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October 2020

End-of-the-Year Money Moves

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Here are some things you might consider before saying goodbye to 2020.

 

What has changed for you in 2020? For many, this year has been as complicated as learning a new dance. Did you start a new job or leave a job behind? That’s one step. Did you retire? There’s another step. Did you start a family? That’s practically a pirouette. If notable changes occurred in your personal or professional life, then you may want to review your finances before this year ends and 2021 begins. Proving that you have all of the right moves in 2020 might put you in a better position to tango with 2021.

Even if your 2020 has been relatively uneventful, the end of the year is still a good time to get cracking and see where you can manage your overall personal finances.

Keep in mind this article is for informational purposes only and is not a replacement for real-life advice. Please consult your tax, legal, and accounting professionals before modifying your tax strategy.

Do you engage in tax-loss harvesting? That’s the practice of taking capital losses (selling securities worth less than what you first paid for them) to manage capital gains. You might want to consider this move, but it should be made with the guidance of a financial professional you trust.1

In fact, you could even take it a step further. Consider that up to $3,000 of capital losses in excess of capital gains can be deducted from ordinary income, and any remaining capital losses above that amount can be carried forward to offset capital gains in upcoming years.1

Do you want to itemize deductions? You may just want to take the standard deduction for the 2020 tax year, which has risen to $12,400 for single filers and $24,800 for joint. If you do think it might be better for you to itemize, now would be a good time to get the receipts and assorted paperwork together.2,3

Could you ramp up your retirement plan contributions? Contribution to these retirement plans may lower your yearly gross income. If you lower your gross income enough, you might be able to qualify for other tax credits or breaks available to those under certain income limits.4

Are you thinking of gifting? How about donating to a qualified charity or non-profit organization before 2020 ends? Your gift may qualify as a tax deduction. For some gifts, you may be required to itemize deductions using Schedule A.4

While we’re on the topic of year-end moves, why not take a moment to review a portion of your estate strategy. Specifically, take a look at your beneficiary designations. If you haven’t reviewed them for some time, double-check to see that these assets are structured to go where you want them to go, should you pass away. Lastly, look at your will to see that it remains valid and up-to-date.

Check on the amount you have withheld. If you discover that you have withheld too little on your W-4 form so far, you may need to adjust your withholding before the year ends.

What can you do before ringing in the New Year? New Year’s Eve may put you in a dancing move, eager to say goodbye to the old year and welcome 2021. Before you put on your dancing shoes, consider speaking with a financial or tax professional. Do it now, rather than in February or March. Little year-end moves might help you improve your short-term and long-term financial situation.

Taxable Events in Retirement Accounts

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What triggers a tax liability for an individual or a trust?

 

When you distribute, sell, or receive assets from a retirement account, taxes usually follow. It is true for individuals; it is true for trusts. These decisions represent taxable events.

Many retirement accounts are tax-deferred, but not tax-exempt. So, at some point, a “day of reckoning” arrives for these accounts, and taxes are due. The tax liability may differ greatly, depending on account ownership.

Trust income is now taxed much more than individual income. This is a result of the Tax Cuts and Jobs Act of 2017.1

As an example, in 2019, a trust could earn up to $2,650 in taxable income without federal taxes on its qualified dividends or capital gains. That threshold was almost 15 times higher ($39,375) for an individual. Factor in a $12,200 standard deduction in that same year, and an individual could potentially have up to $51,575 in qualified dividends to manage their federal income tax liability.1

Additionally, an individual has to have net investment income or modified adjusted gross income in excess of $200,000 per year to face the 3.8% net investment income tax (NIIT). Compare that with a trust: the threshold is just $12,750.2

Using a trust involves a complex set of tax rules and regulations. Before moving forward with a trust, consider working with a professional who is familiar with the rules and regulations.

Say an investment in your retirement account is sold for a capital gain. If it has been held in your account for less than a year, that capital gain is short term; short-term capital gains are usually taxed at the same rate as earned income. If those shares have been in your account for more than a year, then long-term capital gains tax rates likely apply, which are either 0% or 15% for most individuals.3

A trust also faces the possibility of capital gains tax in this situation whether it distributes the gain or it doesn’t. Both trusts and individuals can use capital losses to offset capital gains.1,4

Suppose you receive dividends in a retirement account. In an ordinary brokerage account, qualified dividends are taxable annually whether the money is distributed, reinvested, or left in cash. The threshold for taxation of qualified dividends is much lower for a trust than for an individual. Reinvested dividends in an Individual Retirement Account (IRA) are not taxed.1,5

Regarding IRAs, it is important to note that distributions from traditional IRAs must generally begin once you reach age 72. The money distributed to you is taxed as ordinary income. When such distributions are taken before age 59½, they may be subject to a 10% federal income tax penalty, although the CARES Act allows some exceptions to the penalties for 2020. (You may continue to contribute to a Traditional IRA past age 70½ under the SECURE Act as long as you meet the earned-income requirement.)6

How are taxable events in retirement accounts reported, and when are taxes withheld? Each tax year, Form 1099s tell the story. The 1099-DIV tracks dividends, the 1099-INT displays interest income, and the 1099-R shows distributions out of pensions, IRAs, retirement plans, and insurance contracts.7

Now to withholding. Distributions from employee retirement plans have taxes withheld unless a trustee-to-trustee transfer occurs (i.e., the invested assets go seamlessly from one retirement plan to another, with the individual or trust never taking possession of them). The withholding rate in such instances is 20%. An IRA owner can choose not to withhold tax from an IRA distribution; otherwise, the withholding rate is 10%. There is no withholding at all, of course, on investment income from a taxable brokerage account or capital gains and losses.8

Keep in mind that this article is for informational purposes only and not a replacement for real-life advice. Also, tax rules are constantly changing, and there is no guarantee that the tax treatment of IRAs and other qualified retirement plans will remain the same in years ahead, for individual taxpayers or trusts.

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This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Investment advice offered through American Wealth Management (“AWM”), a SEC-registered investment adviser. Certain personnel of AWM may also be registered representatives of M.S. Howells & Co. (“MSH”), Member FINRA/SIPC, a registered broker-dealer, and therefore, may offer securities through MSH. AWM and MSH are not affiliated entities. 

Citations.

  1. The Tax Adviser, April 25, 2019
  2. Internal Revenue Service, May 28, 2020
  3. Tax Policy Center, May 2020
  4. CRRCPA.com, August 27, 2019
  5. Investopedia, January 21, 2020
  6. TheStreet, May 13, 2020
  7. Nolo.com, August 12, 2020

8. The Balance, July 14, 2020