Menu Close

Tax Planning for Retirement

Retirement Plans:

Retirement Tax Planning Help

Retirement tax planning involves maximizing contributions to retirement plans and minimizing taxes on distributions. The retirement tax laws are complex and there are penalties for making mistakes, so it makes sense to seek help to make sure you are managing your contributions and distributions properly. There are many different types of retirement plans: Traditional IRA, Roth IRA, 401K, 403B, Thrift Savings and Rollovers to name a few. Self-employed taxpayers are allowed to set up Solo-401Ks and SEP-IRAs, which allow for greater contribution limits.


Retirement Plan Options:
Tax law favors employer and self-employed plans, allowing for much larger contributions. If either of these is an option, you should look to fund one of these plans over an individual plan which only allows $6,000 ($7,000 if over age 50). Some employer plans also provide partial matching contributions as a perk, which is free money. If you are self-employed, you should set up your own retirement plan so you can contribute a percentage of your net income, which can be a substantial sum. Generally, IRA contributions are tax deductible and the money grows tax free, until it’s time to make a distribution at which time the distributions are taxable, hopefully at a lower tax bracket in retirement. In contrast, Roth IRA contributions are not currently deductible. Accordingly, distributions are not taxable income, even while the income and gains accumulate tax free. It is recommended that taxpayers have a combination of tax deferred and tax free (Roth) accounts.
IRA Contribution Rules:
The tax laws have specific contribution rules and running afoul of these rules can cause major headaches. Retirement plans that are overfunded are subject to excise taxes and there can be a complicated process to unwind. Many taxpayers are confused about whether they can contribute to a Roth IRA, which is limited if income is over a certain threshold, or whether they can also get a tax deduction for an IRA if they, or their spouse, are eligible to contribute to a retirement plan at work. One strategy, the backdoor Roth, allows the taxpayer to make a non-deductible contribution to an IRA, then convert it to a Roth. This strategy appeals for taxpayers seeking a Roth contribution, who would otherwise be precluding because their income is too high.
Rollover your 401K:
If you have switched jobs recently, you may be wondering what to do with your retirement plan at your previous employer. You may find lower fees and greater investment choices in an IRA. The rollover options and rules can get confusing and penalties for not handling the transaction correctly can be costly. The best option is a trustee-to-trustee transfer from the old custodian directly to your new plan. This will require you to establish a Rollover IRA in advance of the transfer. I do not recommend a traditional transfer by having the distribution check issued to you personally as there is a required 20% withholding on the distribution. You will have 60 days to set up the new account and transfer the funds for the entire gross distribution, which means you will have to make up the funds from the withholding. Whatever portion is not rolled over within this period will be considered taxable income and subject to 10% penalty.

Distributions vs. Loans:
One of the biggest surprise taxpayers encounter is the high taxes associated with early distributions (prior to age 59 ½) from retirement plans. Taxpayers often pull money out of tax deferred retirement plans to pay off debt without consideration of the tax consequences. These distributions are reported on Form 1099R with a distribution coded 1, early distribution with no known exception. If possible, taxpayers should first explore taking a loan from their 401K in lieu of a taxable distribution. However, for taxpayers who separate from their employer the loan becomes due and you will be taxed on the outstanding balance if not paid back immediately. Taxpayers affected by coronavirus are able to borrow from their IRA plans up to $100,000 and recontribute the sum over a three year period.
IRS Tax Forms:
There are two important and often overlooked IRS tax forms taxpayers should be aware of when filing their tax returns. Form 8606 tracks basis for nondeductible IRA contributions. Some taxpayers make contributions to an IRA, though they are not eligible for tax deduction because they are covered by an employer plan. By tracking basis, distributions of contributions won’t be subject to income tax, though earnings and gains are still taxable. IRS Form 5329 can be used to claim an exception to the 10% additional tax on early distributions from retirement accounts. In the case of an IRA distribution before age 59 ½, tax law excludes the penalty if the funds were used for first time home purchase (but only up to $10,000), qualified education expenses, and to pay for health insurance while unemployed.