Retirement accounts and their tax consequences

 Pretax Retirement Accounts

Some of the most common pretax retirement accounts are the 401(k), traditional IRA, 403(b) and 457 plans. Retirement savers were generally given a tax deduction when they made contributions to these plans and will owe taxes when they eventually make withdrawals from these pretax retirement accounts.     

 At some point, you will be forced to begin making withdrawals. These are called required minimum distributions (RMDs), which now kick in at age 72. People who are still working at age 72 (or older) can potentially delay taking RMDs from their 401(k)s until they retire. RMDs will still be required at age 72 for traditional IRAs, regardless of if you have retired or not.

Post Tax Retirement Accounts:  Roth IRAs

You can take tax-free retirement income from both a Roth IRA and a Roth 401(k). Unlike a traditional IRA, you won't get a tax deduction when you contribute to a Roth account, but your growth and withdrawal are tax-free in retirement.

For withdrawals to qualify as tax-free retirement income, you must meet two criteria. First, you must have held your Roth account for at least five years before you can take tax-free withdrawals. And although you can withdraw your contributions at any time tax-free, you generally must be at least age 59½ to be able to withdraw the growth of the account without facing a 10% early withdrawal penalty.

Social Security Retirement Income

There was a time when all Social Security income was tax-free. However, that came to an end ironically at the hands of Ronald Reagan, who is generally thought of as someone who wanted to slash taxes. The good news is that not all your Social Security benefits will be taxed in retirement.

If your provisional income is less than $25,000 ($32,000 for married couples filing a joint return), your Social Security benefits are still tax-free. If your provisional income is between $25,000 and $34,000 ($32,000 and $44,000 for joint filers), then up to 50% of your benefits are taxable. If your provisional income is more than $34,000 ($44,000 for joint filers), then up to 85% of your benefits are taxable.

While I am a huge fan of generating tax-free income in retirement, I hope everyone reading this will have an income large enough that at least some of your Social Security benefit gets taxed.

Pensions Income

Pensions are typically funded with pretax money like your 401(k) or IRA. That means your pension income in retirement will be taxable.

Business owners and the self-employed coming up on retirement may be able to make substantial contributions to a Cash Balance Pension Plan. Depending on your age and income, you may be able to contribute around $300,000 or so, pretax, into your own pension. (This number can be even larger if you have family members working with you in the business). This can be a huge tax planning opportunity and a great way to catch up when it comes to increasing your retirement income.

Stocks, Bonds, ETFs, and Mutual Funds

Assuming you own stocks, bonds, ETFs, or mutual funds outside of your specific retirement accounts (like an IRA or 401(k)), your gains will be taxed when they are realized. If you sell your investment after you've held it for more than a year, the proceeds are taxed at long-term capital gains rates of 0%, 15% or 20%. This can be a huge tax saving when compared to the top 37% tax bracket on ordinary income.

Higher earners may also get hit with the Obamacare surtax. This is a 3.8% surtax on net investment income (NII) on top of the capital gains rate for single taxpayers with modified adjusted gross incomes of more than $200,000 and $250,000 for joint filers. This extra 3.8% tax is due on the smaller NII or the excess of modified AGI over the $200,000 or $250,000 amounts. NII includes income from dividends, taxable interest, capital gains, passive rents, annuities, royalties, etc.

When you sell an investment that you have held for a year or less, the gains are short-term and are taxed at your ordinary income tax rates.

Annuity Income

For those with a non-qualified annuity, when you take retirement income payments from an annuity, there is a good chance that most of the income you receive will be taxable. The portion of the payment that represents your principal (the money you contributed) is tax-free; the rest is taxable. When taking income from an annuity, you take out your account's growth first, which is taxable.  

If you just happen to own an annuity in a 401(k), IRA, Roth IRA and so on, the taxation rules listed above would apply.

Dividend Income

Not all dividend income is created equally. Income paid in the form of dividends by companies to their stockholders is treated for tax purposes as qualified (most common) or non-qualified. Qualified dividends are taxed at long-term capital gains rates. Non-qualified dividends are taxed at ordinary income tax rates.

Municipal Bond Taxation

Municipal bond interest is exempt from federal taxation. Similarly, interest from government bonds issued in your home state is typically exempt from state income taxes. However, when buying and selling municipal bonds, you will still be subject to federal capital gains taxation.

Interest on a Bank Account

Fortunately, or unfortunately, depending on how you look at it, this isn't much of an issue for most people. That is because of today's minuscule interest rates. But it is still good to know that ordinary income tax rates apply to interest on banks' interest, including savings accounts, certificates of deposits, and even money market accounts. Most banks will only issue a 1099 tax form if you earn at least $10 in interest during a calendar year across your accounts with them.

Cash-Value Life Insurance

For those with cash-value life insurance, which I often call the Rich Person Roth, you can potentially get a lifetime of tax-free income. Assuming you follow the IRS rules, you should be able to avoid taxation on gains within your cash life insurance policy. Talk with your trusted financial planner to make sure you understand the rules and guidelines to maximize the value of your policy and the tax-free income it can generate.

You've worked hard building up your retirement nest egg. Make sure to put some effort (or seek expert tax planning guidance) into planning your retirement income streams. Why pay more taxes in retirement than needed? Smart tax planning and retirement income strategies can help you reduce your taxes in retirement and thereby increase your net retirement income.

Thanks to David Rae at Forbes for pulling this valuable information together!

SBA Quadruples Covid 19 EIDL limits

SBA quadruples COVID-19 EIDL limit to $2 million 

The U.S. Small Business Administration (SBA) announced major modifications to the COVID-19 Economic Injury Disaster Loans (EIDL) program, including raising the loan cap from $500,000 to $2 million and adding business debt payments to the list of ways businesses can use the loan proceeds. 

  In a news release issued late Thursday afternoon, the SBA said it was implementing the changes to make it easier for the small business communities still reeling from the pandemic, especially hard-hit sectors such as restaurants, gyms, and hotels, to access the more than $150 billion in funding available for loans.

The following key changes were announced. 

1) All are effective immediately: 

2) Increasing the COVID-19 EIDL cap from $500,000 to $2 million: 

3) Loan proceeds can be used for any normal operating expenses and working capital, including meeting payroll, purchasing equipment, and paying debt. 

4) COVID-19 EIDL funds are now also eligible to prepay commercial debt and make payments on federal business debt. 

5)  Implementation of a deferred payment period: 

6) The SBA said small business owners will not have to begin COVID-19 EIDL repayments until two years after loan origination. 

7) Payments are deferred for the first two years (during which interest will accrue), and payments of principal and interest are made over the remaining 28 years.  The agency previously had implemented an 18-month deferment period for loans made during 2021. Establishment of a 30-day exclusivity window: 

8) To ensure Main Street businesses have additional time to access these funds, the SBA said it is implementing a 30-day exclusivity window of approving and disbursing funds for loans of $500,000 or less. Approval and disbursement of loans over $500,000 will begin after the 30-day period. 

Simplification of affiliation requirements: To ease the COVID-19 EIDL application process for small businesses, the SBA established more simplified affiliation requirements to mimic those of the $28.6 billion Restaurant Revitalization Fund. 

The COVID-19 EIDL program, which runs through Dec. 31, offers 30-year loans with fixed interest rates of 3.75% for small businesses, including sole proprietors and independent contractors, and 2.75% for not-for-profits. The SBA referenced the RRF in an interim final rule (IFR) published Wednesday that provides details on many of the changes to the COVID-19 EIDL program. The IFR notes that while the RRF was appropriated $28.6 billion to provide as grants to the restaurant industry, the program received 278,304 applications seeking more than $72 billion in assistance, nearly three times the amount appropriated. Funding was quickly exhausted, leaving 177,300 businesses without assistance — evidence, the SBA said, of unmet funding needs by businesses in an economy now dealing with an upswing in COVID-19 infections related to the Delta variant of the virus. The IFR also expands COVID-19 EIDL eligibility from organizations with no more than 500 employees to businesses in the hardest-hit industries that have 500 or fewer employees per physical location, provided the business, together with its affiliates, has no more than 20 locations. The new rule allows COVID-19 EIDL recipients to use loan proceeds to make debt payments including monthly installments, deferred interest, and pre-payment on business debt. The same payments, except for pre-payments, are now permitted on loans from federal agencies (including the SBA) and licensed Small Business Investment Companies (SBICs).