Category: Personal Finance

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Retirement Savings Beyond the 401(k)- Traditional IRA

Welcome to part two of our three-part series on retirement savings outside of the employer sponsored 401(k) plan. This series may be relevant to you if you are self-employed or are an employee and desire to save additional funds for retirement in a personal account. Before we dive in to part two of this series that focuses on Traditional IRAs, I would encourage you to first check out the series introduction and part one that focused on Roth IRA savings.

What is a Traditional IRA?

Basically, a traditional IRA is an account type that offers you the opportunity for tax-advantaged retirement savings. Traditional IRAs give individuals the opportunity to save in addition to, or in place of, employer sponsored 401(k) type retirement savings. They are an account type in which you are able to buy investments to take advantage of market gains over time to grow your account value.

What are the pros of opening a Traditional IRA?

  • Ownership of account at brokerage or bank of your choice
  • Flexibility in investment choices
  • No income limits on traditional IRA ownership
  • Deferral of tax on investment growth and earnings until time of withdrawal
  • Avoidance of early withdrawal penalty for some first time homebuyer expenses and certain educated-related expenses

What are the cons of a Traditional IRA?

  • 10% penalty and tax on withdrawals before age 59 1/2
  • Required minimum distributions must be taken beginning at age 72
  • If you have a retirement plan at work, your tax deduction benefit will phase out at higher income levels (see table below)

How is a Traditional IRA different from a Roth IRA?

A traditional IRA is different from a Roth IRA when we look at it from a tax benefit perspective. Contributions to traditional IRAs can be deductible from gross income on the individual tax return in the year of contribution. This simply means that as opposed to the Roth IRA, you receive the tax benefit of contributing to a traditional IRA upfront as you are allowed deductibility of your contributions in the year that they are made. This is much different from the characteristics of a Roth IRA because with those contributions you do not get a deduction at the time of contribution. However, with the Roth IRA, your earnings accumulate tax-free and your qualified withdrawals are tax-free.

Unlike Roth IRA withdrawals which are tax-free, Traditional IRA withdrawals are taxed at the time of withdrawal as ordinary income. This makes them more attractive to someone who feels like they will be in a lower tax bracket during retirement than they are during their working/contributing years.

Also, Roth IRA accounts do not require distributions at age 72 in the same way as Traditional IRAs.

Who can contribute?

Anyone can open and contribute to a Traditional IRA, but not everyone with qualify for tax deductible contributions.

Who can make tax deductible contributions?

See table below for the details on income, contributions, and deductibility.

Filing Status2020 MAGIDeduction
Single or Head of Household$65,000 or LessFull Deduction
>$65,000 but <$75,000Partial Deduction
>$75,000No Deduction
Married Filing Jointly$104,000 or LessFull Deduction
>$104,000 but <$124,000Partial Deduction
>$124,000No Deduction
Married Filing Jointly$196,000 or LessFull Deduction
(spouse covered by employer
retirement plan)		>$196,000 but <$206,000Partial Deduction
>$206,000No Deduction
Married Filing Separately<$10,000Partial Deduction
(you or spouse covered by
employer retirement plan)		>$10,000No Deduction

Which choice is best- Roth vs. Traditional

After looking at the characteristics of the Roth IRA is part one of the series, and now diving into Traditional IRA characteristics in part two of the series, we can compare the two based on both short-term and long-term value and tax advantage.

In my opinion, as long as you qualify for a Roth IRA based on the income qualifications, you should utilize that account type before looking at putting money in any other IRA type. You should also be sure that if you have an employer 401(k) plan available to you, that you are at least contributing enough to get your employer match before looking into other IRA types.

Next steps

If you believe that you are ready ramp up your retirement savings through the use of a Roth IRA as discussed in part one, or a traditional IRA as discussed in part two of this series you should speak to a trusted financial advisor, bank, or look into self-managed options that may be right for you.

For more clarification on the tax effects of IRA savings, talk with your CPA. If you do not yet have a relationship with a CPA, feel free to reach out to us at info@bynumcpa.com.

Check out more blog posts at our site www.wisdomofwealth.net, or if you have questions/requests send them to wisdomofwealthblog@gmail.com

Wisdom of Wealth is owned and operated in partnership between Bynum CPA, PLLC and Arc Accounting, PLLC.

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Retirement Savings Beyond the 401(k) Part I- Roth IRA

In the first part of our three part series on retirement savings options outside of employer sponsored plans, we will be discussing the Roth IRA. Many people have heard of the Roth IRA, or perhaps even been advised to open a Roth IRA by a parent, family member, or friend. As with many things in life, taking the first step in deciding to establish this type of account can be intimidating. However, there is no need to feel that way! We will be discussing who can participate in a Roth IRA, what are the contribution limits, and most importantly what makes the Roth IRA such a powerful long-term savings tool. Let’s dive in!

Who can participate?

There is no age restriction on who can open and contribute to a Roth IRA. The only requirement is that the account holder making contributions have earned income. Earned income is money made through working a job or through business ownership. Passive income types such as rental income, alimony, investment income, social security, and unemployment compensation are a few examples of unearned income that cannot be used to qualify for participation.

Participation is also limited by your MAGI (modified adjusted gross income) for the tax year in which you are making contributions. We will cover more on that in the next section.

As we will discuss in further detail below, keep in mind that your annual contribution limit cannot exceed your amount of earned income. For example, you must have at least $6,000 in earned income to be able to make the full allowable annual 2020 contribution of $6,000.

What are the contribution limits?

Roth IRA contribution limits can fluctuate slightly each year, but the maximum contribution limit for the 2020 year is $6,000 per person ($7,000 if you are 50+). Roth IRA contribution limits can be affected by the MAGI (modified adjusted gross income) of the account holder based on their tax filing status.

The participation phase-out window for a single filing tax payer is from $124,000 to $138,999. With participation being entirely disallowed with MAGI exceeding $138,999. Married filing jointly taxpayers face a phase-out window of $196,000 to $205,999. Participation for married filing jointly taxpayers completely phases out at MAGI equal to or in excess of $206,000.

What makes the Roth IRA special?

So, I know that by now you are probably asking, “What makes this Roth IRA savings option so attractive?” The answer to that questions is the unique quality of a Roth IRA that allows your after-tax contributions to grow tax-free for the life of your account and your withdrawals are also tax-free (if over age 59.5). This is the reason why a Roth IRA is a preferred savings method for someone in their 20’s and 30’s. The time that your invested money can grow tax-free until age 59.5 adds an immense amount of value to your investment.

If I have an emergency, can I access my funds prior to age 59.5?

The short answer is yes. The real answer is that if you are under age 59.5 and have not owned the account at least five years, your earnings are subject to taxes as ordinary income and are also subject to a 10% penalty. If you are under age 59.5 and have owned the account at least five years, your earnings are still subject to tax as ordinary income and you face a 10% penalty. If you are over age 59.5 and and have owned the account at least five years, there are no taxes or penalties assessed on any withdrawals. If you are over age 59.5 and have not owned the account at least five years, your earnings are subject to tax as ordinary income but there is no 10% penalty assessed.

Note: If you are under age 59.5, you may qualify for one of the exceptions to allow a withdrawal not subject to the 10% penalty (but not the tax). The exceptions are first-time home purchase, qualified education expenses, unreimbursed medical expenses, and disability.

I’m ready to open an account, what’s next?

If you are ready to enter the world of retirement savings through use of a Roth IRA, it is always a good idea to find a professional financial advisor (preferably a Certified Financial Planner) who serves as a fiduciary and protects your best interest when making investment choices. If you are interested in connecting with a CFP partner of ours, please reach out through the contact form on the blog page or email us at wisdomofwealthblog@gmail.com.

Be on the lookout for part two of the series next week!

-Wes

Check out our CPA firm website here.

Check out our small business cloud accounting service here.

Note: The information contained within this blog post is current with applicable laws and regulations as of the publishing date. Financial regulations are subject to change.

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Retirement Savings Beyond the 401(k)- Series Introduction

One common question that I receive from individual tax clients and my wife (Megan) gets from financial planning clients is, “What retirement savings options are available to me outside of an employer sponsored retirement plan?” A few of the reasons why someone might be interested in other types of personal retirement accounts can include investment choice flexibility, potential tax savings, or becoming self-employed.

This is a very important topic and I want to spend plenty of time thoroughly explaining the ins and outs of some of the IRA types that exist, so we will be working through this in a three part series over the upcoming days. We will cover these three key segments of IRAs and how each could benefit you:

  • Roth IRA
  • Traditional IRA
  • SEP IRA/SIMPLE IRA

We will discuss the qualifications of who can participate, dollar limits, income phase-out concepts, and why some of these might be a good option for you whether you are an employee who is already in a 401(k) plan or if you are self-employed and need to focus on putting back some money for retirement.

I hope that you will “Like” the Wisdom of Wealth Blog Facebook page and visit the Wisdom of Wealth website to sign up for notifications of new blog posts. I am excited to share some valuable information with you throughout this series, and hope that you will follow along!

Thanks for your support!

-Wes

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I Haven’t Received My Stimulus Payment… Now What?

Many Americans woke up to a nice surprise this past week. They received the direct deposit of their “Economic Impact Payments”. As most of you are probably aware, the economic impact payments were included as part of the 2020 CARES Act which injected cash to the tune of $2 trillion back into the national economy during this time of crisis through loan programs aimed at businesses, as well as direct stimulus payments made to individuals and families.

The basics of the program are that the IRS bases your program eligibility and amount due on the filing status and Adjusted Gross Income (AGI) from your most recently filed tax return (2018 or 2019). If you are filing single and had AGI less than $75k, you are eligible to receive $1,200. If file taxes as married and joint, you would need to have household AGI less than $150k to get the full benefit of $1,200 per adult. Also, you would receive an additional $500 per child dependent 16 years of age or younger that you claimed on your most recently filed tax return. There is a phaseout range for a reduced amount (single $75k-$99k and married $150k-$198k). AGI outside of the top end of these ranges results in not receiving a stimulus payment.

If you feel that you are eligible to receive this benefit, but did not receive yours last week when it came through for others- Don’t worry! The IRS has only sent out one wave of payments which we are now learning went to people who filed and received a refund by direct deposit in either 2018 or 2019. If you had a tax liability due after filing and paid by either sending a check or through direct withdrawal with the IRS, they are now telling us that they will not automatically use the bank information on file that was used for making a payment as the account to deposit your stimulus payment. If you are in this group, you will need to access the new IRS “Get My Payment” tool and update your bank information on file if you wish to receive your payment by direct deposit. If you do not update the banking information that the IRS has on file, you will receive a paper check which will be a much slower method. See link below.

https://www.irs.gov/coronavirus/get-my-payment

If you enter your personal information and receive an error message, also Don’t Worry. This message does not necessarily mean that you are ineligible to receive the stimulus payment. The IRS has announced some issues with the “Get My Payment” tool and say that an individual should check back once per day to access and update their information as the IRS adds access for more taxpayers to this system.

-WB

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Home Sale and Capital Gains Tax…?

Due to the explosive growth of population and industry in Nashville, our geographic area has been in a very bullish housing market for the last 3-5 years. This is generally good news for the local economy since this means more families are moving into an area to fill available jobs, more homes are being built, more land is being purchased for development, more people are employed in building trades, etc. However, there are other questions concerning real estate transactions that arise for people in an area that has a booming real estate market.

Likely the most common question received by financial professionals in this type of economic climate is, “the value of our home has increased greatly since we purchased, and we want to cash in on the increase in value by selling the house and unlocking the equity. What does this mean for our taxes?” This is a very good question for homeowners who are considering the sale of a personal residence. Many of you have probably heard of the concept of capital gains tax, and this is the type of tax we will be discussing in greater detail.

First off, let’s clear up the definition of a “personal residence”, as this is the most important definition to understand when considering this transaction. A house has to be your personal residence for two of the last five years preceding the date of the sale in order to gain exclusion from capital gains tax. This means that if a home is sold for a gain (profit) in 2019, all (or a portion of) that gain is non-taxable if that specific house was your primary personal residence in any full two-year period of the last five leading up to the date of sale. A personal residence is defined as “where you ordinarily live the majority of the time”, and you can only have one main residence at any time.

A married filing jointly taxpayer can exclude up to $500,000 of gain on the sale of a personal residence, and a single taxpayer can exclude up to $250,000 of gain if the following three part test is satisfied.

  • Ownership– You owned the home for at least two years prior to the date of sale.
  • Use– The home was your primary residence (as defined above) for at least two of the five years preceding the date of sale.
  • Exclusion Period– You have not utilized an exclusion of gain for the sale of another residence within the two-year period up to the date of the sale in consideration.

If you do not meet the two year use and ownership test for the sale of your personal residence, you might still be eligible for a partial exclusion of your gain from capital gains tax treatment if one of the following is the reason for your sale:

  • A change in place of employment
  • Health-related move
  • Unforeseen circumstances

So.. What is capital gains tax?

If for some reason you do not meet one of the exclusion tests discussed above, but still decide to sell your home, your gain will be subject to capital gains tax. The capital gains tax is a preferential rate tax that is imposed on the sale of many types of property that we normally consider “investments”. There are two types of capital gains (short-term and long-term). Short-term capital gains are considered sales of investment property held for less than one year. These gains are subject to your ordinary income tax rate. Long-term capital gains are for property held greater than one year and are given preferential rate treatment at the rates discussed below:

  • 0% Rate (Single taxpayer $0-$39,375 taxable income, Married taxpayer $0-$78,750 taxable income)
  • 15% Rate (Single taxpayer $39,376-$434,550 taxable income, Married taxpayer $78,751-$488,850 taxable income)
  • 20% Rate (Single taxpayer $434,551+ taxable income, Married taxpayer $488,851+ taxable income)

If you sell your home and believe you are exempt from capital gains treatment on your gain, you may still receive a 1099-S form from your title company/closing agency and that form would require you to report the sale on your tax return regardless of exemption from capital gains tax implications since the IRS will also be receiving a duplicate of this form to match to your tax return!

This post covers the basics of the tax treatment of a home sale, but is not intended to cover all aspects of the tax law. As with most other tax topics, there are other exceptions/rules that apply to more complicated aspects of these transactions. It is always a good idea to maintain a client relationship with a CPA Tax Pro when engaging in this type of transaction. If you are considering this type of sale, and need CPA guidance and tax preparation services, reach out the me at wes@arcactg.com.

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Welcome!

Thank you for taking the time to check out the Wisdom of Wealth blog! I am new to this, but hope that you will find my writing relevant and follow along! My goal is for the followers of Wisdom of Wealth to gain building blocks from my posts that they find useful in day to day application in their personal financial lives or business management.

In my writing, I plan to address many of the common questions that arise from my practice as a CPA serving individual and business clients among many different backgrounds and industries.

In the meantime, if you would like to check out my virtual bookkeeping/CFO business to see how we are changing the way that modern business owners and modern accountants interact, follow the link below-

http://www.arcactg.com