Avoid a Penalty and Tax Surprise when Withdrawing from Retirement Accounts

Avoid a Penalty and Tax Surprise when Withdrawing from Retirement Accounts

Retirement accounts that provide tax breaks have very specific rules that must be followed if you want to enjoy the financial rewards of those tax breaks.

One of these rules defines WHEN you’re allowed to pull money from your retirement accounts. If you pull money too soon, you’re at risk of being levied with a penalty by the IRS. There are several exceptions to this rule, such as paying for qualified higher education expenses or paying for expenses if you become permanently disabled. In general, though, if you withdraw retirement funds before you reach age 59½, you’ll be hit with a 10% penalty in addition to regular income taxes. In the April 2023 court case Magdy A. Ghaly and Laila Ryad v. Commissioner, the taxpayers learned this rule the hard way.

The Facts

In 2018, Mr. Ghaly took two distributions from his retirement account.

Distribution #1: Withdrawal

Mr. Ghaly was laid off from his job, and in 2018, he withdrew money from his retirement account to provide for his family. He requested and received a withdrawal of $71,147 from his retirement account. His retirement company provided him with a Form 1099-R indicating the withdrawal was taxable.

Distribution #2: Deemed Distribution

In 2015, Mr. Ghaly took a loan from his retirement account. Because the loan followed certain IRS-approved guidelines, it was not considered a taxable distribution from his account that year. However, when Mr. Ghaly failed to repay that loan when it came due in 2018, it became a taxable distribution. His retirement company provided him with a 1099-R tax form for the deemed distribution.

Mr. Ghaly had not yet reached age 59½ before either amount was distributed.

The Findings

In an attempt to restore those distributions to his account to avoid both the tax on the distributions and the early withdrawal penalty, he opened two retirement accounts in 2020 and made the maximum contributions allowed for each account.

The Tax Court ruled against the taxpayers, stating that the contributions Mr. Ghaly made in 2020 were irrelevant when determining if his 2018 distributions were taxable. Mr. Ghaly was required to pay income taxes on the amounts withdrawn (to the extent those distributions were taxable) and was assessed an additional 10% early withdrawal penalty.

The Lesson

If you are planning an early withdrawal from a retirement account, understand before making the withdrawal whether the 10% penalty applies to you. In Mr. Ghaly’s case, he could have explored the substantially equal periodic payment exception or withdrawn money penalty free if used as hardship to pay for his health insurance while unemployed. The lesson: please call if you have questions about an early withdrawal you may be planning before you make it!

Yes! You Owe Tax on That – 6 Surprising Taxable Items

Yes! You Owe Tax on That – 6 Surprising Taxable Items

If something of value changes hands, you can bet the IRS considers a way to tax it. Here are six taxable items that might surprise you:

  • Surprise #1: Hidden treasure. In 1964, a married couple discovered $4,467 in a used piano they purchased seven years prior for $15. After reporting this hidden treasure on their 1964 tax return, the couple filed an amended return that removed the $4,467 from their gross income and requested a refund. The couple filed a lawsuit against the IRS when the refund claim was denied. The Tax Court ruled that the hidden treasure should be reported as gross income on the couple’s 1964 tax return, the year when the hidden treasure was found.

    Tip: The IRS considers many things like hidden treasure to be taxable, even though they are not explicitly identified in the tax code.

  • Surprise #2: Some scholarships and financial aid. Scholarships and financial aid are top priorities for parents of college-bound children, but be careful — if part of the award your child receives goes toward anything except tuition, it might be taxable. This could include room, board, books, or aid received in exchange for work (e.g., tutoring or research).

    Tip: When receiving an award, review the details to determine if any part of it is taxable. Don’t forget to review state rules as well. While most scholarships and aid are tax-free, no one needs a tax surprise.

  • Surprise 3: Gambling winnings. Hooray! You hit the trifecta for the Kentucky Derby. But guess what? Technically, all gambling winnings are taxable, including casino games, lottery tickets and sports betting. Thankfully, the IRS allows you to deduct your gambling losses (to the extent of winnings) as an itemized deduction, so keep good records.

    Tip: Know the winning threshold for when a casino or other payer must issue you a Form W-2G. But beware, the gambling facility and state requirements may lower the limit.

  • Surprise 4: Unemployment compensation. The IRS confused many by making this compensation tax-free during the COVID-19 pandemic. Unemployment compensation income has since gone back to being taxable.

    Tip: If you are collecting unemployment, either have taxes withheld or make estimated payments to cover the tax liability.

  • Surprise 5: Crowdfunding. A popular method to raise money is crowdfunding through websites. Whether or not the funds are taxable depends on two things: your intent for the funds and what the giver receives in return. Generally, funds used for a business purpose are taxable and funds raised to cover a life event are a gift and not taxable to the recipient.

    Tip: Prior to using these tools, review the terms and conditions and ask for a tax review of what you are doing.

  • Surprise 6: Cryptocurrency transactions. Cryptocurrencies like Bitcoin are considered property by the IRS. So if you use cryptocurrency, you must keep track of the original cost of the coin and its value when you use it. This information is needed so the tax on your gain or loss can be properly calculated.

    Tip: Using cryptocurrency for everyday financial transactions is not for the faint of heart because of how much recordkeeping is involved.

When in doubt, it’s a good idea to keep accurate records so your tax liability can be correctly calculated and you don’t get stuck paying more than what’s required. Please call if you have any questions regarding your unique situation.

2024 Social Security Changes

2024 Social Security Changes

2024 Social Security
Find out how your benefits have changed

Average Retirement Benefits
Starting January 2024

Average Benefits – All Workers

  • 2024: $1,907/mo (+$80)
  • 2023: $1,827/mo

Maximum Benefits for Workers Retiring at Full Retirement Age

  • 2024: $3,822/mo (+$195)
  • 2023: $3,627/mo

An 3.2% cost of living increase for Social Security retirement benefits and SSI payments begins with December 2023 benefits (payable in January 2024).

Increase your Social Security retirement benefits by 5-8% per year when you delay applying until you’re age 70.

Social Security Revenues & Expenditures

Revenue Sources = $1.22 trillion

  • 3.9% – Taxation of benefits
  • 5.4% – Interest
  • 90.7% – Payroll taxes

Expenditures = $1.24 trillion

  • 0.6% – Administrative expenses
  • 0.4% – Railroad Retirement financial interchange
  • 99.0% – Benefit payments

SOURCE: 2023 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Table II.B1.

2024 Social Security & Medicare Tax Rates

If you work for someone else, your employer pays 7.65%

If you work for someone else, you pay 7.65%

If you’re self-employed, you pay 15.3%

NOTE: The above tax rates are a combination of 6.2% for Social Security and 1.45% for Medicare. There is also a 0.9% Medicare wages surtax for those with wages above $200,000 single ($250,000 joint filers) that is not reflected in these figures.

Item20242023Change
Maximum amount you may pay in Social Security taxes$10,453.20$9,932.40+$520.80
Maximum earnings amount Social Security will tax at 6.2%$168,600.00$160,200.00+$8,400.00
  • 182+ million people work and pay Social Security taxes
  • Social Security has provided financial protection for Americans since 1935

Social Security Payments Explained

  • Social Security (SS) retirement benefits are for people who have paid into the Social Security system through taxable income.
  • Social Security Disability (SSD or SSDI) benefits are for people who have disabilities but have paid into the Social Security the system through taxable income.
  • Supplemental Security Income (SSI) benefits are for adults and children who have disabilities, plus limited income and resources.

Maximum SSI Payments

Filing Status20242023Change
Individual$943/mo$914/mo+ $29
Couple$1,415/mo$1,371/mo+ $44

How does Social Security work?

  • When you work, you pay taxes into Social Security.
  • The Social Security Administration uses your tax money to pay benefits to people right now.
  • Any unused money goes into Social Security trust funds and is borrowed by the government to pay for other programs.
  • Later on when you retire, you receive benefits.

How to qualify for retirement benefits

When you work and pay Social Security taxes, you earn credits toward benefits. The number of credits you need to earn retirement benefits depends on when you were born.

  • If you were born in 1929 or later, you need 40 credits (10 years of work) to receive retirement benefits
  • You receive one credit for each $1,730 of earnings in 2024
  • 4 credits maximum per year

Did you know you can check your benefits status before you retire?

  • You can check online by creating a my Social Security account on the SSA website. If you don’t have an account, you’ll be mailed a paper Social Security statement 3 months before your 61st birthday.
  • It shows your year-by-year earnings, and estimates of retirement, survivors and disability benefits you and your family may be able to receive now and in the future.
  • If it doesn’t show earnings from a state or local government employer, contact them. The work may not be covered within Social Security.

Sources: SSA.gov

Common Tax Questions Answered

Common Tax Questions Answered

What everyone is wondering:

During tax season, there are a number of areas that generate questions. Here are five of the most common and their answers. But like most things, there can be exceptions, so if in doubt always ask for help.

  • Are my miles earned on my credit card taxable? Taxation of any extras you earn with a credit card – including miles, discounts, even cash back – are not taxable if you had to pay to get them. Other rewards that you receive, for example a reward for signing up for a card or for referring a new cardholder, are considered taxable income per the IRS.
  • Does my employer contribution count towards the 401(k) limit? Your employer’s matching contributions do not count toward your maximum contribution limit, which for this year is $22,500. If you’re 50 or older, you can sock away an additional $7,500 (for a total of $30,000) this year.
  • What happens to loans from my retirement account if I change jobs? When you switch jobs, you must pay back any loans borrowed from your employer-sponsored retirement account within a short amount of time. If the loan isn’t paid back, the outstanding balance is considered a distribution that is subject to income taxes and an early withdrawal penalty.
  • Do I really need to report gifts given to people? Yes, but only if you give more than $17,000 ($34,000 if married) in 2023 to any one person. It must be reported to the IRS on a gift tax return. That’s because the IRS keeps track of gifts you’re allowed to make over the course of your lifetime, which in 2023 is $12,920,000 ($25,840,000 if married). Only after reaching this lifetime dollar amount will you need to actually make a gift tax payment.
  • Do I have to report a loss? You may think the IRS isn’t interested in losses you incur, such as when you sell a stock at a loss or if your business loses money. The reality is that you should always report losses on your tax return because you can use them to offset income under certain conditions. In addition, most losses can be carried forward to future years to offset income.

Have your own question? Reach out. The answer could surprise you.

Shield Your Emergency Fund From Inflation

Shield Your Emergency Fund From Inflation

Most financial experts suggest keeping three to six months’ worth of household expenses in savings to help in case of emergency. But with record inflation, that task just got a lot harder to accomplish as virtually every safe place to put your emergency funds will not provide interest rates that keep pace with inflation. But that does not mean you cannot increase the rate of return on these funds.

Here are some ideas to reduce the impact of inflation on your emergency funds.

  • Actively monitor your savings account rate. An interest rate hike by the Federal Reserve may not instantly change the rate on your current savings account, but it could lead to a higher rate for other accounts offered by your current bank or other banks.

    What you need to know: If your bank is slow to raise your savings rate, be willing to monitor and shift funds to a bank that does. Just make sure the funds are still FDIC insured and are kept at a reputable bank.
  • Take a look at Series I Savings Bonds. Series I Savings bonds are issued and backed by the U.S. government and feature two interest rate components: a fixed rate and an inflation rate. The fixed rate is set when the bond is issued and never changes during the life of the bond. The inflation rate resets semi-annually based on the Consumer Price Index.

    What you need to know: You must hold an I bond for at least 12 months before redeeming it. And although you can redeem it after one year, you’ll have to pay a penalty worth the interest of the previous three months if you redeem the bond within five years. And remember, you must be prepared to pay the penalty if you need the funds for an emergency.
  • Creative use of Roth IRA funds in an emergency. Roth IRAs are funded with after-tax dollars. Because of this, early removal of the initial contribution is tax and penalty free. If you dip into the earnings, however, you will not only be subject to income tax, but also may be subject to a 10% early withdrawal penalty.

    What you need to know: Use of a Roth IRA is often a creative way to fund your emergency account while achieving higher returns with conservative investment choices, but it is not for the faint of heart. If you get this one wrong, it could cost you in taxes, penalties and lost fund value in a bear market. Prior to removing funds from any IRA, it makes sense to conduct a tax planning session.

Higher rates are out there, you just need to be aware and willing to actively manage your emergency funds to ensure you are attacking the risk of inflation.

Tips for Working Beyond Retirement Age

Tips for Working Beyond Retirement Age

You may be one of many Americans who plan to work into retirement. Some report they need to work because their savings declined over the past several years, while others say they choose to work because of the greater sense of purpose and engagement that working provides.

Whatever your reason for continuing to work into retirement, here are some tips to get the greatest benefit from your efforts.

  • Consider delaying Social Security. You can start receiving Social Security retirement benefits as early as age 62, but if you continue to work it may make sense to delay taking it until as late as age 70. This is because your Social Security benefit may be reduced or be subject to income tax due to your other income. In addition, your Social Security monthly benefit increases when you delay starting the retirement benefit. These increases in monthly benefits stop when you reach age 70.
  • Pay attention to bracket-bumping. Keep in mind that you may have multiple income streams during retirement that can bump you into a higher tax bracket and make other income taxable if you’re not careful. For example, Social Security benefits are only tax-free if you have less than a certain amount of adjusted gross income ($25,000 for individuals and $32,000 for married filing jointly in 2022), otherwise as much as 85 percent of your benefits can be taxable.

    Required distributions from pensions and retirement accounts can also add to your taxable income. Be aware of how close you are to the next tax bracket and adjust your plans accordingly.
  • Be smart about health care. When you reach age 65, you’ll have the option of making Medicare your primary health insurance. If you continue to work, you may be able to stay on your employer’s health care plan, switch to Medicare, or adopt a two-plan hybrid option that includes Medicare and a supplemental employer care plan.
  • Look over each option closely. You may find that you’re giving up important coverage if you switch to Medicare prematurely while you still have the option of sticking with your employer plan.
  • Consider your expenses. If you’re reducing your working hours or taking a part-time job, also consider the cost of your extra income stream. Calculate how much it costs to commute and park every day, as well as any other work-related expenses. Now consider how much all those expenses amount to in pre-tax income. Be aware whether the benefits you get from working a little extra are worth the extra financial cost.
  • Time to downsize or relocate? Where and how you live can be an important factor determining the kind of work you can do while you’re retired. Downsizing to a smaller residence or moving to a new locale may be a good strategy to pursue a new kind of work and a different lifestyle.
  • Focus on your deeper purpose. Use your retirement as an opportunity to find work you enjoy and that adds value to your life. Choose a job that expresses your talents and interests, and that provides a place where your experiences are valued by others.
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