following;
- A copy of your signed tax return and all supporting documents sent with your tax filing
- Copies of any worksheets that support your tax filing
- Canceled checks of deducted items
- Receipts supporting deducted items
- Bank statements
- Investment statements
- W-2s
- Form 1099s (all forms)
- Form 1095s (to support having valid health insurance)
- Mortgage statements (including annual interest paid 1098 tax forms)
- Business K-1 tax forms
- Credit card statements
- Copies of any major purchases or sales (example: home closing documentation)
- Mileage logs for business, charitable and medical transportation
- Proper documentation for business meals and cell phone use
- Receipts for any charitable donations (both cash and non-cash donations)
- Support for all your itemized deductions
- Child care receipts and reporting
- Educational expenses
- Substantiation for value of large donations of property
- Proof of fair market value for any inherited items of value
Capital improvements
Now is also a good time to review your capital improvement files. Capital improvements are money you spend to improve the value of your home, secondary residence or other high value property/equipment. These records are needed to support your calculation of value and gain/loss when you sell your property. Consider creating a spreadsheet that recaps each of these expenditures.
When to toss
Don’t toss old records too soon. The typical rule is to retain federal tax records for as long as they may be needed. This is usually the later of 3 years after the filing due date or when you actually file your tax return. But be careful, state rules can differ and if your income is understated by more than 25% the look back for audit increases to 6 years. Finally, remember to keep records of fixed assets as long as you own them plus three years.