401Ks & IRAs

For today’s retirees, 401Ks and IRAs are the most used retirement vehicle for building their nest egg. They offer valuable tax benefits and are great investing tools. Therefore, making the right choices on how to incorporate these retirement assets into your financial plan is critical.  Whether you're deciding if rolling over your 401(K) is a good choice or if you should be contributing money into a Roth IRA, we have information that can help.


How Much Money Do I Need in My 401k When I Retire?

If you are the kind of person that must plan ahead to ensure your family will have enough money to live on, AND you are not blessed with the gift of foresight, you’ve likely spent a few sleepless nights wondering if you have saved enough for retirement. To go along with those restless nights are a multitude of “what-ifs” that begin to creep in. With all that in mind, this article will explore a few rules of thumb and techniques used to estimate how much a retiree will need to have saved so that their nest egg lasts their lifetime.

Average 401(k) Plan Balance by Age

There are several articles with catchy headlines that are enticing for someone actively planning their retirement. These articles come in a few different flavors, one of which is a type of litmus test inviting you to compare how much people your age have saved in their 401K plan against your own balance. While this is a good starting point, such comparisons may fall short of answering your actual concern, even when you have saved more than the average retiree within your age segment. 

A 401K is just one component of a healthy savings plan. Believing that you are OK just because you saved up as much as others is equivalent to checking the air pressure of one of your tires and concluding that you are ready for that family trip, yet one of your other three tires has a flat. Such logic won’t get you very far. To better illustrate my point, let’s look at a summary of data from a study that Fidelity did on this topic:

Average 401(k) balance by age and contribution rate as % of income:

Age 20 to 29: $10,500 - 7%

Age 30 to 39: $38,400 - 8%

Age 40 to 49: $93,400 - 8%

Age 50 to 59: $160,000 - 10%

Age 60 to 69: $182,100 - 11%

Age 70 to 79: $171,400 - 12%

For many hard-working Americans, it is likely that using this benchmark as a guide for how much you should have saved up by your 60’s will leave you wishing you had saved more. To be clear this data is important and very useful for compiling averages, however, such data is not effective towards planning a successful retirement outcome. This type of thinking is a classic “follow the herd” approach. If the entire herd runs off a cliff and you find yourself amongst them, I doubt it will make you feel better knowing that everyone else is also running out of money in retirement.

Salary Multiple Approach

Another flavor of these articles comes in the form of “If you are Y years old, then you should have 6X salary saved”. For example, Fidelity recommends that “you should save ten times your annual income by age 67.” Even though this rule of thumb provides a quick and easy method to check how you are doing, where it falls short is the consideration of individual circumstances and goals of the potential retiree. A better way to contextualize this approach is with a gut-check question, “will this amount of money last me my whole life based on my current level of spending?” If your answer to that question makes you feel uneasy, then it’s time to dig deeper. At the end of the day, the salary multiple approach is not as helpful to those that find themselves in the following situations:

  • Someone who is in poor health or has a chronic condition that requires a significant budget for healthcare

  • Longevity runs in the family, which means that a larger-than-average nest egg is needed to stretch those dollars

  • A person with legacy goals whose intent is to pass a large estate on to family or charity

  • A retiree who wants to maximize what they spend in retirement so that they bounce their last check

  • An individual who has dependents with special needs that will require permanent assistance

Future 401K Balance Calculator

If you Google the question, “HOW MUCH SHOULD I HAVE IN MY 401K AT RETIREMENT,” you will undoubtedly come across a few slightly different-looking calculators. These calculators will all have different designs to look unique to their website, but they generally do the same thing – they ask for your age, current 401K balance, and income. They then assume a myriad of other factors on your behalf, which may or may not apply to YOU.

The answer to this question then comes in the form of 3 figures:

  1. Your total balance at your desired retirement age

  2. How much income can you draw from the portfolio

  3. How much income will you supposedly need

There you go, your financial future is spelled out by three mathematical formulas that also rely on an assumed compound growth rate of your account balance, a rule of thumb withdrawal rate, and a percentage of your income adjusted for inflation. Voila!

Sarcasm aside, this may be a helpful approach to calculate what your 401K could grow to, but by no means should this be used as any reliable solution. A more effective way of ensuring you do not run out of money in retirement takes a lot more effort in modeling, planning, and testing your plan for the curveballs life will undoubtedly send your way.

Conclusion

A common theme among these techniques is that they all sound too easy, and that’s because they are. If you are not yet convinced by their fallacy, ask yourself these questions:

  • Will knowing that you have saved as much as other people your age assure you that you have enough to support your level of spending during retirement?

  • How certain would you feel about your financial future having run a calculator that requires three inputs to forecast how much you will have at your retirement age (but does nothing to let you know how much you can spend)?

  • Does the fact that you now contribute 10% of your salary into a 401K plan mean you will have enough to cover in-home care after your spouse passes?

On balance, these rules of thumb and calculators are great tools to grab your attention and generate “clicks” but don’t provide the necessary depth to make meaningful conclusions. While solving your potential concerns at the surface level, there are too many “financial planning” boxes that are left unchecked and too many questions unanswered.

Each person is different. People have different lifestyles, spending habits, values, and goals – all of which determine how much you should save, how much you should have by the time you retire, how much you will be able to spend while enjoying your retirement, and how your estate will pass to your heirs.

Many qualitative parameters cannot be factored in by statistics, calculators, or by pretending that a specific contribution rate to one’s 401K plan will lead to a successful retirement. A successful retirement (and the best way to get peace of mind) is an ongoing effort, requiring professional software to model a retirement plan and continuous checks and testing for the “what-ifs” currently keeping you up at night. Such testing and “what-if” scenarios might include:

  • What adjustments should I make to my spending if the stock market causes my portfolio to go down by 30%?

  • What if we go through a period of prolonged inflation? How does that impact my lifestyle in retirement?

  • Will I have enough income if my spouse dies prematurely? What’s the best survivor option for my pension?

  • I have my eye on a dream vacation home – does my financial position support this purchase?

  • How much money can I afford to set aside for my grandkids’ college on an annual basis?

  • I have an adult child for who I would like to provide economic support to - will I have enough money in retirement to do this? 

Once you have determined that a more in-depth analysis is the best path forward for your retirement plan, the question is whether you want to outsource it to a CERTIFIED FINANCIAL PLANNER™ practitioner or do it yourself. For those that enjoy it and have the time, managing your own plan is worth the investment. For others, it’s much easier to hire a professional to help you figure this out. If you fall within the latter category, we can help – click here to learn more.


What should I do with my 401(k) when I retire?

So, you’ve finally let the company know that you are ready to retire. You’ve given them notice of your last day and now they are scrambling to make sure they are prepared for your departure.

You’ve already done your planning.  You know your plan looks great and you are ready to take some well-deserved time for yourself.  But have you thought of everything?  What about that 401k – what are your options?  Should you rollover your IRA or keep it in the plan?  Or maybe you cash it out and take that trip of a lifetime you’ve always wanted to do?  Let’s take a look at your options. 

OPTION 1 - Keep your 401k in the Employer Plan

Some things won’t change:

  • Investment Options –You’ll have the same investment options.  If you are happy with the options, that may be fine.  If you are looking for broader investment choices and better diversification in your retirement account, there are likely better options out there.

  • The investments are institutionally priced, so they are typically low cost. However, it will be important to review your annual 401(k) disclosure to be clear on the true cost.

  • Your account grows tax-deferred and if you take withdrawals from the account you will pay ordinary income tax on the entire withdrawn amount. 

Some considerations:

  • If you have less than $5,000 in the plan, the money will be automatically sent to you.

  • Any time you take a distribution from the plan, they will automatically withhold 20% for taxes.  You do not have the option to NOT withhold. 

  • You will have to take Required Minimum Distributions (RMDs) when you turn age 72.  However, instead of being able to aggregate your RMD’s from one account, your 401k will require you take out your RMD from your 401k in addition to your potentially aggregated RMD from a single IRA.

A good reason to keep it in your Employer Plan?

  • If you have planned well enough to retire before the age of 59 ½, as long as you are age 55 or older, you can take withdrawals from the plan WITHOUT paying the 10% penalty.  You still have to pay ordinary income taxes, but the penalty becomes a non-issue.

OPTION 2 – Roll the money over into an IRA

What won’t change:

  • Your money continues to grow tax-deferred.  With the roll over, there are no tax implications if you move the money from the employer plan directly into the IRA. 

Some considerations:

  • Fees and expenses can vary between different providers.  It will be important to do your research to make sure you understand how much you are paying for your investment advice.

A good reason to roll it over into an IRA?

  • Investment Options – you will have many more investment options to choose from than your employer plan

  • Strategic Tax Planning – When you take distributions, you can choose to withhold taxes or pay taxes when you file your taxes at the end of the year.

  • If you are under age 59 ½ you can take distributions for higher education expenses or as a first time homebuyer without paying the 10% penalty.

  • Simplification – you may want to combine your individual retirement accounts from your past employers into one IRA that will allow you easier management of your money as you age.

OPTION 3 – Cash Out!

This is absolutely the LAST thing you want to do with your 401(k) when you retire.  Why? Because every dollar of your withdrawal is going to be taxed as ordinary income – ALL AT ONCE!  And if you are under 59 ½ then you will also pay a 10% penalty on that money. 

Let’s say your 401k is worth $250,000.  You file Married Filing Jointly on your tax return.  If there is no other income, you will pay about $42,000 in taxes.  If you are also under age 59 ½ then you will pay an additional $25,000 early withdrawal penalty.  So what are you left with?  $183,000.  That’s a tough pill to swallow when you worked all of those years to save for retirement!

The bottom line is that this is an individual decision as only you know your cash flow needs, tax situation and retirement goals.  It is important that you do your due diligence and thoroughly explore your options or work with a Financial Planner to help evaluate the best steps for you and your family.


401K Hardship Withdrawals: What Qualifies & What It Means to You

With nearly 18,000,000 Americans out of work as of August 6th, 2020, many people we know are going through financially trying times. Coronavirus pandemic has put millions of people out of work across the country, virtually overnight, and a few months in - many are running out of cash resources to stay current with their bills. 

Many people have saved for their retirement years in 401K plans, which typically do not allow distributions until one is 59 ½, retires or changes employment. However, it can become a true lifeline if you can qualify for a “Hardship Withdrawal” if your plan allows for such a distribution.

There are standard IRS rules that govern Hardship Withdrawals during normal times, but we all know that COVID Pandemic has turned this year into anything but normal. In response to the economic impact from Coronavirus, Congress took action and relaxed some of the rules governing 401K withdrawals for 2020. Let’s take a look at under what circumstances you can take money out during normal times, and when you can take money from your retirement savings accounts in the times of COVID.

There are seven reasons that would qualify one to withdraw funds from their 401K prior to age 59 ½:

  • Expenses and loss of income, experienced if you live in an area designated as “Disaster Area” by FEMA.

  • Payments necessary to prevent eviction from or foreclosure on your primary residence.

  • Expenses for the repairs of damage to your primary residence.

  • Burial or funeral expenses.

  • Tuition and related educational fees and expenses. 

  • Certain medical expenses.

  • Costs related to purchasing a principal residence.

It is important to note, that if you are considering filing for bankruptcy – you probably should not tap your retirement accounts. There is a little known rule, which protects your 401K from creditors. Other retirement accounts, such as 403B plans – which are not set up under ERISA – do not have these protections, which makes your 401K a unique asset. IRAs, while not protected under ERISA, have a degree of protection under federal bankruptcy laws.

There is probably an even less known rule, The Rule of 55. If you lose your job, for any reason (even voluntarily) and you are over the age of 55 – you may withdraw funds from your 401K or your 403B – without the 10% penalty. This rule does not apply to IRAs or 401K/403B plans from previous employers, and, in order to qualify for this favorable treatment, you must have turned age 55 prior to leaving your employer. 

While the 7 reasons listed above would qualify you to take a withdrawal from their 401K – they do not exempt you from paying income taxes on the funds you withdraw. And remember, your 401K plan is meant for saving money for your retirement years, so there is a 10% penalty on withdrawals prior to age 59 ½ to discourage accessing these assets. However, the 10% penalty is waived if:

  • You become totally disabled.

  • Your medical debt expenses exceed 7.5% of your Adjusted Gross Income.

  • Withdrawal is due to a court order as part of a divorce settlement

  • The Rule of 55, as explained above, or

  • You are separated from service and have set up a withdrawal schedule of equal periodic payments over the course of your life expectancy.

As part of the economic relief package due to Coronavirus, Congress allows Americans to take a Coronavirus Related Distribution (CRD) of up to $100,000 from their retirement savings – including 401K plans and IRAs – without the typical 10% penalty. You would still have to pay taxes on the withdrawal, however – you may do so over a 3 year period, or you may pay back the withdrawal amount, and not owe any taxes at all. So far, Coronavirus Related Distributions are available only in 2020, and not all retirement plan sponsors offer it, because the new law is penned as an optional plan feature, rather than a strict rule.

Ultimately, should you be considering an early withdrawal from your company retirement plan, we recommend that you consult with your and tax advisor, such as a CPA, prior to doing so.  As you can see from the discussion above, the rules are complex and changing all the time.  A quick visit or phone call with your CPA may save you heartache at tax time.


To Roth or Not to Roth... That is the Question

As a fee-only financial planning firm, we spend significant time assisting clients with tax planning - planning one's actions in order to minimize the impact of taxes on one's financial situation.  As such, one of the decisions we must often address is whether or not a client should use a Roth IRA, or convert funds from a traditional IRA to a Roth IRA.  Generally, this question is answered on an annual basis.

Learn more about 401Ks and IRAs

For your consideration, there is another great article that addresses these issues from a planning standpoint.  Due credit to the author is given below, you may find the original article at http://www.thetaxadviser.com/issues/2016/nov/deciding-whether-to-roll-over-roth-ira.html

It is impossible to reach a single conclusion that applies to all taxpayers when deciding whether to roll over a traditional IRA or qualified plan account into a Roth IRA. Whether it makes sense to trigger the resulting tax liability depends on factors such as how long the taxpayer intends to leave the funds in the Roth IRA, what the taxpayer's tax rate is now and what it will be when withdrawals are taken, and whether the taxpayer will have to use the funds from the IRA or qualified plan account to pay the tax due at conversion. As with most tax planning alternatives, the practitioner should calculate the numbers before deciding on a particular strategy.

Taxpayers will generally benefit from converting funds to a Roth IRA if all of the following conditions apply:

  • The taxpayer (or beneficiary) will not need to take withdrawals from the Roth IRA for at least 15 to 20 years;

  • The taxpayer's (or beneficiary's) tax rates when withdrawals are taken are no less than they are at the time the conversion occurs; and

  • The taxpayer can pay the tax due on the rollover with funds outside the IRA or qualified plan.

Other factors and practical considerations that should be addressed or discussed with the client include the following.

Paying the tax with funds outside the IRA or qualified plan is generally necessary to making the rollover economically beneficial. If a taxpayer does not have available funds, it is unlikely a rollover will make economic sense (because the funds withdrawn from the IRA or plan and used to pay the tax are subject to income tax and, in many instances, the 10% premature distribution penalty). Practically speaking, many taxpayers may not have outside funds available to pay the tax on a conversion that results in significant taxable income.

Income generated from a conversion may create unexpected tax consequences. For example, items sensitive to changes in adjusted gross income (AGI) (e.g., itemized deductions, the child credit, education credits, etc.) may be adversely affected because of the increase to AGI caused by the IRA conversion income.

Conversions may be particularly beneficial for wealthy taxpayers who plan to leave large IRA balances to beneficiaries. Because Roth IRAs are not subject to the pre-death required minimum distribution rules, the funds can continue to accumulate without taxes for beneficiaries.

A significant benefit of making a conversion, particularly for younger taxpayers, is the ability to withdraw the converted amount tax-free and penalty-free after the funds have been in the Roth IRA for at least five years. Because Roth withdrawals come first from contributions (including converted amounts), this effectively allows tax-free and penalty-free access to some IRA funds before age 59½. However, exceptions to the early withdrawal penalty when IRA funds are used for first-time home expenses and college costs give owners of traditional IRAs penalty-free access to funds when used for those purposes.

Projecting a taxpayer's tax rates in retirement is particularly difficult when that time is 20 or 25 years in the future. Future tax analysis is further complicated by the focus on the current tax system and discussions in Congress on how to simplify and reshape it. If Congress abolishes or dramatically lowers the rates in our current income tax system and replaces or supplements the current system with a value-added tax or national sales tax, paying tax now on a conversion might be a mistake. Further, there is no guarantee that Congress will not change the tax-free status of Roth IRA withdrawals in the future, either directly or indirectly (e.g., as part of an alternative minimum tax computation); however, adverse political consequences may prevent such changes.

Taxpayers with deductions or credits that may otherwise go unused are good candidates for conversions because the conversion income may create little or no additional tax liability. For example, elderly persons with high medical expenses or individuals with expiring tax deductions, such as net operating loss carryovers, or expiring tax credits, such as an adoption or foreign tax credit, may benefit from a Roth conversion. The ability to undo or recharacterize all or part of the conversion after year-end allows these taxpayers to control exactly how much income they want to generate from the conversion, depending on the actual deductions and credits claimed on their return.

Taxpayers who are college students or who have dependents who are college students and will be applying for financial aid need to consider the ramifications of including the income from the conversion in the Free Application for Federal Student Aid (FAFSA). While retirement assets are not included in the FAFSA, any income reported on the taxpayer's return will be included and could affect the amount of financial aid the student will be eligible for.

Caution: Using funds from a traditional IRA or employer plan to pay the tax on the rollover will often result in a 10% premature distribution penalty on those funds. They are subject to income tax (except to the extent the distribution is attributable to nondeductible contributions) and a 10% premature distribution penalty, unless an exception applies (Sec. 72(t)). If the funds are withdrawn from the Roth IRA following the rollover, a 10% early distribution penalty applies if the withdrawal occurs during the five-year period following the rollover (Sec. 408A(d)(3)(F)).

Taxability of Social Security Benefits May Have an Impact

Taxpayers receiving Social Security benefits (or who expect to begin receiving them in the near future) who are considering converting to a Roth IRA should consider the effect of the conversion on the taxability of their Social Security benefits. If their Social Security benefits are already taxable up to the 85% limit because of their level of AGI, rolling over retirement funds into a Roth IRA will have no effect on the amount of taxable Social Security benefits.

Some taxpayers with Social Security benefits may actually be better off with a Roth rollover. The rollover will cause taxable income to increase for one year. However, subsequent taxable income should be less than it would otherwise be without the rollover. Not only will rolled over funds not be subject to the age 70½ minimum distribution rules, but any Roth withdrawals after the age 59½ and five-year requirements have been met are tax-free. Thus, taxpayers who are otherwise close to the Social Security taxability threshold without considering any IRA distributions could see less of their benefits subject to tax by rolling their IRA or employer retirement account funds into a Roth IRA.

Other Income Tax Issues to Consider

In addition to the direct impact a rollover has on the taxpayer's taxable income in the year of the rollover, there may also be an indirect effect. Several AGI-sensitive tax benefits may not be available if income is over a certain level. Thus, in the year(s) in which the taxpayer's income increases because of a rollover to a Roth IRA, benefits such as the child or education credits, the adoption credit, or the deduction for interest expense on a loan for higher education expenses may be limited or even lost.

Other items that could be adversely impacted by a jump in income include the $25,000 rental exception to the passive loss rules, the medical and miscellaneous deductions, and the ability to make certain types of IRA contributions.

Also, when evaluating the costs and benefits of a Roth conversion, planners should carefully consider future tax rates, as well as the potential effect of the 3.8% net investment income tax for some high-income taxpayers. Although net investment income does not include distributions from IRAs and qualified plans, distributions from traditional IRAs and qualified plans will increase the taxpayer's modified AGI, which may be enough when combined with other income to exceed the threshold amounts. Threshold amounts are $250,000 for joint or surviving spouse returns, $125,000 for separate returns, and $200,000 in other cases (Sec. 1411(b) and Regs. Sec. 1.1411-2(d)(1)). Because distributions from Roth IRAs are not included in modified AGI, they cannot cause the 3.8% surtax on net investment income to apply.

Medicare Part B and Part D Premiums

Extra income from a Roth conversion may adversely impact the monthly Medicare Part B and Part D premiums paid by upper-income seniors. These higher-earning seniors pay a surcharge above the regular monthly Part B and Part D premiums based on their AGI. For 2016, the surcharge applies if 2014 modified AGI exceeded $85,000 for single filers and $170,000 for joint filers. The maximum Part B surcharge is 220% (based on the standard payment of $121.80) for single filers with a 2014 AGI above $214,000 and married filers exceeding $428,000 of AGI. The Part B surcharge can be as much as $268 per month in 2016. The Part D surcharge can be as much as $72.90 per month in 2016. So, seniors reporting income from a Roth conversion in 2016 could see their 2018 Medicare Part B and Part D premiums increase.

Observation: Many taxpayers will be able to pay less than $121.80 per month for Medicare Part B. Since Social Security beneficiaries received no cost-of-living adjustment this past year, taxpayers who received benefits and paid Medicare premiums in 2015 are subject to a lower rate of $104.90 per month in 2016.  

This case study has been adapted from PPC's Guide to Tax Planning for High Income Individuals, 17th edition (March 2016), by Anthony J. DeChellis and Patrick L. Young. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2016 (800-431-9025; tax.thomsonreuters.com).


How Making a Qualified Charitable Distribution from your IRA Can Help You

As most people get older, they feel the need to increase their philanthropic behavior. It can be that they have more money, more time or a desire to give back.  Many people make financial donations to a wide variety of charities for the overall benefit of a better society.  Although these donations provide benefits to the charity, they also can provide benefits to the person giving them.

With the recent passing of the Protecting Americans from Tax Hikes (PATH) Act of 2015 in December, the Qualified Charitable Distribution (QCD) provision finally became a permanent provision in the tax code.  This provides more certainty for your financial planning and the strategy can be employed earlier in your financial plan.  In the past, this provision has been passed at the last minute, late in December, creating uncertainty and making it difficult to use in a financial plan.

The Qualified Charitable Distribution (QCD) is a provision that allows an individual over 70 ½ to directly transfer funds from an IRA (other than SEP and SIMPLE) directly to a qualified public charity without including the distribution as taxable income.

How does this benefit you?

  • The Qualified Charitable Distribution can qualify for your annual IRA Required Minimum Distribution (RMD.)

  • Reduced taxable income.  Lower Adjusted Gross income can lead to avoidance of reduction in itemized deductions, taxability of Social Security benefits or higher Medicare premiums.

  • You make financial donations to charities but don’t itemize deductions on your tax return, so you are not able to receive the tax benefit of the charitable deduction.

  • You make financial donations to charities over the normal Adjusted Gross Income (AGI) percentage limits (50%/30%/20%) where the amount donated is over the limit and could not be used in the current year carrying over to future years.

It is most beneficial to individuals or families that are charity minded and don’t need the Required Minimum Distribution (RMD) to live on.

There are rules to be aware of;

The individual needs to be over 70 ½ when the distribution is made

  • The limit for distributions is $100,000 per IRA or beneficiary.

  • The distribution must be made directly from your IRA custodian or financial institution where the IRA is located to the charity. 

  • Distributions can only made from IRAs, not a 401(k)or 403 (b)

  • Cannot be used to fund charitable annuities or charitable remainder trusts

  • The charity must qualify for a charitable income deduction of an individual other than a private foundation, a donor-advised fund or a supporting organization as per Internal Revenue Section 509(a)(3).

  • You would not be able to claim the Qualified Charitable Distribution (QCD) as an itemized deduction.  You already receive the tax benefit by not including the withdrawal/distribution in your taxable income.

To make a Qualified Charitable Distribution (QCD), you would need to request the distribution (check) from the financial institution who holds your IRA to title and submit directly to the named charity. I would recommend verifying with the charity the correct titling and mailing address before submitting distribution request.

For assistance with the Qualified Charitable Distribution (QCD), it is always best to seek the assistance of a qualified professional such as a Certified Financial Planner® Professional.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements. 

Investment advisory services offered through PARAGON Wealth Strategies, LLC., a registered investment adviser.


It's Never Too Early to Save for Retirement

Have you worked and saved your whole life with the goal of retiring one day?  Have you thought about if you have saved enough money to live on for 30 years during retirement?  Has it caused you stress in your life during the years leading up to the retirement decision?  If you knew that if you started saving earlier for retirement, you could retire earlier, is it possible that you would have chosen a different path?

Unfortunately, you can’t turn back time, but there is still a chance for the ones you love.  As the retirement landscape changes, the responsibility to save for retirement has shifted to the individual. 

Will your children or grandchildren receive a pension for working for the same company for their whole career? Will social security be around to supplement their retirement savings?  Will they choose a career that provides enough income to take care of a family and put money away for retirement?

We all want our children and grandchildren to have better lives than we did.  As we share our knowledge and personal experiences of saving for retirement with the younger generations, we all realize that the earlier we start, the better the odds of success.

Hopefully our adult children already are on the path of saving for retirement through the use of IRAs, Roth IRA’s,  or work retirement plans like a 401(k) or 403(b). What about your grandchildren?  

What better gift can you give to your grandchild than to teach them about working, savings and investing at an early age?  Why not help and guide your grandchildren to a successful retirement utilizing the 50 year time horizon they have to receive tax free growth available through a Roth IRA?

The IRA options for a child would include the same for as those for adults -  traditional or Roth.  Both these types of IRA accounts would follow the same rules as if it was an adult contributing including the income limits, contribution limits, tax deductibility, contribution deadlines and distribution rules.  Each individual situation and the type of IRA that is best that individual should be considered, but for this blog I will be mostly referring to Roth IRAs due to benefit of the tax free growth.

While there is no age limit to start an IRA, the only IRS requirement is taxable compensation or earned income.  Taxable compensation or earned income includes wages, salaries, tips, other taxable employee income or net-earning from self-employment.  Earned income does not include interest from savings accounts or investment income, including dividends or capital gains. 

The limit for IRA contributions for 2015 is the lesser of $5,500 or total earned income.  The child does not have contribute the full amount that they earn, but they allowed to up to their total earned income or the annual limit on IRAs.  The exact dollars that the child received from working do not need to go directly into the IRA. There is the option of working with your child to show how important saving is and matching their contribution, as long as the total IRA contribution is not over child’s total earned income or the annual contribution limit of $5,500.

Depending on how old your child, earned income can come from many different sources.  Although the IRS doesn’t consider doing chores around the house and receiving an allowance as earned income, there may be other work that your child is engaging in to qualify.  Does your child earn money from babysitting, mowing lawns, acting, and modeling?  Are they old enough to work and have a part time job with w-2 income?

Let’s look at an example:

Let’s say that a child starts at 15 years old, contributing $2,000 a year at the end of the year for 7 years until they start working full time at age 22, and then contribute the maximum limit of $5,500 (as of 2015) at the end of the year for another 40 years.  Using an average annual rate of return of 7%, the future value at the end of 40 years would be over $1,357,171.  If no contributions were made until age 22 and the $5,500 contributions were made for 40 years, the future value would be $1,097,993, a difference of $259,178.

When a child has income, it may lead to filing a tax return for your child and possible tax implications, even though unlikely.  For specific rules on reporting a child’s income please refer to IRS Publication 929, Tax Rules for Children found at www.irs.gov. It is best to consult with a qualified tax preparer for questions regarding specific tax treatment of a children’s income.

If the child is under the age of majority (depending on what state you live in, usually under the age of 18 but can be up to 21,) the account can be set up as “Custodial Roth,” with the parent directing the IRA for the benefit of the child.  Once the child reaches the age of majority the account would transfer back to a standard IRA and the child will have full control. An IRA can be set up a qualified financial institution including banks and investment companies.  Not all institutions offer these types of accounts, so don’t be discouraged if your institution doesn’t, there are many others out there. 

While there are other options for children to start savings for retirement.  Some grandparents open up custodian brokerage accounts for their children and grandchildren using individual stocks or mutual funds. These accounts may provide a way to save for retirement and build assets over a lifetime, but the investment income while they are a child may be taxable(to both the child and parent depending on amounts) and included when applying for financial aid.  

As mentioned earlier, we all our children and grandchildren to have a better live than we did.  What better option of teaching them to start saving for retirement early.    Why not help them secure their successful retirement before they even start working.  They may one day be able to retire without the fear and worry about if they have enough money to retire that many of us are facing now or have already experienced.


The Backdoor Roth - What's that??

Roth IRAs have become very popular as a retirement savings vehicle. There are a few ways to get money into a Roth IRA, but we are going to look specifically at a technique known as the ‘Backdoor Roth.’

Roth IRAs appeal to many people because of the many benefits they offer. They were established with the Taxpayer Relief Act of 1997. The basic premise is as follows:

  1. ANYONE with earned income below certain adjusted gross income (AGI) thresholds may contribute to a Roth IRA.

  2. Contributions to a Roth IRA are made with after-tax dollars. Unlike traditional IRAs, you cannot take a deduction for Roth contributions.

  3. A Roth IRA is a tax-deferred vehicle. Earnings and appreciation are not taxed currently.

  4. If the account-owner satisfies certain requirements, then the distributions come out TAX-FREE! In order to qualify for the tax-free distributions, the account-owner must have had a Roth IRA for at least 5 years, AND be at least age 59 ½, whichever is later. The account-owner can alwayswithdraw contributions, which come out first.

  5. Unlike traditional IRAs, where the IRS comes knocking at age 70 ½ for you to begin withdrawing funds in the form of required minimum distributions (RMDs), a Roth IRA accountholder NEVER has to take distributions.

Here’s the catch - not everyone can contribute to a Roth IRA. As I just mentioned, there are limits based on AGI. In 2014, those who file as married filing jointly (MFJ) may contribute if their AGI is less than $191,000. For single filers, the AGI limit is $129,000. The maximum contribution for 2014 is $5,500. If you are age 50 or better, you may make a catch-up contribution of another $1,000. If your AGI is between $181,000 - 191,000 for MFJ ($114,000-129,000 for Single), then your contribution will be reduced.

Now that we’ve laid the groundwork, let’s look at the Backdoor Roth contribution. Here’s the key - the limits on traditional IRA contributions relate to deductibility of the contribution, not whether you can contribute.   ANYONE with earned income (who is under age 70 ½) may contribute to a traditional IRA. So an individual with income in excess of the AGI limits to contribute to a Roth IRA makes a contribution, instead, to a traditional IRA. The contribution is in after-tax dollars. Once the contribution is in the traditional IRA, the account-owner proceeds to convert the IRA balance into a Roth IRA. The after-tax contribution moves into the Roth IRA, virtually replicating a contribution to the Roth.

The only way this strategy works is if the account-owner does not have any other IRAs. The IRS views all IRAs as one bucket of money. For those with self-employed plans, SEP IRAs are included in that bucket. Once pre-tax dollars are present, then there will be a taxable distribution as part of the conversion. For example, let’s say I set up a traditional IRA and make a $5,000 non-deductible contribution to it in 2014. I then convert that $5,000 over to my Roth IRA.

Looks good, right? No so much, because I have a SEP IRA with $10k in it. From the IRS’s perspective, I have $15,000 in IRAs, not $5,000. The SEP IRA balance will be included in the calculation to determine how much tax I have to pay on the conversion. Since 2/3 of my IRA funds are pre-tax, 2/3 of my Roth conversion will be taxable too. Ouch!

So what’s the moral of the story? If the Backdoor Roth strategy appeals to you, get tax advice first!

Please remember that there can be no assurance that any strategy referenced in this article will be profitable, suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Paragon Wealth Strategies, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Paragon Wealth Strategies, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Paragon Wealth Strategies, LLC’s current written disclosure statement discussing our advisory services and fees is available upon request.


Should I pull money out of my 401k to pay off credit card debt?

We got this question on a financial advisor forum.  Here is the fact pattern:

I am 65, planning to stay at current job for 5 more years. I have $300,000 in 401k and $60,000 in credit card debt. I am thinking of taking $50,000 to pay off most of debt and set aside $5000 in savings. I have no penalty to withdraw but will have taxes . Is this a good idea? My hope is that I would have money to pay cash and not charge up new debts.

And... here is my answer.  Probably not the "soft and cuddly financial advisor" response the gentleman was looking for.  But... retiring broke isn't "soft and cuddly" either.  Frankly, retiring broke... sucks.  We coddle ourselves financially in this society.  People who are financially successful... DON'T.

My answer follows:

Honestly, I don't think that is a good idea.  It may seem like a quick fix... but you know what they say about quick fixes!  My first question that I would ask, if I were your advisor, is WHY do you have the $60,000 of credit card debt?  That answer needs to be addressed honestly.  If it was because of a one-time event (divorce, medical issues, helping a child with college, etc) then that is an entirely different animal than if your answer is... "I'm not really sure... but... lemme see..."

Based upon what you are saying in your question, I suspect the credit card balances have creeped up on you over time - this is usually a result of an incorrect, or a missing, BUDGET.

First and foremost, I would create a rock-solid budget.  Don't fool yourself and don't let anything such as "monthly credit card bill" be on that budget.  Get GRANULAR with that budget and make proactive decisions about what you WILL spend, and what you will NOT spend, in advance, and then stick to your decision.  Analyze each expense for it's real value to your life, and decide if it can be lowered.  For example - are you paying $150 a month for a cable bill?  Would a basic package and Netflix be a better solution - and save $100 per month?  How often to you go out for lunch?  If it's more than once a week, then STOP that, and bring your lunch to work. Do you go to a coffee shop for morning coffee?  Knock that off too, and brew up your favorite coffee at home and bring it in a Thermos.  What is your grocery bill?  How long would a 50lb bag of potatoes, a big bag of soup beans, and a dozen cans of green beans feed you?  I'm serious - do what it takes, no excuses.  Are you married?  If so, is "spousal spending" the problem?  Talk it out and get on the same page. 

Get motivated, get focused, get MEAN with that budget.  A no excuses, no surrender mentality with your finances is what this will take.  Your parents who grew up in the great depression could probably live off half of what you spend... and give you change and the end of the week!   

Once you have gone through this exercise, you will know the answer - are you living beyond your means - or perhaps your basic monthly expenses are just too much for what you are bringing in, and you need to see what other options exist (a move?  Downsize?  Even renting out a room?) 

Now get creative, get focused, stay MEAN with that buget!  After all, you only have one life to live (as far as we know) and one retirement. 

At this point,  you will have diagnosed the real problem - NOW you can come up with a workable strategy.  I would initially say, do NOT withdraw from your 401k - but maybe you could scale back on 401k contributions going forward to free up the cash flow to pay off the credit card debt, as a last resort.  If you need help or coaching, hire a fee-only financial advisor and tell them their job is to NAG and get MEAN!  You CANNOT borrow money for retirement - no one will lend it to you!

Use a "debt payoff calculator" that you can find online, or make a spreadsheet detailing your payoff strategy.  Tape it to your refrigerator and your bathroom mirror, and then stick to it; the only exception should be emergencies (real ones, not "I need a new TV" emergency).  Think Rocky Balboa. This is no joke; being broke and running out of money in retirement is NOT a financial plan.

Good luck with this; it is difficult but you have 5 years to fix the problem.  Do not discount the benefits of balance transfers to your lowest interest card, or negotiating with the credit card issuer, if that is an option.

Here is the original link: https://www.nerdwallet.com/article/finance/401k-loan-credit-card-debt


How do I Invest More Than I Can Put in my 401k or IRA?

We run across this question often as an investor's income increases to the point where they can save beyond the amounts that they can put into IRA's.

First, if you have an employer retirement plan such as a 401k or 403b, then that account would likely be your first choice. Make sure you are maxing those to get any matching funds, and the additional tax deductions as you can put in $17,500 annually into those ($23000 if you are over age 50) and get a tax deduction. 

If you don't have a plan like that, and have maxed your IRA, then you should definitely continue to save and invest - you just don't get a tax deduction for it.  You should consider going to Fidelity/Schwab/Vanguard or a firm like that, and open an account just in your name (or jointly with your spouse, if you are married) and begin saving and investing in that account, as much as you can, in a similar way to how you would invest your IRA money.  Focus on low-cost, no-load mutual funds (or highly tax-efficient Exchange Traded Funds) and begin building your portfolio according to your risk tolerance, using the tools that the firm provides.  Don't be shy about asking for help, either.

Accounts such as these are wonderful, and in my opinion, often better accounts to have once you are retired.  First, the tax treatment of these accounts are more advantageous when you need money OUT of the accounts, as you are taxed under capital gain tax rules instead of ordinary income tax rules.  You can "harvest" out of the account - meaning you can sell an asset that has lost money, and use that loss to offset the taxes on other assets that might have made a profit, or use that loss to offset your income tax, up to $3000 a year.  Also, at age 70 and 1/2, you MUST begin drawing out of your IRA or other retirement accounts (just to pay the tax on them) while there is no such rule with Joint or Individually held accounts just in your name.  And, there are no silly "rules" to remember about how much you can put in, when you can pull the money out, or any of that "stuff."  You just put in as much as you want to, and if you need money, you can pull whatever you need out of the account, pay any taxes due, and use the money as you please.

How could it get any better?