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- Written by: Julie Welch, CPA/PFS, CFP
Savings Incentive Match Plan for Employees (SIMPLE plans) are retirement plans that can be set up by small businesses with less than 100 employees that have no other retirement plan. The SIMPLE plan can be either an IRA or a 401(k), depending on which one you (if you are self-employed) or your employer set up.
Under a SIMPLE plan, you can choose to defer up to 100% of your current salary and have it put into a retirement plan. If you are self-employed, you can choose to defer a portion of your earnings from your business. Anything you choose to defer reduces your current income, and you will pay no tax on the earnings until you withdraw the money. However, the FICA tax, also known as the Social Security tax or self-employment tax, applies to the amounts you choose to defer.
The maximum amount of salary you can defer into a SIMPLE plan is $12,000 ($14,500 if you are 50+). This amount may be adjusted annually for inflation. If you are self-employed and have employees, you must offer this plan to your employees, but you can contribute to your plan even if your employees choose not to contribute to theirs.
If you make contributions to your SIMPLE plan, you (if you are self-employed) or your employer must also make contributions. There is a choice that your employer makes. Generally, your employer must match your contributions to your SIMPLE plan up to 3% of your pay. Alternatively, your employer can choose to contribute 2% of your pay even if you choose to make no contributions, as long as your pay is at least $5,000. Only $255,000 of your compensation can be taken into account for the calculation for 2013.
Unlike most pension and profit sharing plans, you immediately vest in any contributions that either you or your employer contributes to your SIMPLE plan. Thus, if your account balance is $12,000 and you terminate your employment, you will get the full $12,000.
Distributions you take from your SIMPLE plan can be subject to a 10% penalty unless you are at least age 59 ½ or meet another exception. Any distributions you make from your SIMPLE plan during the two-year period beginning on the first day you began participating in the SIMPLE plan are subject to a 25% penalty.
If you are self-employed or you are an employer, you can use either IRS Form 5304-SIMPLE or IRS Form 5305-SIMPLE to set up a SIMPLE plan. Use Form 5304-SIMPLE if you let each participant select where they set up their account. Use Form 5305-SIMPLE if you require all participants to use one financial institution for the accounts.
Example:
You make $24,000. Your employer has a SIMPLE plan and matches your contributions up to 3% of your pay. You choose to defer $4,000 into the SIMPLE plan.
Your contribution into the SIMPLE plan $4,000
Your employer’s contribution ($24,000 x 3%) + $720
Total contributions into = $4,720 your SIMPLE plan
Additionally, you may be eligible for the “saver’s credit” if you make a contribution of up to $2,000 to your IRA, 401(k) plan, or SIMPLE plan.
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- Written by: Julie Welch
Penalties generally apply if you withdraw money from your retirement plan before you reach age 59 ½. The penalty is 10% of the taxable distribution. The penalty is 25% if you take a distribution from a SIMPLE retirement plan within two years of becoming a participant.
Example:
You are 40 years old, receive $10,000 from your traditional IRA, are in the 28% Federal tax rate bracket, and do not meet any of the exemptions to the penalties. You owe the following tax and penalty:
Income tax at 28% tax rate $2,800
Early distribution penalty 1,000
You can avoid the penalty if:
- You receive a distribution from your retirement plan or IRA, and you are totally and permanently disabled.
- You are at least 55 years old and receive a distribution from a retirement plan upon termination of employment. This exemption does not apply to distributions from IRAs.
- You receive a distribution as a beneficiary of an estate after the death of someone else.
- You receive a distribution from your IRA that you use to pay qualified first-time homebuyer expenses. This exception only applies to distributions from IRAs
- You begin receiving annual distributions from your IRA that you will receive over your life expectancy or the joint life expectancy of you and your spouse. This exception applies only to distributions from traditional IRAs unless the distributions are from your company’s retirement plan and start after you retire.
- You receive a distribution from your IRA that you use to pay medical expenses in excess of 7.5% of your adjusted gross income.
- You receive a distribution from your IRA that you use to pay qualified higher education expenses.
Qualified higher education expenses include expenditures:
- For tuition, fees, books, supplies, and equipment required for enrollment or attendance
- At a postsecondary educational institution, including graduate-level courses
- For you, your spouse, your child, or your grandchild
Qualified first-time homebuyer expenses include expenditures:
- Up to $10,000 during your lifetime
- For amounts used within 120 days to buy, build, or rebuild a principal residence for a first-time homebuyer, including any usual or reasonable settlement, financing, or other closing costs
- For you, your spouse, your child, your grandchild, or an ancestor of you or your spouse
You can be a first-time homebuyer even if you have previously owned a home. To be considered a first-time homebuyer, you (and your spouse if you are married) may not have owned a home during the previous two years.
Example:
In 2010, you and your spouse sell your home and move into an apartment. In 2014, you buy a new principal residence. You withdraw $6,000 from your traditional IRA to use for financing costs and closing costs. You will not have to pay the 10% early distribution penalty on your IRA withdrawal.
Additionally, generally the income tax and early distribution penalty do not apply if you roll over your distribution to another qualified plan or IRA within 60 days.
If you take another nonqualified distribution from your Roth IRA that you funded with Roth IRA contributions, you may still avoid the 10% early distribution penalty if the distribution is not taxable to you. However, if you convert a traditional IRA to a Roth IRA, and within five years take a distribution, the 10% early distribution penalty could apply even if the distribution is tax-free to you.
Example:
You are 50 years old and made Roth IRA contributions of $2,000 per year for four years, giving you $8,000 ($2,000 x 4) of basis in your Roth IRA. You take a $5,000 distribution. Since you have at least $5,000 of basis from making Roth contributions, the $5,000 is tax-free to you. Additionally, since no amount is taxable to you and since the distribution was entirely attributable to annual contributions you made, the 10% early distribution penalty will not apply.
If instead you made a Roth IRA conversion of $8,000 two years ago, the full $8,000 was taxed to you at the time. If you made no other Roth IRA contributions, you would still have $8,000 of basis in your Roth IRA. A $5,000 distribution would be tax-free to you. However, since the conversion amount is distributed within the five-year period of when you made the conversion and the distribution is nonqualified, you will pay a $500 ($5,000 x 10%) early distribution penalty.
NOTE: Distributions from your traditional deductable or nondeductible IRA may be subject to income tax even though they are not subject to the early distribution penalty. Generally distributions from Roth IRAs will be totally tax-free.
NOTE: The rules for distributions from SIMPLE retirement plans are different. See Internal Revenue Service Publication 590, available by calling 1-800-TAX-FORM.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.
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- Written by: Julie Welch, CPA/PFS, CFP
When it comes time to withdraw money from a retirement plan, you should consider both nontax as well as tax considerations. Here are several of the nontax factors:
- Your need for the money
- Your life expectancy
- Your health
- Your future plans
The two main tax factors are:
- The penalties on withdrawing money from the retirement plan
- The tax a client pays on withdrawing the money
There are many penalties that apply to both distributions and the failure to make distributions from retirement plans. The rules for avoiding the 50% penalty are:
- Not too little
- Not too late
Not too Little
Once the age of 701/2 is reached, begin taking distributions from retirement plans and non-Roth IRAs. The minimum distribution one must receive annually is the amount that will distribute the entire balance in accounts over the distribution period. A 50% excise tax applies to distributions less than this amount. This 50% excise tax does not apply to distributions from retirement plans other than IRAs if one continues working after age 701/2 and one owns less than 5% of the company.
Calculate the minimum distribution by dividing the account balance on December 31st of the prior year (or the plan year-end in the case of a retirement plan) by the distribution period. Determine the distribution period using one’s age as of December 31st of the current year. The following table shows the distribution period. There are special rules if the spouse who is the beneficiary is more than 10 years younger than the retirement plan owner.
Minimum Distribution Periods
Table for determining distribution period. Final Regulations 1.401(a)(9) issued in April 2002. Effective beginning January 1, 2003.
Distribution Distribution Distribution Distribution
Age Period Age Period Age Period Age Period
70 27.4 82 17.1 94 9.1 106 4.2
71 26.5 83 16.3 95 8.6 107 3.9
72 25.6 84 15.5 96 8.1 108 3.7
73 24.7 85 14.8 97 7.6 109 3.4
74 23.8 86 14.1 98 7.1 110 3.1
75 22.9 87 13.4 99 6.7 111 2.9
76 22.0 88 12.7 100 6.3 112 2.6
77 21.2 89 12.0 101 5.9 113 2.4
78 20.3 90 11.4 102 5.5 114 2.1
79 19.5 91 10.8 104 5.2 115+ 1.9
80 18.7 92 10.2 104 4.9
81 17.9 93 9.6 105 4.5
For example:
A traditional IRA had a $50,000 balance on December 31st of last year. This year this person will be age 71. Their spouse will be age 68. The minimum distribution is:
Account balance $50,000
Divided by
Life expectancy ÷ 26.5
Minimum distribution $ 1,887
As a result of the regarding distributions from your retirement plans, you may wish to consider the following ideas:
- Reviewing the beneficiary designation form for the IRAs and retirement plans and naming contingent beneficiaries may be beneficial. The rules look to the beneficiary or beneficiaries as of September 30 of the year following the year the owner dies. However, the beneficiary must be named as either a beneficiary or contingent beneficiary while the owner is still living.
- Withdrawing the first required distribution in the year the owner turns age 701/2, rather than waiting until April 1 of the year following the year the owner turns age 701/2. This helps avoid bunching two distributions in one year and allows for a smaller required distribution in the second year.
Not Too Late
The owner must begin receiving distributions from the qualified plans and non-Roth IRAs no later than April 1st of the year following the calendar year in which the owner reaches age 701/2 (the required beginning date). A 50% excise tax applies to distributions received too late. An exception to this 50% tax applies to distributions from retirement plans other than IRAs if the owner continues working after age 701/2 and they own less than 5% of the company.
The April 1st date is relevant only in the year following the year the owner reaches age 701/2. After that, the owner must receive annual distributions by December 31st. Many people make the mistake of bunching two distributions in the year after reaching age 701/2 — one on April 1st and the second on December 31st. As a result, they pay tax at a higher rate and subject more of their Social Security benefits to tax than if they had received only one payment. However, if the tax rate is lower now than it will be in the future, it may be good planning to bunch two payments into one year.
However, if the owner waits until 2012 to take their first required distribution, they will have two distributions in 2012 since they must also take their next required distribution by December 31, 2012.
Distributions After You Die
If an owner’s retirement plan or IRA has money in it when they die, this money is distributed to the beneficiary or beneficiaries named for the retirement account. The beneficiary or beneficiaries as of September 30 of the year following the year the deceased passes may use the life expectancy tables to calculate the minimum amount to withdraw. A beneficiary must be designated as either a beneficiary or contingent beneficiary while the owner is still living. However, if there is no beneficiary designated for the retirement account, generally the plan must distribute the money by December 31st of the fifth year following the death.
If a spouse is the beneficiary, the spouse may roll over the plan balance into an account in his or her name as owners. Thus, the new account will be your spouse’s account.
Reporting
For information on how to report these penalties, see Federal Form 5329.
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- Written by: Julie Welch, CPA/PFS, CFP
“How long should my client keep his/her tax returns and supporting documentation?” is a frequently asked question. The safe, quick answer is keep old tax returns, W-2’s, and information with tax planning relevance permanently. Keep less important supporting documentation for seven years.
Generally, the IRS has three years from the due date of the return to audit and adjust the return. Similarly, your client has three years following the due date to amend his return.
| The due date for your 2014 tax return is April 15, 2015. Even if you file a return on March 1, 2015, the IRS has until April 15, 2018, to audit the return. You have until April 15, 2018, to amend the return. If you extend the due date of the return, the period of time the IRS has to audit your client’s return and the period of time you have to amend the return are also extended. |
Sometimes the IRS has longer than three years to audit a return. For example, the IRS has six years to audit a return if a person fails to report over 25% of gross income. If a return is not filed, or a fraudulent return has been filed, the IRS can audit records for that tax year at any time.
All supporting documentation should be kept, including summaries, cancelled checks, receipts, and 1099’s for at least the three years following the due date of the tax return. To be safe, many advisers recommend these records be kept for seven years.
Tax returns and W-2s should be kept permanently. Keeping a tax return permanently provides support if the IRS contends your client did not file a return or filed a fraudulent return. Furthermore, you may need to refer to an old return to obtain information about:
• Home purchases and sales
• Depreciation of a home office, rental property, or business equipment
• Individual retirement account (IRA) contributions
• The purchase price of stocks, bonds, and mutual funds
• The taxability of pensions and annuities
Keep W-2s permanently because they include important information about Social Security wages and withholdings and income tax withholdings. If you ever need to prove earnings or Social Security and Medicare contributions, you will have the records if W-2s are kept.
Supporting Documentation
Generally, most records can be destroyed after seven years. For tax planning support, however, there are countless situations when it is desirable to have records from earlier years. For example, when a client sells a home, it is necessary to calculate their gain. To calculate the gain, you need records of the cost of the home, improvements to the home, and depreciation of the home. For some people, this information may go back forty years or more. Furthermore, if you rolled over the gain on the pre-1998 sale of your prior home, it is necessary to have records for the prior home.
Another example of when earlier records are helpful is when your client sells mutual funds. There are several planning strategies you can use to reduce your client’s gain in this situation. To use them, however, it is necessary to have information about purchases, distributions, and sales from earlier years.
In summary, you should never throw out tax returns, W-2s, and records might have future tax relevance. In particular, you should keep all home records, brokers’ statements for securities you still own, and retirement plan information. You should keep other tax-related records for seven years.
NOTE: A current Earnings and Benefit Statement can be requested on the Internet at www.socialsecurity.gov. Earnings records should be verified frequently. Errors discovered after three years have passed are difficult to correct. Also, socialsecurity.gov can be used to get an estimate of future Social Security benefits based on an actual Social Security earnings record.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.
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- Written by: Julie Welch
Up to 85% of Social Security benefits can be taxed. However, it is possible that no Social Security benefits is taxable.
To determine how much of your client’s Social Security benefits is taxable, you must figure your clients modified adjusted gross income. Generally, the modified adjusted gross income is the sum of:
• income
• One-half of Social Security benefits
• Tax-exempt interest
Compare this amount to a base amount. The base amounts are $25,000 for single people, $32,000 for married couples filing jointly, and $0 for married people filing separately. If the modified adjusted gross income is less than your base amount, then none of the Social Security benefits is taxed.
If the modified adjusted gross income is more than the base amount, then a portion of the benefits is taxable. Use the following worksheet to determine the amount that is taxable.
How much of your client's Social Security benefits is taxable?
Modified Adjusted Gross Income MAGI)
Adjusted gross income
(excluding taxable Social Security) _____________________
+ 1/2 of Social Security benefits _____________________
+ Tax exempt interest _____________________
+ Excluded income from U.S. Savings Bonds
used to pay higher education expenses _____________________
+ Excluded income from employer's adoption
assistance program _____________________
+ Qualified education loan interest deduction
+ Foreign income excluded under IRC
Section 911, 931, or 933 _____________________
TOTAL MAGI _____________________
Is the client’s MAGI more than the following:
$44,000 if married filing joint? $34,000 if
single, head of household, or married filing
separately if client and their spouse lived apart
the entire year? $0 if married filing separately
and client and their spouse live together?
If NO, go to 50% Rule
If YES, go to 85% Rule
50% RULE
MAGI from above _____________________
Enter amount for your filing status: _____________________
$32,000 if married filing joint? $25,000 if
single, head of household, or married filing
separately if client and their spouse lived apart
the entire year? $0 if married filing separately
and client and their spouse live together?
Subtract _____________________
Is the above amount more than $0?
If NO,
None of your benefits is taxable
If YES,
1/2 of amount from above calculation _____________________
1/2 of Social Security Benefits _____________________
The smaller of the above amounts is your client’s taxable Social Security benefits
85% RULE
Total Social Security benefits received _____________________ A
Multiply times .5 _________x .5_________
1/2 of Social Security benefits _____________________ B
MAGI from above _____________________ C
Enter amount for your filing status: _____________________ D
$32,000 if married filing joint? $25,000 if
single, head of household, or married filing
separately if client and their spouse lived
apart the entire year? $0 if married filing
separately and client and their spouse live
together?
Subtract D from C _____________________
Multiply times .5 _________x .5_________
Subtotal _____________________ E
Enter amount for your filing status: _____________________ F
$6,000 if married filing joint? $4,500 if
single, head of household, or married filing
separately if client and their spouse lived
apart the entire year? $0 if married filing
separately and client and their spouse live
together?
Compare B, E, and F. Enter the smallest _____________________ G
Enter amount for your filing status: _____________________ H
$44,000 if married filing joint? $34,000 if
single, head of household, or married filing
separately if client and their spouse lived
apart the entire year? $0 if married filing
separately and client and their spouse live
together?
Subtract H from C (if less than $0, enter $0) _____________________
Multiply times .85 _________x .85________
Subtotal _____________________ I
Add G and I _____________________ J
Multiply A times .85 _____________________ K
The smaller of J and K is your taxable Social Security benefits
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