If you are experiencing financial hardship due to the coronavirus pandemic, you may want to consider withdrawing money from your retirementaccount while you still can. The special exemption allowing early withdrawals without a penalty ends soon.
Passed in March 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act allows individuals adversely affected by the pandemic to make hardship withdrawals of up to $100,000 from retirement plans this year without paying the 10 percent penalty that individuals under age 59 ½ are usually required to pay. This exemption is only for withdrawals made by December 30, 2020.
If you decide to withdraw money from your retirement account, you will still have to pay income taxes on the withdrawals, although the tax burden can be spread out over three years. If you repay some or all of the funds within three years, you can file amended tax returns to get back the taxes that you paid.
To qualify for the exemption, you must meet one of the following criteria:
You or a spouse or dependent have been diagnosed with COVID-19
You or your spouse have suffered financial hardship due to the pandemic, such as a lost job, a job offer rescinded, reduced pay, business closed, or inability to work due to lack of childcare.
This step should not be taken lightly. Withdrawing money now means your retirement funds will be reduced and limits the retirement plan’s ability to grow. But for some people, it may be the best option to pay bills and avoid running up high-interest credit carddebt.
For information from the Consumer Financial Protection Bureau on how the withdrawal exemption works, click here.
Although people are willing to voluntarily care for a parent or loved one without any promise of compensation, entering into a caregiver contract (also called personal service or personal care agreement) with a family member can have many benefits. It rewards the family member doing the work. It can help alleviate tension between family members by making sure the work is fairly compensated. In addition, it can be a be a key part of Medicaid planning, helping to spend down savings so that the elder might more easily be able to qualify for Medicaid long-term care coverage, if necessary.
The following are some things to keep in mind when drafting a caregiver contract:
Meet with your attorney. It is important to get your attorney's help in drafting the contract, especially if qualifying for Medicaid is a goal.
Caregiver's duties. The contract should set out the caregiver's duties, which can be anything from driving to doctor's appointments and attending doctor's meetings to grocery shopping to help with paying bills. The length of the term of the contract is usually for the elder's lifetime, so it is important to cover all possibilities, even if they are not currently needed. The contract can continue even if the elder enters a nursing home, with the caregiver acting as the elder's advocate to ensure the best possible care.
Payment. Payment to the caregiver can either be made with a lump-sum payment or in weekly or monthly installments. For Medicaid purposes, it is very important that the pay not be excessive. Excessive pay could be viewed as a gift for Medicaid eligibility purposes. The pay should be similar to what other caregivers in the area are making, or less. To calculate a lump-sum payment, take the monthly rate and multiply it by the elder's life expectancy. (Note that some states, Georgia for example, do not recognize the ability to create a lump sum contract based upon life expectancy.)
Taxes. Keep in mind that there are tax consequences. The caregiver will have to pay taxes on the income he or she receives.
Other sources of payment. If the elder does not have enough money to pay his or her caregiver, there may be other sources of payment. A long-term care insurance policy may cover family caregivers, for example. Also, there may be state or federal government programs that compensate family caregivers. Check with your local Agency on Aging to get more information.
Seniors and retirees should know that they may be able to use online tax preparationsoftware free of charge. Most low- and middle-income Americans qualify for the free help, but do not take advantage of it. And all seniors are eligible for free counseling assistance from the IRS.
The tax preparation software industry has had a decades-long deal with the Internal Revenue Service (IRS) to make free versions of its software available to low- and middle-income individuals. However, a report by ProPublica in April 2019 revealed that the software companies were making it difficult for customers to find the free tax filing software, including going so far as to hide it from a Google search. According to the IRS’s Taxpayer Advocate Service, around 70 percent of taxpayers qualified for free filing, but only 1.6 percent used the free software in 2018. The IRS has now amended its agreement with the software industry to bar the companies from hiding the free products.
The IRS Free File website links to the available free products. Each company sets its own eligibility standards based on income, age, and state residency. As long as your adjusted gross income was $69,000 or less, you will find at least one free product to use. There are also two products that are in Spanish.
If you would rather not prepare your own tax return, seniors can use the IRS’s Tax Counseling for the Elderly (TCE) program. The TCE program is available to taxpayers who are 60 years old or older and specializes in answering questions about pensions and retirement plans.
While the new tax law doubled the federal estate tax exemption, meaning the vast majority of estates will not have to pay any federal estate tax, it doesn't mean you should ignore its impact on your estate plan.
In December 2017, Republicans in Congress and President Trump increased the federal estate tax exemption to $11.18 million for individuals and $22.36 million for couples, indexed for inflation. (For 2019, the figures are $11.4 million and $22.8 million, respectively.) The tax rate for those few estates subject to taxation is 40 percent.
While most estates won't be subject to the federal estate tax, you should review your estate plan to make sure the changes won't have other negative consequences or to see if there is a better way to pass on your assets. One common estate planning technique when the estate tax exemption was smaller was to leave everything that could pass free of the estate tax to the decedent's children and the rest to the spouse. If you still have that provision in your will, your kids could inherit your entire estate while your spouse would be disinherited.
For example, as recently as 2001 the federal estate tax exemption was a mere $675,000. Someone with, say, an $800,000 estate who hasn’t changed their estate plan since then could see the entire estate go to their children and none to their spouse.
Another consideration is how the new tax law might affect capital gains taxes. When someone inherits property, such as a house or stocks, the property is usually worth more than it was when the original owner purchased it. If the beneficiary were to sell the property, there could be huge capital gains taxes. Fortunately, when someone inherits property, the property’s tax basis is "stepped up," which means the tax basis would be the current value of the property. If the same property is gifted, there is no "step up" in basis, so the gift recipient would have to pay capital gains taxes. Previously, in order to avoid the estate tax you might have given property to your children or to a trust, even though there would be capital gains consequences. Now, it might be better for your beneficiaries to inherit the property.
In addition, many states have their own estate tax laws with much lower exemptions, so it is important to consult with your attorney to make sure your estate plan still works for you.
Raising a grandchild can be tough financially, but grandparents should be aware that there is a tax credit available that could help them. Working grandparents who are supporting their grandchildren may qualify for the earned income tax credit, which could reduce the amount they pay in taxes by thousands of dollars or allow them to receive a refund.
The earned income tax credit is a benefit for working people with low to moderate incomes and dependents, and this includes grandparents. (Taxpayers without a dependent may also qualify, but it is more difficult.) To be able to claim the tax credit, you must be raising a child who meets the following criteria:
Is your son, daughter, adopted child, stepchild, foster child, brother, sister, half brother, half sister, step-sister or a descendent of any of them, such as a grandchild or niece or nephew
Is younger than 19 at the end of the year, younger than 24 and a full-time student at the end of the year, or any age and permanently and totally disabled
Lives with you for more than half the year
In addition, to qualify for the tax credit your income must be below certain limits, depending on how many dependents you have. The limits for 2019 are as follows:
One child. Filing as an individual, your income must be less than $41,094. Filing jointly, your income must be less than $46,884.
Two children. Filing as an individual, your income must be less than $46,703. Filing jointly, your income must be less than $52,493.
Three or more children. Filing as an individual, your income must be less than $50,162. Filing jointly, your income must be less than $55,952.
The maximum amount of the tax credit also depends on how many dependents you have. In 2019, the following are the maximum credit amounts:
$6,557 with three or more qualifying children
$5,828 with two qualifying children
$3,526 with one qualifying child
For more information from the IRS about the tax credit, click here.
The rules surrounding taxes on gifts often create confusion during tax season or any other time. Below are some of the nuts and bolts of the gift tax, including when a gift tax form needs to be filed.
The annual gift tax exclusion for 2018 and 2019 is $15,000. This means that any person who gave away $15,000 or less to any one individual (anyone other than their spouse) does not have to report the gift or gifts to the IRS. Any person who gave away more than $15,000 to any one person, however, is technically required to file a Form 709, the gift tax return. But just because you are required to file a Form 709 doesn't mean you necessarily have to; this depends on your past gift-giving history.
The IRS allows you to give away a total of $11.4 million (in 2019, up from $11.18 million in 2018) during your lifetime before a gift tax is owed. This $11.4 million exclusion means that even if you are technically required to file a Form 709 because you gave away more than $15,000 to any one person last year, you will owe taxes only if you have given away more than a total of $11.4 million in the past. As a result, the filing of a Form 709 is irrelevent for most people because the vast majority of people do not have $11.4 million to give away.
For those who have the means, there are several ways to give away more than $11.4 million over a lifetime without owing taxes. Keep in mind that Form 709 is only required when you give away more than the annual exclusion. So a married couple with a married child can give away $60,000 in one year without having to report the gift: each parent gives the child and the child's spouse $15,000 each. If a couple did this for 25 years, they would have given away $1.5 million without even having to report the gifts, much less having them count against their lifetime $11.4 million exclusion. Also it would be possible for the couple to give away $120,000 within a short span of time -- $60,000 in December and $60,000 in January of the next calendar year. (Note that if both spouses have made gifts, each must file a separate Form 709.)
Another way for a gift to be exempted from reporting requirements, no matter the gift's size, is to pay for someone else's medical care or educational tuition. It is important to note that the money must be paid directly to the school, university, or health care provider to be exempt, and that pre-payments can often be made as soon as the person is admitted to the school (schools include not just colleges but nursery schools, private grade schools, or private high schools). However, if you contribute to someone else's 529 college savings plan, you are subject to the $15,000 gift exclusion rule. A special regulation in the tax code enables a donor to use up five years' worth of her exclusions and gift $75,000 (in 2019) to a 529 at one time.
Also note that gifts to a spouse are usually not subject to any federal gift taxes as long as your spouse is a U.S. citizen. If your spouse is not a U.S. citizen, you can give only $155,000 without reporting the gift (in 2019). Anything over that amount has to be reported on Form 709.
If you have given away property other than money, like stock, you have to report that on your gift return, too, if the value is more than $15,000. If the stock had gone up in value since you bought it, you report the value as of the date that you gave it away. You may want to inform the recipient that the basis, or the amount that you bought the stock for, becomes their basis. The basis is used when the property is sold to determine the profit or loss.
Finally, tax deductible gifts made to charities need not be reported on a gift tax return unless the donor retains some interest in the gifted property.
There are some individuals who just aren’t interested in handing down their assets to the next generation when they die. Perhaps their children are so successful, they don’t need an inheritance. Or, according to the article “Giving your money away when you die: 10 questions to ask” from MarketWatch, they may be more interested in the kind of impact they can have on the lives of others.
If you haven’t thought about charitable giving or estate planning, these 10 questions should prompt some thought and discussion with family members:
Should you give money away now? Don’t give away money or assets you’ll need to pay your living expenses, unless you have what you need for retirement and any bumps that may come up along the way. There are no limits to the gifts you can make to a charity.
Do you have the right beneficiaries listed on retirement accounts and life insurance policies? If you want these assets to go to the right person or place, make sure the beneficiary names are correct. Note that there are rules, usually from the financial institution, about who can be a beneficiary—some require it be a person and do not permit the beneficiary to be an organization.
Who do you want making end-of-life decisions, and how much intervention do you want to prolong your life? A health care power of attorney and living will are used to express these wishes. Without these documents, your family may not know what you want. Healthcare providers won’t know and will have to make decisions based on law, and not your wishes.
Do you have a will? Many Americans do not, and it creates stress, adds costs and creates real problems for their family members. Make an appointment with an estate planning attorney to put your wishes into a will.
Are you worried about federal estate taxes? Unless you are in the 1%, your chances of having to pay federal taxes are slim to none. However, if your will was created to address federal estate taxes from back in the days when it was a problem, you may have a strategy that no longer works. This is another reason to meet with your estate planning attorney.
Does your state have estate or inheritance taxes? This is more likely to be where your heirs need to come up with the money to pay taxes on your estate. A local estate planning attorney will be able to help you make a plan, so that your heirs will have the resources to pay these costs.
Should you keep your Roth IRA for an heir? Leaving a Roth IRA for an heir, could be a generous bequest. You may also want to encourage your heirs to start and fund Roth IRAs of their own, if they have earned income. Even small sums, over time, can grow to significant wealth.
Are you giving money to reputable charities? Make sure the organizations you are supporting, while you are alive or through your will, are using resources correctly. Good online sources include GuideStar.org or CharityNavigator.org.
Could you save more on taxes? Donating appreciated assets might help lower your taxes. Donating part or all your annual Required Minimum Distributions (RMDs) can do the same, as long as you are over 70½ years old.
Does your family know what your wishes are? To avoid any turmoil when you pass, talk with family members about what you want to happen when you are gone. Make sure they know where your estate planning documents are and what you want in the way of end-of-life care. Having a conversation about your legacy and what your hopes and dreams are for family members, can be eye-opening for the younger members of the family and give you some deep satisfaction.
“You wouldn't trust your toddler with a pile of cash, right? Well, this estate-planning technique may allow you to safely pass your IRA on to future generations—if you do it right.”
Some of the biggest blunders in IRA distributions come to those who inherit these accounts. On the bright side, if handled correctly, you can structure the distribution, so your children or grandchildren reap the benefits for many years, says CNBC in the article “Leaving an IRA to a loved one? How to avoid a tax bomb.”
Naming a trust as an IRA beneficiary is a good way to protect large IRAs, since it provides some means of control. By naming a trust, you can protect heirs who are minors, vulnerable to creditors, not able to handle large sums of money or disabled. Trusts only need $12,750 of taxable income in 2019 to be subject to the top tax rate of 37%.
If you don’t structure the trust right, you could accelerate the liquidation of the IRA at warp speed.
Most people think of their spouse, when it comes to naming a beneficiary for an IRA. Unless your spouse needs the funds, it’s best to name the next generation. What are the pitfalls? Not all IRA custodians allow you to list a trust on the beneficiary form. The tax code has very specific conditions, when trusts are the beneficiaries of retirement accounts. If you fail to follow the rules, your heirs could face huge tax bills. For a trust to be viable as a designated beneficiary, it must meet a four-step test:
It must be valid under your state’s laws.
It must be an irrevocable trust, or one that will become irrevocable upon your death.
Beneficiaries must be identifiable from the trust document.
The IRA custodian or trust administrator must have received a copy of the trust by October 31 of the year after the death of the IRA’s owner.
The beneficiaries must be people, not charities and not your estate. If your beneficiaries are not people, then your IRA may not have a designated beneficiary. In that case, your heirs can’t stretch the IRA by taking required minimum distributions, based on the longer life expectancy of a child or a grandchild.
Worse—if your trust fails to meet the test, it is subject to the same rules as if there was no designated beneficiary at all. That means it’ll be depleted faster than you may have wished. If you die before you start taking RMDs (70½) then the IRA must be distributed within five years after death. If you die after you start taking RMDs, then distributions pay out over what would have been your life expectancy.
Speak with an estate planning attorney about the type of trust that will work best. There are two to chose from: a conduit trust, which distributes the RMDs directly to the beneficiary, or a discretionary trust, if you’re worried about a child who can’t manage money or who may be indebted to creditors. Note that RMDs are taxable income to the beneficiary when they receive it, but if the distribution is held in the trust, then the trust owes the taxes.
“These 10 states impose the lowest taxes on retirees, according to Kiplinger's 2018 analysis of state taxes. All of them exempt Social Security benefits from state taxes.”
Retirement dreams often come up against the harsh reality of finances, and tax burdens are one of those realities. If your retirement plans include a relocation, and if you want to minimize your tax burden, then this article from Kiplinger’s Personal Finance, “10 Most Tax-Friendly States for Retirees, 2018,” deserves your careful consideration.
Most of the states listed below exempt at least part of retirement income, like pensions and withdrawals from tax-deferred retirement plans. They also have low property taxes, which matters more now that the Tax Cuts and Jobs Act limits the amount that can be deducted in state and local taxes on federal returns to $10,000 a year.
Georgia. The Peach State’s low tax climate is attracting retirees by the bushel. How’s this sound: Not only is Social Security exempt from state taxes, so is up to $35,000 of most types of retirement income for those age 62-64. For those 65 and older, the exemption is $65,000 per taxpayer, or $130,000 per couple. There’s no state estate tax and no inheritance tax.
Kentucky. The Bluegrass State’s riding high with an exemption for Social Security taxes, plus up to $31,110 per person for a wide variety of retirement income. There is an additional exclusion for qualified military, civil service and state and local government pensions. Kentucky also has a homestead exemption on the assessed value of a qualifying single-unit property, which is assessed every two years, according to the cost-of-living index.
New Hampshire. The Granite State rocks taxes: there’s no state income tax, no estate or inheritance tax and no taxes on Social Security benefits. There’s also no sales tax. There is a 5% tax on dividend interest, but a $1,200 exemption is available for residents 65 or older.
Nevada. Hit the tax jackpot in this state. There are no taxes on groceries and the average combined state and local sales tax rate is 8.14%. No state income tax, no estate tax, no inheritance tax. You can cash in your retirement funds—tax free.
Pennsylvania. The Keystone State exempts most retirement income from state taxes. Social Security benefits, public and private pensions and distributions from 401(k) and IRA plans are tax free. There are often high local income taxes, but they only apply to earned income. However, there is a state inheritance tax, calculated as a percentage of the value of the estate transferred to beneficiaries and there are different rates depending on the relationship of the heir to the decedent and the decedent’s date of death.
Florida. The Sunshine State is chock full of retirees who come for the climate and enjoy the state’s tax policies. There are no state income taxes, no estate tax and no inheritance tax. The average combined state and local tax rate is 6.8%.
Mississippi. The Magnolia state’s tax policies are in full flower, with no state income tax on Social Security benefits, IRA and 401(k) plan withdrawals, income from public and private pensions and other types of qualified retirement income. Starting in 2019, the first $1,000 of taxable income is except from the 3% rate, and by 2022, the first $5,000 will be except.
South Dakota. No state income tax, no estate tax and no inheritance tax make the Mount Rushmore state a friendly place for retirees. Social Security benefits and other retirement income enjoys a tax-free ride. Sales taxes are low, but most everything is taxed, including groceries, non-prescription drugs and many services. South Dakota started collecting tax from out-of-state retailers late this year.
Wyoming. Abundant tax revenue from oil and mineral rights makes Wyoming one of the lowest taxed states in the nation. There’s no income tax, sales taxes are low and the median property tax on the median home value of $199,000 is $1,223, the ninth-lowest in the country.
Alaska. Okay, we know that not many readers are packing up to move to this rugged state. However, if you did, you’d enjoy no state income tax, so everything from Social Security benefits to retirement account withdrawals to investment gains are tax free. There’s no state sales tax, and in Anchorage and Fairbanks, there are no local sales taxes. Once you’ve established residency for at least a year, you get a dividend check from the state’s oil wealth savings accounts.
Each state listed here comes with a tradeoff. In Nevada, you have to be willing to live with extreme temperatures, while in Alaska, you may not get to see friends and family often. However, if taxes are a concern, now you know some of your options.