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what-you-need-to-know-about-retirement-plan-early-withdrawals

What You Need to Know About Retirement Plan Early Withdrawals
What You Need to Know About Retirement Plan Early Withdrawals 1600 941 smolinlupinco

Retirement plan distributions are typically subject to income tax. If you take an early withdrawal, they may be subject to additional tax penalties. But what defines “early?” 

Generally, it’s when withdrawals are taken out of a traditional IRA or another qualified retirement plan before the plan participant reaches the age of 59½.  These distributions are often taxable and may also be subject to a 10% penalty tax (or 25% if taken from a SIMPLE IRA during the first two years of plan participation). 

While there are ways to avoid that penalty tax (but not standard income tax), the rules can be complicated—which one taxpayer had to learn the hard way. 

Exceptions to early withdrawal penalty tax

Some exceptions to the 10% early withdrawal penalty are only available to taxpayers who take early distributions from traditional IRAs. Other exceptions only apply to qualified retirement plans, such as 401(k)s. 

Exceptions include (but are not limited to): 

  • Medical cost payments exceeding 7.5% of your adjusted gross income
  • Annuity-like withdrawals made under IRS guidelines
  • Withdrawals made from an IRA, SEP, or SIMPLE plan up to the qualified amount of higher education expenses for you or a family member 
  • Withdrawals made by qualified first-time homebuyers of up to $10,000 from an IRA, SEP, or SIMPLE plan

Another exception is the total and permanent disability of the IRA owner or retirement plan participant.  

New court case results in tax penalty

In one court case (TC Memo 2023-9), a taxpayer took a $19,365 retirement plan distribution before reaching the age of 59½ after losing his job as a software developer. Per the U.S. Tax Court, he had a diabetes diagnosis which he treated with insulin shots and other medications.

The taxpayer filed a tax return for the year of the retirement plan withdrawal but did not report the amount as income due to his medical condition. However, the plan administrator reported the amount as an early distribution with no known exception on Form 1099-R, which was sent to the IRS and the taxpayer. 

According to the court’s ruling, the taxpayer did not qualify for an exception due to the disability.  They noted that an individual is considered disabled if they are “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration” at the time of the withdrawal.

Because the taxpayer, in this case, had been able to work up to the year at issue despite the diabetes diagnosis, the $4,899 federal income tax deficiency was upheld. 

Lesson learned: work with a knowledgeable tax professional

As the taxpayer in this case learned, guidance is important when taking early retirement plan distributions. If you’re unsure whether you’re eligible for an exception to the 10% early withdrawal penalty tax, our CPAs can help.

Contact us to consult with a professional today. 

5-tax-saving-ways-to-pay-for-your-childs-college-education

5 Tax-Saving Ways to Pay for Your Child’s College Education
5 Tax-Saving Ways to Pay for Your Child’s College Education 1600 942 smolinlupinco

Do you have a child or grandchild currently attending college? Congratulations! 

To help cover the costs of post-secondary education, you may have saved up over the course of several years in a tax-favored account, such as a 529 plan. Once your child is enrolled in college, though, you may be able to claim a number of tax breaks. 

For example: 

1. Tuition tax credits

The American Opportunity Tax Credit (AOTC) can be taken up to $2,500 per student for the first four years of college. This includes a 100% credit for the first $2,000 and a 25% credit for the second $2,000 in tuition, fees, and books. This credit is 40% refundable up to $1,000, which means you can get a refund if the credit amount is higher than your tax liability. 

You can also take the Lifetime Learning Credit (LLC) of up to $2,000 per family for each additional year of post-secondary education, which includes a 20% credit for up to $10,000 in tuition and fees. 

That said, only one education tax credit can be claimed per eligible student per year. To claim the credit, the taxpayer must receive a Form 1098-T statement from the school. 

Note that both credits will be phased out for those with certain modified adjusted gross income (MAGI): 

  • Between $160,000 and $180,000 for married couples filing jointly
  • Between $80,000 and $90,000 for singles

2. Scholarships

If certain conditions are met, scholarships can be exempt from income tax. One of these conditions is that the scholarship cannot be compensation for services and must instead be used for tuition, fees, books, and supplies—not for room and board.

Remember that a tax-free scholarship will reduce the expenses considered when computing the AOTC and LLC. As a result, those credits may be reduced or eliminated. 

3. Employer assistance

If your child’s college expenses are covered by your employer, that payment is considered a fringe benefit and is taxable to you as compensation. 

If it’s part of a scholarship program outside of the pattern of employment, however, it will be treated as a scholarship—assuming the scholarship requirements are met. 

4. Tax-exempt gifts

When someone gifts you money to cover your child’s college expenses, that person is generally subject to gift tax. For 2023, the gift tax exclusion threshold is $17,000 per recipient; married donors who give combined gifts may exclude gifts of up to $34,000. 

However, if someone—such as a grandparent—submits your child’s tuition payments directly to the educational institution, there is an unlimited gift tax exclusion. This applies only to direct tuition costs (as opposed to room and board, books, supplies, and more). 

5. Retirement account withdrawals

You can withdraw money from your IRA or Roth IRA account at any time without incurring the 10% early withdrawal penalty, as long as those withdrawals are used to pay for college costs. Note, however, that the distributions are subject to tax under the usual rules. 

You may also have the option to withdraw from or borrow against your employer retirement plan—but before doing so, ensure you fully understand any and all tax implications, including any potential penalties. 

Plan ahead with Smolin

Not all of the above-mentioned tax breaks can be used in the same year, and some may also impact qualification amounts for other tax breaks. 

Not sure which option is best for your situation? Our CPAs can help. Contact us if you would like to discuss any of these options, or other alternatives that may apply to your situation. 

secure-2-0-helps-you-save-for-retirement

SECURE 2.0 Helps You Save for Retirement
SECURE 2.0 Helps You Save for Retirement 1488 875 smolinlupinco

Built on the original SECURE Act of 2019, the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0) was signed into law on December 29, 2022. 

The SECURE Act of 2019 made major changes to retirement provisions, including the required minimum distribution (RMB) rules. Here are some additional changes you should be aware of with SECURE 2.0. 

Increased age for beginning RMDs 

Employer-sponsored qualified retirement plans, traditional IRAs, and individual retirement annuities are all subject to RMB rules, which require that distribution begins by a specified start date. 

Under the SECURE 2.0 law, as of January 1, 2023, the start date will increase from age 72 to age 73. On January 1, 2033, this will increase to age 75. 

Higher “catch-up” contributions

Currently, participants in certain retirement plans are able to make additional catch-up contributions once they reach age 50 or older, with a limit on catch-up contributions to 401(k) plans of $7,500 for 2023. 

With SECURE 2.0, this limit is increased for individuals between the ages of 60 and 63 to $10,000 or 150% of the regular catch-up amount, whichever is greater. The provision will be effective for taxable years beginning January 1, 2025 (along with increased catch-up amounts for SIMPLE plans). 

After 2025, the increased amounts will be indexed for inflation.

Allowance of tax-free rollovers

With SECURE 2.0, beneficiaries of 529 college savings accounts will be permitted to make direct trustee-to-trustee rollover contributions from a 529 account to a Roth IRA in their names, without tax or penalty. 

This provision is effective for distributions after December 31, 2023, and several rules still apply. 

“Matching” contributions for employees with student loan debt

SECURE 2.0 will allow employers to make matching contributions to 401(k) and certain other retirement plans for qualified student loan payments. As a result, employees who are repaying student loan debt and cannot afford to save for retirement can still receive matching contributions from employers in their retirement plans. 

This will be effective beginning January 1, 2024. 

Changes to ABLE accounts

There are also changes to non-retirement plan provisions, including a change to tax-exempt Achieving a Better Life Experience (ABLE) accounts, which are designed to assist individuals with disabilities. 

Currently, ABLE account beneficiaries must have experienced a disability or blindness before age 26. With SECURE 2.0. This age limit is increased to 46, making more people eligible for ABLE account benefits. 

This is effective for tax years beginning after December 31, 2025. 

Questions? Contact us

These are only some of the many changes brought about by SECURE 2.0. If you have any questions about how the new law will affect you, contact us.

save-for-your-childrens-college-education-the-tax-wise-way

Save for Your Children’s College Education the Tax-Wise Way
Save for Your Children’s College Education the Tax-Wise Way 1600 941 smolinlupinco

If you have children, you’ve likely got college savings on your mind. Here are some tax-favored ways to save for future education costs so that you can take advantage of your options. 

Savings bonds

When used to finance college expenses, Series EE U.S. savings bonds offer two tax-saving benefits: 

  1. Until the bonds are cashed in, you don’t have to report interest on them for federal tax purposes. 
  2. If the bond proceeds are put toward qualified college expenses, interest on qualified Series EE and Series I bonds may be exempt from federal tax. 

To qualify for the college tax exemption, bonds must be purchased in your name or jointly with your spouse—not in your child’s name. Additionally, proceeds must be used for education-related expenses only (i.e., tuition and fees but not room and board). If only some of the proceeds are used for qualified expenses, then only some interest will be exempt. 

Note that if your modified adjusted gross income (MAGI) exceeds certain thresholds, the exemption will be phased out. For example, the exemption for bonds cashed in 2023 begins to phase out when MAGI hits $137,800 for married joint filers (or $91,850 for other returns). The exemption is completely phased out when MAGI is at or above $167,800 (or $106,850 for others).

529 plans

Qualified tuition programs, or 529 plans, are established by state governments or private institutions. These programs allow you to purchase tuition credits or contribute to an account specifically designed for your child’s future education costs. 

These contributions are not deductible and are calculated as taxable gifts to the child. They are, however, eligible for the 2023 annual gift tax exclusion of $17,000. Donors who contribute more than the annual exclusion limit for the year may treat the gift as if it were given in increments throughout a five-year period. 

Until college costs are paid from the funds, earnings on these contributions accumulate tax-free. Distributions from 529 plans are also tax-free to the extent that the funds are used to pay for qualified higher education expenses, including up to $10,000 in tuition costs for elementary or secondary school. 

Distributions of earnings not used for qualified higher education expenses will generally be subject to income tax in addition to a 10% penalty. 

ESAs 

For each child under the age of 18, you can establish a Coverdell education savings account (ESA) and make contributions of $2,000. Note that this age limit does not apply to beneficiaries who have special needs. 

Once AGI is above $190,000 on a joint return ($95,000 for others), the right to make contributions will begin to phase out. If the income limit becomes an issue, the child can then contribute to their own account. 

Despite contributions not being deductible, income in the account is not taxed and distributions are tax-free when put toward qualified education expenses. If the child does not pursue higher education, the money must be withdrawn when they turn 30, and any earnings will be subject to tax plus penalty. However, those unused funds can be transferred to another family member’s ESA if they have not yet reached age 30. (This age requirement does not apply to those with special needs.)  

Talk to a financial advisor today

This is not an exhaustive list of all the tax-wise ways to save for your children’s college education. If you would like to discuss these options or learn about others available, contact us to speak with a certified CPA. 

getting-the-most-out-of-your-401k-plan

Getting the Most Out of Your 401(k) Plan
Getting the Most Out of Your 401(k) Plan 1594 938 smolinlupinco

The best way to reduce taxes and set yourself up for a comfortable retirement? Putting money toward a tax-advantaged retirement plan. If you’re not already making the most of an employer-offered 401(k) or Roth 401(k), now is the time to start. The sooner you start contributing to your retirement plan, the more substantial your nest egg will be. 

Looking to build up that nest egg even more? Consider increasing your contribution (if you’re not already contributing the maximum amount allowed). Thanks to tax-deferred compounding—or, in the case of Roth accounts, tax-free—boosting contributions can significantly impact the amount of money you’ll have once you retire. 

Retirement plan contributions in 2023

With a 401(k), an employee can elect to have a certain payment amount deferred and then contributed to their plan by an employer on their behalf. Due to inflation, these amounts are unsurprisingly increasing—the contribution limit in 2023 will be $22,500, compared to $20,500 in 2022. 

Employees who will be 50 years of age or older by the end of the year will also be able to make additional “catch-up” contributions of $7,500 in 2023 (compared to $6,500 in 2022). As a result, these employees can save a total of $30,000 in 2023 (compared to $27,000 in 2022). 

401(k) contributions

There are many benefits to contributing to a traditional 401(k). For example: 

  • Contributions are pre-tax, which reduces your modified adjusted gross income (MAGI), and can also help to reduce or avoid the 3.8% net investment income tax.
  • Plan assets can grow tax-deferred, which means you don’t have to pay any income tax until you take distributions.
  • All or some of your contributions can be matched by your employer pre-tax. 

If you’re already contributing to a 401(k) plan, you may want to take a closer look at your contributions for 2023, aiming to increase your contribution rate to get as close to the $22,500 limit as possible—with an extra $7,500 for those aged 50 or older. 

Note that your paycheck will be reduced by the amount of contribution only, as these are pre-tax and income tax is not withheld. 

Roth 401(k) contributions

High-income earners may benefit from Roth 401(k) contributions, as they don’t have Roth IRA contributions as an option. This is because if your adjusted gross income exceeds a certain threshold, your ability to contribute to a Roth IRA is reduced or eliminated. 

If your employer offers a Roth option in their 401(k) plans, you can designate some or all of your contributions as Roth contributions. While these contributions won’t reduce your MAGI, qualified distributions will be tax-free. 

Plan your financial future with Smolin

If you’re not sure how much to contribute, or how to determine the best combination of traditional and Roth 401(k) contributions, our knowledgeable tax advisors can help. 

Contact us to get the most out of your 401(k) plan or to discuss other tax and retirement-saving strategies.

iras-and-rmds-answering-your-faqs

IRAs and RMDs: Answering Your FAQs
IRAs and RMDs: Answering Your FAQs 1600 941 smolinlupinco

You may be aware of the fact that you can’t let funds sit in your traditional IRA indefinitely. Once you reach age 72, you’re required to start taking withdrawals. 

You may also be aware that the rules for taking required minimum distributions, or RMDs, are complex. Here are some answers to frequently asked questions about taking withdrawals from a traditional IRA (including SIMPLE IRA or SEP IRA). 

Can I withdraw money before retirement?

The simple answer: yes. 

That said, if you want to take money out of a traditional IRA before the age of 59.5, those distributions are taxable and you may be subject to a 10% penalty tax. 

That 10% penalty tax—but not regular income tax—can be avoided if you pay: 

  • Qualified higher education expenses
  • Up to $10,000 of expenses if you’re a first-time homebuyer
  • Health insurance premiums if you’re unemployed 

When can I take my first RMD for an IRA?

You must take your first RMD by April 1 of the year after the year in which you turn 72. Note that this rule applies whether or not you’re still employed. 

How do I determine my RMD? 

When calculating your RMD, take the account balance from the end of the preceding calendar year and divide it by the distribution period from the IRS’s Uniform Lifetime Table. 

If the sole beneficiary is a spouse who is 10 or more years younger than the owner, a separate table will be used. 

What if I have multiple accounts? 

For those with more than one IRA, the RMD for each must be calculated separately each year. 

However, you don’t have to take a separate RMD from each IRA—you may combine the RMD amounts for all IRAs, and either withdraw the total from one IRA or a portion from each. 

Can I withdraw amounts exceeding my RMD? 

Yes—you can always withdraw more than your RMD. Note, however, that you cannot put excess withdrawals toward RMDs in future years. 

When planning for RMDs, weigh your income needs against the ability to maintain the IRA tax shelter for as long as possible. 

Can I withdraw more than once a year? 

Yes. As long as you withdraw the total annual minimum amount by December 31 (or, if it’s your first RMD, April 1), you may withdraw your yearly RMD in any number of distributions throughout the year.

What if I don’t take an RMD? 

If your distributions for any given year are less than your RMD, you’ll be subject to an additional tax. This tax is equal to 50% of the amount that was not paid out but should have been. 

Plan ahead with us

Questions about your retirement planning? Our knowledgeable tax advisors can help. Contact us to learn more. 

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