3 Things 3-21
Although MAS is a financial services company, not everything published herein will be about numbers or investing. But no matter the topic, we hope for three things: 1) That you find the time you spend engaged worthwhile. 2) That you’ll reach out to us for help in any of our areas of expertise if something we discuss creates an urging in you to do so. 3) That you’ll share this with somebody new each time you read it.
Your 401k/IRA Is Not All Yours
If you have a tax-qualified retirement plan like a 401k or an IRA, Uncle Sam is expecting his cut of your retirement distributions. That’s because unlike a Roth IRA, where you pay taxes upfront and get to take all future distributions (including those made possible by capital gains) without paying taxes, in traditional retirement accounts, the taxes are deferred until you start taking out cash. While this allows for tax-free growth, you eventually have to pay up. So what are your options?
Well, you could: 1) do nothing 2) convert your 401k/IRA to a Roth 401k/IRA all at once 3) convert your 401k/Ira over time.
1. If you do nothing, you will just pay taxes at the future rate when you start taking distributions. This may or may not be an issue for you. On one hand, tax rates are likely to be higher by the time you retire (if retirement is more than a couple of years away), but on the other hand, you may be in a lower tax bracket when you retire if you have less income.
2. If you convert all of it at once, you’ll have to pay taxes on the converted amount immediately. Be sure you are prepared for that by figuring what the additional income does to your tax bracket. There are currently 7 tax rate/brackets. The single filer brackets are shown below:
10% - $0 - $9,950
12% - $9,951 - $40,525
22% - $40,526 - $86,375
24% - $86,376 - $$164,925
32% - $164,926 - $209,425
35% - $209,426 - $523,600
37% - $523,601 or more
See the simplified example below (note it doesn’t count any other income adjustments):
Pre conversion annual income: $30,000
Traditional IRA balance: $30,000
Total amount planned to convert to Roth: $30,000
Pre-conversion highest tax bracket: 12% (on income of $30,000)
Post-conversion highest tax bracket: 22% (on income of $60,000)
In the above example, your income would double and the taxes you paid on $20,000 of the additional $30,000 would almost double (12 to 22 equals an 83% increase). Note that if you did the full conversion, you’d never have to pay taxes on any distributions as long as you followed the early-withdrawal rules so if you could afford to pay the taxes now and you think you might be in a higher bracket at retirement, this still might be advisable.
3. You could switch from a Traditional IRA to a Roth gradually by converting only the amount that “fills up” the current bracket, or some version of that plan that doesn’t cause excessive bracket jumps in one year. So in the same example from above, instead of converting all $30,000 and moving from the 12% bracket to the 22% bracket for one-third of your income, you could convert only $10,000 this year. If you did that, your income would increase by 33% but your tax rate would remain the same at 12%. You could repeat this annually until you had converted it all.
Let us know if you think you might want some help figuring out your situation.
If You Might Not Qualify For A Third Stimulus Check But You Want To, Give - To Yourself
As noted in a previous newsletter, we are on our third round of stimulus checks. With each round, the income stipulations for receiving a check have tightened a bit. Here’s a recap:
In round one, you no longer qualified for a check if you were single and your income exceeded $99,000 or you were married filing jointly and your income exceeded $198,000.
In round two, you no longer qualified for a check if you were single and your income exceeded $87,000 or you were married filing jointly and your income exceeded $174,000.
In round 3, you no longer qualify for a check if you are single and your income exceeds $80,000 or you are married filing jointly and your income exceeds $160,000.
If you’re well over the income limits there’s probably not much you can do, but if you’re relatively close to the edge, make sure you’ve done all you can do to reduce your income (legally) before you give up on getting a check.
Two relatively simple things you can do to reduce your income are:
Contribute to a Traditional IRA. You can contribute $6,000 ($7,000 if you’re over 50) as a single and your spouse can do the same. Be sure to check the specific rules about contributions for your situation.
Contribute to a Health Savings Account. If you have a high deductible health plan you are allowed to contribute to an HSA (and thereby reduce your taxable income). Again check the rules for your specific situation.
If you’re close to the income limits, contributing to one or both of these accounts might just bring you back inside and put you in the money.
Let us know if we can help you figure it out.
Just A Thought
“The greatest mistake you can make in life is to be continually fearing you will make one.” ― Elbert Hubbard