Death, Taxes and IRAs

IRAs are taxable after you die.

When people talk about “death” taxes, they usually mean “estate” taxes.  Now, for 2017, there is no federal estate tax if your estate is under $5,490,000.  So for most people, you don’t have to deal with estate tax.  But IRAs are a different animal!


An IRA is considered to be taxable income.  So – if you die, your beneficiary will have to pay tax on that IRA money.  So, maybe you don’t care – since you’ll be dead anyway.  But if you do care about leaving a taxable legacy to your heirs, here’s a few things to think about.


1.  Roth IRAs are not taxable.  Not to you, not to your heirs.  (I always like Roth IRAs.)


2.  A lot of people sign up for IRAs but they don’t know who the beneficiary should be (or they don’t have all the information they need to complete that part of the paperwork.)   When they sign up they just put “estate” down in the beneficiary box.   This is usually a bad thing.  What happens is that your heirs wind up having to file a form 1041, an Estate and Trust tax return.  Now, if you Google “estate tax” you’ll probably find all the tax rates on estates – and you’ll read the tax brackets for if you have over $5,450,000.   (And that’s a form 706 – it’s a different animal.)


The 1041 form for income tax on estates and trusts is for the income earned by the estate – which includes your IRA income.  The first $2,550 is taxed at 15%, the next bracket up to $6,000 is taxed at 25%, the next bracket up to $9,150 is at 28%, then up to $12,500 is at 33%, and anything over that is $39.6%.  It doesn’t take a whole lot of money to kick your IRA income into the top tax bracket!  Just to give you a comparison – a single person won’t hit the 39.6% tax bracket until he or she reaches $418,400 in taxable income.


So what does this mean?  Well, if your heirs aren’t rich, they’re going to be better off if they inherit your IRA directly from you instead of from your estate.


3.  If your goal is to leave a legacy to your children – life insurance is better than an IRA.  (I can’t tell you how much I hate sounding like a life insurance salesman but it’s true.)  Your IRA is your retirement account – it’s supposed to be money for you to spend during your retirement.  In a perfect world, you spend it all before you die.  (And of course, have enough to enjoy a long and happy retirement.)  Life insurance provides your loved ones with tax free cash after you die.


This is really a personal decision on your part.  Do you want to leave something for the kids or not?   For some people that’s a major priority, for others, not at all.  It’s your choice.  But not matter what you decide, be sure to work with your financial advisor to make sure your heirs are properly listed as beneficiaries to your taxable retirement accounts.

The Three Sexiest Retirement Savings Strategies

Great retirement planning is sexy!

Start planning now to have the retirement you choose, not the one that’s forced on you.


I just used the words “sexy” and “retirement” in the same sentence and I’m serious! Everybody needs to save for retirement, we all know that. That’s not sexy, that’s just a fact of life. But if you can get free money or tax free income while you’re saving – well, that makes it downright sexy!


So what are the three sexiest retirement savings strategies? The employer match, the Roth IRA, and the solo 401(k). Let me explain why.


First: The Employer Match. An employer match is where your boss matches a certain amount of your 401(k) contribution. For example: let’s say you make $50,000 a year and your employer has a 3% match. Three percent of $50,000 is $1,500. Your employer will “match” what you put in, so you’ll need to contribute at least $1,500 into your 401(k) to get the $1,500 from your employer. That’s free money to you! When you contribute to your 401(k) – it’s not counted on your tax return, but you still pay social security and medicare withholding on that money. The employer match has no withholding on it. It’s a straight contribution to your retirement savings. Free money. Free money is sexy! If you work for a company with an employer matching program, you need to get in on the action!


Second: the Roth IRA. A Roth IRA has no up front tax benefits to it. You put the money in after you’ve already paid tax on that money. What’s sexy about the Roth is that your investment grows tax-free. And more importantly, when you retire – you take that money out tax-free! I cannot stress just how valuable being able to access tax-free income during your retirement is! The Roth is probably the most accessible of the retirement options I’m talking about, but there are limits as to who can contribute to a Roth. Here’s a link to the IRS website showing the current limitations: Roth Limitations


Third: The Solo 401(k).  If you’re a solo business owner, or you and your spouse own a business together, then a solo 401(k) might be the plan for you.   For one thing – you can contribute up to 100% of your earned income (up to the maximum contribution allowed) to your 401(k).  This is great for folks who are actively trying to “catch up” on their retirement savings (and also happen to have another source of income!)


A solo 401(k) also allows you to make an “employer match” of up to 25% of your earned income.  You see, when you work for yourself, you’re both the employer and the employee!


So how do those numbers work?  Let’s say you own an S Corporation and you pay yourself a wage of $50,000. You can make an elective deferral – that’s what they call your 401(k) contribution – of up to $18,000 (or $24,000 if you’re 50 or older.)   That means your W2 is going to show that you have $32,000 of taxable income.  ($50,000 minus the $18,000 that you applied towards your 401(k).  You’ll have paid social security and medicare taxes on the full $50,000 – because you still pay the FICA on your retirement savings, just like if you worked for someone else.


But now, you’re still allowed to make an employer match of up to 25% of your earned income – in this case, I mean wages.  So, you could contribute another $12,500 towards your 401(k) as an employer match TAX FREE!  You don’t pay regular income tax on that money because it’s a business expense, right?  So it’s deducted from your business income as an employee benefit (where you’re the employee.)   And, since it’s an employer match – you don’t pay FICA either.  How cool is that?


Saving for retirement is necessary for everybody, but if can manage to swing tax free savings or tax free income it makes saving much more exciting.  You might even call it sexy!



Saving for Unemployment

Save Money

Photo by 401K 2012 at

I know what you’re thinking—don’t I mean saving for retirement?  That’s what everybody talks about, right?  Correct.  Everybody talks about retirement, including myself, but this time I really mean saving for unemployment.


Why?  It’s simple really.  Hopefully, unless we die first, we all get to retire once.  Some people go back to work, but it’s usually a “retirement job”.  But for those of us in the baby boomer generation (post World War 2, 1946 to 1964), according to the US Bureau of Labor Statistics, we can expect to be unemployed an average of 5.2 times over our working lifetimes.


Us Baby Boomers are all headed towards retirement already.  So if the Boomers experience an average of 5 bouts of unemployment—what about then Gen-Xers and the groups after them?  The Boomer generation experienced some of the greatest economic growth our country has ever seen—it’s quite possible that the younger generations could experience even more bouts of unemployment than we have.


So when I say you need to save for your unemployment, I am very serious.


Here’s what I’m seeing in the tax office.  People come to me to do their taxes after they’ve been laid off.  They have no savings so they dip into their 401(k)s to pay for groceries and stuff until they find a job.  They keep spending at the same level they did while they were still employed, but their 401(k) money often has no withholding and there’s a 10% penalty for taking it out too soon.  Tax time rolls around and they are stuck with a huge income tax bill—which they can’t afford to pay—so they take more money out of their 401(k)!  It’s a vicious cycle.  Sadly, there’s not much I can do to help here, especially after the damage is already done.


The big concern all these people have in common is that they did not have anything in their savings accounts when they lost their jobs.  That’s a big problem all across America—people don’t have money in their savings accounts!


Think about this:  Suppose your take home pay is $2,000 a month.  Let’s say your rent is $1,000 a month.  You spend about $500 a month on food and other necessities, and you’ve got about $500 extra that you play with.  (Yes, I’m making the numbers easy.)  Your bare minimum to survive is $1500 a month.  Now, if you have zero dollars in your bank account and you lose your job—well you’re in dire straits in less than 30 days, right?  You can’t make your rent payment.  But if you have been putting $200 a month away for the past year, you’d have $2400 in the bank.  At least your rent would be paid for another month and if you qualified for any unemployment benefits you might have 2 months worth of rent and food.  Having some savings set aside buys you an important commodity:  time.


Ideally, you want to have enough money to support you for at least six months of joblessness.  The fellow in our scenario above would want to have $9,000 put away. ($1500 of monthly minimum expenses times 6 months = $9,000.)  At $200 a month, that would take him almost 4 years of saving and I know that’s a little intimidating.  But baby steps are how you get there.  Everybody has to start someplace.  Unless you’ve already been saving, it’s going to take some time to shore up enough money to support yourself for half a year.  The big point here is to get started.


Pick a goal.  Don’t have one?  I’ll give you one.  Start with $1,000 in the bank.  $1,000 is way better than nothing isn’t it?  Gives you a little cushion, right?  If you’ve already got $1,000 saved, then your next goal is $5,000.  If the $1,000 is still too intimidating then your goal is $100.  You don’t even have to have the $100 in a bank—you can hide that under your mattress if you want. But by the time you get to $1,000 you really need to have a bank account.


Don’t get me wrong, it’s still important to save for retirement.  But statistically speaking, you’re five times more likely to be unemployed for awhile before you ever reach retirement age.  Oh, and what if I’m wrong and you never go jobless even once during your entire working career?  Well that’s okay, now you’ve got some extra money saved for your retirement!


Oh and a note from my editor:    Also know that you can deduct certain job search expenses as miscellaneous itemized deductions only if these expenses exceed 2% of your income and the job is in the same line of work as your prior one.  Such expenses include employment agency placement fees, resume expenses, travel and transportation expenses, and local and long distance phone calls.   And another note from me:  The IRS keeps telling us that all the time, but in real life I have very few clients who actually get any tax benefit from that deduction.  Keep your receipts, just in case, but for most folks, that deduction is pretty worthless.


How Much Can I Contribute to My 401(k)?

Piggy Bank

Photo by Danielle Elder on

Good question! Starting in 2012, you can put up to $17,000 away for retirement in a 401(k) plan. This figure also holds for people who have 403(b) plans and any of the 457 plans as well. If you happen to be over 50, you’re allowed what’s called a catch-up contribution so you can add an additional $5,500, making your total 401(k) contribution $22,500 for 2012.

Remember, money that goes into a 401(k) is tax-deferred so although you’re not paying tax on the money now, you will pay tax on it when you do withdraw it for retirement. If you take the money out of the plan before you reach the age of 59 ½, there’s a 10% additional penalty on top of the regular tax that you’ll pay. As much as I think 401(k) plans are a great deal, if you think that you’re going to need the money before you retire, you might want to re-think your contribution.

A good rule of thumb is that a person should be contributing 10% of his or her income into a retirement program. If you can afford 15%, that’s better, but 10% for sure.

Some companies have what’s called a Roth 401(k)—it basically works like a Roth IRA: you pay your income tax on your retirement plan contributions now, but when you take the money out later it’s tax free. Roth 401(k) plans have the same limits as regular 401(k) plans. If you have access to one of these plans you should seriously consider using it. For anyone who is in a 15% or lower tax bracket, choosing the Roth should be a no-brainer. If you’re in the 25% tax bracket and under 40, I’d still go with the Roth. After that, I’d start doing some serious considerations of what my future plans were, how early I’d want to retire, and other factors.

If your income is below $58,000, you can make fully deductible IRA contributions in addition to your 401(k) contributions (For married couples it’s $92,000.) This gives you some wiggle room. If you’re not comfortable committing to your 401(k) contribution rate, you can make up the rest with an IRA if you’ve got the funds at the end of the year.

If you haven’t started saving for retirement yet, this is the time to start.

I Lost My Job, Now What? Tax Issues of Unemployment, Part 2: The 401(k)

Empty office building

Photo by Tomi Knuutila on

There are so many issues with losing a job that you hate to think about taxes, but it’s important to think things through. In the last post, I talked about severance pay. In this post I want to talk about your 401(k) and what to do with that money.

First and foremost—it’s important to get your money out of that company’s 401(k) program as quickly as possible. For most people I’m not recommending just taking the money out, I’m recommending what you call a direct trustee to trustee transfer into an IRA. You want to remember that term “trustee to trustee transfer” because that phrase will save you money.

Why take the money out of the 401(k)? Why not just leave it there and roll it into my new company’s 401(k) when I land another job? I get that question a lot. First, you have a lot more control over your money if it’s in an IRA than in a 401(k) so that’s very important. Second, many 401(k) plans are tied into the stock of their company—if your company is laying people off, then that’s a signal that the company’s stock probably isn’t doing so well either. Do you really want to leave your money in a sinking ship? Third, and probably most importantly, if you wind up needing to access that money before you land a new job the IRA is the better place to be as far as taxes are concerned.

What exactly is a trustee to trustee transfer and why should I do one? A trustee to trustee transfer is when you have the money in your 401(k) plan transferred directly to your IRA account without you ever touching the money. Your financial adviser will have you sign the proper forms to make this happen. If you’ve got one of those self-directed plans like in an E-Trade account you’ll be able to find the right forms on their website

But how does this save me money? Because, by doing a trustee to trustee transfer, there are no tax issues. Let me use an example: Let’s say you have $10,000 in your company’s 401(k). You’re in the 25% tax bracket, if you just take the money out, you’ll pay $2,500 in taxes plus another $1,000 in penalties for a total of $3,500 in extra income tax. That’s not good. A direct trustee to trustee transfer is just a tax free way to move your retirement money from one account to another.

Let’s say instead that you want to rollover the money into an IRA but you don’t want to do a direct trustee to trustee transfer. You have your company cut you a check for the full amount of your 401(k) and you’ll handle depositing the money yourself later (You have 60 days to do the rollover). What happens is they cut you a check for $8,000 and give $2,000 to the IRS for taxes. You deposit the full $8,000 into your IRA so you won’t be taxed on that, but you will be taxed on the $2,000 that went to the IRS. That means you’re going to be billed $700 for the $2000 that you gave to the IRS. ($500 for the 25% tax plus another $200 for the 10% penalty.) That’s got to be the craziest thing in the word! You just paid tax on your tax! Oh sure, they’ll refund you the $1300 but that $700 is gone! Zippo! And for what? Don’t fall into this trap.

But I lost my job! What if I need access to my retirement funds? Good point, that happens to a lot of folks. But unless your 401(k) amount is pretty small, I’d still recommend doing the trustee to trustee transfer first, and then only taking out money from your IRA only when it’s absolutely necessary.

Here’s a different example: Jill has an annual salary of $40,000. She gets laid off in December and cashes in her 401(k) which has $100,000 in it. Normally, her annual Federal taxes are just under $3,600, but with the 401(k) added her income taxes are over $40,000 (with the 10% penalty included.) Her taxes for the year would actually be more than what her regular annual income would be. She’s gone from the 15% tax bracket to the 28% tax bracket, and with the 10% penalty for people who are under 59 and ½ years old that’s a 38% tax rate.

But Jill could have done a direct trustee to trustee transfer and saved herself a bundle. Let’s say she does the transfer, but later she needs to access some of that money to make ends meet. We know that she’s been managing on $40,000 a year. Let’s assume that she gets $10,000 in unemployment benefits for the year so she only needs to access $30,000 out of her IRA to stay level. Her taxable income will still be the same so she’ll owe just under $3,600 in regular tax, plus she’ll owe another $3,000 in penalties for the IRA money giving her a total tax bill of $6,600. It’s certainly not a perfect situation; that 10% penalty is painful, but it’s definitely better than paying a 38% tax rate. In this situation, Jill still has food on the table, a roof over her head, and some money still left in her retirement plan.

If you’ve been laid off and have 401(k) benefits left in the company, talk to your tax person and your financial adviser to figure out a plan that’s best for you and your family. You don’t have to go it alone.

How Much Should I Put into my 401(k)?

How much should I save with my 401(k)?

The more you save for retirement, the more you’ll have when you retire.


Updated June 10, 2016.


One question I hear all the time is, “How much should I put into my 401(k)?”   A good answer to that question is, “as much as you can.”  But how do you figure that out?


For 2016, the maximum amount that you can put into your 401(k) is $18,000, unless you’re 50 years old or over, then you can put $24,000 per year in.  If you can afford to put the maximum into your retirement plan, I recommend you do so.  I have never yet heard anyone complain of having too much money for their retirement.


But what if you can’t afford to put $18,000 into your retirement?  What if that’s all you make?  How do you determine how much to save?  As much as I always want to encourage people to put money into a retirement plan, if your financial situation is tight, and you might be forced to take that money out within the same year, don’t even put it in.  The very first thing you want to do is have a little cushion in a savings account.  If the car breaks down, or the roof needs a repair, you’ve got a little back up.


Let’s say your annual income is $30,000 a year and you have no savings whatsoever.  Make a goal of saving 10% of your income.  That’s 10% of $30,000, not 10% of your take home pay.  To do that, you’d need to save $60 per week to save $3,000 in one year.  (I gave you two weeks of vacation there.)  If you can’t live with that, adjust down a little until you find an amount that you can save regularly without hurting yourself.


Once you’ve got a little savings cushion, then you can start the retirement savings.  I always recommend that if your employer has a matching program, put in as much money as your employer will match.  For example:  let’s say your income is still $30,000 and your employer has a program where he’ll match what you put into your 401(k) up to 5% of your income.  If you put in $1,500, he’ll match it with $1,500.  That’s a 100% return on your investment.  If you put in $3,000, he’ll still only match with the $1,500.  If you can afford to save extra, that’s great, but the priority is the match.


Another consideration when deciding upon retirement contributions is reducing your income.  Suppose you’ll have a graduating senior in the spring.  401(k) contributions would lower the income reported on your tax return, which could impact your scholarship potential.  On the other hand, if you already have a child in college, education credits start phasing out at $80,000 ($160,000 if married filing jointly).   If you’re near a tripping point for a tax credit or deduction, it might make sense to increase your 401(k) contributions so that you can qualify for the credit.   Check with your tax professional to see what works best for you.