Even worse, some can be socked with a 10 percent early withdrawal penalty tax, and this can happen even when there’s no income tax hit.
Any withdrawals from any of your Roth accounts are federal-income-tax-free qualified withdrawals if you, as a Roth IRA owner,
are age 59 1/2 or older, and
have had at least one Roth IRA open for over five years.
Such withdrawals are usually state-income-tax-free too. Good!
You must pass both the age and the five-year tests to have a qualified withdrawal.
The five-year period for determining whether your withdrawals are qualified starts on January 1 of the first tax year for which you make a Roth contribution. It can be a regular annual contribution or a conversion contribution.
A non-qualified withdrawal is potentially subject to both federal income tax and the 10 percent early withdrawal penalty tax. The only exceptions are
when the special first-time home purchase provision applies, or
when the account owner (that would be you) is disabled or dead.
401(k) plans let you and your employees defer current income into the plan. You can match your employees’ deferrals make discretionary profit-sharing contributions or both.
These may be your best choice if you want to let your employees fund the bulk of their own accounts:
Some highlights:
1. You can defer up to 100% of your “covered compensation” or $19,500, whichever is less. (Covered comp is wages, salary, and bonus up to $290,000.)
2. You can let employees age 50 or older make extra “catch-up” contributions of up to $6,500 not limited by antidiscrimination rules.
3. You can match part or all of employee deferrals and make profit-sharing contributions. These are nontaxable until participants start withdrawing funds from their accounts. The employer’s contributions are tax deductible.
4. Total “annual additions” from employee deferrals (but not catchups), employer matches, and employer profit-sharing contributions are limited to 100% of covered compensation, but not more than $58,000.
5. You can let employees take tax-free loans from their accounts. Most loan provisions allow loans up to $50,000 or 50% of the vested account balance, whichever is less, and repay it in substantially level installments, at least quarterly, over five years. If employees leave their job and take their accounts with outstanding loans, the unpaid balance is taxable unless they repay it from another source.
6. You can let employees take “hardship withdrawals” of their own deferrals (but not employer contributions or earnings) for “immediate and heavy” financial needs: medical bills, a down payment on a house, college costs, or amounts needed to prevent eviction or foreclosure on their primary residence. If the plan allows loans and hardship withdrawals, employees have to take the maximum loan before taking a hardship withdrawal. Employees who take hardship withdrawals can’t make new deferrals for 12 months.
7. Plan withdrawals are taxed as ordinary income. There’s a 10% penalty for withdrawals before age 59½ except for specified exceptions: death, permanent and total disability, health insurance while unemployed, amounts deductible as medical or dental expenses, college costs, early retirement at age 55 or older, or qualified domestic relations orders.
8. Rollovers to another qualified plan or IRA are nontaxable.
Here’s how: with both the SEP IRA and the solo 401(k) retirement plans, your investment in your tax-favored retirement
creates tax deductions for the money you invest in the plan,
grows tax-deferred inside the plan, and
suffers taxes only when you take the money from the plan.
Example. You invest $1,000 a month in your retirement. You are in the 40 percent tax bracket (combined federal and state), and you earn 10 percent on your investments. At the end of 30 years, you have $1.58 million in after-tax spendable cash, which comes from (in round numbers):
$1.2 million in after-tax cash from the retirement plan ($2 million gross less 40 percent in taxes—we’re taking the entire amount out of the plan in this example)
$380,000 in the side fund (created by investing the $400 of monthly tax savings—$1,000 deduction x 40 percent)
If you had no government help on the taxes and invested $1,000 a month in an investment that earned 10 percent (6 percent after taxes), you would have a little more than $950,000.
Winner. The retirement plan wins by $630,000—after taxes ($1.58 million vs. $950,000).
Okay, that’s the big picture. It tells you that tax-advantaged investing multiplies profits. So, do it.
New IRS guidance expands the possibilities for what is an adverse COVID-19 impact on you for purposes of taking up to $100,000 out of your retirement accounts and repaying it without penalties.
First, let’s look at the rules as they existed before this new IRS guidance. The CARES Act created the first set of favorable rules, and those rules are still in play.
What the CARES Act Says
A coronavirus-related distribution from your qualified retirement plan, Section 403(b) plan, or IRA gets two tax benefits:
If you withdraw and keep the money, you pay no 10 percent early withdrawal penalty and you can spread the income equally over tax years 2020, 2021, and 2022. You also can elect to include it all in tax year 2020, if you want.
You can repay the money within three years of the distribution date and pay no tax or penalty on the amount.
Under the CARES Act relief, you qualify for a coronavirus-related distribution if
you, your spouse, or your dependent is diagnosed with COVID-19 with a CDC-approved test;
you experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
you experience adverse financial consequences as a result of being unable to work due to lack of childcare due to COVID-19; or
you experience adverse financial consequences as a result of closing or reducing your business hours due to COVID-19.
And then there are two additional CARES Act rules for coronavirus-related distributions:
You can’t treat more than $100,000 per person as a coronavirus-related distribution, and
You must take the distribution on or after January 1, 2020, and before December 31, 2020.
IRS Expands Relief
With the new IRS relief, you now also qualify for coronavirus-related distributions if you experience adverse financial consequences because
you, your spouse, or a member of your household has a reduction in pay or self-employment income due to COVID-19;
you, your spouse, or a member of your household has a job offer rescinded or start date for a job delayed due to COVID-19;
your spouse or a member of your household is quarantined, is furloughed or laid off, or has work hours reduced, due to COVID-19;
your spouse or a member of your household is unable to work due to lack of childcare due to COVID-19; or
your spouse or a member of your household owns or operates a business that closed or reduced hours due to COVID-19.
Household
For purposes of applying the additional factors, a member of the individual’s household is someone who shares the individual’s principal residence.
Merriam-Webster defines a household as
those who dwell under the same roof and compose a family, and
a social unit composed of those living together in the same dwelling.
You have to think roommates living together create a household, and if one of them is affected by COVID-19—say, lost his or her job and stopped contributing to the rent—the remaining roommates were adversely affected and should be entitled to the IRA grab and repay strategy.
Your Repayment Options
You have many repayment options, as we explain below. To make this easy, let’s say you grab $30,000 from your IRA today and you want to know how you can repay the $30,000 with no taxes or penalties. Here are five scenarios:
Scenario 1. You repay the $30,000 before you timely file your 2020 tax return:
You don’t include any of the $30,000 in income on your 2020 tax return. You pay no taxes or penalties.
Scenario 2. You elect to include all $30,000 as income on your timely filed 2020 tax return, but then repay the full $30,000 sometime between filing the 2020 return and July 15, 2023:
You amend your 2020 tax return to remove the $30,000 from income and claim a refund of tax paid on that amount.
Scenario 3. You include $10,000 as income on your timely filed 2020 tax return, but then repay the full $30,000 sometime between filing the 2020 return and July 15, 2023:
You claim $10,000 of income on your original 2020 tax return, and
You later amend your 2020 tax return to remove the $10,000 from income and claim a refund of tax paid on that amount.
Scenario 4. You include $10,000 as income on your timely filed 2020 tax return, but then decide to repay $10,000 of the total $30,000 distribution, which you do on March 1, 2022:
You claim $10,000 of income on your 2020 tax return,
You claim no income on your 2021 tax return (because you made the $10,000 repayment prior to filing the return), and
You claim $10,000 of income on your 2022 tax return.
Scenario 5. You include $10,000 as income on your timely filed 2020 tax return, but then decide to repay $20,000 of the total $30,000 distribution, which you do on November 1, 2021. This one is tricky because you have two ways to do it:
You claim no income from the distribution on either your 2021 or 2022 tax return, or
You claim $10,000 of income on your 2022 tax return and amend your 2020 tax return to remove the $10,000 from income and claim a refund of tax paid on that amount.
As you can see, you have many options when it comes to taking up to $100,000 from your retirement plan.
For years, financial and tax advisors have lectured about the wonderfulness of Roth IRAs and why you should convert traditional IRAs into Roth accounts.
But, of course, you didn’t get around to it. In hindsight, maybe that was a good thing. For many, the financial fallout from the COVID-19 crisis creates a once-in-a-lifetime opportunity to do Roth conversions at an affordable tax cost and also gain insurance against future tax rate increases.
Roth IRAs Have Two Big Tax Advantages
Advantage #1: Tax-Free Withdrawals
Unlike withdrawals from a traditional IRA, qualified Roth IRA withdrawals are federal-income-tax-free and usually state-income-tax-free, too. What is a qualified withdrawal? In general, the tax-free qualified withdrawal is one taken after you meet both of the following requirements:
You had at least one Roth IRA open for over five years.
You reached age 59½, became disabled, or died.
To meet the five-year requirement, start the clock ticking on the first day of the tax year for which you make your initial contribution to any Roth account. That initial contribution can be a regular annual contribution, or it can be a contribution from converting a traditional IRA into a Roth account.
Example: Five-Year Rule. You opened your first Roth IRA by making a regular annual contribution on April 15, 2017, for your 2016 tax year. The five-year clock started ticking on January 1, 2016 (the first day of your 2016 tax year), even though you did not actually make your initial Roth contribution until April 15, 2017. You meet the five-year requirement on January 1, 2021. From that date forward, as long as you are age 59½ or older on the withdrawal date, you can take federal-income-tax-free Roth IRA withdrawals—including withdrawals from a new Roth IRA established with a 2020 conversion of a traditional IRA.
Advantage #2: Exemption from RMD Rules
Unlike with the traditional IRA, you as the original owner of the Roth account don’t have to take annual required minimum distributions (RMDs) from the Roth account after reaching age 72. That’s good, because RMDs taken from a traditional IRA are taxable.
Under those rules, if your surviving spouse is the sole account beneficiary of your Roth IRA, he or she can treat the inherited account as his or her own Roth IRA. That means your surviving spouse can leave the account untouched for as long as he or she lives.
If a non-spouse beneficiary inherits your Roth IRA, he or she can leave it untouched for at least 10 years. As long as an inherited Roth account is kept open, it can keep earning tax-free income and gains.
Silver Lining for Roth Conversions
A Roth conversion is treated as a taxable distribution from your traditional IRA because you’re deemed to receive a payout from the traditional account with the money then going into the new Roth account.
So, doing a conversion will trigger a bigger federal income tax bill for the conversion year, and maybe a bigger state income tax bill, too. That said, right now might be the best time ever to convert a traditional IRA into a Roth IRA. Here are three reasons why.
1. Current tax rates are low thanks to the TCJA.
Today’s federal income tax rates might be the lowest you’ll see for the rest of your life. Thanks to the Tax Cuts and Jobs Act (TCJA), rates for 2018-2025 were reduced. The top rate was reduced from 39.6 percent in 2017 to 37 percent for 2018-2025.
But the rates that were in effect before the TCJA are scheduled to come back into play for 2026 and beyond. And rates could get jacked up much sooner than 2026, depending on politics and the need to recover some of the trillions of dollars the federal government is dishing out in response to the COVID-19 pandemic.
Believing that rates will only go back to the 2017 levels in the aftermath of the COVID-19 mess might be way too optimistic.
2. Your tax rate this year might be lower due to your COVID-19 fallout.
You won’t be alone if your 2020 income takes a hit from the COVID-19 crisis. If that happens, your marginal federal income tax rate for this year might be lower than what you expected just a short time ago—maybe way lower. A lower marginal rate translates into a lower tax bill if you convert your traditional IRA into a Roth account this year.
But watch out if you convert a traditional IRA with a large balance—say, several hundred thousand dollars or more. Such a conversion would trigger lots of extra taxable income, and you could wind up paying federal income tax at rates of 32, 35, and 37 percent on a big chunk of that extra income.
3. A lower IRA balance due to the stock market decline means a lower conversion tax bill.
Just a short time ago, the U.S. stock market averages were at all-time highs. Then the COVID-19 crisis happened, and the averages dropped big-time.
Depending on how the money in your traditional IRA was invested, your account might have taken a substantial hit. Nobody likes seeing their IRA balance go south, but a lower balance means a lower tax bill when (if) you convert your traditional IRA into a Roth account.
When the investments in your Roth account recover, you can eventually withdraw the increased account value in the form of federal-income-tax-free qualified Roth IRA withdrawals. If you leave your Roth IRA to your heirs, they can do the same thing.
In contrast, if you keep your account in traditional IRA status, any account value recovery and increase will be treated as high-taxed ordinary income when it is eventually withdrawn.
As mentioned earlier, the current maximum federal income tax rate is “only” 37 percent. What will it be five years from now? 39.6 percent? 45 percent? 50 percent? 55 percent? Nobody knows, but we would bet it won’t be lower than 37 percent.
The Bottom Line
If you do a Roth conversion this year, you will be taxed at today’s “low” rates on the extra income triggered by the conversion.
On the (far bigger) upside, you avoid the potential for higher future tax rates (maybe much higher) on all the post-conversion recovery and future income and gains that will accumulate in your new Roth account.
That’s because qualified Roth withdrawals taken after age 59½ are totally federal-income-tax-free, as long as you’ve had at least one Roth account open for more than five years when withdrawals are taken.
If you leave your Roth IRA to an heir, he or she can take tax-free qualified withdrawals from the inherited account—as long as at least one of your Roth IRAs has been open for more than five years when withdrawals are taken.
The Setting Every Community Up for Retirement Enhancement
(SECURE) Act changed the landscape for
retirement and savings planning.
Here are eight important reminders about this new
law:
You can’t use contributions made in 2020 but applied to 2019 for any SECURE
Act provisions that apply to contributions made after December 31, 2019.
If you inherit an IRA, you now have to empty it within 10 years. But
there are many exceptions to this rule, including one for the surviving spouse.
You determine whether your inherited IRA qualifies for the old stretch
IRA rules on the date of death of the original owner.
The “qualified birth and adoption” distribution exception to the 10
percent penalty is $5,000 per child per parent, based on our reading of the
law.
Your inherited IRA distributions don’t count toward your RMDs for your
other retirement accounts.
Minors who inherit an IRA get the old stretch rules, but once they reach
the age of majority, they have 10 years from that date to deplete the account.
The new $10,000 Section 529 allowable distribution for payments of
principal and interest on student loans is a lifetime limit on the beneficiary,
but you (the account holder) can apply excess distributions to the
beneficiary’s sibling, and those distributions count toward the sibling’s
$10,000 lifetime limit.
The ability to retroactively create a stock bonus, pension,
profit-sharing, or annuity plan does not allow plan participants to make
retroactive elective deferrals. The retroactively created plan allows business
contributions only. Remember, the retroactive ability applies in 2021. You hurt
your plan participants by waiting. Don’t wait. Put your 2020 plan in place now.
Have you procrastinated about
setting up a tax-advantaged retirement plan for your small business? If the
answer is yes, you are not alone.
Still, this is not a good
situation. You are paying income taxes that could easily be avoided. So
consider setting up a plan to position yourself for future tax savings.
For owners of profitable
one-person business operations, a relatively new retirement plan alternative is
the solo 401(k). The main solo 401(k) advantage is potentially much larger
annual deductible contributions to the owner’s account—that is, your account.
Good!
Solo 401(k) Account Contributions
With a solo 401(k), annual deductible
contributions to the business owner’s account can be composed of two different
parts.
First Part: Elective Deferral Contributions
For 2020, you can contribute
to your solo 401(k) account up to $19,500 of
your corporate
salary if you are employed by your own C or S corporation, or
your net
self-employment income if you operate as a sole proprietor or as a
single-member LLC that’s treated as a sole proprietorship for tax purposes.
The contribution limit is
$26,000 if you will be age 50 or older as of December 31, 2020. The $26,000
figure includes an extra $6,500 catch-up contribution allowed for older 401(k)
plan participants.
This first part, called an
“elective deferral contribution,” is made by you as the covered employee or
business owner.
With a corporate
solo 401(k), your elective deferral contribution is funded with salary
reduction amounts withheld from your company paychecks and contributed to your
account.
With a solo 401(k)
set up for a sole proprietorship or a single-member LLC, you simply pay the
elective deferral contribution amount into your account.
Second Part: Employer Contributions
On top of your elective
deferral contribution, the solo 401(k) arrangement permits an additional
contribution of up to 25 percent of your corporate salary or 20 percent of your
net self-employment income.
This additional pay-in is
called an “employer contribution.” For purposes of calculating the employer
contribution, your compensation or net self-employment income is not reduced by
your elective deferral contribution.
With a corporate
plan, your corporation makes the employer contribution on your behalf.
With a plan set up
for a sole proprietorship or a single-member LLC, you are effectively treated
as your own employer. Therefore, you make the employer contribution on your own
behalf.
Combined Contribution Limits
For 2020, the combined
elective deferral and employer contributions cannot exceed
$57,000 (or
$63,500 if you will be age 50 or older as of December 31, 2020), or
100 percent of
your corporate salary or net self-employment income.
For purposes of the second
limitation, net self-employment income equals the net profit shown on Schedule
C, E, or F for the business in question minus the deduction for 50 percent of
self-employment tax attributable to that business.
Key point. Traditional
defined contribution arrangements, such as SEPs (simplified employee pensions),
Keogh plans, and profit-sharing plans, are subject to a $57,000 contribution
cap for 2020, regardless of your age.
Example 1: Corporate Solo 401(k) Plan
Lisa, age 40, is the only
employee of her corporation (it makes no difference if the corporation is a C
or an S corporation).
In 2020, the corporation pays
Lisa an $80,000 salary. The maximum deductible contribution to a solo 401(k)
plan set up for Lisa’s benefit is $39,500. That amount is composed of
Lisa’s $19,500
elective deferral contribution, which reduces her taxable salary to $60,500,
plus
a $20,000 employer
contribution made by the corporation (25 percent x $80,000 salary), which has
no effect on her taxable salary.
The $39,500 amount is well
above the $20,000 contribution maximum that would apply with a traditional
corporate defined contribution plan (25 percent x $80,000). The $19,500
difference is due to the solo 401(k) elective deferral contribution privilege.
Variation. Now assume Lisa
will be age 50 or older as of December 31, 2020. In this variation, the maximum
contribution to Lisa’s solo 401(k) account is $46,000, which consists of
a $26,000 elective
deferral contribution (including the $6,500 extra catch-up contribution), plus
a $20,000 employer
contribution (25 percent x $80,000).
That’s much more than the
$20,000 contribution maximum that would apply with a traditional corporate
defined contribution plan (25 percent x $80,000). The $26,000 difference is due
to the solo 401(k) elective deferral contribution privilege.
Example 2: Self-Employed Solo 401(k) Plan
Larry, age 40, operates his
cable installation, maintenance, and repair business as a sole proprietorship
(or as a single-member LLC treated as a sole proprietorship for tax purposes).
In 2020, Larry has net
self-employment income of $80,000 (after subtracting 50 percent of his
self-employment tax bill). The maximum deductible contribution to a solo 401(k)
plan set up for Larry’s benefit is $35,500. That amount is composed of
a $19,500 elective
deferral contribution, plus
a $16,000 employer
contribution (20 percent x $80,000 of self-employment income).
The $35,500 amount is well
above the $16,000 contribution maximum that would apply with a traditional
self-employed plan set up for Larry’s benefit (20 percent x $80,000). The
$19,500 difference is due to the solo 401(k) elective deferral contribution
privilege.
Variation. Now assume Larry
will be age 50 or older as of December 31, 2020.
In this variation, the maximum
contribution to Larry’s solo 401(k) account is $42,000, which consists of
a $26,000 elective
deferral contribution (including the $6,500 extra catch-up contribution), plus
a $16,000 employer
contribution (20 percent x $80,000).
That’s much more than the
$16,000 contribution maximum that would apply with a traditional self-employed
defined contribution plan (20 percent x $80,000). The $26,000 difference is due
to the solo 401(k) elective deferral contribution privilege.
As you can see, in the right circumstances, the 401(k) can make for a great retirement plan.
If
you are self-employed, you have much to think about as you enter your senior
years, and that includes retirement savings and Medicare. Here a few thoughts
that will help.
Keep
Making Retirement Account Contributions, and Make Extra “Catch-up”
Contributions Too
Self-employed
individuals who are age 50 and older as of the applicable year-end can make
additional elective deferral catch-up contributions to certain types of
tax-advantaged retirement accounts.
For
the 2019 tax year, you can take advantage of this opportunity if you will be 50
or older as of December 31, 2019.
You
can make elective deferral catch-up contributions to your self-employed 401(k)
plan or to a SIMPLE IRA.
You
can also make catch-up contributions to a traditional or Roth IRA.
The
maximum catch-up contributions for 2019 are as follows:
401(k) Plan
SIMPLE IRA
Traditional or
Roth IRA
$6,000
$3,000
$1,000
Catch-up
contributions are above and beyond
the
“regular” 2019 elective deferral contribution limit of $19,000 that otherwise
applies to a 401(k) plan.
the
“regular” 2019 elective deferral contribution limit of $13,000 that otherwise
applies to a SIMPLE IRA.
the
“regular” 2019 contribution limit of $6,000 that otherwise applies to a
traditional or Roth IRA.
How
Much Can Those Catch-up Contributions Be Worth?
Good
question.You might dismiss catch-up contributions as relatively
inconsequential unless we can prove otherwise. Fair enough. Here’s your proof:
401(k)
catch-up contributions. Say you turned 50 during 2019 and contributed on
January 1, 2019, an extra $6,000 for this year to your self-employed 401(k)
account and then did the same for the following 15 years, up to age 65. Here’s
how much extra you could accumulate in your 401(k) account by the end of the
year you reach age 65, assuming the indicated annual rates of return below:
4% Return
6% Return
8% Return
$136,185
$163,277
$196,501
Is
There an Upper Age Limit for Regular and Catch-up Contributions?
Another
good question.
While
you must begin taking annual required minimum distributions (RMDs) from a
401(k), SIMPLE IRA, or traditional IRA account after reaching age 70 1/2, you
can continue to contribute to your 401(k), SIMPLE IRA, or Roth IRA account
after reaching that age, as long as you have self-employment income (subject to
the income limit for annual Roth contribution eligibility).
But
you may not contribute to a traditional IRA after reaching age 70 1/2.
Claim a
Self-Employed Health Insurance Deduction for Medicare and Long-Term
Care Insurance Premiums
If
you are self-employed as a sole proprietor, an LLC member treated as a sole
proprietor for tax purposes, a partner, an LLC member treated as a partner for
tax purposes, or an S corporation shareholder-employee, you can generally claim
an above-the-line deduction for health insurance premiums, including Medicare
health insurance premiums, paid for you or your spouse.
Key
point.
You don’t need to itemize deductions to get the tax-saving benefit from this
above-the-line self-employed health insurance deduction.
Medicare Part A
Premiums
Medicare
Part A coverage is commonly called Medicare
hospital insurance. It covers inpatient hospital care, skilled nursing
facility care, and some home health care services. You don’t have to pay
premiums for Part A coverage if you paid Medicare taxes for 40 or more quarters
during your working years. That’s because you’re considered to have paid your
Part A premiums via Medicare taxes on wages and/or self-employment income.
But
some individuals did not pay Medicare taxes for enough months while working and
must pay premiums for Part A coverage.
If
you paid Medicare taxes for 30-39 quarters, the 2019 Part A premium is $240
per month ($2,880 if premiums are paid for the full year).
If
you paid Medicare taxes for less than 30 quarters, the 2019 Part A
premium is $437 ($5,244 for the full year).
Your
spouse is charged the same Part A premiums if he or she paid Medicare taxes for
less than 40 quarters while working.
Medicare Part B
Premiums
Medicare
Part B coverage is commonly called Medicare
medical insurance or Original Medicare. Part B mainly covers doctors and
outpatient services, and Medicare-eligible individuals must pay monthly
premiums for this benefit.
Your
monthly premium for the current year depends on your modified adjusted gross
income (MAGI) as reported on Form 1040 for two years earlier. For example, your
2019 premiums depend on your 2017 MAGI.
MAGI
is defined as “regular” AGI from your Form 1040 plus any tax-exempt interest
income.
Base premiums. For 2019, most folks pay the base premium of $135.60
per month ($1,627 for the full year).
Surcharges for higher-income individuals. Higher-income
individuals must pay surcharges in addition to the base premium for Part B
coverage.
For
2019, the Part B surcharges depend on the MAGI amount from your 2017 Form 1040.
Surcharges apply to unmarried individuals with 2017 MAGI in excess of $85,000
and married individuals who filed joint 2017 returns with MAGI in excess of
$170,000.
Including
the surcharges (which go up as 2017 MAGI goes up), the 2019 Part B monthly
premiums for each covered person can be $189.60 ($2,275 for the full year), $270.90
($3,251 for the full year), $352.20 ($4,226 for the full year), $433.40 ($5,201
for the full year), or $460.50 ($5,526 for the full year).
The
maximum $460.50 monthly premium applies to unmarried individuals with 2017 MAGI
in excess of $500,000 and married individuals who filed 2017 joint returns with
MAGI in excess of $750,000.
Medicare Part D
Premiums
Medicare
Part D is private prescription drug coverage. Premiums vary depending on the
plan you select. Higher-income individuals must pay a surcharge in addition to
the base premium.
Surcharges for higher-income individuals. For 2019, the Part
D surcharges depend on your 2017 MAGI, and they go up using the same scale as
the Part B surcharges.
The
2019 monthly surcharge amounts for each covered person can be $12.40, $31.90,
$51.40, $70.90, or $77.40. The maximum $77.40 surcharge applies to unmarried
individuals with 2017 MAGI in excess of $500,000 and married individuals who
filed 2017 joint returns with MAGI in excess of $750,000.
Medigap Supplemental
Coverage Premiums
Medicare
Parts A and B do not pay for all health care services and supplies. Coverage
gaps include copayments, coinsurance, and deductibles.
You
can buy a so-called Medigap policy, which is private supplemental
insurance that’s intended to cover some or all of the gaps. Premiums vary
depending on the plan you select.
Medicare Advantage
Premiums
You
can get your Medicare benefits from the government through Part A and Part B
coverage or through a so-called Medicare
Advantage plan offered by a private insurance company. Medicare Advantage
plans are sometimes called Medicare Part C.
Medicare
pays the Medicare Advantage insurance company to cover Medicare Part A and Part
B benefits. The insurance company then pays your claims. Your Medicare
Advantage plan may also include prescription drug coverage (like Medicare Part
D), and it may cover dental and vision care expenses that are not covered by
Medicare Part B.
When
you enroll in a Medicare Advantage plan, you continue to pay Medicare Part A
and B premiums to the government. You may pay a separate additional monthly
premium to the insurance company for the Medicare Advantage plan, but some
Medicare Advantage plans do not charge any additional premium. The additional
premium, if any, depends on the plan that you select.
Key point. Medigap policies
do not work with Medicare Advantage plans. So if you join a Medicare Advantage
plan, you should drop any Medigap coverage.
Premiums for Qualified Long-Term Care Insurance
These
premiums also count as medical expenses for purposes of the above-the-line
self-employed health insurance premium deduction, subject to the age-based
limits shown below. For each covered person, count the lesser of premiums paid
in 2019 or the applicable age-based limit.
Your
age as of December 31, 2019, determines your maximum self-employed health insurance
tax deduction for your long-term care insurance as follows:
Roth
IRAs tend to get a lot of hype, and for good reason: because you pay the taxes
up front, your eventual withdrawals (assuming you meet the age and
holding-period requirements—more on these below) are completely tax-free.
While
we like “tax-free” as much as the next person, there are times when a
traditional IRA will put more money in your pocket than a Roth would.
Making the
Decision on What’s Best
Example. Say that your tax
rate is 32 percent and that you will invest $5,000 a year in an IRA and earn 6
percent interest. Should you put the $5,000 a year into a Roth or a traditional
IRA?
Say
further that neither you nor your spouse is covered by a workplace retirement
plan, so you can contribute the $5,000 a year without worry because it’s under
the contribution limits. If your income is too high for the Roth IRA, you make
the $5,000 contribution via the backdoor.
Traditional IRA
If
you invest the $5,000 in a traditional IRA, you create a side fund of $1,600
($5,000 x 32 percent). On the side fund, you pay taxes each year at 32 percent,
making your side fund grow at 4.08 percent (68 percent of 6 percent).
Roth IRA
Roth
contributions are not deductible; this means no side fund, so your annual
investment remains at $5,000.
Cashing Out
For
the Roth, your marginal tax rate at the time of your payout doesn’t matter
because you paid your taxes before the money went into the account. The
whole amount is now yours, with no additional taxes due.
But
for the traditional IRA, your current tax bracket matters a great deal. You
have taken care of the taxes on the side fund annually along the way, but the
traditional IRA (both growth and contributions) is taxed at your current
marginal tax rate at the time you cash out.
The
table below shows you how this looks with tax rates of 22 percent, 32 percent,
and 37 percent at the time you cash out (winners are in bold):
Marginal tax
rate at cash-out
10 years @ 6%
20 years @ 6%
30 years @ 6%
40 years @ 6%
22%
Trad: $74,557
Roth: $69,858
Trad: $202,074
Roth: $194,964
Trad: $421,482
Roth: $419,008
Trad: $801,048
Roth: $820,238
32%
Trad: $67,571
Roth: $69,858
Trad: $182,578
Roth: $194,964
Trad: $379,581
Roth: $419,008
Trad: $719,024
Roth: $820,238
37%
Trad: $64,079
Roth: $69,858
Trad: $172,830
Roth: $194,964
Trad: $358,630
Roth: $419,008
Trad: $678,012
Roth: $820,238
You
can see that the traditional IRA needs a low tax rate at the time of cash-out
to win. But even in the 22 percent cash-out tax rate, the Roth wins at the
40-year mark.
Rate of Growth
What
about your rate of growth? Do variances here change things any? Let’s take a
look.
Here,
we’ll look at different rates of growth for a fixed period (30 years) before
you withdraw your money. Once again, we’ll consider three different marginal
tax rates at the time you cash out—22 percent, 32 percent, and 37 percent.
Marginal tax
rate at cash-out
3% for 30 years
6% for 30 years
9% for 30 years
12% for 30 years
22%
Trad: $257,760
Roth: $245,013
Trad: $421,482
Roth: $419,008
Trad: $716,547
Roth: $742,876
Trad: $1,256,032
Roth: $1,351,463
32%
Trad: $233,259
Roth: $245,013
Trad: $379,581
Roth: $419,008
Trad: $642,260
Roth: $742,876
Trad: $1,120,886
Roth: $1,351,463
37%
Trad: $221,008
Roth: $245,013
Trad: $358,630
Roth: $419,008
Trad: $605,116
Roth: $742,876
Trad: $1,053,312
Roth: $1,351,463
In
the scenarios above, the traditional IRA/side fund combo wins only when your
marginal tax rate is lower at the time of withdrawal and only at the
lower growth rates.
At
higher rates of return—9 percent and 12 percent, in our examples above—the Roth
still wins, even if you’re in a higher tax bracket when you withdraw your
money.
Tax Factor
What’s
going on here? For starters, the side fund is not tax-favored in any way. Plus,
taxes hobble your cash-out on the traditional IRA:
You
pay taxes as you earn the money in the side fund.
You
pay taxes on the accumulated growth inside the traditional IRA when you
withdraw the money.
