Do you want to save more for retirement on a tax-favored basis? If so, and if you qualify, you can make a deductible traditional IRA contribution for the 2018 tax year between now and the tax filing deadline and claim the write-off on your 2018 return. Or you can contribute to a Roth IRA and avoid paying taxes on future withdrawals.
You can potentially make a contribution of up to $5,500 (or $6,500 if you were age 50 or older as of December 31, 2018). If you’re married, your spouse can potentially do the same, thereby doubling your tax benefits.
The deadline for 2018 traditional and Roth contributions for most taxpayers is April 15, 2019 (April 17 for those in Maine and Massachusetts).
There are some ground rules. You must have enough 2018 earned income (from jobs, self-employment or alimony) to equal or exceed your IRA contributions for the tax year. If you’re married, either spouse can provide the necessary earned income. And you can’t make a deductible contribution to a traditional IRA if you were 70½ or older as of December 31, 2018. (But you can make one to a Roth IRA after that age.)
Finally, deductible IRA contributions are phased out (reduced or eliminated) if last year’s modified adjusted gross income (MAGI) is too high.
Types of contributions
If you haven’t already maxed out your 2018 IRA contribution limit, consider making one of these three types of contributions by the April deadline:
1. Deductible traditional. With traditional IRAs, account growth is tax-deferred and distributions are subject to income tax. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k), the contribution is fully deductible on your 2018 tax return. If you or your spouse doparticipate in an employer-sponsored plan, your deduction is subject to the following MAGI phaseout:
- For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
- For a spouse who participated in 2018: $101,000–$121,000.
- For a spouse who didn’t participate in 2018: $186,000–$196,000.
- For single and head-of-household taxpayers participating in an employer-sponsored plan: $63,000–$73,000.
Taxpayers with MAGIs within the applicable range can deduct a partial contribution. But those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.
2. Roth. Roth IRA contributions aren’t deductible, but qualified distributions — including growth — are tax-free, if you satisfy certain requirements.
Your ability to contribute, however, is subject to a MAGI-based phaseout:
- For married taxpayers filing jointly: $189,000–$199,000.
- For single and head-of-household taxpayers: $120,000–$135,000.
You can make a partial contribution if your 2018 MAGI is within the applicable range, but no contribution if it exceeds the top of the range.
3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions, you’ll only be taxed on the growth.
Traditional and Roth IRAs provide a powerful way to save for retirement on a tax-advantaged basis. Contact us to learn more about making 2018 contributions and making the most of IRAs in 2019 and beyond. 205-345-9898 or firstname.lastname@example.org.
© 2019 CovenantCPA
If you participate in a qualified retirement plan, such as a 401(k), you must generally begin taking required withdrawals from the plan no later than April 1 of the year after which you turn age 70½. However, there’s an exception that applies to certain plan participants who are still working for the entire year in which they turn 70½.
The basics of RMDs
Required minimum distributions (RMDs) are the amounts you’re legally required to withdraw from your qualified retirement plans and traditional IRAs after reaching age 70½. Essentially, the tax law requires you to tap into your retirement assets — and begin paying taxes on them — whether you want to or not.
Under the tax code, RMDs must begin to be taken from qualified pension, profit sharing and stock bonus plans by a certain date. That date is April 1 of the year following the later of the calendar year in which an employee:
- Reaches age 70½, or
- Retires from employment with the employer maintaining the plan under the “still working” exception.
Once they begin, RMDs must generally continue each year. The tax penalty for withdrawing less than the RMD amount is 50% of the portion that should have been withdrawn but wasn’t.
However, there’s an important exception to the still-working exception. If owner-employees own at least 5% of the company, they must begin taking RMDs from their 401(k)s beginning at 70½, regardless of their work status.
The still-working rule doesn’t apply to distributions from IRAs (including SEPs or SIMPLE IRAs). RMDs from these accounts must begin no later than April 1 of the year following the calendar year such individuals turn age 70½, even if they’re not retired.
The law and regulations don’t state how many hours an employee needs to work in order to postpone 401(k) RMDs. There’s no requirement that he or she work 40 hours a week for the exception to apply. However, the employee must be doing legitimate work and receiving W-2 wages.
For a customized plan
The RMD rules for qualified retirement plans (and IRAs) are complex. With careful planning, you can minimize your taxes and preserve more assets for your heirs. If you’re still working after age 70½, it may be beneficial to delay taking RMDs but there could also be disadvantages. Contact us to customize the optimal plan based on your individual retirement and estate planning goals. 205-345-9898 or email@example.com.
© 2019 CovenantCPA
If you own a business and don’t have a tax-advantaged retirement plan, it’s not too late to establish one and reduce your 2018 tax bill. A Simplified Employee Pension (SEP) can still be set up for 2018, and you can make contributions to it that you can deduct on your 2018 income tax return.
A SEP can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the SEP is to first apply. That means you can establish a SEP for 2018 in 2019 as long as you do it before your 2018 return filing deadline. You have until the same deadline to make 2018 contributions and still claim a potentially substantial deduction on your 2018 return.
Generally, other types of retirement plans would have to have been established by December 31, 2018, in order for 2018 contributions to be made (though many of these plans do allow 2018 contributions to be made in 2019).
With a SEP, you can decide how much to contribute each year. You aren’t obligated to make any certain minimum contributions annually.
But, if your business has employees other than you:
- Contributions must be made for all eligible employees using the same percentage of compensation as for yourself, and
- Employee accounts must be immediately 100% vested.
The contributions go into SEP-IRAs established for each eligible employee.
For 2018, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction), subject to a contribution cap of $55,000. (The 2019 cap is $56,000.)
To set up a SEP, you just need to complete and sign the very simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). You don’t need to file Form 5305-SEP with the IRS, but you should keep it as part of your permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.Although there are rules and limits that apply to SEPs beyond what we’ve discussed here, SEPs generally are much simpler to administer than other retirement plans. Contact us with any questions you have about SEPs and to discuss whether it makes sense for you to set one up for 2018 (or 2019). 205-345-9898 or firstname.lastname@example.org.
© 2019 CovenantCPA
For many businesses, offering employees a 401(k) plan is no longer an option — it’s a competitive necessity. But employees often grow so accustomed to having a 401(k) that they don’t pay much attention to it.
It’s in your best interest as a business owner to buck this trend. Keeping your employees engaged with their 401(k)s will increase the likelihood that they’ll appreciate this benefit and get the most from it. In turn, they’ll value you more as an employer, which can pay dividends in productivity and retention.
Promote positive awareness
Throughout the year, remind employees that a 401(k) remains one of the most tax-efficient ways to save for retirement. Regardless of investment results, the pretax advantage and any employer match make a 401(k) plan an ideal way to save.
For example, point out that, for every $100 of pay they defer to the 401(k), the entire $100 is invested in the plan — not reduced for taxes as it would be if it were paid directly to them. And any employer match increases investment potential.
At the same time, make sure employees know that your 401(k) plan operates under federal regulations. Although the value of their accounts may go up and down, it isn’t affected by the performance of your business, because plan assets aren’t commingled with company funds.
Encourage patience, involvement
The fluctuations and complexities of the stock market may cause some participants to worry about their 401(k)s — or to try not to think about them. Regularly reinforce that their accounts are part of a long-term retirement savings and investment strategy. Explain that both the economy and stock market are cyclical. If employees are invested appropriately for their respective ages, their accounts will likely rebound from most losses.
If a change occurs in the investment environment, such as a sudden drop in the stock market, present it as an opportunity for them to reassess their investment strategy and asset allocation. Market shifts have a significant impact on many individuals’ asset allocations, resulting in portfolios that may be inappropriate for their ages, retirement horizons and risk tolerance. Suggest that employees conduct annual rebalancing to maintain appropriate investment risk.
As part of their benefits package, some businesses provide financial counseling services to employees. If you’re one of them, now is a good time to remind them of this resource. Employee assistance programs sometimes offer financial counseling as well.
Another option is to occasionally engage investment advisors to come in and meet with your employees. Your plan vendor may offer this service. Of course, you should never directly give financial advice to employees through anyone who works for your company.
A 401(k) plan is a substantial investment for any company in time, money and resources. Encourage employees to appreciate your efforts — for their benefit and yours. We can help you assess and express the financial advantages of your plan. Call us at 205-345-9898 or email us at email@example.com.
© 2019 CovenantCPA
Employee stock ownership plans (ESOPs) offer closely held business owners an exit strategy and a tax-efficient technique for sharing equity with employees. But did you know that an ESOP can be a powerful estate planning tool? It can help you address several planning challenges, including lack of liquidity and the need to provide for children outside the business.
An ESOP in action
An ESOP is a qualified retirement plan, similar to a 401(k) plan. But instead of investing in a selection of stocks, bonds and mutual funds, an ESOP invests primarily in the company’s own stock. ESOPs are subject to the same rules and restrictions as qualified plans, including contribution limits and minimum coverage requirements.
Typically, companies make tax-deductible cash contributions to the ESOP, which uses the funds to acquire stock from the current owners. This doesn’t necessarily mean giving up control, though. The owners’ shares are held in a trust, and the trustees vote the shares.
An ESOP’s earnings are tax-deferred: Participants don’t recognize taxable income until they receive benefits — in the form of stock or cash — when they leave the company, die or become disabled.
Retirement and estate planning benefits
If a large portion of your wealth is tied up in a closely held business, lack of liquidity can create challenges as you approach retirement. Short of selling the business, how do you fund your retirement and provide for your family?
An ESOP may provide a solution. By selling some or all of your shares to an ESOP, you convert your shares into liquid assets. Plus, if the ESOP owns 30% or more of the company’s outstanding common stock immediately after the sale, and certain other requirements are met, you can defer or even eliminate capital gains taxes. How? By reinvesting the proceeds in qualified replacement property (QRP) — which includes most securities issued by U.S. public companies — within one year.
QRP provides a source of retirement income and allows you to defer your gain until you sell or otherwise dispose of the QRP. From an estate planning perspective, a simple but effective strategy is to hold the QRP for life. Your heirs receive a stepped-up basis in the assets, eliminating capital gains permanently.
If you want more investment flexibility, you can pay the capital gains tax upfront and invest the proceeds as you see fit. Or you can invest the proceeds in qualifying floating-rate long-term bonds as QRP. You avoid capital gains, but can borrow against the bonds and invest the loan proceeds in other assets.
If estate taxes are a concern, you can remove QRP from your estate, without triggering capital gains, by giving it to your children or other family members. These gifts may be subject to gift and generation-skipping transfer taxes, but you can minimize those taxes using traditional estate planning tools.
Weigh the pros and cons
ESOPs offer significant benefits, but they aren’t without their disadvantages. Contact us to help determine if an ESOP is right for you at 205-345-9898.
© 2019 Covenant CPA
Retirement plan contribution limits are indexed for inflation, and many have gone up for 2019, giving you opportunities to increase your retirement savings:
- Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $19,000 (up from $18,500)
- Contributions to defined contribution plans: $56,000 (up from $55,000)
- Contributions to SIMPLEs: $13,000 (up from $12,500)
- Contributions to IRAs: $6,000 (up from $5,500)
One exception is catch-up contributions for taxpayers age 50 or older, which remain at the same levels as for 2018:
- Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $6,000
- Catch-up contributions to SIMPLEs: $3,000
- Catch-up contributions to IRAs: $1,000
Keep in mind that additional factors may affect how much you’re allowed to contribute (or how much your employer can contribute on your behalf). For example, income-based limits may reduce or eliminate your ability to make Roth IRA contributions or to make deductible traditional IRA contributions.
For more on how to make the most of your tax-advantaged retirement-saving opportunities in 2019, please contact us at 205-345-9898.
© 2018 Covenant CPA
Tax planning is a year-round activity, but there are still some year-end strategies you can use to lower your 2018 tax bill. Here are six last-minute tax moves business owners should consider:
- Postpone invoices. If your business uses the cash method of accounting, and it would benefit from deferring income to next year, wait until early 2019 to send invoices. Accrual-basis businesses can defer recognition of certain advance payments for products to be delivered or services to be provided next year.
- Prepay expenses. A cash-basis business may be able to reduce its 2018 taxes by prepaying certain expenses — such as lease payments, insurance premiums, utility bills, office supplies and taxes — before the end of the year. Many expenses can be deducted up to 12 months in advance.
- Buy equipment. Take advantage of 100% bonus depreciation and Section 179 expensing to deduct the full cost of qualifying equipment or other fixed assets. Under the Tax Cuts and Jobs Act, bonus depreciation, like Sec. 179 expensing, is now available for both new and used assets. Keep in mind that, to deduct the expense on your 2018 return, the assets must be placed in service — not just purchased — by the end of the year.
- Use credit cards. What if you’d like to prepay expenses or buy equipment before the end of the year, but you don’t have the cash? Consider using your business credit card. Generally, expenses paid by credit card are deductible when charged, even if you don’t pay the credit card bill until next year.
- Contribute to retirement plans. If you’re self-employed or own a pass-through business — such as a partnership, limited liability company or S corporation — one of the best ways to reduce your 2018 tax bill is to increase deductible contributions to retirement plans. Usually, these contributions must be made by year-end. But certain plans — such as SEP IRAs — allow your business to make 2018 contributions up until its tax return due date (including extensions).
- Qualify for the pass-through deduction. If your business is a sole proprietorship or pass-through entity, you may qualify for the new pass-through deduction of up to 20% of qualified business income. But if your taxable income exceeds $157,500 ($315,000 for joint filers), certain limitations kick in that can reduce or even eliminate the deduction. One way to avoid these limitations is to reduce your income below the threshold — for example, by having your business increase its retirement plan contributions.
Most of these strategies are subject to various limitations and restrictions beyond what we’ve covered here, so please consult us before you implement them. We can also offer more ideas for reducing your taxes this year and next. Call us at 205-345-9898.
© 2018 Covenant CPA
Will you be age 50 or older on December 31? Are you still working? Are you already contributing to your 401(k) plan or Savings Incentive Match Plan for Employees (SIMPLE) up to the regular annual limit? Then you may want to make “catch-up” contributions by the end of the year. Increasing your retirement plan contributions can be particularly advantageous if your itemized deductions for 2018 will be smaller than in the past because of changes under the Tax Cuts and Jobs Act (TCJA).
Catch-up contributions are additional contributions beyond the regular annual limits that can be made to certain retirement accounts. They were designed to help taxpayers who didn’t save much for retirement earlier in their careers to “catch up.” But there’s no rule that limits catch-up contributions to such taxpayers.
So catch-up contributions can be a great option for anyone who is old enough to be eligible, has been maxing out their regular contribution limit and has sufficient earned income to contribute more. The contributions are generally pretax (except in the case of Roth accounts), so they can reduce your taxable income for the year.
More benefits now?
This additional reduction to taxable income might be especially beneficial in 2018 if in the past you had significant itemized deductions that now will be reduced or eliminated by the TCJA. For example, the TCJA eliminates miscellaneous itemized deductions subject to the 2% of adjusted gross income floor — such as unreimbursed employee expenses (including home-off expenses) and certain professional and investment fees.
If, say, in 2018 you have $5,000 of expenses that in the past would have qualified as miscellaneous itemized deductions, an additional $5,000 catch-up contribution can make up for the loss of those deductions. Plus, you benefit from adding to your retirement nest egg and potential tax-deferred growth.
Other deductions that are reduced or eliminated include state and local taxes, mortgage and home equity interest expenses, casualty and theft losses, and moving expenses. If these changes affect you, catch-up contributions can help make up for your reduced deductions.
2018 contribution limits
Under 2018 401(k) limits, if you’re age 50 or older and you have reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a SIMPLE instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do. Also keep in mind that additional rules and limits apply.
Catch-up contributions are also available for IRAs, but the deadline for 2018 contributions is later: April 15, 2019. And whether your traditional IRA contributions will be deductible depends on your income and whether you or your spouse participates in an employer-sponsored retirement plan. Please contact us at 205-345-9898 for more information about catch-up contributions and other year-end tax planning strategies.
© 2018 Covenant CPA
One could say that there are only two key milestones in retirement planning: the day you begin participating in a retirement savings account and the day you begin drawing money from it. But, of course, there are others as well.
One is the day you turn 50 years old. Why? Because those age 50 or older on December 31 of any given year can start making “catch-up” contributions to their employer-sponsored retirement plans by that date. These are additional contributions to certain retirement accounts beyond the regular annual limits.
Maybe you haven’t yet saved as much for retirement as you’d like to. Or perhaps you’d just like to make the most of tax-advantaged savings opportunities. Whatever the case may be, let’s get caught up with the latest catch-up contribution amounts.
401(k)s and SIMPLEs
Under 2018 401(k) limits, if you’re age 50 or older, after you’ve reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a Savings Incentive Match Plan for Employees (SIMPLE) instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do.
If you’re self-employed, retirement plans such as an individual 401(k) — or solo 401(k) — also allow catch-up contributions. A solo 401(k) is a plan for those with no other employees. You can defer 100% of your self-employment income or compensation, up to the regular yearly deferral limit of $18,500, plus a $6,000 catch-up contribution in 2018. But that’s just the employee salary deferral portion of the contribution.
You can also make an “employer” contribution of up to 20% of self-employment income or 25% of compensation. The total combined employee-employer contribution is limited to $55,000, plus the $6,000 catch-up contribution.
Catch-up contributions to non-Roth accounts not only can enlarge your retirement nest egg, but also can reduce your 2018 tax liability. And keep in mind that catch-up contributions are available for IRAs, too, but the deadline for 2018 contributions is April 15, 2019. If you have questions about catch-up contributions or other retirement saving strategies, please contact us.
© 2018 Covenant CPA
Which criteria tell the real story
If you gave your retirement plan a report card, what would it look like? Does it do the job of preparing your participants for retirement? And how do you benchmark your plan’s performance? Let’s take a closer look.
First, a quick reality check: What criteria do you already use to benchmark your plan’s performance? Traditional measures such as fund investment performance relative to a peer group, the breadth of fund options, benchmarked fees, and participation rates and average deferral rates (including matching contributions) are critical. But they’re only the beginning of the story.
Add to that list helpful administrative features and functionality, including auto-enrollment and auto-escalation provisions, investment education, retirement planning, and forecasting tools. In general, the more, the better.
A sometimes overlooked plan metric is average account balance size. This matters for two reasons. First, it provides a first-pass look at whether participants are accumulating meaningful sums in their accounts. Naturally, you’ll need to weigh that number in light of the age of your workforce, and how long your plan has been in existence. Second, it affects recordkeeping fees — higher average account values generally translate into lower per-participant fees.
Knowing your plan asset growth rate is also helpful. Unless you have an older workforce and participants are retiring and rolling their fund balances into IRAs, look for a healthy overall asset growth rate, which incorporates both contribution rates and investment returns.
What’s a healthy rate? That’s a subjective assessment and you’ll need to examine it within the context of current financial markets. A plan whose assets shrank during the financial crisis a decade ago could hardly be blamed for that pattern. Overall, however, you might hope to see annual asset growth of at least 15%.
Keeping participants on track
Ultimately, however, the success of a retirement plan isn’t measured by these discrete elements, but by aggregating multiple data points and others to derive an “on track to retire” score. That is, how many of your plan participants have account values whose size and growth rate are sufficient to result in a realistic preretirement income replacement ratio, such as 85% or more?
It might not be possible to determine that number with precision. Such calculations at the participant level, sometimes performed by recordkeepers, involve sophisticated guesswork with respect to participants’ retirement ages and savings outside the retirement plan, as well as their income growth rates and the long-term rates of return on their investment accounts.
Communicating with participants
So, after you analyze how your participants are doing, what can you do with the data? The most important thing is communicating each employee’s “on track” status directly and urgently to him or her.
A study by Empower Retirement, a retirement plan recordkeeping company, found, perhaps not surprisingly, that many retirement savers begin to increase their deferral rates when told their on-track statuses, expressed as an income replacement percentage. This preparedness metric proved to be significantly more motivational than merely being reminded of their account balances and growth rate.
Once you’ve given your participants their individual “on-track” statuses, you can also point them to tools that can generate projections of the impact on their on-track statuses of adjustments to their deferral rates. A sophisticated modeling tool would also project different forecasts based on varying asset allocation mixes.
It’s unrealistic to expect a comprehensive on-track analysis to reveal that all your plan participants pass the test with flying colors. What’s important is finding and adjusting the right levers to increase your plan’s performance each year. Also, while doing so, it’s still critical to keep your eye on the ball with respect to the full range of fiduciary duties attendant to sponsoring a retirement plan.
Sidebar:Retirement preparedness: A national perspective
A large survey published early this year by Fidelity Investments offers some perspective about participants’ retirement readiness. Here’s a recap of the 2017 “America’s Retirement Score” report based on the survey’s four preparedness groupings:
On target.About one-third (32%) of American households fall into this category. Being on target means being on track to cover more than 95% of projected expenses in retirement.
Good.This group, defined as heading toward a capacity to cover 81% to 95% of their estimated expenses in retirement, comprises 18% of working American households. They’ll likely be able to cover essential expenses, but not discretionary ones such as travel and entertainment.
Fair.Slightly more than one in five (22%) are projected to be able to cover 65% to 80% of their expenses. Unless they improve their statuses, they’ll need to make “modest” lifestyle adjustments in retirement.
Needs attention.At 28% of American households, this group is the second largest, behind the “on target” group. Projected to cover less than 65% of their expenses, these people will need to make “significant” downward lifestyle adjustments to cover their expenses.
By generation, the largest “on target” cohort is Baby Boomers, in part because greater numbers of them are covered by traditional defined benefit pensions. Their average score is an 86. Gen X and Millennials are essentially tied at 77 and 78 ratings, respectively, according to the report.
©2018 Covenant CPA