What To Do If Brokerage Firms Don’t Report Wash Sales for RSUs
April 05, 2024The amount of data that flows through the services of large record-keeping institutions is mind-blowing. But, as much as we rely on them for accuracy in reporting, we also need to record and monitor our own cost basis for tax purposes.
Restricted Stock Units (RSUs) are a popular form of employee (stock) compensation many companies use. RSUs allow employees to earn stock in their company over time, often as a reward for meeting performance targets. However, when it comes time to report these RSU awards on tax returns combined with the subsequent purchases and sales of the company or other stock, many employees can be confused and frustrated with broker reporting. Careful planning can help maximize your return and prevent costly mistakes.
Cost basis is the original price for a given security, whether purchased or vested. The cost basis of stock from an RSU is typically the fair market value at the time of vesting. When the stock (received after vesting of RSUs) is ultimately sold or transferred, either in part or in full, the cost basis is used to determine the taxable gain or loss on the transaction.
A wash sale occurs when you sell or trade stock or securities at a loss, and within 30 days before or after that sale you:
- Buy substantially identical stock or securities (SISS) {vesting is buying for this},
- Acquire SISS or securities in a fully taxable trade,
- Acquire a contract or option to buy SISS, or
- Acquire SISS for your IRA, Roth IRA, SEP, or Simple,
- Sell stock, and your spouse or a corporation you control buys a substantially identical position.
If your loss was disallowed because of the wash sale rule, all is not lost! You would add the disallowed loss to the cost of the new stock or securities (not meaningful in an IRA because there is no gain or loss to tax on a sale). The result is an increase to your basis in the new stock or securities. This adjustment postpones the loss deduction until the new stock or securities are sold. Your holding period for the new stock or securities includes the holding period of the stock or securities sold (long-term vs. short-term).
Check out Example 2 from IRS Publication 550 on page 60:
You are an employee of a corporation with an incentive pay plan. Under this plan, you are given 10 shares of the corporation’s stock as a bonus award. You include the fair market value of the stock in your gross income as additional pay. You later sell these shares at a loss. If you receive another bonus award of substantially identical stock within 30 days of the sale, you cannot deduct your loss on the sale. (Unless you sell all of the SISS, including the most recent grant.)
Unfortunately, firms may not and are not required to report wash sales cost basis for equity compensation, such as RSUs. This lack of reporting makes it difficult for employees to accurately report these types of sales on their taxes. In the absence of wash sale reporting, employees should take steps to keep accurate records of their RSU/stock activities. This includes recording the grant date, the fair market value at the time of vesting, and any subsequent sales or transfers of the stock from RSUs or purchase of the same stock outside of the employee RSU benefit. If the stock generates dividends, those would also need to be recorded. By maintaining these records, you’ll have the information you need to report activity on your taxes accurately.
Brokers are also not required to calculate wash sales on options trading.
Lastly, suppose you hold the same stock or a substantially similar investment (like a mutual fund or ETF) through other brokerage firms, and a wash sale is triggered. In all wash sale cases, you must manually calculate and report when filing tax returns. You would gather all your account activity and 1099b forms from multiple brokerages and use Form 8949 to report buy/sale information for your taxes.
The lack of reporting by firms for RSUs has created a significant burden for employees and tax professionals. Until more comprehensive reporting requirements are implemented, employees should take the necessary steps to keep accurate records of RSU activities to avoid any tax issues. Consult with a tax professional if you have any questions or are unsure how to proceed, especially if you live or work in multiple states and countries. By making informed decisions, you can maximize your returns and minimize your taxes regarding RSU investments.
Topic No. 409, Capital Gains and Losses | Internal Revenue Service (irs.gov)
About Form 8949, Sales and Other Dispositions of Capital Assets | Internal Revenue Service (irs.gov)
Working In The U.S. Temporarily? Here’s What You Need To Know About Retirement
January 04, 2024We get many retirement benefits questions on our financial coaching line from professionals working in the United States but plan to return eventually to their home countries or take another ex-pat assignment. Frequent questions include: should I participate in my company’s 401(k) plan, and if so, should I choose to make a pre-tax, Roth, or after-tax voluntary contribution? In addition, how can I access my savings when I leave the US?
Get professional tax advice
If you’re a professional from another country working legally in the United States and do not have permanent resident status (e.g., a “green card”), the US taxation system can seem like a maze: one wrong move, and you’re stuck in a corner. Do not try and navigate this yourself. Instead, seek professional tax advice from a tax preparer experienced in ex-pat/non-citizen issues. You’ll need guidance on federal and state withholding, tax treaties, tax filing, benefits choices, and what to do when you leave the US.
Ask ex-pat colleagues first for referrals to a tax professional with experience working with people like you. It’s not expensive and could save you from financial and legal problems later. For a basic overview of types of US tax preparers, see How to Find a Good Tax Preparer.
What do I need to know about US retirement savings programs?
The US retirement savings system is made up of Social Security, defined contribution plans (401(k), 403(b) or 457), traditional pension plans (defined benefit), and individual retirement accounts (IRA and Roth IRA).
Social Security
This is the government-sponsored retirement system, similar to what’s often called a “public pension” in other countries. As a non-citizen employee, you will likely pay the same taxes as US citizens into Social Security and Medicare, which you will not recoup unless you continue to be a US resident. Your employer will also make contributions on your behalf.
If you do not plan to live in the US when you retire, you may or may not be able to receive Social Security income benefits. It depends on how long you paid into the system, your immigration status, country of residence, and whether you started receiving payments before leaving the US.
401(k), 403(b), and 457 plans
Most large employers offer employer-sponsored retirement savings plans, such as 401(k) and 403(b) plans. Employees may contribute a percentage of their gross pay each period to a tax-advantaged account. Frequently, the employer will match up to a set percentage of what you contribute or will sometimes make contributions regardless of whether you make your own contributions.
In addition, you’ll get to choose how your contributions are invested from a menu of mutual funds or other investment vehicles. You may also choose whether you contribute your money into a pre-tax (traditional), after-tax (Roth), or after-tax voluntary account. See tips below for determining what works for you.
IRA and Roth IRA
If you are considered a resident for US tax purposes (have US earned income, have a Social Security number, and meet the substantial presence test), you may open a traditional or Roth IRA. However, if you are a non-citizen and don’t plan to seek US citizenship or permanent residency, you may not be able to reap all the benefits of an IRA or Roth. If you’re eligible, you may contribute up to certain limits.
| IRA limit | IRA catch-up amount | 401(k)/403(b) limit | 401(k)/403(b) catch-up amount | SIMPLE limit | SIMPLE catch-up amount | SEP | |
| 2024 | $7,000 | $1,000 | $23,000 | $7,500 | $16,000 | $3,500 | $69,000 |
| 2023 | $6,500 | $1,000 | $22,500 | $7,500 | $15,500 | $3,500 | $66,000 |
Traditional pension plans
These are no longer widely available to new employees, but some larger companies and state/local government jobs still offer them. A pension may be fully funded by employer contributions or by combining employer and employee contributions. Typically, it takes 10-20 years to be “vested” in a pension, where the employee is eligible to receive a fixed monthly payout at retirement.
Should I enroll in my 401(k)?
Saving in your employer-sponsored retirement plan has multiple benefits, even if you don’t plan to continue working and living in the US later in your career. If there’s a match on your contributions, that’s like earning additional income. There’s the potential for tax-deferred or tax-free growth, depending on the type of contributions you make. Plus, you can’t beat the ease of contributions deducted automatically from your paycheck!
Always consider your future taxes.
For non-citizens making decisions about which retirement contribution type to choose, you’ll need to consider where you will be living when you withdraw the money, how old you will be when you plan to withdraw it, and whether you think you’ll be a US permanent resident or citizen at that time. If you still expect to be a non-citizen when you withdraw the money, note that you must file a US tax return in any year in which you have US income, including retirement plan withdrawals. According to the IRS, “Most U.S.-source income paid to a foreign person are subject to a withholding tax of 30%, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty. You may or may not owe that rate in taxes, but the funds will be withheld from the distribution regardless.
If you’ve overpaid through the withholding, you will get a refund after filing your tax return for that year. See this IRS US Tax Guide for Aliens for in-depth reading. Now, do you see why I say you need a tax advisor if you’re an ex-pat working in the US?
If by the time you withdraw the money, you have become a US citizen or a permanent resident but are living overseas, you won’t be subject to the 30 percent withholding. You will, however, have to file a US income tax return every year regardless of your income.
For U.S. citizens, check out this article about what you need to know about taxes while working and living abroad.
Pre-tax, Roth, or After-tax voluntary contributions?
The financial planning goal is to minimize taxes and penalties. Your company’s matching or profit-sharing contributions to your retirement plan are always pre-tax, so they will be taxed when you withdraw them. How much of your retirement contributions will be taxed depends on how you contribute:
Traditional pre-tax contributions are deducted from your taxable income, so you’ll pay less in income taxes today. Earnings grow tax-deferred for retirement. After age 59 1/2, you may withdraw them without penalty, paying US income taxes on whatever you take out. Before that, you may withdraw them only if you a) retire, b) leave the firm, or c) have an extreme financial hardship.
Roth contributions: Roth 401(k) contributions are made after-tax and grow tax-free for retirement if withdrawn 1) after 5 years and 2) after age 59 ½. Therefore, if you meet those requirements for distribution, your Roth distribution would not be included in your taxable US income. See this IRS tool to see if your Roth distribution could be taxable. However, your home country (or country of residence) could tax it, depending on the tax treaty with the US.
If your plan allows, you can leave the funds in the account until after age 59 ½. If you must take an earlier distribution after leaving the firm, you will only be taxed and penalized on the related growth and company contributions, not your original contributions. See this IRS Guide to Roth 401(k)s for more information.
After-tax voluntary contributions: Many employer-sponsored plans permit after-tax voluntary contributions above, or as a substitute for, Roth or pre-tax contributions. This will give you some flexibility, as you may withdraw those contributions at any time (although the growth of your funds will be subject to tax). If you plan to withdraw contributions after leaving the firm, taxation is similar to the Roth 401(k). Your retirement plan may also permit you to convert after-tax voluntary contributions to the Roth account, which could come in handy if you end up staying in the US, or roll them over to a combination of a traditional IRA and Roth IRA when you leave the firm.
On the downside, you typically won’t receive an employer match on voluntary contributions. Your original contributions can be withdrawn at any time tax-free, but any earnings or growth made in the account will be taxed when withdrawn. (That means gains withdrawn before 59 ½ will be taxed and subject to an additional 10 percent penalty.)
If you leave the US, are you required to take distributions?
If you leave to work and reside overseas, you would be able to take a distribution from your company’s retirement plan but are generally not obliged to take any until age 73. If possible, leave it to continue to grow, protected from taxes. Pre-tax contributions later distributed are included in your taxable income and, if taken before age 59 1/2, may be subject to an additional 10% penalty.
Ask for guidance
If your company offers a workplace financial wellness benefit, talk through the pros and cons of your choices with a financial coach. Your financial coach can help you understand the implications of your options, given your personal situation. Also, while you’re working in the US, don’t forget to use a tax advisor experienced in non-resident taxation., such as a certified public accountant or an enrolled agent. This is well worth the relatively low cost of getting good tax advice.
How to Invest in a Taxable Account
January 04, 2024Investing in your retirement account can be quite different from investing in a taxable account. Here are some options to consider when investing in a taxable account:
Use it for short term goals. One of the advantages of a taxable account is that you don’t need to worry about any tax penalties on withdrawals. For that reason, it probably makes the most sense to use a taxable account for goals other than retirement and education like an emergency fund, a vacation, or a down payment on a car or home. In that case, you don’t want to take risk so cash is king. To maximize the interest you earn, you can search for high-yielding rewards checking accounts, online savings accounts, and CDs on sites like Deposit Accounts and Bankrate.
Keep it simple for retirement. Just like in a 401(k) or IRA, you can simplify your retirement investing as much as possible with a target date fund that’s fully diversified and automatically becomes more conservative as you get closer to the target retirement date. There are a couple of differences in a taxable account though. The bad news is that you’ll be paying taxes on it each year so you want a fund that doesn’t trade as often. The good news is that you’re not limited to the options in an employer’s plan so you can choose target date funds with low turnover (how often the fund trades and hence generates taxes) like ones composed of passive index funds.
Invest more conservatively for early retirement. If you plan to retire early, a taxable account can be used for income until you’re no longer subject to penalties in your other retirement accounts or to generate less taxable income so you can qualify for bigger subsidies if you plan to purchase health insurance through the Affordable Care Act before qualifying for Medicare at age 65. In either case, you’ll want to invest more conservatively than with your other investments since this money will be used first and possibly depleted over a relatively short period of time. Consider a conservative balanced fund or make your own conservative mix using US savings bonds (which are tax-deferred and don’t fluctuate in value like other bonds do) or tax-free municipal bonds instead of taxable bonds if you’re in a high tax bracket.
Make your overall retirement portfolio more tax-efficient. You can also use a taxable account to complement your other retirement accounts by holding those investments that are most tax-efficient, meaning they lose the least percentage of earnings to taxes. Your best bets here are stocks and stock funds since the gains are taxed at a capital gains rate that’s lower than your ordinary income tax rate as long as you hold them for more than a year. In addition, the volatility of stocks can also be your friend since you can use losses to offset other taxes (as long as you don’t repurchase the same or an identical investment 30 days before or after you sell it). When you pass away, there’s also no tax on the stocks’ gain over your lifetime when your heirs sell them.
In particular, consider individual stocks (which give you the most control over taxes) and stock funds with low turnover like index funds and tax-managed funds. Foreign stocks and funds in taxable accounts are also eligible for a foreign tax credit for any taxes paid to foreign governments. That’s not available when they’re in tax-sheltered accounts so you may want to prioritize them in taxable accounts over US stocks.
For retirement, you’ll probably want to max out any tax-advantaged accounts you’re eligible for first. But if you’re fortunate enough to still have extra savings, there are ways to make the best use of a taxable account. Like all financial decisions, it all depends on your individual situation and goals.
5 Estate Planning Steps Literally Everyone Needs To Take
January 04, 2024You may be thinking that you do not have the need for an estate plan or at least there is no harm in delaying getting started with estate planning. The truth is that anyone with savings, debt, a spouse, children, a home, or a retirement plan needs to at least have the basics in place.
Hopefully, it’s true that you won’t need it for decades to come, but should something happen and you don’t have a plan, it could make a HUGE difference, sometimes even while you’re still alive.
Here are the 5 critical steps – make a plan to check these off the list today.
Step 1: Create or review your will
If you have a current will, congratulations! You have already taken an important step in the estate planning process. Your will controls the distribution of everything you own that doesn’t have a beneficiary designation and can also name a guardian for any minor children. Things that you pass via will include:
- Tangible personal property like your home, your car, and all your stuff
- Individually held financial accounts such as savings, checking, stocks, bonds, and mutual funds held outside retirement accounts which do not have a beneficiary designation.
Don’t have a will? If you die without a will, your state has laws that determine who gets your money called laws of intestacy. These laws vary from state to state but generally give first priority to your spouse and children. If you have neither, then blood relatives including parents, siblings, and others are your default heirs, under a specified order of priority. If no blood relatives can be found, your money goes to the state Treasury.
Protect your children! Should your minor children lose both parents, your will determines who will raise them and manage your money on their behalf until they reach the age of majority. If you die without a will, the state will name a guardian to take the children – and it may not be who you think is the most appropriate person!
In your will, you can designate a guardian for your children, as well as one or more alternates in the event your first choice is not available. You can name the same person, or a different one, to manage any money left to your children as well.
Step 2: Review your assets and update beneficiary designations
Many people think that once they have made a will, all of their assets will pass according to that document. Actually, a large number of your most valuable assets are not subject to probate, meaning they may NOT pass by will. Use this checklist to keep track of specific exceptions to your will.
Do you…
- Own any bank accounts, mutual funds, or brokerage accounts in joint name with someone else?
-If yes, the joint account owner will automatically own the assets upon your death (in most cases). Also, in most states, you can designate an individual account to be “Payable On Death” (POD) or “Transfer On Death”(TOD) to a named beneficiary for the same result and the account will “skip” your will (and probate).
- Own real estate with another person?
-If yes, real estate owned as joint ownership with rights of survivorship also does not pass by your will but goes directly to the other joint owner automatically.
- Have insurance policies, annuity contracts, employer retirement plans and/or IRA’s?
-If yes, keep your beneficiaries updated. All of these account types require you to name who will receive the account or policy value upon your death. If you fail to name a beneficiary or all beneficiaries have died before you, the account will be payable to your estate.
- Have a trust?
-If yes, your trust will determine how the trust property is distributed to beneficiaries, but only if you take the necessary steps to re-title accounts and other assets to the trust. Failure to change the title to the name of your trust will cause them to pass by other means, regardless of what the trust says.
All of these exceptions pass directly to the person named, and not by your will. It is extremely important to keep your beneficiary designations up to date – it is not uncommon for older life insurance policies and previous employer retirement plans to be paid out to ex-spouses or other unintentional parties. Updating your will does not fix these accounts, since they are not subject to your will.
Step 3: Evaluate your insurance coverage
Whether your income stops due to death or disability, the effect on your family is the same. Where will the money come from to replace your paycheck? Insurance may be your best option. Without it, your family may need to sell assets, move to a less expensive home and/or disrupt college and retirement plans.
- Life insurance. Use this calculator to get an idea of how much insurance you need to have in place. Once you decide on the right amount for you, be sure to find out what benefits you have through work first. Sometimes, you can get all of the life insurance you need there at the most affordable rates, but if you can’t, look into supplementing with a personal policy.
- Disability insurance. This is your paycheck insurance – should something happen that keeps you from being able to work, this insurance kicks in to replace some of that until you’re able to work again. Statistically speaking, this is the insurance you’re more likely to use during your working years. First, confirm any coverage you have through work and find out if you can add to it, if necessary — most group plans are broken into Short-Term and Long-Term and often have lower premiums than individual policies. It’s important to know that most policies only provide 60 – 70% replacement income, so should you become disabled, you’ll still have a drop in income. Use this calculator to see if you need to purchase coverage beyond what you have through work.
Step 4: Check your powers of attorney
Remember that your will doesn’t take effect until you actually pass away, but what happens if you have an accident or are otherwise unable to make financial or healthcare decisions for yourself? You can designate someone else to make these decisions for you using the following important documents:
Advanced Directives – There are two types of documents, called advance directives, that can be prepared as part of your estate planning for future medical decisions.
- Living Wills – If you have strong feelings about what type of medical care you want (or don’t want!) and you are unable to communicate, a living will can do it for you. This is a document that you can use to state under what circumstances you wish to be kept alive by artificial means. If you do not express your views in writing, all available means of treatment to maintain your life are usually provided, even if family members object. Therefore, if there are conditions where you would not want treatment, it is important that you state your wishes while you are able to do so.
- Medical Power of Attorney – While the title and wording of this document may vary from state to state, most states permit a document that enables you to select someone to make medical decisions on your behalf. This power can only be exercised when you are unable to communicate but is not limited to situations where you are terminally ill.
Durable Power of Attorney – There can be a number of situations where you may need someone else to make financial transactions on your behalf. Whether you’re traveling overseas, in a coma, or sequestered in a jury, a document called a durable power of attorney permits the person named as your agent to sign documents, trade securities, and sell property. You do not have to be unable to act for yourself in order for your agent to act on your behalf.
The agent does have to act in good faith, and may not abuse the power of attorney for his/her own advantage. If you sign a power of attorney that is not specifically durable, the power is revoked upon your disability or inability to communicate. With a durable power of attorney, your agent can make the necessary transactions in order to pay your medical bills or make sure your family has the money they need.
Living Trust – Another method is to place your assets in a living trust. Don’t confuse this with the living will described above. Although they sound similar, they are very different. A trust is simply an arrangement that provides for a third party to manage your assets for a beneficiary, upon your death. A living trust allows you to start a similar arrangement while you are still alive. You can be your own trustee, and simply name a successor trustee to take over upon your death or disability. A living trust is a more expensive estate planning tool than a durable power of attorney, but it can also be customized to your specific needs. It is particularly useful for more complicated situations such as second families or people who own property in multiple states.
Step 5: Monitor your estate plan
Things change. That’s why you should review your estate plan whenever a life event occurs for you and your family. Even if it seems like nothing’s changed, you should review your estate plan every few years at a minimum. A good rule of thumb is that you should update your will any time someone enters or leaves your life (aka birth, marriage, divorce, death)
Documents to review
- Your will and any trusts
- Powers of attorney
- Beneficiary designations on employer-sponsored retirement plans (401(k), 403(b), 457, etc), IRAs, life insurance policies, annuities, HSAs
An estate plan, like a financial plan, is always evolving as your life changes. It can be easy to delay making an estate plan because there are several important decisions you must make, but don’t fall victim to analysis paralysis. You can always change your documents as long as you’re still of sound mind, so choose what works for your life today, and then make updates as things change. Also, be sure to check with legal benefits offered by your employer to help with the estate planning process.
Be A Tax Savvy Investor
January 04, 2024Take advantage of long-term capital gains rates
Hold stocks and mutual funds for more than twelve months to have your gains taxed at lower capital gains rates.
Consider tax-advantaged investments
Municipal bonds are issued by state and local government agencies. The interest is tax free at the federal level, but may be subject to the alternative minimum tax. Those issued by the state or municipality where you live are tax free at the state or local level as well.
Sell investments at a loss
If you have stocks or mutual funds in a taxable account that are worth less than you paid for them, and your losses exceed your gains, you can take losses of up to $3,000 against your taxable income. Be sure to evaluate selling costs and the investment’s future potential first.
Watch out for the wash sale
You can sell mutual fund or stock losers and buy them back again if you feel they are good long-term investments (but make sure you wait at least 31 days before you buy them back or the IRS will disallow your loss).
Don’t buy mutual funds at the end of the year
Mutual funds may pay out capital gains accrued throughout the year as a taxable distribution toward the end of the year (even if you just bought the fund, you’ll owe taxes on this payout!). Wait until after the distribution is made if you wish to minimize your tax bill.
Know the limit if you’re selling your home
Qualifying homeowners are exempt from the first $250,000 of capital gains ($500,000 if married filing jointly) when they sell their home.
Understand the different tax rates for dividends versus interest
Qualified dividends paid from stock investments are taxed at the same rate as long-term capital gains. Interest earned on investments such as CDs, savings accounts, and money market funds, however, are taxed at higher ordinary income tax rates.
How To Find The Right Tax Professional For Your Needs
January 04, 2024There are lots of reasons to consider outsourcing the preparation of your income taxes to a pro, whether you just don’t want to take the time anymore or you have a more complicated situation such as income sourced from multiple states, income from your side gig or just want to make sure you’re taking advantage of any and all tax savings opportunities. It’s important to know that all tax preparers are not the same – there are different credentials and specialties within the world of tax preparation.
The first step in finding a pro is determining what type of preparer you need. Here are the 5 categories to choose from.
The type of preparer you need depends on your situation
Paid tax preparer:
For a routine return (aka you’re married with kids, own a home and have donations and maybe some investment income, but nothing more complicated), a tax preparer from a storefront service like H&R Block or Jackson Hewitt could do the trick. The convenience of extended hours and immediate tax preparation along with the relatively low cost (starting at about $60 on up, depending on the complexity of your return) is what attracts most customers. While most paid tax preparers must pass employer-administered examinations, they may not be as rigorous as those required to gain the designations or certifications other pros hold.
Also keep in mind that anyone can call themselves a tax preparer as long as they have an IRS issued preparer tax identification number (PTIN), but that doesn’t necessarily mean they know what they’re doing. If you’re looking to hire a tax preparer that doesn’t work for a large service, be sure to ask about experience and other credentials. And beware of any preparer asking you to sign a blank tax return or promising you any type of refund guarantee before looking at your information – they’re most likely up to no good and you’re always on the hook for taxes you owe, no matter who prepares your return.
Accountant:
Someone who practices accounting but hasn’t taken or passed the CPA examination may not be a bad choice for a basic return. Seek someone with a personal tax emphasis. Rates can range from $40 to $75 or more per hour.
Enrolled Agent:
EAs are the only taxpayer representatives who receive their right to practice from the United States government. (CPAs and attorneys are licensed by the states.) Agents have either worked for the IRS for five continuous years or have passed a two-day exam, and must complete 72 hours of continuing education every 3 years. Billing may be hourly (usually $100 to $200 per hour) or by the tax return, which can run from $100 (for a basic 1040) on up depending on the complexity. You may choose to work with an EA if you have an unusual tax situation or have past tax issues that you need help cleaning up.
Certified Public Accountant:
A CPA earns the title by passing the Uniform CPA examination, a rigorous 4-part test that ensures those holding the license are knowledgeable in all areas of accounting. CPAs must also complete a certain amount of on-the-job training in auditing and taxes (the amount varies by state) before they can earn their license and then must maintain their license with a certain amount of continuing education each year (varies by state ). Some CPAs specialize in corporate work and may not be the best choice for personal taxes, while others specialize in tax, but not in individual income taxes. A CPA may be the best choice if you have business income, own rental property or have other tax complexities that extend beyond income you earned from working and/or investing.
Tax Attorney:
If your tax situation is very complex or you are in deep trouble with the IRS, you may want to consider a tax attorney. Of course, a tax attorney is the most expensive of the tax pros, with rates typically running from $150 to $600 an hour.
How to find the best one for you
The best place to start your search for a tax pro is with friends and colleagues or even your local chamber of commerce. You can also check with the National Association of Tax Professionals, which has listings with certifications noted. The Better Business Bureau or the pros certifying agency can tell you if the person you’re considering hiring is in good standing, with no disciplinary actions.
Interviewing a preparer before you hand over your W-2 can prevent problems later. Make sure you’re comfortable with their answers to these questions.
- What’s your education and experience? (at minimum they should have a college degree or several years of experience with references available)
- Are you licensed or registered? By what agency? For how long? (If they are not licensed or registered, ask to talk with other clients to make sure they know what they’re doing)
- What’s your specialty (personal taxes, corporate taxes, audit issues)?
- What continuing education courses have you taken recently?
- Who from your office would work on my taxes? (many larger offices have interns prepare returns that are then reviewed by more experienced CPAs – if that’s the case, you may be better off going to a smaller office and paying less)
- In the event I’m audited, could you represent me?
- What are your rates, and how much do you expect the total cost of the return to be? (beware of anyone wanting to charge by the form – you could be overcharged. The best preparers either charge by the hour or are willing to give you a not-to-exceed estimate)
- When would the return be finished? (if you’re coming to them after mid-March, don’t be surprised if the answer is after the filing deadline – busy tax preparers often file extensions for clients who procrastinate getting their information in on time, although that doesn’t extend your time to pay any taxes due)
Whatever your needs, there’s a tax pro out there ready to make your life easier. Choose the right one, and you’ll more than likely get your money’s worth.
Commonly Used Tax Deductions
January 04, 2024Income taxes are one of our largest expenses. They can also become one of our biggest financial planning stressors. While you can’t avoid paying taxes, you can try to minimize the total amount of income taxes that you owe. By paying less in taxes, you’ll have more money to save for your goals. The good news is that you can use popular tax deductions to help reduce your tax bill.
How income tax deductions work for you
Standard deduction amounts were significantly boosted when the tax law changed in 2018, which means your limited itemized deductions have a higher threshold to even be used. Many more people, especially married filing joint filers, are finding themselves using the standard deduction even if they have things like mortgage interest and property taxes. You choose which method to use, typically based on which one will lower your taxable income more.
| Filing Status | 2023 Standard Deduction | 2024 Standard Deduction |
|---|---|---|
| Single | $13,850 | $14,600 |
| Married Filing Jointly | $27,700 | $29,200 |
| Qualified Widow(er) | $27,700 | $29,200 |
| Married Filing Separately | $13,850 | $14,600 |
| Head of Household | $20,800 | $21,900 |
Additional Considerations:
- The standard deduction is higher for those over 65 or blind; it is higher if you meet those conditions and your filing status is Single or Head of Household.
- For the 2023 tax year, the standard deduction amount for an individual claimed as a dependent by another taxpayer cannot exceed the greater of $ 1,250 or the sum of $400 and the individual’s earned income, up to the regular standard deduction amount.
- If your tax filing status is Married Filing Separately and your spouse itemizes deductions, you may not claim the standard deduction. If one spouse itemizes income tax deductions, then the other spouse must itemize to claim any deductions.
- Non-resident aliens must itemize deductions on their tax returns as they are not eligible to claim the standard deduction.
Most commonly used tax deductions
Here are some of the most commonly used tax deductions you may be eligible to use when attempting to minimize your taxes:
Mortgage interest deduction – Homeowners can deduct their mortgage interest (subject to mortgage limits) on Schedule A of their 1040 form. The limit for mortgage debt incurred after 2017 for deductible interest is reduced to $750K while existing acquisition debt of up to $1 million is “grandfathered”. No matter when the mortgage debt was incurred, you can no longer deduct the interest from a loan secured by your home to the extent the loan proceeds weren’t used to buy, build, or improve your home.
State and local taxes (SALT) – You can also deduct up to $10,000 of state, local, and property taxes (or sales and property taxes if you don’t live in a state with income taxes). This is an aggregate limit and is $5,000 for married couples filing separately. The so-called “SALT limitations” underscore the importance of limiting state and local taxes as much as possible.
Examples of state and local taxes that can be itemized on a tax return include the following:
- Withholding for state and local income taxes as shown on Form W-2 or Form 1099.
- Personal property taxes
- Real estate taxes
- Estimated tax payments you made during the year
- Payments made during the year for taxes that arose in a previous year
- Extension tax payments you made during the year
Charitable donations – The IRS agrees that it is better to give than to receive, and they offer some helpful tax savings for giving (if you itemized deductions). There are deductions available for cash and household items donated to charities.
For charitable contributions to be deductible, they must have been made to qualified organizations. Contributions to individuals are never deductible. You may determine if the organization you contributed to qualifies as a charitable organization for income tax deduction purposes by referring to the IRS Tax Exempt Organization Search tool. For more information, see Publication 526, Charitable Contributions and Can I Deduct My Charitable Contributions?
Less frequent itemized deductions
Some other less frequently used tax deductions may apply to your financial situation. You can deduct medical expenses if they exceed 7.5% of your Adjusted Gross Income. The new tax laws eliminated other miscellaneous deductions from previous years.
Action Item: Not sure if you will be able to itemize deductions this year or next? Consider completing an estimate of your itemized deductions potential using a copy of Schedule A . If your itemized deductions exceed the standard deduction amount for your filing status you will want to itemize. If you are using the standard deduction amount, you can focus your tax planning efforts on reducing or deferring your taxable income.
Tax deductions that are no longer in place since 2018
Here are some of the tax deductions that the tax law change eliminated in 2018:
Moving expenses – It is no longer possible to deduct moving expenses when you relocate for a job or self-employment unless you are an active duty member of the military moving due to a military order.
Home equity loan interest for non-home-related use – Home equity loan interest cannot be deducted unless you used the loan to buy, build, or make significant improvements on your home (and the loan is secured by your home). This applies to home equity loans already outstanding used to consolidate debt or pay for other things. If you have outstanding home equity debt partially used to update or remodel your home, you can deduct only the interest attributed to the portion used to do the work.
Miscellaneous itemized deductions – The IRS no longer allows you to claim miscellaneous deductions on Schedule A that were previously subject to a 2 percent floor. Examples of these miscellaneous deductions include:
- Investment fees
- Unreimbursed employee business expenses
- Tax preparation expenses
- Safe deposit box rental
- Certain legal fees
Alimony payments – Alimony (aka maintenance payments between divorced couples) is now non-deductible to the payor and considered non-taxable income to the recipient. Under the previous tax laws, alimony and separate maintenance payments were deductible by the payor and considered taxable income for the recipient.
Casualty and theft losses – Beginning with the 2018 tax year and through the tax year 2025, you can only deduct casualty and theft losses if they occurred due to an event officially declared a federal disaster.
How To Tackle Tax Season
January 04, 2024When the tax deadline approaches, it can be stressful, especially if you are unsure if you have to pay the IRS. It’s too easy to procrastinate with that potential IOU looming over your head. However, having a game plan to organize and execute filing your taxes can take the bite out of tax season.
Gathering information
Build a tax file for your incoming tax statements. Getting it all together saves the hassle of stopping in the middle of your tax preparation. Visit your checking, savings, and online brokerage accounts for 1099s. Check your mortgage provider for statements on interest paid. If you have an escrow, this may also include property taxes. If not, check your local jurisdiction online to download a statement.
One way to “de-stress” your tax planning is to know in advance if you and the IRS agree on the facts of the previous year. Nothing is more annoying than preparing your return and then getting that letter from the IRS that they found a discrepancy. It can slow down the process of your tax refund. You can view your official transcript with the IRS online account by visiting Your Online Account | Internal Revenue Service (irs.gov). (The IRS made this easier by removing the biometric data requirement.)
Getting your tax filing done
One recent survey shows that almost half (45%) of its respondents use tax planning software. Others (38%) choose to hire a tax preparer in person or virtually. The remainder prepares it the old-fashioned way. People with simple situations (no businesses, no real estate investment, and little to no investment income) are generally satisfied using tax filing software. However, one thing that can get overlooked is the options available to prepare your taxes for free if you fall below a certain income threshold. In addition, over 94% of individual tax returns are filed electronically.
Choosing a tax preparation method has much to do with your personal preference. For example, if you prefer to have a person prepare your return for you and your situation is relatively simple, a national chain franchise like H&R Block, Jackson Hewitt, or their local equivalent could be your cheapest and quickest solution. Just be aware that there is a wide variation in skills and experience among the people who work in these companies.
If your situation is complex or you have lingering issues with the IRS, you may want to consider an Enrolled Agent or CPA specializing in individual taxes. Enrolled Agents are authorized to represent you in front of the IRS and earn their status either through experience as a former IRS employee or by passing a 3-part comprehensive IRS test on individual and business tax returns. You can search for a local one here. Like Enrolled Agents, CPAs can represent you in front of the IRS and have even more rigorous requirements, but they’re not necessarily more qualified as tax preparers. You will want to interview your prospective CPA to determine how much of their practice they dedicate to helping someone with the same tax concerns as you.
Plan for next year today
To make next year’s filing even less stressful than this year, begin planning before the year is over. Maintain that tax file for important documents as they come in throughout the year, so you do not have to pull it all together this time next year. If your refund is getting dangerously close to you having to pay, update your Form W-4 now to increase your withholding. Also, determine if putting more aside into your 401(k) or HSA could benefit you in the future.
Financial Rules of Thumb: The 50-30-20 Rule
September 20, 2023One way to measure whether or not a particular expense or goal fits into your spending plan is to measure it against your existing financial goals and commitments. A popular way to look at this is called “The 50-30-20 Rule.”
The 50-30-20 Rule
The rule basically says that one way to achieve financial security is to limit your fixed expenses (or needs) to 50% of your after-tax income, your discretionary expenses to 30%, and setting aside 20% toward your goals. Let’s break that down by type so you can see what we mean.
50% to “needs.”
Examples of things that fit in this category include:
- Housing
- Transportation
- Food
- Clothing
- Utilities
- Healthcare
One part of this rule that’s often debated is how much of these categories are true needs versus wants (or discretionary spending). Let’s take the purchase of a vehicle as an example. How much you spend on a vehicle can vary widely. For many people, having a vehicle is a need. They need it to get to work and earn money to pay bills. On the other hand, plenty of people live in big cities who get by just fine without this “need!” Likewise, we all need food to live and clothing to avoid being arrested in public. However, spending on these two categories very easily bleeds over to wants.
Making trade-offs
So you have to be honest with yourself about whether the things you’re putting in this category are absolutely vital to your life or if part of the expense could be classified as a want. Maybe another way to think of it is as a trade-off — it’s fine to spend more on housing if having a more expensive place is important to you; it just means you’ll need to spend less on a car to make it balance.
30% to “wants.”
Examples here include:
- Entertainment, including cable
- Dining out
- Gym membership
- Hobbies
- Personal care beyond the basics
- Cell phone beyond the basic plan
As you can see, the rules can be tricky, so you have to be honest with yourself. Most of us need regular haircuts to maintain a decent appearance. However, spending on a pricey salon cut goes above and beyond, so it belongs in this category.
20% to goals
This category obviously includes savings (including what you put into your retirement account at work) and includes debt payments. So if you’re paying $250 per month on a student loan, that counts toward your 20%.
Tying it all together
Remember, this rule is meant to be a guideline, particularly when you’re just getting started and have no idea what you should be spending on things like rent or a car payment. But it can also offer insights into areas where you may need to cut back. For example, if you run your own numbers and find that your needs far exceed 50%, it may be time to think bigger picture about making some changes – do you need to sell your car for a cheaper payment? Think about moving to lower housing or transportation expenses?
This rule can help show you whether or not you can afford to add a new want into your life. If your wants are way beyond 30%, that definitely means that you can’t afford to add a payment for something like a boutique fitness membership, cleaning service, or upgraded cable package to your life at this point.
Rolling Voluntary 401(k) After-Tax Money To Roth IRA
May 01, 2023Using after-tax 401(k) contributions to execute backdoor conversions to a Roth IRA can be an effective strategy if you want to utilize these funds to retire early. When do employees think about executing this strategy? Consider the following factors:
- You want to retire early
- A large portion of your net worth is tied up in retirement accounts
- Your work retirement plan allows for after-tax contributions to your 401(k) into a separate account
- Your plan also allows in-service direct rollovers from the after-tax account to a retirement account outside of the plan
- You have (or will have) savings or investments in outside retirement accounts that can help to supplement your early retirement
The Basics
At a fundamental level, after-tax Roth IRA conversions allow folks who retire early access to retirement principal without the 10% penalty typically assessed on early withdrawals from these accounts.
In a Roth IRA, you can access contributions anytime because you have already paid tax on the money. You can access the after-tax conversion basis directly rolled into your Roth IRA from your 401(k) without penalty as well. However, each taxable conversion has its own 5-year rule, and if you withdraw the funds within the first five years, unless you have a qualifying reason, the withdrawal may be penalized.
Investments in Roth IRAs have the potential to grow with the market, and earnings are distributed tax-free as long as you hold the account until the age of 59.5 or 5 years, whichever is longer. You may be able to withdraw from your Roth IRA if you have a qualifying reason to take the money out.
Early withdrawals are subject to Roth IRA ordering rules for distribution:
- Contributions
- Conversions (taxable then after-tax)
- Earnings
Seek tax advice before any conversion so you understand the tax implications for your specific situation.
After-tax Contributions to Work Retirement Plans
Certain employer retirement plans allow employees to make three types of contributions:
- Pre-tax/regular
- Roth
- After-tax voluntary
Employees can contribute up to $22,500 (plus a $7,500 catch-up contribution if over 50 years of age) to the pre-tax and/or Roth 401(k) portion of the retirement plan in 2023.
In addition, if your plan allows it and depending on if your employer contributes or not, you may be able to contribute up to another $43,500 to the after-tax voluntary bucket. The IRS aggregate limit of employer and employee contribution increased to $66,000 in 2023 for most workplace retirement plan accounts like 401(k)s.
Use the following equation to figure out how much you can contribute to the after-tax bucket in your retirement plan through work:
| After-tax Contribution Equation | ||||||
| $66,000 is the IRS limit in 2023 | Minus | Pre-tax and/or Roth Contribution$22,500 (+$7,500 if over 50 years) | Minus | Employer Contribution(Discretionary and/or Non-Discretionary) | Equals | Potential After-tax Contribution Allowable |
In-Service After-tax Voluntary Conversion to a Roth IRA
Generally, when completing a 401(k) after-tax voluntary conversion to a Roth IRA, the conversion principal from a direct after-tax rollover is deposited into a Roth IRA, and earnings are rolled over into a Traditional IRA. However, earnings can also be converted to a Roth and tax paid.
When money is converted from the after-tax voluntary bucket of a 401(k) to a Roth IRA over a series of years, employees can build a significant amount of converted principal available to be accessed in early retirement that would otherwise likely be locked up until age 59.5. Though the conversion basis can be accessed, if conversion earnings are distributed before 59.5 and/or five years, whichever is longer, the gains are taxed and penalized.
Why can’t I access these converted funds in my Roth 401(k)? *
In most cases, pre-retirement pro-rata distribution rules apply to unqualified early distributions from a 401(k). If you have a Roth 401(k) and take an early distribution, it will most likely be a mix of taxable (with penalty) and nontaxable funds.
After-tax conversions work in Roth IRAs because distribution rules are ordered as follows:
- Contributions
- Taxable Conversions
- After-tax Conversions
- Earnings
How and when can I access money from a Roth IRA without penalty?
- Always access your contributions penalty-free
- Taxable conversions are penalty-free five years after the conversion
- You can access the nontaxable conversion principal penalty-free at any time
- Access earnings free and clear after 59.5 or five years, whichever is longer
Let’s say you are 30 years old and looking to retire before the age of 50. Having money in a retirement account that is accessible, without penalty, is important regardless of age. Each year for 10 years, you make after-tax contributions to your 401(k) of $10,000, which grow to $11,000 before you request an in-service conversion rollover of this money into a Roth IRA. You invest the Roth IRA for growth, and it earns another $10,000. That growth will be tax and penalty-free as long as you wait until age 59.5 and at least five years to withdraw the earnings. However, the basis that you have converted over the years from your after-tax voluntary 401(k) account can be taken out without penalty or tax, regardless of age.
Here is what happens if you decide to withdraw the entire amount prior to age 59.5:
401(k) Contributions and Gains
After-tax contributions to 401(k) – $100,000
Total gains realized on after-tax contributions – $10,000
Backdoor Conversion to Roth IRA
Basis converted to Roth IRA – $100,000
Growth converted to Roth IRA and taxed upon conversion – $10,000
Withdrawal from Roth IRA prior to age 59.5
Contributions (tax and penalty-free) – $0
Taxable Conversion (10% penalty if held less than 5 years) – $10,000
After-Tax Conversion (tax and penalty free) – $100,000
Gains realized after conversion to Roth IRA (taxable and 10% penalty) – $10,000
Important Notes
* There may be plan-specific rules. Please check with the administrator for your work retirement.
* There are always exceptions to the rules, so before conversion, please seek advice from a tax expert that will help you understand the conversion tax implications.
* There are different distribution rules for after-tax contributions made before 1987. Consult your tax advisor for more information.
* Conversions may affect net unrealized appreciation (NUA) treatment on employer’s stock positions.
Should You Contribute To Pre-Tax Or Roth 401k?
May 01, 2023For all the efforts that companies undertake to make participating in their retirement plan benefits easy, there’s no simple way to help employees decide whether the money they contribute from their own paychecks should be traditional (also called pre-tax) or Roth (also sometimes called after-tax Roth). The answer can be very nuanced depending on your situation, and for the most part, we won’t know whether we chose correctly until it’s too late. We’ll only really know if we got the answer right when it comes time to withdraw and we actually know our taxable income, current tax brackets, and lifestyle needs.
Since my crystal ball seems to be broken, I’ve attempted to distill the various factors in a way that makes more sense. Keep in mind that many of the factors listed in the chart below are just different ways of saying the same thing, but the intention is to present it in the way that makes the most sense to you.
The biggest factor affecting this decision: taxes
If we all could just know what tax rates will be when we retire and start withdrawing from our retirement savings, along with what our own income will be at that point, this would be a simple choice – if you knew your tax rate would be lower when withdrawing from your retirement account, you’d choose pre-tax and avoid paying taxes on the money today so that you could pay at a lower rate in the future.
On the flip side, if you knew that tax rates would be higher when you’re withdrawing and you’d be paying more in taxes, choose Roth to pay today’s lower rates, then enjoy your savings without tax consequences in the future.
Predicting the future of tax rates
I’m personally making Roth contributions right now in my 401(k) because I believe that we are currently experiencing the lowest tax rates I’ll see in my lifetime. And while I very well may have a lower income in retirement, the tax brackets themselves may be different, so even if I have a lower income, I think I might have a higher tax rate in the future. (keep in mind that I could be wrong about this – reason tells me that tax rates will have to go up in the future, but Congress has surprised us before!)
I like that I can change this strategy at any time. For example, when my husband sold some stock he’d been given as a child for a big capital gain, I switched to pre-tax for the rest of that year in an effort to lower our overall taxable income.
Income limits and the ability to withdraw without taxes
I also like the idea of having investments available to me in retirement that I can liquidate and withdraw without concern for the tax consequences, and my husband and I have too high of a combined income to contribute to Roth IRAs, so I like that the Roth 401(k) doesn’t have an income limit.
Now, there is a way around those income limits using a “back-door” Roth IRA, but that doesn’t work for me because I also have a rather large rollover traditional IRA.
Another consideration: access to the contributions for early retirement
You can’t withdraw Roth 401(k) contributions before 59 1/2 without penalty. However, you can withdraw contributions to a Roth IRA early. If you’re lucky enough to retire before then, you can always roll your Roth 401(k) into a Roth IRA. Then, tap those contributions if necessary, without concern for taxes or early withdrawal penalties. That’s another reason you want to at least have some retirement savings as Roth, regardless of tax rates.
Factors to consider:
| Factor: | Traditional (pre-tax) | Roth (after-tax) |
| You think your taxes are higher today than they’ll be when you withdraw | Makes more sense | Makes less sense |
| You think your taxes are lower today than they’ll be when you withdraw | Makes less sense | Makes more sense |
| You want to avoid required distributions after age 72 | Makes less sense | Makes more sense, as long as you roll to a Roth IRA |
| You think your income tax bracket will be lower when you withdraw | Makes more sense | Makes less sense |
| You think your income tax bracket will be higher when you withdraw | Makes less sense | Makes more sense |
| You need more tax deductions today | Makes more sense | Makes less sense |
| You have a long time until withdrawal and plan to invest aggressively | Makes less sense | Makes more sense |
| You’d like access to your contributions before the traditional retirement age | Doesn’t make sense | Makes sense |
Splitting the difference
If you’re unsure or thinking about it makes your head hurt, you could always split your contributions between the two. In other words, if you’re putting 10% away, you could do 5% pre-tax and 5% Roth. The total $22,500 (plus $7,500 catch-up for over 50) applies as a total to both. However, there’s no rule that you have to put your money into just one bucket or the other at a time.
One more thing to know
No matter your contribution type, any matching dollars or employer contributions will always be pre-tax, per IRS rules. So even if you put all your own contributions into Roth, you’ll still have pre-tax money if you receive any from your job. Now, you may be able to convert those contributions to Roth, depending on plan rules. But if you do that, you’ll have to pay taxes on the amount converted, so plan carefully.
How To Save For Retirement Beyond The 401(k)
May 01, 2023Preparing for retirement is an essential part of financial planning. Employer-sponsored retirement plans, such as 401(k) plans, are a common tool for saving. While contributing to a 401(k) can be a great way to save for retirement, it’s important to consider other options as well.
First things first
Are you fortunate enough to work for a company that offers to match employer-sponsored retirement plan contributions? If so, you should put the required minimum into the account to get that free money. Doing less is basically like turning down a raise!
Once you’re doing that, there are reasons that you may want to save additional funds outside the 401(k). Of course, if you don’t have a match or a 401(k) available, you may also need another way to save. Besides not having a 401(k) option, the most common reason to invest outside a 401(k) is investment selection. So, here are some other common options:
IRA
For the self-employed, there are actually many different tax-advantaged retirement accounts you can contribute to. If you work for a company that doesn’t offer a retirement plan, you can still contribute to an IRA. If this is the case, you can contribute up to $7,000 (or $8,000 if 50+) to an IRA. Additionally, you can deduct traditional IRA contributions no matter your income. However, income limitations exist on deducting contributions when you already have a 401(k) or 403(b) available.
A popular choice these days is the Roth IRA. This is partially because of the tax benefits. However, there is also more flexibility in accessing Roth IRA money early versus traditional or even Roth 401(k)s. For example, you can withdraw your Roth IRA contributions without taxes or penalties. Another benefit is your ability to withdraw up to $10k in growth for a first-time home purchase. You don’t have that option with a 401(k), at least not without tax consequences.
HSA
If you have access to a high-deductible health insurance plan, you can contribute to a health savings account (HSA). Contributions are limited to $4,150 per person or $8,300 per family (plus an extra $1,000 if age 55+). The contributions are tax-deductible, and the money can be used tax-free for qualified health care expenses. If you use the money for non-medical expenses, it’s subject to taxes plus a 20% penalty. However, the penalty goes away once you reach age 65, turning it into a tax-deferred retirement account that’s still tax-free for health care expenses (including most Medicare and qualified long-term care insurance premiums). You may also consider avoiding using the HSA even for medical expenses and investing it to grow for retirement.
US Government Savings Bonds
Each person can purchase up to $10k per year in Series EE US Government Savings Bonds. For Series I Savings Bonds, that limit is $10k (plus another $5k from tax refunds). The federal government guarantees these tax-deferred bonds, which don’t fluctuate in value. As such, they can be good conservative options for retirement savings. However, you can’t cash them in the first 12 months, and you lose the last 3 months of interest if you cash them in the first 5 years. Interest rates may remain low, but the I Bonds are based on inflation, which is slowly creeping up.
Regular account
If you’ve maxed out your other options, you can always invest for retirement in a regular taxable account. You can minimize taxes by investing according to your tax bracket. For example, invest in tax-free municipal bonds if you’re in a high tax bracket. Holding individual securities for at least a year will keep capital gains taxes low. You can also choose low-turnover funds like index funds and ETFs. Another strategy is to use losses to offset other taxes, including up to $3k per year from regular income taxes. The excess carries forward indefinitely. Just be aware that if you repurchase an identical investment within 30 days, you won’t be able to take the loss off your taxes.
Regardless of how you choose to save for retirement, the most important thing is that you save enough. Run a retirement calculator to see how much you need to save. Then, increase contributions through payroll or direct deposit. If you can’t save enough now, try gradually increasing your savings rate each year. Like it or not, your ability to retire depends on you.
The 401(k) Self-Directed Brokerage Window
May 01, 2023Are you a hands-on investor seeking investments beyond your 401(k) plan’s core list of investment choices? If so, you may have a self-directed brokerage account (SDBA) option in your retirement plan.
Who typically uses a self-directed brokerage account in a 401(k) plan?
SDBAs are intended for experienced investors who are comfortable making their own investment decisions. This option is generally popular among savers with larger retirement plan balances or who work with an outside financial advisor. For example, Schwab recently reported that the average account balance of those using this option is just over $273,000. Compare this to Fidelity’s reported average balance of all 401(k) participants, which is just under $104,000.
What does a self-directed brokerage account offer?
The main benefit is that SDBAs give you more flexibility regarding the investment options available. Wider access can be a refreshing alternative if you are generally unhappy with the currently available investment options.
For example, let’s say your 401(k) plan doesn’t include target-date or asset allocation funds. With the SDBA, you can add those funds to your retirement portfolio. This can be appealing if you’re trying to access asset classes not represented in your core portfolio. Examples include emerging market stocks, international small cap, and value or growth-oriented funds. SDBAs can even help you diversify with alternative asset classes such as real estate and commodities.
Beware of the paralysis of too many choices
But as behavioral finance studies on the paradox of choice have shown us, too many options can hinder participation. This is true for 401(k) plans as well. Choosing the right investments for your goals, risk tolerance, and time horizon also requires discipline. Most investors lack a written game plan or investment policy statement. As a result, many individual investors are prone to the “behavior gap” and underperform the actual funds they own due to mistakes related to emotional decision-making and market timing.
Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. Bankrate warns investors that the additional choices commonly associated with self-directed accounts do not lead to better outcomes for most investors. In order to follow a disciplined investment plan, focus on things within your control, such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401(k)).
Pay attention to the fees
It’s important to note that while SDBAs offer greater investment flexibility, they may also come with higher fees. These fees can include transaction fees, account maintenance fees, and trading commissions. So, carefully consider the costs and benefits of an SDBA and your investment objectives and risk tolerance before opening one.
Minimizing your overall investment costs is one thing you have some control over as an investor. So, it’s equally important to understand all fees and expenses as it is to know your core 401(k) plan expenses.
Some 401(k) plans charge an annual maintenance fee for using the mutual fund or brokerage window. It is also necessary to identify if there are any commissions and transaction costs associated with trades made through SDBA accounts. You can check your plan’s fee disclosure to better understand the actual costs related to your 401(k) plan.
Check mutual fund expenses
In some cases, you may also see increased mutual fund expenses when you go outside your core investment options. This is because most funds available in the SDBA are retail share classes. Retail share classes tend to be much more expensive than the institutional funds many large retirement plans provide access to. On the other hand, if your 401(k) plan has expensive mutual funds, the self-directed brokerage account is a potential remedy.
How does its performance compare?
Finally, it is important to note that there is a reason self-directed brokerage accounts are underutilized. The average investor is often better served by simplifying their investments as much as possible. That is why it is important to establish benchmarks to track your performance.
Self-directed brokerage accounts give you an opportunity to try to outperform or diversify your plan’s core options. But if you choose to take the self-direct route and find that your investment performance consistently lags behind the core investment portfolio, you may need to take a simpler approach to your retirement savings plan.
What is a 403(b) Plan?
March 21, 2023What is a 403(b) Plan?
If you have ever worked for a nonprofit organization, you likely have heard the term 403(b) retirement plan. While not as common as the 401(k), a 403(b) shares many of the same benefits that make it a very powerful retirement tool for those working for public schools and other tax-exempt organizations.
The Details
As noted above, 403(b) plans have much in common with the 401(k) plan, which is very common in the private sector. Participants that may have access to 403(b) include:
- Employees of public schools, state colleges, and universities
- Church employees
- Employees of tax-exempt 501(c)(3) organizations
The 403(b) plan has the same caps on annual contributions applying to 401(k) plans.
Employers can match contributions based on the specific plan details, which vary from employer to employer.
Employees may also be able to contribute to a pre-tax 403(b) and/or Roth 403(b), as both options may be available based on the plan details. A traditional 403(b) plan allows employees to have pre-tax money automatically deducted from each paycheck and deposited into their retirement account. The employee receives a tax break as these contributions lower their gross income (and income taxes owed for the year). The taxes will be due on that money only when the employee withdraws it in retirement.
A Roth 403(b) is funded with after-tax money, with no immediate tax advantage. But the employee will not owe any more taxes on that money or the profit it accrues when it is withdrawn (if they are 59 ½ and have a Roth for five years).
Pros and Cons
Being able to save for retirement automatically is a tremendous benefit of the 403(b) construct. The tax-deferred (pre-tax) or tax-free growth(Roth) nature of these savings is also a huge incentive for employees to save as much as possible – not to mention the free money an employer match may provide. Many 403(b) plans will have a shorter vesting period relative to their 401(k) cousin, which allows. This means employees will have access to the matching funds quicker should they change employers.
On the downside, withdrawing funds before age 59 ½ will likely result in a 10% early withdrawal penalty. And many 403(b) plans offer a more limited range of investment options than other retirement plans.
Other Considerations
While not common, some employers may offer a 403(b) and 401(k) plan. In that instance, employees are still restricted to the current year’s limit for both plans combined. For example, if the limit is $22,500 and $10,000 is contributed to the 401(k), the max 403(b) contribution is $12,500.
Another unique, but not necessarily common, feature that may be available in additional catch-up contributions. Employees with 15 or more years of service with certain nonprofits or government agencies can contribute an additional $3,000 yearly. However, regardless of age, there is a lifetime limit of $15,000.
Summary
Like the 401(k), the 403(b) retirement plan is critical to retirement planning and saving for individuals with access to them. The automatic saving nature of the plan makes it very convenient to save for the future. Saving early, often, and as much as you can afford will set you up for your coveted retirement. Happy Saving!
Employer Retirement Plan Backdoor Roth Conversions
January 13, 2023One increasingly popular strategy we have seen is the backdoor Roth conversion through an employer’s workplace retirement plan. If your employer’s plan allows, this strategy will enable you to convert after-tax voluntary 401(k) contributions to a Roth 401(k). When is it a good idea to contribute to an after-tax voluntary 401(k) and convert to a Roth 401(k)? Here are some factors to evaluate if you are considering this strategy:
- Your plan allows after-tax voluntary contributions, and you want to save more than the pre-tax/Roth 401(k) 2024 elective deferral contribution limit of $23,000 or $30,500 if you’re over 50 years old.
- You have a fully-funded emergency savings account, a reasonable debt situation, and do not need the liquidity.
- You make too much to contribute to a Roth IRA but still want to save Roth dollars for your retirement.
- You don’t want the hefty tax bill of a taxable conversion of pre-tax to Roth.
- And most importantly, you love TAX-FREE money for your retirement!
The Basics
At a fundamental level, converting after-tax voluntary 401(k) money to a Roth 401(k) allows employees to save significantly more, tax-free, for retirement.
You don’t get a current-year tax deduction for the money deposited after-tax and then converted to a Roth 401(k), but the funds grow and are distributed tax-free as long as you hold the account until the age of 59.5 and it has been 5 years since your initial contribution into the Roth 401(k).
After-tax Voluntary Contributions in Work Retirement Plans
Some employer retirement plans allow employees to make three types of contributions 1) pre-tax, 2) Roth, and 3) after-tax voluntary. After-tax voluntary contributions have already been subject to income tax.
Generally, employees can contribute up to $23,000 (plus a $7,500 catch-up contribution if over 50) to their pre-tax and/or Roth portion of the 401(k) in 2024. The combined annual IRS contribution limit is $69,000 in 2024 for most employer-sponsored retirement plans.Further, if your plan allows it and depending on whether your employer contributes or not, you may be able to make after-tax voluntary contributions above the basic limit.
It’s a good idea to work with your retirement plan administrator to find out exactly how much you can contribute (if the plan allows) to the after-tax voluntary account, but to get an idea, use the following equation:
| After-tax Contribution Equation | ||||||
| $69,000 is the IRS limit in 2024 | Minus | Pre-tax and/or Roth Contribution $23,000 (+$7,500 if over 50 years) | Minus | Employer Contribution(Discretionary and/or Non-Discretionary) | Equals | Potential After-tax voluntary Contribution Allowable |
Backdoor Roth 401(k) Conversion
In addition to contributing to the after-tax voluntary portion of your 401(k), your company’s plan may allow you to convert this contribution to your Roth 401(k). You may be able to contribute up to $46,000 in 2024 of after-tax voluntary dollars and then convert all of it to your Roth 401(k)! That’s right – up to $46,000 growing tax-free for retirement. Some plans also allow you to roll this money outside the plan via a rollover to a Roth IRA.
What if my 401(k) Doesn’t Allow an In Plan Conversion?
If your plan doesn’t allow the backdoor option while working, you’ll have to wait until you separate from your employment. Typically, you can then roll after-tax voluntary contributions to a Roth IRA and after-tax voluntary earnings to a pre-tax Traditional IRA account, or you can convert the earnings and pay tax on that portion of the conversion.
Example
Henry has a great job as a software engineer. He earns a significant income and lives a simple life. He maxes out his pre-tax contribution to his 401(k), which is $23,000 in 2023, and his company contributes $9,500. Henry also contributes an additional $36,500 to the after-tax voluntary portion of his 401(k).
| After-tax Contribution Equation Example | ||||||
| $69,000 is the IRS limit in 2024 | Minus | Pre-tax and/or Roth Contribution $22,500 (+$7,500 if over 50 years) | Minus | Employer Contribution(Discretionary and/or Non-Discretionary) | Equals | Potential After-tax Voluntary Contribution Allowable |
| $69,000 | – | $23,000 | – | $9,500 | = | $36,500 |
His retirement plan allows him to convert the after-tax voluntary contributions to his Roth 401(k). In fact, if his plan allows, Henry can set up his conversions to happen automatically as soon as he contributes his after-tax voluntary dollars. He continues to convert the money to his Roth 401(k), building up tax-free funds for retirement.
Conclusion
The 401(k) Backdoor Roth Conversion is an excellent opportunity to save more for retirement in your 401(k) than the pre-tax and Roth contribution limits will allow. It makes the most sense for those who already have a stable financial foundation and do not anticipate liquidity needs before retirement.
Notes
* There are always exceptions to the rules, so before conversion, seek advice from a tax expert that will help you understand the conversion’s tax implications to your specific situation.
* There may be plan-specific rules. Please check with the administrator for your workplace retirement plan.
* There are different distribution rules for after-tax voluntary contributions made before 1987. Consult your tax advisor for more information.
* Conversions may affect net unrealized appreciation (NUA) treatment on employers’ stock positions.
Choosing A Top 2% Financial Planner
February 10, 2022Are you looking for a financial planner to help you sort out all the volatility in the stock market? Not to mention the constant discussion of potential tax law changes? Don’t worry. This is not a sales pitch.
In fact, as workplace financial educators, we often get asked if we provide financial planning and coaching directly for individuals. Unfortunately, we have to turn them down since we only work with employees through financial wellness benefits their employer provides. Financial Finesse strives to have the most impressive team of financial planners that anyone would recommend to a friend or family member.
So how did we find them? The answer is a rigorous series of interviews and auditions from which only the top 2% are hired. While you can’t duplicate the process exactly, there are many aspects that can be applied to your search.
Follow the money
Before we even begin looking at resumes, we make it very clear that we are not hiring commissioned salespeople. In fact, our planners have to give up any sales licenses upon being hired. After all, even the most honest planners can talk themselves into believing something that their paycheck is dependent upon.
To avoid these types of biases, look for planners that don’t sell financial products. Look for planners that charge a fee. However, be aware that “fee-based” planners usually charge a fee and collect a commission. Instead, you want a “fee-only” planner that doesn’t accept commissions at all.
One resource is the National Association of Personal Financial Advisors or NAPFA, which is an organization of fee-only financial advisors. Many of them charge fees based on a percentage of the assets they manage. They also typically require a minimum level of assets to work with them. However, some charge fixed annual, monthly, or hourly fees instead. I find this to be the most unbiased approach and usually the most cost-effective as well.
Know your ABCs and CFPs
You wouldn’t go to a doctor without an MD or a lawyer without a law degree, would you? Doctors and lawyers are legally required to have certain designations in order to practice, but not so for financial planners. They must simply pass two tests. One on securities law to sell or provide advice on investments and another on insurance law to sell insurance.
To fill the gap, an alphabet soup of designations has arisen that planners can purchase with the hope of buying some credibility. It’s essentially just another form of marketing. This has led to a lot of confusion for people looking for expertise.
While there are many respected financial planning credentials, all of our planners are required to have the CFP® mark. The CFP® mark has long been the most widely recognized designation in the profession. To become CFP® certified, a financial planner must attain a certain level of financial education, pass a comprehensive financial planning exam, have at least three years of full-time experience, and undergo a background check. To stay in good standing, planners must continue taking continuing education courses and maintain high ethical standards. While no screening process is perfect, it can weed out a lot of people you don’t want handling your money. Other worthy designations include the ChFC and PFS (which is only available to a CPA, which is another trustworthy credential).
Experience matters
While you must have three years of experience to gain a CFP® certification, Financial Finesse requires at least ten years. Research has shown that it takes about 10,000 hours of deliberate practice to master a skill, including financial planning. This is especially important in the financial industry. Many financial planners enter the profession with no financial background then set loose after little more than sales training.
For example, I started my financial career right out of college largely based on having done well selling cutlery. Needless to say, I’m a much better planner now than I was then. I wasn’t the only one without any real financial experience though. Most of my colleagues were in the same boat, and many decided to switch careers within the first few years, forcing their clients to find a new planner.
Ten years also usually gives financial planners exposure to a full market cycle. That’s important because there many hard-learned lessons at each stage of the cycle. It’s probably best if a planner isn’t learning those lessons with your life savings.
Personality matters too
Once we screen resumes for credentials and experience, we conduct a series of interviews and auditions. These interviews test the candidate’s financial knowledge, ability to provide education and guidance, and whether they’re a good cultural fit. Likewise, once you’ve narrowed your search, interview at least three to determine the one most personally compatible with you. Are they easy to talk with? Do they seem to listen and really understand you? Do they come across as trustworthy?
Trust but verify
Before we hire anyone, we check their references and credit report. Ask your prospective planner if they have any clients similar to you that you can call for a reference. Almost anyone can find someone to provide a good reference so you’ll want to do your own research too. You can find information on the Investment Advisor Public Disclosure website if the planner is an investment broker or advisor.
It may seem like a lot to do, but choosing a financial planner is a big decision. This can be a lifelong relationship with someone that can help you achieve some of your most important goals. Don’t you want them to be in the top 2%?
Mega Roth Conversions
January 14, 2022
The Risks Of Employer Stock
November 15, 2021One of the biggest risks lurking in people’s investments is having too much in a current or former employer’s company stock. What’s too much?
Rule of thumb
You should generally have no more than 10-15% of your investment portfolio in any single stock. It’s worth noting that an investment adviser can lose their license for recommending more than that.
More than just a stock when it’s your job
So why is this such a bad idea? What if your company stock is doing really well? Well, remember Enron, anyone? While it’s practically impossible for a well-diversified mutual fund to go to zero, that could easily happen with an individual stock. In that case, you could simultaneously be out of a job and a good bulk of your nest egg.
Now, I’m not saying your company is the next Enron. It could be perfectly managed and still run into trouble. That’s because you never know what effect a new technology, law, or competitor can have, regardless of how good a company it is.
Nor does the company have to go bankrupt to hurt your finances. Too much in an underperforming stock can drag down your overall returns, and even a well-performing stock can plummet in value just before you retire. As volatile as the stock market is as a whole, it’s nothing compared to that of an individual stock.
Why do we over-invest in our own companies?
So why do people have so much in company stock? There are two main reasons. Sometimes, it’s inadvertent and happens because you receive company stock or options as compensation. For example, your employer may use them to match your contributions to a sponsored retirement plan. Other times, it’s because people may feel more comfortable investing in the company they work for and know rather than a more diversified mutual fund they may know little about.
A general guideline is to minimize your ownership of employer stock. After all, the expected return is about the same as stocks as a whole (everyone has an argument about why their particular company will do better, just like every parent thinks their child is above average). Still, as mentioned before, the risks are more significant. That being said, there are some situations where it can make sense to have stock in your company:
When it might make sense to keep more than usual in company stock
1) You have no choice. For example, you may have restricted shares that you’re not allowed to sell. In that case, you may want to see if you can use options to hedge the risk. This can be complicated, so consider consulting with a professional investment adviser.
2) You can purchase employer stock at a discount. If you can get a 10% discount on buying your employer’s stock, that’s like getting an instant 10% return on your money. If so, you might want to take advantage of it but sell the shares as soon as possible and ensure they don’t exceed 10-15% of your portfolio.
3) Selling the stock will cause a considerable tax burden. Don’t hold on to a stock just because you don’t want to pay taxes on the sale, but if you have a particularly large position, you may want to gift it away or sell it over time. If you do the latter, you can use the same hedging strategies as above.
4) You have employer stock in a retirement account. This is a similar tax situation because if you sell the shares, you’ll pay ordinary income tax when you eventually withdraw it. However, if you keep the shares and later transfer them out in kind to a brokerage firm, you can pay a lower capital gains tax on the “net unrealized appreciation.” (You can estimate the tax benefit of doing so here.) In that case, you may want to keep some of the shares, but I’d still limit it to no more than 10-15% of your total portfolio.
5) You have a really good reason to think it’s a particularly good investment. For example, you work at a start-up that could be the proverbial next Google. It may be too small of a company for analysts to cover, so it may genuinely be a yet-to-be-discovered opportunity. In that case, go ahead and get some shares. You may strike it rich. But remember that high potential returns come with high risk so ensure you’ll still be financially okay if things don’t pan out as hoped.
The ups and downs of the stock market typically get all the media and attention. But your greatest investment risk may come from just one stock. So don’t put all your eggs in it.
Expense The Unexpected: The Emergency Fund
September 28, 2021Finances are different for everyone, and so are the life events we all go through. An emergency fund is your financial line of defense against life’s lemons. Although there are many financial rules of thumb, there is no “normal” way to handle your emergency fund. However, there are some answers to common questions to help you financially prepare for unexpected expenses.
What is the reason for my emergency fund?
The emergency fund is your safety net to avoid getting into a difficult financial situation due to loss of income and significant, unexpected, one-time expenses. Having one in place can reduce stress, anxiety, and other emotions that could make handling the non-financial aspects of an emergency much more difficult.
It may seem a little obvious that an emergency fund is for emergencies. However, one of the challenging aspects of an emergency fund is knowing what expenses qualify as an emergency. This fund’s sole purpose is to prepare you for costs that you cannot or would not typically plan out. For example, oil changes and new tires are vehicle expenses you know you will have at some point. However, you wouldn’t typically plan for vehicle costs that could vary widely depending on the situation. Examples of this are towing costs, medical care, and insurance deductibles you might pay in a car accident, something you would not plan to happen.
How much do I need?
How much would a new furnace cost? If you could not work, how much would you need to cover essential expenses until you could? Asking yourself these kinds of questions will help you set a goal amount for your emergency fund. The Expense Tracker can help you add those expenses up, or you can use your online banking to crunch the numbers. That exercise can also help you figure out how much you can afford to save each month as you work up to your goal amount.
The general rule of thumb is three to six months of your expenses. However, you can always start with a goal you find achievable. Say, for example, $1,000. Once you reach that goal, aim for three months of rent, then three months of the following essential expense, and so on.
How do I save that much?
Start small – If you have not started your fund, consider putting $25 from every paycheck into a savings account. You can use the Daily Savings Calculator to see the impact that even a few dollars will make in the long run. Then, check your budget or spending plan to see how much you can save after you’ve paid essential expenses and before budgeting for discretionary spending.
Keep it separate, saver – Open a separate savings account to help you resist the temptation to dip into it. Remember, this account is for emergencies, so keep it away from your daily spending accounts and separate it from vacation and holiday savings. This method will help you stay organized, visualize your progress, and provide you peace of mind.
Automate your savings: Set up a direct deposit or automatic monthly transfer to your separate savings account. Your employer may be able to take money directly out of your check and deposit it for you. Otherwise, set up an automatic transfer from checking to savings on payday. This method will help you avoid adding a manual transfer to your list of to-do’s that you may end up not getting around to doing.
Will I ever need to change the amount?
As your life changes, the amount you need in your emergency fund will change as well. It’s a good idea to revisit your emergency fund plan every six months or any time you experience a life event that impacts your income. Marriage, starting or adding to your family, buying a home, and divorce are just a few examples of when you may need to increase your emergency fund. A good savings plan can roll with the punches right alongside you!
How do I prioritize emergency savings against debt and other goals?
Deciding whether you should pay down debt, increase cash savings, or invest is all about the big picture. Since everyone has different financials, that picture will not be the same for everyone. What is going to impact you the most financially? Paying down debt and saving money long term or having a plan B that allows you to keep making minimum payments if you lose income? There is no right or wrong answer. Perhaps a good compromise is to have one month’s worth of minimum credit card and loan payments before you start to pay down debt or invest aggressively. You will have peace of mind knowing that you won’t fall further into debt or face collection action, and you will have started your path to being debt-free!
Your emergency fund is there to help you expense the unexpected. So make a plan and use the above suggestions to be ready for whatever comes your way!