IRS Tips about Taxable and Nontaxable Income

Are you looking for a hard and fast rule about what income is taxable and what income is not taxable? The fact is that all income is taxable unless the law specifically excludes it.

Taxable income includes money you receive, such as wages and tips. It can also include noncash income from property or services. For example, both parties in a barter exchange must include the fair market value of goods or services received as income on their tax return.

Some types of income are not taxable except under certain conditions, including:

• Life insurance proceeds paid to you are usually not taxable. But if you redeem a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.
• Income from a qualified scholarship is normally not taxable. This means that amounts you use for certain costs, such as tuition and required books, are not taxable. However, amounts you use for room and board are taxable.
• If you got a state or local income tax refund, the amount may be taxable. You should have received a 2013 Form 1099-G from the agency that made the payment to you. If you didn’t get it by mail, the agency may have provided the form electronically. Contact them to find out how to get the form. Report any taxable refund you got even if you did not receive Form 1099-G.

Here are some types of income that are usually not taxable:

• Gifts and inheritances
• Child support payments
• Welfare benefits
• Damage awards for physical injury or sickness
• Cash rebates from a dealer or manufacturer for an item you buy
• Reimbursements for qualified adoption expenses

For more on this topic see Publication 525, Taxable and Nontaxable Income. You can get it at IRS.gov or call to have it mailed at 800-TAX-FORM (800-829-3676).

Additional IRS Resources:

• Bartering Tax Center
• Remember to include Form 1099-G income when you file your taxes

Wave Accounting Adds Bank Reconciliation (click to view video)

Wave Accounting writes: Just as Wave revolutionized small business accounting, we've reinvented bank reconciliation (bank rec) to make it easier and faster. Our thanks to everyone who voted on this feature — your feedback drives our decisions!

What is bank reconciliation?

The purpose of bank reconciliation is to ensure that all the transactions on your bank statement are reflected in Wave, and to account for transactions you know about that haven't yet been processed your bank account.

We've built bank rec in Wave to be super efficient and easy. Just doing your normal bookkeeping will take you half-way there, and the rest of the steps are easy to follow.

Have a look: 

Generation Roth: Millennials Discover The Secret To A Tax-Free Retirement

Ashlea Ebeling for Forbes writes: During a visit to a Pennsylvania steel plant recently President Obama touted the flexibility that his gimmicky new myRA account provides young workers just starting to save. “In an emergency you can withdraw contributions without paying a penalty. So it’s a pretty good deal.”   Fact is, myRA is just a Roth individual retirement account with training wheels; the full, grown-up version is an ideal savings vehicle for millennials, including well-paid ones who also have a 401(k).

A Roth IRA has two main advantages for younger folks. Money you contribute to an old-fashioned, pretax IRA or 401(k) isn’t taxed now, but all withdrawals in retirement are taxed at high ordinary income rates. Roth IRAs work in reverse: You get no tax deduction for your contribution, but withdrawals after age 59 are tax free. By then your income should be higher, in real dollars, than at, say, 25, so your tax rate is likely to be higher, too, making the back-end tax break more valuable than the front-end one. A Roth could also shield you from a growing list of tax and benefit penalties on higher-income retirees. (See Romney IRA: Exit Strategy by William Baldwin.)

The second big selling point for a Roth IRA is flexibility. Retirement is decades away and you might need cash sooner–to start a business, pay the rent while you return to school or, as Obama suggested, for an emergency. Take money out of a pretax IRA or 401(k) before retirement and you can get hit with a 10% early withdrawal penalty, as well as ordinary income taxes. (There are ways you might be able to avoid the penalty, but an estimated 5.7 million folks still got stuck paying it in 2011.) [snip]

To read the rest of the article click to visit the Forbes site and Ashlea Ebeling's Article "Generation Roth: Millennials Discover The Secret To A Tax-Free Retirement"

IRA Exit Strategy

William Baldwin for Forbes writes: Take a close look at your retirement account. Do you have Mitt Romney Syndrome?

This is an affliction that strikes successful people. They fatten their IRAs and 401(k)s only to discover that compulsory withdrawals, which begin at age 70, hoist them into unexpectedly high tax brackets.

While details of the ex-governor’s IRA are not public, it appears that his tax-deferred savings are well into eight-figure territory. When this fact came out in the presidential campaign, a wave of sympathy was felt in tax-planning offices across the country. What a shame that all that money was going to come out at high ordinary income rates.

You don’t have to be Romney-rich to confront unpleasantness with your tax rates. In fact, many of the surprises in the code leave the wealthy unscathed while doing a lot of damage to families with incomes between $200,000 and $500,000.

There are antidotes. They constitute what Robert S. Keebler, a CPA in Green Bay, Wis., calls “bracket management.”

Consider a Keebler client we will call Harry. Harry is a midwestern engineer in his 60s. His retirement assets will, assuming a conservative growth rate, tote to $7.8 million by the time Harry turns 70. At that point he has to start withdrawing the money so the IRS can get a piece of it. The withdrawals would start at $291,000 a year and follow an upward curve, peaking at $642,000. [snip]

To read the rest of William Baldwin's Article "IRA Exit Strategy", Visit Forbes by Clicking Here.

Are You Overlooking the Assisted Living Tax Deduction?

Sara Stevens for APlaceForMom.com writes: With a million seniors residing in over 31,000 assisted living facilities nationwide, according to the CDC’s National Survey of Residential Care Facilities, assisted living is big business. Not only that, 86.2% of residents are paying out of their own personal financial resources. For a one-bedroom apartment the median cost is $3,450 per month. That translates to a lot of money consumers are paying out of pocket for assisted living.

Daunting as that sounds, there are ways that seniors and caregivers can get a tax deduction for assisted living facility costs if they can be characterized as medical or dental expenses. Diligent recordkeeping throughout the year, even for related expenses like mileage from doctor visits, can add up to a lot of write-offs come tax time. Want to ease the financial burden? Read on for some tips on assisted living write-offs, and find out what you can and can’t deduct.

Qualifying for Assisted Living Write-Offs

As long as you’ve been keeping those records throughout the year for assisted living costsand medical expenses, then when tax time rolls around, you’ll be well prepared to qualify for write-offs. First and foremost, the taxpayer must be entitled to itemize deductions.However, other requirements differ depending on who the taxpayer is: the senior or the caregiver.

• For seniors, or if you’re preparing taxes on a senior’s behalf, you can deduct qualified medical expenses the taxpayer paid for during the tax year (see the next section of this article to find out what qualifies for a deduction). A doctor’s certification for a medical condition can help you provide verification of medical expenses if needed.
• For caregivers, you’ll need to first make sure your loved one qualifies as a dependent. They should also be a U.S. citizen or national, or a resident of the U.S., Canada, or Mexico. Next, determine whether you paid at least half of  the support for that person and the senior does not have income exceeding $3,950.
  • If you provided more than half of your loved one’s support, then you can deduct those qualified expenses on your tax return.
  • If you are part of a formalized multiple support agreement with other family caregivers, you can still deduct medical expenses if, collectively, the caregivers provide more than half of your loved one’s support – even if you, individually, did not contribute more than half.
  • You will also be allowed to take a dependency exemption for that individual.

Caregivers take note: According to the IRS, Publication 502,

“For you to include these expenses, the person must have been your dependent either at the time the medical services were provided or at the time you paid the expenses.”

There may also be different requirements for married couples filing separate returns, so make sure to check with a financial advisor if you’re not sure whether you qualify for assisted living write-offs.

How Much You Can Deduct for Assisted Living?

There are limits to how much you can deduct for qualified medical expenses. “Although the deduction floor for medical expenses has increased to 10% of adjusted gross income (AGI), beginning in 2013, it remains at 7.5% of AGI through 2016 for taxpayers who were age 65 or older as of Dec. 31, 2013,” reports Business Management Daily.

That means, if either you or your spouse was born before January 2, 1949, the threshold is lower, and you can start claiming tax deductions for any medical expenses in excess of 7.5% of AGI. For example, if you are over 65, your AGI is $40,000, 7.5% of which is $3,000, and you have $4,000 worth of qualifying medical expenses, you can deduct $1,000 worth of expenses.

What You Can Write Off—And What You Can’t

So what qualifies as a medical expense, and can you take a tax deduction for assisted living? Generally, anything that is directly related to the individual’s medical care, including health or Medicare insurance, long-term care insurance, eyewear, hospitals, hearing aids, and so forth, qualifies as a medical expense. You can find a complete list in IRS Publication 502. But what about the actual monthly cost of assisted living?

According to Craig Kellner, CPA and Partner at EFP Rotenberg LLP, Board Member of Empire State Association of Assisted Living and a specialist in assisted living situations, a facility like a nursing home is easy to take a deduction on, but it’s not so simple when it comes to assisted living:

“Nursing homes are primarily used for medical care, and medical care is always deductible. Assisted living is not necessarily there for medical reasons. It’s often a safety or companionship issue, so an assisted living facility is not usually deductible.”

However, if your loved one is receiving substantial medical care, is in a special needs unit, or is in dementia care at an assisted living facility, then they may qualify for a tax deduction. “You need to have a certified plan of care from a licensed health care practitioner, and be unable to perform at least two activities of daily living,” such as bathing, dressing, or eating, says Craig Kellner. “Then those costs would be deemed to be medical.” Or, if they have dementia and require substantial supervision to protect their health and safety, then AL costs may be deductible.

For other types of housing, such as senior independent living communities, generally the only deductible expenses would be directly related to medical costs – if you pay out of pocket for nurse visits, for example.

More Tax Deduction Tips for Seniors and Caregivers

There are a few other things to keep in mind when you’re putting your taxes together this year, whether you’re preparing them yourself, or having a tax preparer or loved one do it for you – or if you’re the one doing taxes for a senior family member.

• Tracking down paperwork: Craig Kellner has a good tip for anyone preparing their loved one’s taxes and trying to get the most out of medical deductions. He notes that older clients sometimes forget things, or have trouble finding the paperwork they need. “Look at prior years’ returns for the type of expenses they had in the past,” he says, so you can be as complete as possible about their qualifying deductions. It’s also possible to get a transcript of income received by the individual from the IRS, which can help immensely when you’re filling out that 1040.
• Deducting insurance premiums: Not every insurance policy is tax-qualified, especially when it comes to long-term care insurance. Check with the policyholder to make sure the policy qualifies – if it does, then you can deduct the premiums as a medical expense, says the Assisted Living Federation of America.
• Don’t forget the fees: If the assisted living facility charges any entrance or initiation fees directly related to medical care, then those are deductible. According toElderLawAnswers, “The assisted living facility is responsible for providing residents with information as to what portion of fees is attributable to medical costs.”
• About the Author
  Sarah J. Stevenson is a writer, artist, editor and graphic designer living in Northern California. Her visual art has been exhibited around California, and her writing has appeared in a variety of web sites and print publications. In addition to writing about older adults, she also writes for younger ones--her first novel for young adults, THE LATTE REBELLION, was published in 2011 by Flux. For more information, please visit: http://www.sarahjamilastevenson.com View Sarah's Google Profile.
• Visit the Blog "A Place For Mom" here.

Retirement: Make your nest egg tax-efficient

Jane Bennett Clark for Kiplinger's Money Power/Chicago Tribune writes:  When calculating living expenses in retirement, many preretirees forget to include taxes, says Andrea Blackwelder, a certified financial planner in Denver. That's a big mistake because when it comes time to tap your tax-deferred accounts, such as your traditional IRAs and your 401(k), your withdrawals will be taxed as ordinary income, which means the money is taxed at your top tax bracket.

You can take steps while you're working that will minimize the tax bite in retirement. Contributing some of your savings to a Roth IRA is one strategy. Withdrawals of earnings from a Roth are tax-free as long as you're 59 ½ and have owned the Roth for at least five years (you can always withdraw contributions tax-free). But not all workers are eligible to contribute to a Roth. In 2014, single workers with modified adjusted gross income of $129,000 or more are ineligible; for married couples who file jointly, the cutoff is $191,000.

You can get around these limits by converting your traditional IRAs to a Roth because there are no income limits on conversions. You'll have to pay taxes on all pretax contributions and earnings, but withdrawals of converted amounts are always tax- and penalty-free as long as you're 59 ½ and have owned the Roth for at least five years. Another idea is to contribute to a Roth 401(k), if your employer offers one. You can contribute to a Roth inside your 401(k) no matter how much you earn, up to the maximum annual amount of $17,500 (plus a catch-up contribution of up to $5,500 if you're 50 or over). Roth 401(k)s are subject to required distribution rules once you turn 70½.

Roth IRAs aren't subject to mandatory withdrawals, so you can let the money continue to grow tax-free until you need it. Even workers who are on the cusp of retirement or are already retired could benefit from converting to a Roth because all future earnings will be tax-free. It's prudent, though, to first discuss this step with a financial planner or tax professional because a large rollover could boost you into a higher tax bracket.

As you construct a tax-efficient portfolio for your retirement years, don't overlook the benefits of having a taxable account, too. Once you retire, you could lower your tax bill by tapping this account first. You'll be able to take advantage of low capital-gains rates while your tax-deferred IRAs and tax-free Roths continue to grow. For most retirees, the maximum long-term capital-gains rate is 15 percent; if you're in the 10 percent to 15 percent tax brackets, you'll pay 0 percent on the gains.  Subscribe to the Chicago Tribune by Clicking Here.

Eight Tax Savers for Parents

Your children may help you qualify for valuable tax benefits. Here are eight tax benefits parents should look out for when filing their federal tax returns this year.

1. Dependents.  In most cases, you can claim your child as a dependent. This applies even if your child was born anytime in 2013. For more details, see Publication 501, Exemptions, Standard Deduction and Filing Information.

2. Child Tax Credit.  You may be able to claim the Child Tax Credit for each of your qualifying children under the age of 17 at the end of 2013. The maximum credit is $1,000 per child. If you get less than the full amount of the credit, you may be eligible for the Additional Child Tax Credit. For more about both credits, see the instructions for Schedule 8812, Child Tax Credit, and Publication 972, Child Tax Credit.

3. Child and Dependent Care Credit.  You may be able to claim this credit if you paid someone to care for one or more qualifying persons. Your dependent child or children under age 13 are among those who are qualified. You must have paid for care so you could work or look for work. For more, see Publication 503, Child and Dependent Care Expenses.

4. Earned Income Tax Credit.  If you worked but earned less than $51,567 last year, you may qualify for EITC. If you have three qualifying children, you may get up to $6,044 as EITC when you file and claim it on your tax return. Use the EITC Assistant tool at IRS.gov to find out if you qualify or see Publication 596, Earned Income Tax Credit.

5. Adoption Credit.  You may be able to claim a tax credit for certain expenses you paid to adopt a child. For details, see the instructions forForm 8839, Qualified Adoption Expenses.

6. Higher education credits.  If you paid for higher education for yourself or an immediate family member, you may qualify for either of two education tax credits. Both the American Opportunity Credit and the Lifetime Learning Credit may reduce the amount of tax you owe. If the American Opportunity Credit is more than the tax you owe, you could be eligible for a refund of up to $1,000. See Publication 970, Tax Benefits for Education.

7. Student loan interest.  You may be able to deduct interest you paid on a qualified student loan, even if you don’t itemize deductions on your tax return. For more information, see Publication 970.

8. Self-employed health insurance deduction.  If you were self-employed and paid for health insurance, you may be able to deduct premiums you paid to cover your child under the Affordable Care Act. It applies to children under age 27 at the end of the year, even if not your dependent. See Notice 2010-38 for information.  

Forms and publications on these topics are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

The Difference BetweenTax Planning and Tax Preparing

Eleanor Blayney for the Wall St Journal - EXPERTS writes: What mistakes do people make when planning their approach to taxes?

 ELEANOR BLAYNEY: Tax payers often confuse “tax planning” with “tax preparation.”  The first looks forward for opportunities and strategies to reduce your future tax liabilities. “Tax preparation,” by contrast, requires looking in the rear-view mirror, gathering and organizing your information from a past year, primarily for compliance with tax laws.

Nevertheless, most people think they’re planning when they’re preparing.  This time of year especially, everyone fixates on taxes, trying to reduce the amount they’ll owe on April 15. The problem is there aren’t many ways to significantly reduce 2013 taxes when you’re midstream in 2014. Once the tax horse is out of the proverbial barn, the best advice involves reminding taxpayers of deductions and credits they might otherwise forget. However, any competent tax preparer or online tax-preparation software will optimize a taxpayer’s options, such as filing status, the use of standard versus itemized deducting, or the availability of credits based on dependents.

The goal of tax preparation is to avoid leaving money on the table. The goal of tax planning is to have more money on the table in the first place.  Americans would be far better off if they worked with a Certified Financial Planner to consider strategies they can use going forward–such as timing income and deductions across different tax years, the best retirement plan options, or IRA and 401(k) conversions into Roths–as they do on making sure the i’s are dotted and the t’s crossed on their 1040 for last year.

As for other mistakes–like getting big refunds every year or confusing what is owed on April 15 with total tax liability–don’t get me started.
To Subscribe to the Wall St Journal Click Here.

Reckon One Hits the Market, And Finally Reckon is in the Fight

Sholto MacPherson for BoxFreeIT writes: Accounting software company Reckon quietly took the wraps off its long awaited cloud accounting program Reckon One yesterday, ending nearly 12 months of anticipation.

• inShare

Reckon One was designed as a browser-based program in the same style as Xero, QuickBooks Online and MYOB Essentials Accounting (formerly MYOB LiveAccounts).

“We are now in this market,” said Daniel Rabie, Reckon’s strategic director. “I still believe there is a long way to go and we have a lot to prove but we now have a platform (from which) to compete.”

Reckon One took a modular approach where users could limit the monthly cost of the program by sending fewer invoices or creating fewer projects in the project management module. Feedback from Reckon partners had confirmed the success of the “design by you” philosophy, Rabie said.

“Every business is unique and has unique requirements. I believe over time all software will start moving to a concept where people design apps (according) to what they need. They might need to send a huge amount of invoices but they need basic features of everything else,” Rabie said.

Businesses that needed one advanced feature were forced to buy more advanced and expensive versions of rival programs when they only used 20 percent of the features, Rabie added.

“Xero is excellent software but the concept is flawed. The medium module of Xero is not cheap and businesses are dealing with all this unnecessary complexity in the software. We needed to get the (modular) concept right and I think we nailed it,” Rabie said. Reckon One was available in over 200 combinations, its website claimed.

Like most cloud accounting programs, Reckon One had many fewer features than Reckon’s desktop software. But even by cloud accounting standards some parts of the program were fairly basic, such as an inability to customise invoices and limited reporting.

The program would be developed in line with feedback from partners and users, Rabie said.

“It’s a very solid first release. The app is working solidly, it has maybe a basic level of functionality but all the features are in there. We believe for most micro businesses we are competitive enough,” Rabie said.

Reckon One has been in beta for nearly three months and had many happy businesses using it, Rabie claimed, although he refused to reveal the number of users.

Although businesses could sign up to Reckon One through its website, Reckon was promoting the program first to its accounting and bookkeeping partners for feedback before marketing it more broadly.

Reckon also refreshed its website to reflect the focus on customising applications for businesses.

- 

Sholto Macpherson is a business technology journalist specialising in cloud software. He lives and works in Sydney, Australia., You can read him regularly @ BoxFreeIT here.

Dividends, Income, And The 'T' Word (taxes, an example of self-directed retirement planning)

Ron Katalinich @ SeekingAlpha writes: 2014 will be my first full year of retirement. My years of investing are ready to provide all the income I need to fund the future. In the spirit of the Dividends & Income forum I decided to poke around my tax bill due April 15, 2015.

The "T" in the title does stand for taxes. Having received the "gold watch" after 30 years with the same company, I decided I will do two things for myself while in retirement; manage my own investing and do my own taxes. The only qualifier is that it must be simple and I, not the IRS, retain as much of it as possible.

With this in mind let's look at a working plan to retirement:

Pulling out my last paycheck stub from August 31st last year, I looked at federal withholdings, state withholdings, SS withholdings, Medicare withholdings, 401K deposits and so on and so forth. I was an OINK; One Income No Kids and saw a significant portion of the pay go everywhere else. Fast forward to 2014 and see what the plan is:

1. First we answered that famous question "How much do you need in retirement?" 15 years of check stub analysis determined that it will take anywhere from $5000-6000 per month to live very comfortably as we wish. But thanks to the company raising my health insurance premium to $1673 per month I will explain our needed income based on $6000/mo.

2. Asset review to fund the income:

· While not included in the creation of monthly income, real estate sales gave us a cash emergency fund to pay for toys. The home sales were small in size and exempt from taxes. I could pay the bills for 1.5 years. We currently have no mortgage.

· My 401K is now a simple IRA. It is 70% of the portfolio used in funding(Monthly 7% from me and a 6% match deposits for 30 years)

· Remember OINK?, that gave us the chance to create a smaller 25% portfolio nest egg spread across mutual funds. The largest is a totally tax exempt muni paying monthly interest payments. (Some of it's size is from an inheritance which may be in everyone future if you retire in your 60s)

· And lastly 5% are in ROTHs. We ran to them years ago but stopped funding due to apathy and or stupidity.

Without naming names the investments are spread across Large-Cap Dividend Champions, CEFs, BDCs, Taxed and Tax Exempt bond funds. Overall we are 55% equity and 45% fixed income.

· I worked for a utility that offered a "retirement plan". My Cash Balance sits with the company. It will continue to increase at a small rate (3%) based on some smoke and mirrors calculation for up to another 10 years at which time IRS rules say I'll have to roll it over. If I wait that long it will increase my income producing portfolio by 40%.

· Lastly is Social Security…. I'll take it at age 66 (I'm 60). At that time my wife will also receive the spouse 50% benefit. The total will reduce the portfolio stress by as much as 50%. This will extend the life of everything by 20 more years.

It's interesting to realize that the annual total of $72,000 is more "take home" pay than I received in a lot of the years while I worked. But what is more interesting is that it represents the "just for us" money. Nothing is added nothing is set aside. When tax time comes, line 1 is all zeros and this puts us in the lowest of the IRS income tax brackets!!

On to the tax stuff: The 2014 federal taxes (filing joint) are: (Source: IRS website)

• 10% on taxable income from $0 to $18,150, plus
• 15% on taxable income over $18,150 to $73,800, plus
• 25% on taxable income over $73,800 to $148,850, plus
• 28% on taxable income over $148,850 to $226,850, plus
• 33% on taxable income over $226,850 to $405,100, plus
• 35% on taxable income over $405,100 to $457,600, plus
• 39.6% on taxable income over $457,600.

I use to be in the 25% bracket and brought home almost $72K but now my new job pays the same but it's different!

Monthly IRA distributions of $5000/mo. times 12 = $60,000
Cash deposits from bond fund $1000/mo. times 12 = $12,000
Total = $72,000

The simple IRAs distributions will be $5000 per month. Had I been smarter, all this could have been ROTH money, but its too late now. Every dollar withdrawn is a dollar taxed not to mention you cannot take a distribution without the required 10% minimum withholding so the bank deposit will be $4500.

From the non-sheltered accounts the $1000 per month is 80% tax exempt by investing in state issued municipal bonds. The makeup of the rest of those funds will be subject to taxes. So for the math let's add $2400 in taxed income to the $60K.

Fast forward to tax season and fill in the blanks. Out of our $72,000 it becomes an AGI of only $62,400, the benefit of the muni monies. On page two of the 1040 form AGI is reduced using the Standard Deduction and our two exemptions for a lowly taxable income of $42,100. If you figure the income tax on the AGI, the amount due is $5408 or an effective tax rate of 8.7% (Tax/AGI)

The IRS withholding rule on distribution takes out too much tax triggering new car fever or that spring trip using the refund. But wait it gets better.

If you read other articles in this forum many investors not only use DG investing but also value investing for the maximum total return. These folks can get their gains for free under this scenario.

When it comes time to figure your tax, if your employed and have a salary much higher than my example here, you just use the tax table and call it a day. Under this scenario if you have had gains listed on Schedule D you do not use the tax tables. A worksheet is used to determine what portion of line 43 is free of tax. For my situation, ALL gains are removed from the taxable income. Thus a larger portion of the $72,000 can come from selling that stock you sweated over and finally rose the 50% you were hoping for. SELL! and don't fear the tax!

If we say the extra $2400 as part of the AGI was all capital gains, the tax on the original $62,400 decreases to $5048 which is a 6.7% decrease i.e. keep the $2400 it was just cash all along.

So back to the beginning of this article, what to do to minimize taxes?

• I believe that most of America is not setup in ROTH IRAs or ROTH 401Ks. So for the simple IRAs where a dollar out is a dollar taxed you might as well invest for the maximum possible return up to the limit of eating Rolaids and aspirins. If your timeline is many years then stuff the ROTH IRAs with everything you can afford.
• For mutual funds held outside IRAs consider tax exempt bonds. I KNOW returns can never match a good DG company, but they areinvisible to the tax tables. This allows MORE INCOME generationnot subject to income tax.
• You all can stop talking about those fabulous total returns, cash out and take the gain. With a little math plan on taking profit up to the 15% tax bracket limit reported on line 43 of the 1040 form. Cash the check and spend it....... its free of charge.

DISCLOSURE: I have not mentioned one stock or fund by name. In reading the articles here at SA, I am convinced you all are much smarter than I in deciding what's the right investment. What we all have in common though is the tax law. What I hope to share is a simple method to maximize the Income part and minimize the Tax part of retirement.

Multiple Support Agreement: Tax Tip Nitty-Gritty

Robert D Flach for MainStreet.com writes: Generally to be able to claim someone as a dependent on your tax return the person must be either your qualified child or a qualified relative. To be a qualified relative for 2013, the person must be either a member of your household for the entire year or a relative, have gross taxable income of less than $3,900, and must receive more than half of his or her total support from you.

If you do not provide more than half of the total support for a qualifying family member, an elderly parent for example, but you do pay more than 10% of that person's support, and you and other members of your family together pay more than half of the total support, you can claim him or her as a dependent under a "multiple support agreement." Only one of the family members who provide more than 10% of the support can claim the person being supported as a dependent. A different qualifying family member can claim the dependency exemption each year.

The qualifying persons who are not claiming the exemption must each sign a Form 2120 ("Multiple Support Declaration"), which is attached to the tax return of the person claiming the exemption.

Jane Taxpayer and her three brothers each provide 20% of the total support for their mother, whose only income comes from Social Security, and who lives in an assisted living facility. Early each year they get together and compare tax situations to determine which sibling would receive the most overall federal, state and local income tax benefit by claiming the mother as a dependent. When the refunds come, the person claiming the exemption gives each of his or her siblings a check for one-fourth of the total tax benefit.

Visit MainStreet.com by clicking here.

401k contribution percentage

Over at Reddit we came across the following discussion: 401k contribution percentage (self.personalfinance)

submitted 12 hours ago by Cmat1

I should start off by saying I'm completely clueless when it comes to this stuff...

My employer offers a 50% match up to the first 6%. Currently, about 10% of my paycheck is going into the 401k each month, with an automatic 1% increase every year.

I'm 28 years old, married, and making about $61k. My wife makes around $34k.

After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate? Why is this a better option than contributing a larger amount to a 401k?

Again, completely clueless here so any help is appreciated.

• 46 comments
• share

all 46 comments

sorted by: 

best

[–]United StatesaBoglehead 12 points 12 hours ago

After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate?

Yes.

Why is this a better option than contributing a larger amount to a 401k?

401k fund choices tend to be limited and expensive. With an IRA you get to choose which low cost fund family you invest in. Vanguard, Fidelity, or Charles Schwab are well known low-cost IRA providers.

• permalink

[–]Cmat1[S] 4 points 11 hours ago*

This makes sense. My 401k is with T.Rowe, 100% into this . I assume the advice of only contributing up to the match % still stands? There is around $52k in there currently.

EDIT: after reading up on my plan more, I've found out that the company will match 100% up to the first 4%, followed by 50% up to 6%. I assume I'll want to have 6% as my max contribution percentage.

My parents started a Roth for me with State Farm a number of years back. There's about $11k in there now. I have no idea when the last time a contribution was made but I know it's been at least 10 years.

My plan is to move it over to Vanguard then start making monthly contributions. I've heard good things about them with their low costs etc. Is there any particular fund I should be looking at moving into given my situation?

• permalink
• parent

[–]PsyAyeAyeDuck 4 points 9 hours ago

EDIT: after reading up on my plan more, I've found out that the company will match 100% up to the first 4%, followed by 50% up to 6%. I assume I'll want to have 6% as my max contribution percentage.

This means that your employer will match up to 5% if you contribute 6% of your salary to your 401k.

• permalink
• parent

[–]United Stateskaspitone 1 point 11 hours ago

Not exactly sure what your situation is, but check out Vanguard's Target Retirement Funds. They're low cost and completely hands off and the perfect fund for anyone not keen on balancing their portfolio or finding what funds to invest in.

• permalink
• parent

[–]KhabaLox 7 points 9 hours ago

The above suggestion is very good, but I'll still provide an alternative. This requires a little more research and knowledge, but it's arguably a good idea to do a modicum of learning about this since it's such an important part of your financial life.

The alternative is to invest in 3-5 index funds that cover 3 sectors: US Equities, International Equities, and Bonds. For example, you might go with 60% US Equities, 20% International and 20% Bonds.

A rule of thumb I've hear is to allocate your age (or your age less 10) in percentage to bonds, so you probably want to be in the 18-28% range for bonds. Personally I'm a bit lower, but it depends on your risk/reward profile. Bonds are less risky than equities, but provide less return over the long run.

For US equities, you have your choice of a 500 index, which follows the S&P 500, or a Total Market Index, which tracks the entire US equity market. The latter is probably better for a more hands-off approach. If you go with the 500 index, you might want to complement it with an Extended Market index, but doing so is basically replicating the Total Market Index.

For International, you can go with a Total Intl Index, or you can be more specific by focusin on developed economies (i.e. Eur, Japan, Korea, etc.) or Emerging Markets (BRICS, etc.). For simplicity, it's probably best to just go with the Total Intl Market fund.

• permalink
• parent

[–]Dandz 3 points 8 hours ago

Vanguard's Retirement Date fund are just a mix of 4 funds, thier total US stock, total Intl stock, total US bond, and total Intl bond. So if you are following the strategy you mention, the TD funds are about the same except they rebalance automatically and are a tiny bit more expensive. Unless you are slicing and dicing to put more emphasis on a market sector (like small caps for an example) a TD fund makes a lot of sense.

• permalink
• parent

[–]KhabaLox 2 points 8 hours ago

Agreed. Doing it yourself requires more attention, but allows a little bit of finer tuning.

• permalink
• parent

[–]United StatesKhaloc -2 points 7 hours ago

Vtsax and vbmfx. Put [your age]% in vbmfx and the rest in vtsax. If you want more risk/return do [your age -10]% in vbmfx and the rest in vtsax. Readjust the numbers once a year.

• permalink
• parent

[–]worrst 4 points 10 hours ago

What if your employer offers Roth 401k with diversified Vanguard stocks/bond plans?

• permalink
• parent

[–]United StatesaBoglehead 5 points 10 hours ago

Then it's up to you on which route (IRA or 401k) you take. It's a nice problem to have.

• permalink
• parent

[–]Neil_Armschlong 1 point 9 hours ago

I have no 401k match currently but I'm putting 10% into my 401k each paycheck. I also just maxed out my 2013 Roth IRA. Both my 401k and Roth IRA are using the Vanguard Target Retirement Date 2050 (I'm 23). Would you recommend adding more to my 401k or maybe adding in some Vanguard ETF's?

• permalink
• parent

[–]United StatesMindTheGAAP 1 point 9 hours ago

The reason you want to be wary of adding in extras to the all-in-one fund is that it can skew your asset allocation. If you like what you're investing in through the 2050 fund (index funds that represent the market as a whole) then keep shoveling money through that. If you want to get more concentrated in small caps or international stocks that go for it - you just need to be aware of the impact it'll have on your portfolio composition.

• permalink
• parent

[–]KhabaLox 0 points 9 hours ago

maybe adding in some Vanguard ETF's?

IMO, if you're saving/investing for retirement, you don't need the flexibility ETFs get you, but you pay for that privilege through commissions. If you are DCA'ing (that is, contributing monthly and increasing the holding of your ETF every month), those commissions are going to add up.

After maxing your Roth contributions each year, I would contribute more to your 401(k). It's fine to have both accounts 100% in the 2050 fund. If you max out the 401(k), then you can think about setting up a taxed investment account.

• permalink
• parent

[–]exconsultant32 2 points 6 hours ago

Vanguard ETFs trade commission-free if traded directly through Vanguard.

• permalink
• parent

[–]KhabaLox 1 point 6 hours ago

Interesting. I didn't know that. I wonder how they can afford to do that. I assume that doesn't extend to options trades on the ETFs, just strictly buy and sell orders?

• permalink
• parent

[–]user41day 1 point 9 hours ago

I think even in that case, it's still better to contribute upto match, then IRA. You have the ultimate control over your IRA while your 401k is still up to your employer's discretion (they could change their fund availability on you).

• permalink
• parent

[–]United StatesFiram 2 points 10 hours ago

You could do that, but most of the time, even with Vanguard funds, there is some overhead charged by the 401k provider. The most notable exception to this is TSP, which has very low rates, but incomplete international exposure, if you can about that.

• permalink
• parent

[–]worrst 1 point 9 hours ago

So lets say in the future you are no longer with the company, can you convert your 401k into a Roth IRA? Are there any penalties?

• permalink
• parent

[–]rbelmont 1 point 9 hours ago

Generally (always?) - you can convert the 401k to an IRA when have a change in employment status. Also, worth looking into... some 401k programs offer a feature called an in-service distribution which let's an employee to do a direct rollover into a self-directed IRA. I looked into it a while ago, found out our 401k provider didn't offer this feature, and dropped it. I investigated it enough to think it was an option for me, as long as I put the money to work in other investments in short order. But there's a lot of information (some of it bad information) about the rules on in-service distributions that you'll need to investigate.

• permalink
• parent

[–]KhabaLox 1 point 9 hours ago

You can roll a Roth 401(k) into a Roth IRA, and you can roll a Traditional 401(k) into a Traditional IRA.

http://www.investopedia.com/articles/retirement/09/roth-401k-rollover.asp

The rollover options for a Roth 401(k) follow those of a traditional 401(k). That is, you can roll the funds over to an IRA or into a new employer's 401(k). Just like the distribution of a traditional 401(k) is moved into a traditional IRA, the distribution from a Roth 401(k) rolled into a Roth IRA. If your new employer has a Roth 401(k) option and allows for transfers, you may also be able to roll the "old" Roth 401(k) into the "new" Roth 401(k).

• permalink
• parent

[–][deleted] 8 hours ago

[deleted]

[–]worrst 1 point 8 hours ago

What do you mean Roth IRA =/= IRA? There's traditional and Roth IRA, no? Yes, I know IRA does not have anything to do with my job.

• permalink

[–]judgemebymyusername 1 point 8 hours ago

Disregard.

• permalink
• parent

[–]judgemebymyusername 1 point 9 hours ago

Tax diversification is the main reason to split between 401k and Roth once you've hit your employer match. Most of what I've read suggests 401k to match, then max out Roth, then max out 401k, then taxable accounts. Paying off debt should be somewhere in there too of course.

• permalink
• parent

[–]worrst 1 point 9 hours ago

So if reading correctly then if there is a Roth 401k plan then it shouldnt matter if I max it out on my Roth 401k first or Roth IRA since neither one of them will be taxed in the future. Only service fees if it applies to any.

• permalink
• parent

[–]judgemebymyusername 1 point 8 hours ago

That is correct. But there are conflicting viewpoints on going 100% Roth.

I highly suggest skimming through this http://www.bogleheads.org/wiki/Roth_versus_Traditional

• permalink
• parent

[–]duhhhh 1 point 5 hours ago

I see a few cases to go 100% Roth.

1) You are young and low expense/low tax bracket now. It makes sense to contribute as much as you can to Roth IRA and Roth 401k. You can contribute to a traditional 401k later when you are in a higher tax bracket and have family expenses of your own.

2) You are older, plan to start a pension/social security as soon as you retire, and have been contributing to a traditional 401k for many years. If you won't have significantly lower income in retirement, then maxing out a Roth 401k today allows you to save more in retirement accounts and balance out your earlier traditional contributions. If you plan several years between retirement and pension/social security, then it probably makes more sense to roll some of the traditional assets at that lower income point instead.

3) You have kids you expect to go to college and you want to have few assets to maximize financial aid. Home equity and retirement accounts do not count as assets for financial aid. So maxing out a Roth 401k shelters more of your savings than maxing out a traditional 401k.

• permalink
• parent

[–]judgemebymyusername 1 point 4 hours ago

For #3, that frustrates the hell out of me. My parents contributed no help to my college, and I plan on doing the same for my children. Parental assets should not be part of the fin aid calculation IMO.

• permalink
• parent

[–]Thisismyredditusern 2 points 3 hours ago

On the other hand, my parents paid for my schooling and I pay for my kids' schooling. I guess it wouldn't matter if all aid were purely merit based, but much of it is needs based. They have no easy way of distinguishing between your family and mine and if you start giving money away, people are often not honest. They err on the side of not giving people like me free money. I don't think that's a bad thing. Or they could just get rid of needs based aid.

• permalink
• parent

[–]judgemebymyusername 1 point 2 hours ago

People need needs based aid. But it's unfair to assume that parents will give their children money. I was ineligible for some scholarships because of the FAFSA calculation.

• permalink
• parent

[–]Thisismyredditusern 1 point 2 hours ago

Do you think the kids whose parents were supporting them should have had the same access to the financial aid you wanted?

• permalink
• parent

continue this thread

[–]ZoraQ 3 points 10 hours ago

Some 401K plans offer brokerage options that allow you to move your 410K funds into a brokerage account under the 401K umbrella. This opens your options to all the funds that your brokerage house offers without the 401K fees. I do this under my 401K with fidelity and invest in Fidelity and non-Fidelity funds. OP may or may not have this option but may be worth investigating.

• permalink
• parent

[–]United StatesaBoglehead 1 point 10 hours ago

Indeed. Good point.

• permalink
• parent

[–]KhabaLox 2 points 9 hours ago

After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate?

Yes.

I feel we should point out the difference between Roth and Non-Roth IRAs and 401(k)s. It's probably accurate to say OP should contribute to a Roth IRA after maximizing his match in the 401(k), but he might want to go the Traditional IRA route instead, depending on his current tax situation and his prediction about his income in retirement and income tax rates at that time.

Going with the Roth, you are locking in your current marginal tax rate on that income, so if it would have been higher in the future, you come out ahead. On the other hand, if you go the Traditional route, the tax break comes all at the top marginal rate, whereas the tax break from the Roth (that you get when you withdraw in retirement) is applied across all the tax rates, so it's effect is somewhat diminished.

• permalink
• parent

[–]Thisismyredditusern 1 point 3 hours ago

That is a very concise summary of the Traditional versus Roth debate. Well done.

• permalink
• parent

[–]KhabaLox 1 point 3 hours ago

I left out the part about flexibility with respect to taxable income in retirement. One of the advantages of having a Roth account is that you can pull money out of it and reduce your Traditional withdrawal if you get some sort of windfall income.

• permalink
• parent

[–]aurochal 2 points 8 hours ago

So if I get a position in the federal government, should I fund my TSP completely before my Roth IRA? I read a lot about how great the TSP is for its low expense ratio funds. Wouldn't it make sense to decrease my taxable income as much as possible to get the most benefit out of contributing to a Roth IRA i.e. paying lower marginal taxes now for tax-free returns?

• permalink
• parent

[–]Dre_wj 1 point 2 hours ago

TSP is one of the lowest expense retirement vehicles out there. Sleep well even if it is your sole account (outside of the FERS benefit and SS).

• permalink
• parent

[–]United StatesaBoglehead 1 point 38 minutes ago

The TSP has a Roth option, and yes - I would (and do) fund the TSP up to the annual limit before putting money towards an IRA.

• permalink
• parent

[–]duhhhh 6 points 11 hours ago

The reason is tax diversification in retirement.

With a Roth withdrawls are not counted as income. If you need to buy a car with retirement assets you can withdraw that money from a Roth without pushing you into a higher tax bracket. Also social security income is taxed if your other income exceeds certain threshholds. Traditional IRA/401k withdrawls count as income.

• permalink

[–]Zagor64 2 points 11 hours ago

As /u/Boglehead said, you have total control over an IRA (where to open it, what funds you want to invest in etc.) while in the 401k you are basically stuck with what ever is there and it is usually not very good. The only downside to an IRA is the max limit. You can only contribute up to $5500 a year while you can contribute up to $17500 in the 401k.

• permalink

[–]United Statespentium4borg 2 points 11 hours ago

After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate? Why is this a better option than contributing a larger amount to a 401k?

Yes, you get more control over your investments (and the cost of those investments) in an IRA compared to a 401(k). But if you have more money to invest than maxing out your IRA and what's required to get your 401(k) match, you should then allocate that extra money to your 401(k) as well.

• permalink

[–]DrovemyChevytothe 2 points 10 hours ago

It depends on how much you can afford to contribute. If you can do the 10% into your 401k, plus the full Roth IRA contributions each year ($5500 for both you and your wife), then great, don't change your 401k amount.

But Roth IRA is a better deal and cheaper than 401k, after you reach the free money from the employer match.

• permalink

[–]nullsetcharacter 1 point 1 hour ago

At your income you should be maxing the 401k and maxing the IRA every year.

• permalink

[–]Fantom1107 1 point 1 hour ago

Maxing both his 401k and IRA would be 38% of his income. That's a bit excessive.

• permalink
• parent

[–]nullsetcharacter 0 points 52 minutes ago

It isn't excessive at all. I save more than 38% of my income, maxing out all retirement vehicles and then saving some extra in taxable accounts. It really isn't a problem if you know how to not waste money on dumb stupid shit that normal people seem to always want to buy. Excessive would be 80% of one's income, but 38% is actually a pretty good number to save.