Tax Planning

• Overview
  
• Moving Your IRA Money Around
  
• 401(k) Plans
  
• Getting Your Money Out
  
• 401(k) Loans
  
• Company Pension and Profit-Sharing Plans
  
• Retirement Income
  
• Pension Payout Trap

Overview
When you withdraw money out of a traditional IRA, much-if not all-of it is taxable. As you consider a withdrawal around year-end, weigh the potential advantage of holding off until the new year arrives. If you can wait to put your hands on the money, you can make Uncle Sam wait an extra year before he gets his share. But if you’ll find yourself in a higher tax bracket in the future-due to higher income or increases in the tax rates-you may want to speed up IRA withdrawals to avoid the stiffer tax bite.

In the year you reach age 70 1/2, the law demands that you begin withdrawals from your traditional IRA. But the first mandatory distribution-the one for the year you turn 70 1/2-can be put off until as late as the following April 1. Holding off trims your taxable income and your tax bill in the current year. But you must double up in the second year. In addition to the withdrawal made by April 1, another has to be made by December 31. If the resulting boost in taxable income shoves you into a higher tax bracket, your income-deferral strategy could backfire. (Note: You do not have to begin withdrawals from a Roth IRA at age 70 1/2 or at any other age. Since payouts are not taxable, the IRS doesn’t care when you start. Mandatory withdrawals are required from a Roth you inherit, though.)

Moving Your IRA Money Around
Although a key trade-off for the IRA tax breaks is the threat of the 10% early-withdrawal penalty, you are not locked into the same investment from the time you put your money in the tax shelter until you retire. You may move your money around freely to take advantage of changes in market conditions or your investment philosophy.

401(k) Plans
There is a limit on how much you can contribute to a 401(k) each year, but the limit is far above the IRA cap. For 2017 the cap is $18,000 and it will continue to increase as adjusted by inflation. In addition, workers age 50 and older the end of the year will be allowed to make “catch up” contributions above and beyond the set dollar limitations. For 2017, the catch up amount was $6,000, setting a $24,000 contribution ceiling for a worker age 50 and older. Clearly, Congress wants to encourage us to save for our retirements. Your personal limit depends on your salary and what percentage the company permits you to put into the retirement plan. Most firms allow contributions of between 2% and 15% of compensation.

A special attraction of 401(k) plans is that most firms offering them sweeten the pot by matching part of the employee’s contribution. Matching contributions do not count toward the annual contribution cap. If you quit after just a few years you may forfeit part or all of the matching deposits.

A 401(k) counts as a company retirement plan for purposes of the squeezing your right to deduct regular IRA contributions, but steering part of your salary into a 401(k) may boost the size of your allowable IRA deduction. Because 401(k) contributions reduce your taxable salary, they may pull your AGI down to a level that permits IRA deductions.

Getting Your Money Out
Basically, salary funneled to a 401(k) account is usually locked up until you leave the company, unless you die or become disabled first.

You may be able to get at your money early if you face financial hardship, though you have to be in pretty bad shape to qualify. Basically, you must prove an immediate and heavy financial need-to pay medical bills, cover a down payment on a home or avoid being evicted, for example-to qualify for a hardship withdrawal. You also have to show that you don’t have another source for the cash-that your savings are depleted and you’re unable to borrow from a bank. The IRS imposes other restrictions, too, and it’s up to your company to decide whether or not to permit hardship withdrawals and, if so, under what circumstances.

Even if your plan provides for such withdrawals, you’re not home free. Hardship withdrawals made before age 59 1/2 are subject to a 10% early-distribution penalty. The money will also be taxed in your top bracket. The most you can pull out for hardship expenses is the total of your personal contributions to the account. You are not allowed to touch company deposits or earnings.

You can get your money when you leave the job, but if that’s before the year you reach age 55, you have to worry about the 10% early withdrawal penalty. Note, however, that the penalty is waived for the following reasons:

• After your death
• Because of your disability
• As part of a series of roughly equal payments based on your life expectancy or the joint life expectancy of you and a beneficiary
• To pay deductible medical expenses that exceed of 10% of your adjusted gross income.

At any age, you can avoid the penalty on a 401(k) payout by rolling the funds into an IRA.
If you were born before 1936 and receive a lump-sum distribution from your 401(k) when you leave the company, it might qualify for the 10-year forward averaging method to trim the tax due.

401(k) Loans
There may be a way to tap your account early without being burned by the 10% penalty. Company plans can permit employees to borrow from their accounts. Basically, you can borrow no more than half of your account, up to a maximum loan of $50,000, and the loan must be repaid within five years, unless the money is used to buy a principal residence. If you use the money to buy a house, you can take longer to pay it back. Although the law permits such loan provisions, it’s up to your company whether you can borrow from the plan.

Company Pension and Profit-Sharing Plans
The same 10% penalty that hits early withdrawals from individual retirement accounts applies if you receive money from a company plan early. Although early is defined in the law as before you reach age 59 1/2, an exception to the penalty means most employees can take penalty-free payouts starting the year they reach age 55. The age 55 exception applies if you get the payout because you leave the job-which, of course, is usually the case. The penalty stretches to age 59 1/2 only for withdrawals while you’re still on the job. (Note that the exception applies in the year you reach age 55; you don’t have to be 55 when you leave the job and get the money as long as that birthday comes by December 31.)

Since the point of retirement plans is to help make sure you’ll have money to live on in retirement, the 10% penalty is designed to encourage you to roll over early payouts into an IRA. Such a rollover lets you bypass the 10% penalty but, once inside the IRA, the money is still tied up until you’re at least 59 1/2.

As with 401(k) plans, there are other exceptions to the early-withdrawal penalty. At any age, it does not apply if:

• You are disabled
• The distribution is made to your beneficiary after your death.
• The payments are made in roughly equal installments over your life expectancy or the life expectancy of you and your beneficiary.
• The money is used to pay medical expenses in excess of 10% of your adjusted gross income.

Retirement Income
If you receive regular payments from a company pension or annuity, tax may or may not be withheld. The same goes for withdrawals you take from a regular IRA. Believe it or not, it’s up to you whether part of the money will be withheld for taxes.

If you want to forbid Uncle Sam from dipping into your retirement checks, all you have to do is file a form with the payer. The company that pays your pension or annuity should periodically remind you of your option to block withholding and tell you how to do it.

Note, though, that withholding on these payments isn’t necessarily a bad thing, since it stretches the tax bill over the entire year rather than leaving the bill to be paid all at once at tax time. Withholding might make life easier if the alternative is to make quarterly estimated tax payments, which are discussed later. If you allow it, the amount held back from pension and annuity checks is based on information you provide on a form W-4P, just as withholding on wages is controlled by a W-4.

You don’t have to retire to be affected by these rules. If you roll over funds from one IRA account to another, 20% will be withheld unless you order the company that makes the payment not to withhold.

Pension Payout Trap
Don’t get tripped up by the withholding rule that can sting employees who get lump-sum payments from company retirement plans-the kind of payment you might receive not only when you retire, but also if you quit or are laid off.

Not so long ago, withholding on such payments was voluntary. The best course for most taxpayers, in fact, was to say “no” to withholding, take the money and roll it over into an individual retirement account (IRA). Doing so within 60 days meant no tax was due on the payout, so there was no need for withholding.

Now, however, if you take the money, 20% of it is automatically withheld for the IRS. That’s true even though a rollover will still allow you to avoid the tax. In that case, the IRS would have the money you don’t owe until you file a tax return for the year and demand a refund.

Congress set the 20% withholding rule to raise money-an estimated $2 billion over five years. But only unsuspecting taxpayers will pay it because there’s an easy way around withholding: Simply ask your employer to send the money directly to your rollover IRA. As long as the money doesn’t pass through your hands, there is no withholding.

Even if you intend to spend some of the money right away, your best bet is still probably to ask your employer to make the direct IRA transfer. Then, when you withdraw funds from the IRA, it’s up to you whether there will be withholding. For more information on the advantages and potential problems concerning lump sum distributions.

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