Often if you are in dire need for money the most tempting area to look is your IRA, 401(k), and other qualified retirement accounts. These funds, set aside for your retirement, may seem to be the answer to your financial woes.
Should I take an early withdrawal?
Is it a good idea to tap into retirement account funds prior to reaching age 59½? Here are some things to consider:
The penalty. Retirement funds taken out for non-qualified use are not only subject to regular income tax, but are also subject to a 10% early withdrawal penalty.
Debt collectors love it. Debt collectors are commonly prohibited from access to your retirement accounts. So if you are using the funds to put off debt collectors, be aware that you may be using funds that might be protected if you became insolvent.
There is an opportunity cost. Currently the funds in your traditional IRA, 401(k), and similar retirement plans grow tax deferred. So a dollar today will compound until you withdraw the funds at retirement. This growth is lost with early withdrawals.
Not for your kids. It is usually not a good idea to use early withdrawals to help pay a child’s debt or school costs. There are better ways to help children financially than to pay the stiff penalty on your early withdrawal.
If you still need to make the early withdrawal
Withdraw “after-tax” contributions first. This can be Roth IRA contributions or other after-tax contributions. Why? Since these funds have already been taxed, there is often no additional tax burden or early withdrawal penalty.
Certain withdrawals from qualified plans are allowed. This includes hardship withdrawals for qualified medical expenses, qualified educational expenses, and up to $10,000 to purchase a first time home.
Consider taking out a loan from your employer-provided 401(k). You will then repay this loan to your retirement account with interest. But be careful, you are required to repay any outstanding balance when you leave your job.
Look into substantially equal payments. Look into taking the distributions as part of a series of substantially equal periodic payments over your life expectancy. If done right, this can help avoid the 10% early withdrawal penalty.
While it is never a great idea to tap into funds that are specifically set aside to make your retirement stress-free, if you must do so it is worth being thoughtful about how you go about the withdrawal.
There is still time to make a contribution to a traditional IRA or Roth IRA for the 2019 tax year. The annual contribution limit is $6,000 or $7,000 if you are age 50 or over.
Prior to making a contribution, if you (or your spouse) are an active participant in an employer’s qualified retirement plan (a 401(k), for example), you will need to make sure your modified adjusted gross income (MAGI) does not exceed certain thresholds. There are also income limits to qualify to make Roth IRA contributions.
Maximum 2019 IRA Contribution amounts: $6,000 or $7,000 (with age 50+ catch-up provision)
Note: Married traditional IRA limits depend on whether either you, your spouse or both of you participate in a qualified employer-provided retirement plan. If married filing separate and either spouse participates in an employer’s qualified plan, the income phaseout to contribute is $0-10,000.
If your income is too high to take advantage of these IRAs you can always make a non-deductible contribution to an IRA. While the contributions are not tax-deferred, the earnings are not taxed until they are withdrawn.
Your credit score is more important than ever. Once viewed as a necessity when applying for a mortgage, it now factors into renting an apartment, paying for utilities, buying a cell phone, and determining the amount you pay for home and auto insurance! Here are tips to help you improve and maintain a good credit score:
Know which bills must be paid on time. One bill that goes more than 30 days past its due date can drop your credit score 40 points and can stay on your credit report for seven years! If you are in a cash pinch and can’t pay all your bills on time, prioritize mortgage, car loan and credit card bills that report late payments to credit agencies. Utilities and medical organizations generally don’t report a delinquency until your account is sent to a collection agency.
Watch revolving credit balances. Each credit card has a credit ceiling. This credit limit is compared to how much of it you use. The higher amount of the credit limit you use, the lower your credit score. Even if you pay the bill in full each month! Ideally, try to keep the spending balance less than 20 percent of your credit limit. If your routine spending is higher than this, consider requesting a higher line of credit, but do not use it. The sole purpose of this request is to create a higher credit score.
Pay off debt. Current debt balances account for as much as 30 percent of your credit score. When you consider this and the high interest rates that come with debt, it’s important to get those balances to zero as soon as possible. Your debt-to-income ratio (total debt divided by your total income) doesn’t directly affect your credit score, but it’s a key metric used by underwriters when determining loan eligibility and interest rates.
Add new debt only when necessary. Adding new debt can reduce your credit score in a few different ways: your debt profile increases, your debt-to-income ratio rises, and even the credit inquiry itself can take a chunk out of your score. If you have a relatively short credit history, too many credit inquires will affect you even more.
Consider keeping dormant credit cards open. Have an open credit card that you’ve paid off or have never used? Your instinct might tell you to close the account, but keeping it open may actually help your credit score. An active credit card in good standing for a long period of time helps your credit score. Plus, the additional unused credit limit on your books lowers the ratio of spending to total credit limit and improves your score.
Actively monitor your credit reports. You can get a free credit report from each reporting agency every 12 months on the Annual Credit Report website. These reports tell you everything you need to know about items impacting your credit score. Reviewing these items on a routine basis is an important exercise to ensure a correct report. If you find a mistake, you can work to get it removed and improve your score.
Your credit score is too important to ignore. Taking an active role by implementing some of these smart tactics is a great way to improve your score and overall credit health.
Every year is an election year when it comes to making decisions on your annual income tax return. Here are four common examples that can create tax savings opportunities if you elect the correct option.
Tax filing status. Typically, filing a joint tax return instead of filing separately is beneficial to a married couple, but not always! For instance, if one spouse has a high amount of medical expenses and the other doesn’t, your total medical deduction may be greater filing separately due to the 7.5% of adjusted gross income (AGI) threshold before you can deduct these expenses.
Higher education expenses. Thanks to new legislation, many parents of college students again face a decision: Whether to take one of the two credits for higher education expenses or the tuition and fees deduction. The tuition and fees deduction, once expired, is now extended through 2020. To complicate matters, the credits and the deduction are all phased out based on different modified adjusted gross income (AGI) levels. Before you elect which tax benefit makes the most sense, you will need to evaluate all options.
Investment interest. Investment interest expenses can be deducted up to the amount of net investment income for the year. This income does not usually include capital gains, because of favorable tax treatment of this type of gain. However, you can elect to include capital gains to help you deduct your interest expense. You can even cherry-pick which capital gains to use for this deduction. If you take this election you forego the favorable tax rate for long-term gains.
Installment sales. If you sell real estate or other assets in installments over two or more years, the tax liability is spread over the years that payments are received. Thus, you may be able to postpone the tax due. This technique can reduce the total tax paid depending on your effective tax rate each year. However, you can also elect out of installment sale treatment by paying the entire tax in the year of the sale. You may wish to take this election if your income is lower in the year of the sale.
Thankfully there is help navigating these key tax elections. Simply call with any questions.
