IRA Insights: Take-Aways From a Recent Webinar

 I recently attended a webinar about individual retirement accounts (IRAs) and income taxes that was sponsored by the Financial Planning Association (FPA). The speaker was Ed Slott, a leading national authority on IRAs who is widely quoted in financial publications for professionals and consumers. Ed and two of his staffers answered dozens of questions live and via the online chat.

Below are six key take-aways:

Tax Season Never Ends- Most people think they are done with taxes on April 15. That may be true for tax return preparation, but not for tax planning. Tax planning is an ongoing process throughout a taxpayer’s lifetime and beyond (i.e., tax-deferred accounts inherited by beneficiaries).

Many People Have a “Tax Problem”- There is more than $40 trillion invested in tax-deferred retirement savings accounts. Once account owners reach age 73, they must start taking required minimum distributions (RMDs). These withdrawals are taxed as ordinary income, which can push them into a higher marginal tax bracket.

The 10-Year Rule- This rule applies to most non-eligible designated beneficiaries (e.g., adult children, grandchildren, and non-spouse individuals) who inherit a tax-deferred retirement account, such as a traditional IRA or 401(k), when the original account owner passed away after 2019. This rule took effect as a result of the SECURE Act. The entire inherited account must be fully distributed by December 31 of the 10th year following the year of the original owner’s death.

The “At Least As Rapidly” Rule- This is an additional guideline for inherited tax-deferred accounts that applies when account owners of a tax-deferred retirement account, such as a traditional IRA, pass away after beginning their RMDs. If the original account owner had already started RMDs before passing, the beneficiary must continue withdrawing RMDs each year during the 10-year period, thereby making withdrawals at least as rapidly as the original owner was required to.

No Extension on the 10-Year Rule- There was a five-year delay in IRS clarification about exactly how withdrawals under the 10-Year Rule must be taken by non-eligible designated beneficiaries. This did not, however, extend the ten-year window to deplete an inherited account. For example, if an account owner died in 2022, the ten-year period is 2023 to 2032, and the account must be fully withdrawn by December 31, 2032. RMD penalties for non-spouse beneficiaries are now in effect. The penalty is 25% of the amount that should have been withdrawn but was not.

Tax Laws Are Transitory- Mr. Slott noted that tax laws “are always written in pencil” and are subject to change. A big unknown right now is the future of the Tax Cuts and Jobs Act (TCJA), which is set to expire at year-end. If the TCJA is left to expire, marginal tax rates will revert to higher rates that were in effect in 2017. Slott advised the audience to “always pay taxes when rates are the lowest” and to take a long view and consider, not only current year taxes, but taxes in the future.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

So, I “Bit the Bullet” and Finally E-filed Our Taxes

Last year, I wrote a post that described the pros and cons of filing your income taxes by paper or electronically (e-filing). Looking back, it was also a “personal pep talk” for me because I knew I was part of a dying breed of paper income tax filers. 

Only about 8.2% of tax returns are filed by paper or, in numerical terms, nearly 13.2 million tax returns of the nearly 160.8 total returns that are filed. I needed to justify why I was swimming against the tide, so I researched and wrote the post.

My Rationale for Paper Filing

 

In my prior post, I noted that I am a tax geek. I actually like preparing our household tax return because it provides valuable insights into our finances. To me, it feels like piecing together a quilt or completing a complex jigsaw puzzle. The reward is having all the pieces fit together at the end.

 

I’m also frugal. I reasoned…why pay for software or a tax preparer to do something that I could easily do, myself, for free? I was also busy and didn’t want to take the time to transfer all my hand-calculated data into IRS Free File Fillable Forms and then figure out how to e-file it.

 

In addition, last year we owed tax, so there was no tax refund to wait for or get stolen by identity thieves. I knew the IRS was swamped but, if they didn’t get to my tax return for 4 or 5 months, so what? That was not my problem. It was theirs. Last year, I couldn’t see a personal downside to paper filing and the cost was minimal (priority mail and printing forms).

 

Here’s What Happened to Our Tax Return

 

In a word, nothing. Okay…very little. Yes, the IRS got my paper filed tax return. I know this from USPS priority mail tracking and the fact that they cashed my check. After that, my return probably went into a file folder on a table in the cafeteria of the Austin, TX processing center. It may still be there now. Check out the photo in the article link above. Wow! A massive sea of paper tax returns just sitting there!

Last November (2022), I knew something was wrong. I was due a benefit increase from Social Security because my 2021 earnings as an entrepreneur should have knocked out a low-earning year from my teens in the 35-year benefit calculation formula. The Social Security Administration (SSA) has not yet sent me that letter.

When we got the SSA notice at year-end about 2023 Social Security benefits, our 2023 Medicare premiums were based on 2020 income, instead of 2021 income as they should have been with a two-year look back. Obviously, if our tax return has not yet been processed, the IRS cannot send SSA the current data that it needs.

So, I found out that there is another downside to paper filing besides those that I wrote about last year: for older adults, it’s being caught in between two federal government agencies that share tax data with one another. Someday- I don’t know when- SSA will get our 2021 tax information from the IRS and send us a few letters.

So…We Capitulated

This year, I hired a tax pro to file our tax return electronically. First, we are due a refund and want our money quickly. Second, I don’t want to compound the SSA problem. We pay IRMAA tax and the gap between what we should be paying for Medicare and are not keeps growing. Eventually, we’ll have to pay back what we owe.

I hand-calculated everything as usual, again because I enjoy it and also because line-by-line tax preparation is a very useful financial planning aid. My draft also saved the tax pro time, which saved me money. 

He taught me a thing or two but, in the end, the difference between our tax calculations was a negligible $37, much less than the cost of the e-filing tax-preparer. 

Next year, with a good template to follow, I may just try to tackle tax software.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Ten Tax Planning Tips for 2022

Now that 2021 income tax season has been over for a month and the dust has settled, it is time to start some serious tax planning for 2022. Planning now provides seven months to take action and/or implement changes to avoid a stressful “tax scramble” at the end of the year. In an earlier blog post, I described 12 tax planning topics for 2022.

 

In this post, I continue the conversation with ten tax planning tips for 2022 (in no particular order) for readers to consider:

¨    Plan for Tax Benefits That Go Away- On a recent webinar, I heard stories about dramatic increases in 2021 tax refunds for families with children resulting from the expanded child tax credit and child and dependent care credit. “Normal” tax rules apply in 2022, however, which may require a withholding change for many families to avoid getting a smaller refund, or owing tax, in 2023. To do this, file a new W-4 form or make larger estimated payments.

 

¨    Determine Your 2022 “Safe Harbor”- The safe harbor rule is an “income tax get-out-of-jail-free card” to avoid an IRS under-withholding tax penalty. It works like this: withhold 100% (110% with an adjusted gross income or AGI more than $150,000) of tax owed for the previous year (i.e., 2021) or 90% of current year (2022) tax liability using a W-4 form at work for job-related income tax withholding; withholding for Social Security, a pension, and required minimum distributions through account custodians; and/or quarterly estimated payments using IRS Form 1040-ES.

¨    Improve Your Tax Records- If disorganized records were a problem for 2021 taxes due in 2022, set up a better system. Since there is no longer a non-itemizer’s charitable deduction in 2022 and only about 10% of tax filers itemize, you’ll probably have fewer receipts to save. Common filing methods include file folders, a large envelope, and a designated desk drawer. To err on the side of caution in the event of an audit, experts advise keeping tax records for at least six years.

 

¨    Set Up Spreadsheets- Taxpayers with recurring income and/or expenses (freelancers, landlords, Airbnb and VRBO hosts, employees with side hustles, etc.) should consider purchasing software or setting up a simple Excel spreadsheet to aggregate their business income and expenses throughout the year.

 

¨    Ramp Up Retirement Savings- Consider increasing retirement savings in a tax-deferred employer retirement savings plan (e.g., 401(k), 403(b), and traditional IRA). Saving even 1% more of pay can make a difference in later life. There are online calculators like this one than can show you what you could save. Also consider some savings in taxable and/or tax-free accounts so you have tax diversification (i.e., assets that are taxed in different ways).

 

¨    Beware Roth IRAs- There’s nothing wrong with Roth IRAs. They are a great retirement savings tool. However, if your 2022 income could be close to the limits to make contributions ($144,000 for individuals and $214,000 for couples filing jointly in 2022), it may be best to wait until early 2023 when your actual income is known. Otherwise, you may need to do an excess contributions withdrawal and pay tax on any money that an early contribution earned.

 

¨    Consider a SEP- With millions of Americans quitting jobs during the last year and many becoming part-time freelancers or full-time entrepreneurs, a simplified employee pension (SEP) can be a great retirement savings option. Depending on business income, SEPs often have higher contribution limits than IRAs. The deadline for making 2022 SEP contributions is the tax filing deadline in April 2023. Take time now to research potential account custodians.

 

¨    Plan for IRMAA- Older adults on Medicare should project their 2022 income as best they can, although it is difficult to know now what taxable mutual fund distributions or self-employment earnings might be. If income appears to be on track to trigger an income-related monthly adjusted amount (IRMAA) Medicare surcharge, it may be wise not to aggravate the situation with taxable capital gains and Roth IRA conversions. Seek professional advice, if needed.

 

¨    Determine “Bunching” Potential- Bunching is a legal tax minimization strategy where taxpayers aggregate sufficient tax-deductible items to exceed the standard deduction for their age and tax filing status. The 2022 standard deduction is $12,950 for individuals ($14,700 age 65+) and $25,900 for married filing jointly ($28,700 if both spouses are age 65+). An example of a bunching strategy is combining three deductible items: state income and local property taxes up to the $10,000 cap; unreimbursed medical expenses for an elective procedure, and charitable donations.

 

¨    Tax-Saving Actions- Now is the time to do research, seek professional advice, and determine “process steps” for strategies to reduce your taxes in 2022 or beyond. Five examples are tax-loss harvesting, Roth IRA conversions, qualified charitable contributions (age 70½ +), setting up a donor advised fund, and increased contributions to a tax-deferred retirement savings plan, health savings account or HSA (if eligible), or flexible spending account or FSA (if available).

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.