Lets talk about the Rule 59 1/2, which applies to all types of IRAs. Rule 59 1/2 states that if you make any non-qualifying withdrawals before age 59 1/2, you will be subjected a 10% early withdrawal penalty. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. So, what is considered a "qualified" withdrawal?
1) You may make withdrawals before age 59 1/2 if you become permanently disabled.
2) If you die before age 59 1/2, your estate or your beneficiary will not be affected by the rule.
3) You may make withdrawals to pay for non-reimbursed medical expenses IF AND ONLY IF the expenses exceeds 7.5% of you adjusted gross income (AGI, which means your gross income after all qualifying deductions are made)
4) You may make withdrawals up to $10,000 for purchase, building, or rebuilding of your first home. This can include children, grandchildren, and your spouse if you already bought your first home.
5) You may make withdrawals to pay for higher education expenses. This can include you, your children, and your grandchildren.
6) If you are out of a job and have medical insurance, you may make withdrawals to pay the premium.
In Tradional IRAs, when you start withdrawing money, you will owe income taxes on them EXCEPT on the part where your contributions were not tax-deductible. Remember about the age 59 1/2 rule, if you make non-qualifying withdrawals you will owe 10% penalty tax and income tax on deductible contributions and earnings. Click here to learn more about Traditional IRAs.
In Roth IRAs, when you make withdrawals after age 59 1/2, you may not owe any taxes, depending on when you open the Roth IRA. You may also withdraw your contributions anytime, even before Age 59 1/2 and you won't owe any taxes or penalties! Click here to learn more about Roth IRAs.
Tuesday, February 20, 2007
Roth IRA
A Roth IRA is where you cannot make tax deductions because your contributions are supposedly be made with after-tax dollars. Usually when you get your paycheck, a portion of it went to taxes. What's ever left over is yours and you can put this in the Roth IRA. Since you cannot make tax deductions, any withdrawals you make after age 59 1/2 are tax free. Tax free withdrawals are generally not allowed within the first 5 years beginning with the first tax year contributions and conversions. For example, lets say you contribute $1000 into the Roth in 2006. The 5 year holding period on the earnings began on January 1, 2006 and expires on December 31, 2010. Lets say that a year later, you convert your Traditional IRA into a Roth IRA on March 1, 2007. The 5 year holding period begins on January 1, 2007 and ends on December 31, 2012 on all earnings from the conversion.
I also heard that you can withdraw your contributions anytime without paying income taxes or penalties. I asked that question to a tax expert at Kiplinger and he said "Roth contributions can be withdrawn at anytime, tax- and penalty-free, regardless of your age." According to IRS publication 590, under subheading Roth IRA, title "Are Distributions Taxable?", it states "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)." In other words, you can withdraw your contributions anytime without paying income taxes or penalties.
Not everyone can get a Roth IRA. If you are single and your adjusted gross income (AGI) is above $120,000, you cannot get a Roth IRA. If you are married and filing jointly (or qualify widow(er)) and your AGI is above $177,000, you do not qualify for a Roth IRA. If you are married, but filing separately, and the spouse lives with you, you do not qualify for a Roth IRA if your AGI is above $10,000. (These figures are for tax year 2011. For up to date figures, go see IRS Publication 590).
When you make withdrawals from your Roth IRA, you may or may not pay taxes. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. When you take distributions or make withdrawals, this is how your distributions are paid out in this order:
1) Your annual contributions. You can withdraw this at anytime without penalty or taxes.
2) Taxable portion of first rollover (the conversion). This only applies if your lifetime withdrawals exceeds your lifetime contributions. If you make withdrawals on this portion before age 59 1/2, you will pay a 10% penalty.
3) Non-taxable portion of first rollover. This only applies after the taxable portion of rollover has been withdrawn. You will pay no taxes or penalties on this portion at anytime.
4) Each subsequent rollover, in order, with the taxable portion coming out first and then the non-taxable.
5) And finally, any earnings. If you get to this point, you will pay income taxes during the 5 year holding period. If withdrawn before age 59 1/2, you will pay a 10% penalty, unless it was a qualifed withdrawal. See Age 59 1/2 Rule. After age 59 1/2 and after the 5 year holding period, you do not pay any taxes on the earnings.
Things to remember about Roth IRAs
1) Not everyone can get a Roth IRA. It depends on your Adjusted Gross Income and filing status.
2) None of your contributions are tax-deductible, but when you withdraw your contributions, they are tax-free and penalty-free.
3) Your withdrawals after age 59 1/2 may be tax-free.
4) You must hold the earnings and any conversions in your Roth IRA for 5 full tax years in the beginning.
Some questions I get:
Q1: What if I open my first Roth IRA at age 60, does the 5 year holding period still apply?
A1: Yes, but you can withdraw your contributions at anytime without paying any taxes.
Q2: If I open another Roth IRA somewhere, does the 5 year holding period apply?
A2: 5 year holding period only applies to your first Roth IRA.
Q3: If I convert or rollover my Traditional IRA into a Roth IRA, what should I know before doing this?
A3: One, you will pay income tax on the earnings and any part of your contributions you made tax-deductible. Second, you have to move the entire balance into the Roth IRA within 60 days of receiving receipt. Third, the 5 year holding period will apply on this conversion, whether you previously have a Roth IRA or not.
I also heard that you can withdraw your contributions anytime without paying income taxes or penalties. I asked that question to a tax expert at Kiplinger and he said "Roth contributions can be withdrawn at anytime, tax- and penalty-free, regardless of your age." According to IRS publication 590, under subheading Roth IRA, title "Are Distributions Taxable?", it states "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)." In other words, you can withdraw your contributions anytime without paying income taxes or penalties.
Not everyone can get a Roth IRA. If you are single and your adjusted gross income (AGI) is above $120,000, you cannot get a Roth IRA. If you are married and filing jointly (or qualify widow(er)) and your AGI is above $177,000, you do not qualify for a Roth IRA. If you are married, but filing separately, and the spouse lives with you, you do not qualify for a Roth IRA if your AGI is above $10,000. (These figures are for tax year 2011. For up to date figures, go see IRS Publication 590).
When you make withdrawals from your Roth IRA, you may or may not pay taxes. You should know that the IRS does not prohibit you from withdrawing money. You can make withdrawals at anytime, but you may pay a penalty and possibly income tax. When you take distributions or make withdrawals, this is how your distributions are paid out in this order:
1) Your annual contributions. You can withdraw this at anytime without penalty or taxes.
2) Taxable portion of first rollover (the conversion). This only applies if your lifetime withdrawals exceeds your lifetime contributions. If you make withdrawals on this portion before age 59 1/2, you will pay a 10% penalty.
3) Non-taxable portion of first rollover. This only applies after the taxable portion of rollover has been withdrawn. You will pay no taxes or penalties on this portion at anytime.
4) Each subsequent rollover, in order, with the taxable portion coming out first and then the non-taxable.
5) And finally, any earnings. If you get to this point, you will pay income taxes during the 5 year holding period. If withdrawn before age 59 1/2, you will pay a 10% penalty, unless it was a qualifed withdrawal. See Age 59 1/2 Rule. After age 59 1/2 and after the 5 year holding period, you do not pay any taxes on the earnings.
Things to remember about Roth IRAs
1) Not everyone can get a Roth IRA. It depends on your Adjusted Gross Income and filing status.
2) None of your contributions are tax-deductible, but when you withdraw your contributions, they are tax-free and penalty-free.
3) Your withdrawals after age 59 1/2 may be tax-free.
4) You must hold the earnings and any conversions in your Roth IRA for 5 full tax years in the beginning.
Some questions I get:
Q1: What if I open my first Roth IRA at age 60, does the 5 year holding period still apply?
A1: Yes, but you can withdraw your contributions at anytime without paying any taxes.
Q2: If I open another Roth IRA somewhere, does the 5 year holding period apply?
A2: 5 year holding period only applies to your first Roth IRA.
Q3: If I convert or rollover my Traditional IRA into a Roth IRA, what should I know before doing this?
A3: One, you will pay income tax on the earnings and any part of your contributions you made tax-deductible. Second, you have to move the entire balance into the Roth IRA within 60 days of receiving receipt. Third, the 5 year holding period will apply on this conversion, whether you previously have a Roth IRA or not.
Traditional IRA
When you contribute money to your Traditional IRA, your contributions may be fully, partially, or non tax-deductible. This all depends on your filing status, how much income you make, and whether or not you contribute to your employer's sponsor retirement plan such as a 401k.
How much can you deduct?
Before you read on, you should figure out your Adjusted Gross Income (AGI) if you are earning lots of money (somewhere above $50,000). The IRS website in Publication 590 (2005 edition) on page 15 shows you how to figure out your AGI.
If you are currently covered by an employer's retirement plan, your allowable deductions may be further limited. If you or your spouse are covered by an employer's retirement plan, you may be entitled to a partial deduction or no deduction. This depends on your income and filing status. First thing you need to do to figure out whether you can make deductions or no deductions is your Modified Adjusted Gross Income (your final income after all deductions are made). Don't ask me on how to get this number since I never done it before. But if you do figure out this number, determining whether your contributions are deductible or not will be easy.
Rule age 70 1/2
In Traditional IRAs, the Rule Age 70 1/2 applies. This rule say you cannot make any more contributions after age 70 1/2 and must start withdrawing at least the minimum distribution requirement. It also means you can not apply for a Traditional IRA after age 70 1/2. To figure out the minimum distribution requirement, you need three things. 1) Your account balance on December 31 of the previous year. 2) Appendix C of Publication 590 (page 85-100). Find out which table best describes your filing status. For most of you, it would be Table III on page 100. 3) A calculator. Here is the formula to figure out the minimum distribution requirement: (Your account balance on Dec 31 of the previous year) DIVIDED BY (your life expectancy as stated in the appropriate Table, which is usually Table III).
Example: Lets say you become age 70 1/2 in 2006. Your ending account balance on Dec 31, 2005 was $86,000. The minimum distribution requirement is: ($86,000/27.4) = $3138.69. You may start making withdrawals when you become age 70 1/2. If you do not, you must take the minimum distribution by April 1, 2007. This date is called the "Required beginning date." Remember, this is only the mimimum. You can always take more out, but this will not affect the minimum requirement distribution.
Continuing with this example. In 2007, you are age 71. Your account balance on Dec 31, 2006 was: $83,000. The minimum distribution for 2007 is: ($83,000/26.5) = $3132.08. You must take this minimum amount by December 31, 2007 (not April 1, 2008). Failure to meet this minimum amount will result in a 50% tax on the amount you have not taken. Let's say in 2006 you only took $2000 from your Traditional IRA. Your minimum requirement is $3132.08. Since you did not meet the minimum requirement, the amount you will be taxed on is $1132.08 (3132.08 - 2000). You will owe: $566.04 in taxes. And that's as far as I will go with the Rule 70 1/2.
When you make withdrawals from your Traditional IRA, your withdrawals may be subjected to income tax. You will pay taxes on the gains, interests, dividends, and any part of your contributions you made tax-deductible. The only tax-free withdrawals you have is the contributions you didn't make tax-deductible. If you make withdrawals before age 59 1/2, you will be hit with a 10% tax. Click here to learn more about Rule 59 1/2.
Few key pointers you should remember about Traditional IRAs
1) Almost every working citizen can get it, except for people who are age 70 1/2 and above.
2) Your contributions may be fully, partially, or not deductible. This depends on your AGI, your filing status, whether you are covered by your employer's retirement plan, and whether or not you receive social security.
3) Minimum distribution requirement kicks in when you reach age 70 1/2.
4) Your withdrawals are taxable except on the contributions you didn't make tax-deductible.
How much can you deduct?
Before you read on, you should figure out your Adjusted Gross Income (AGI) if you are earning lots of money (somewhere above $50,000). The IRS website in Publication 590 (2005 edition) on page 15 shows you how to figure out your AGI.
If you are currently covered by an employer's retirement plan, your allowable deductions may be further limited. If you or your spouse are covered by an employer's retirement plan, you may be entitled to a partial deduction or no deduction. This depends on your income and filing status. First thing you need to do to figure out whether you can make deductions or no deductions is your Modified Adjusted Gross Income (your final income after all deductions are made). Don't ask me on how to get this number since I never done it before. But if you do figure out this number, determining whether your contributions are deductible or not will be easy.
- If your filing status is single or head of household, and your AGI is $50,000 or less, your contributions to the Traditional IRA is fully deductible. If your AGI is above $50,000 but less than $60,000, your contributions are partially deductible. If your AGI is $60,000 and above, then none of your contributions are deductible.
- If you are married filing a joint return or a qualified widower, and your AGI is $70,000 or less, your contributions are fully deductible. If your AGI is above $70,000 but less than $80,000, your contributions are partially deductible. If your AGI is $80,000 and above, then none of your contributions are deductible.
- If you are married filing separately and your AGI is less than $10,000, your contributions are partially deductible. If your AGI is above $10,000, none of your contributions are deductible.
If you are not covered by a retirement plan at work, then the figures on the previous paragraph changes.
- If your status is single or head of household: AGI does not matter, so your entire contributions to the annual limit are fully deductible.
- If your status is married and filing a joint return or a qualified widower: If your AGI is $150,000 or less, then your contributions are fully deductible. If your AGI is above $150,000 but less than $160,000, your contributions are partially deductible. If your AGI is above $160,000, then none of your contributions are deductible.
- If your status is married and filing separately: If your AGI is less than $10,000, your contributions are partially deductible. If your AGI is above $10,000, then your contributions are not deductible.
Rule age 70 1/2
In Traditional IRAs, the Rule Age 70 1/2 applies. This rule say you cannot make any more contributions after age 70 1/2 and must start withdrawing at least the minimum distribution requirement. It also means you can not apply for a Traditional IRA after age 70 1/2. To figure out the minimum distribution requirement, you need three things. 1) Your account balance on December 31 of the previous year. 2) Appendix C of Publication 590 (page 85-100). Find out which table best describes your filing status. For most of you, it would be Table III on page 100. 3) A calculator. Here is the formula to figure out the minimum distribution requirement: (Your account balance on Dec 31 of the previous year) DIVIDED BY (your life expectancy as stated in the appropriate Table, which is usually Table III).
Example: Lets say you become age 70 1/2 in 2006. Your ending account balance on Dec 31, 2005 was $86,000. The minimum distribution requirement is: ($86,000/27.4) = $3138.69. You may start making withdrawals when you become age 70 1/2. If you do not, you must take the minimum distribution by April 1, 2007. This date is called the "Required beginning date." Remember, this is only the mimimum. You can always take more out, but this will not affect the minimum requirement distribution.
Continuing with this example. In 2007, you are age 71. Your account balance on Dec 31, 2006 was: $83,000. The minimum distribution for 2007 is: ($83,000/26.5) = $3132.08. You must take this minimum amount by December 31, 2007 (not April 1, 2008). Failure to meet this minimum amount will result in a 50% tax on the amount you have not taken. Let's say in 2006 you only took $2000 from your Traditional IRA. Your minimum requirement is $3132.08. Since you did not meet the minimum requirement, the amount you will be taxed on is $1132.08 (3132.08 - 2000). You will owe: $566.04 in taxes. And that's as far as I will go with the Rule 70 1/2.
When you make withdrawals from your Traditional IRA, your withdrawals may be subjected to income tax. You will pay taxes on the gains, interests, dividends, and any part of your contributions you made tax-deductible. The only tax-free withdrawals you have is the contributions you didn't make tax-deductible. If you make withdrawals before age 59 1/2, you will be hit with a 10% tax. Click here to learn more about Rule 59 1/2.
Few key pointers you should remember about Traditional IRAs
1) Almost every working citizen can get it, except for people who are age 70 1/2 and above.
2) Your contributions may be fully, partially, or not deductible. This depends on your AGI, your filing status, whether you are covered by your employer's retirement plan, and whether or not you receive social security.
3) Minimum distribution requirement kicks in when you reach age 70 1/2.
4) Your withdrawals are taxable except on the contributions you didn't make tax-deductible.
Wednesday, February 14, 2007
The dividend in life insurance vs dividend in investments
What is a dividend? To many people, they think its free money. But they don't know the difference between a dividend in a life insurance policy versus a dividend in investments. To them, its all the same. Here, I'm going to define these two types of dividend.
Dividend in a life insurance policy: This is where an insurance company refunds the excess amount of premiums you paid into the policy. That means you are already overpaying your premiums in the first place. So its basically you are getting your change back. For example, let's say you bought something at a store and the total cost is $25. You pay $50, so the cashier returns you $25. Well, in life insurance, they don't return the change back to you immediately, they invest it in their own accounts and then give it back to you later in the year.
Dividend in investments: This is when an investment company makes profits and pay a portion of these profits to shareholders. This is called a dividend. Remember, anything related to investments are not guaranteed. If you do receive a dividend, you have the choice of keeping it in your pocket or re-invest it to buy more shares. You will pay taxes on the dividend, unless your investments are in tax-deferred accounts such as IRAs.
Dividend in a life insurance policy: This is where an insurance company refunds the excess amount of premiums you paid into the policy. That means you are already overpaying your premiums in the first place. So its basically you are getting your change back. For example, let's say you bought something at a store and the total cost is $25. You pay $50, so the cashier returns you $25. Well, in life insurance, they don't return the change back to you immediately, they invest it in their own accounts and then give it back to you later in the year.
Dividend in investments: This is when an investment company makes profits and pay a portion of these profits to shareholders. This is called a dividend. Remember, anything related to investments are not guaranteed. If you do receive a dividend, you have the choice of keeping it in your pocket or re-invest it to buy more shares. You will pay taxes on the dividend, unless your investments are in tax-deferred accounts such as IRAs.
Monday, February 05, 2007
How to borrow money from IRA
"Wait a minute! You can't borrow money from your IRA!" I read an article somewhere that said you can as long as you are able to pay it all back within 60 days. Let's say you are below the age 59 1/2 and you need the money for whatever purposes that doesn't fit the exception rule. There is no loan interest and there is no withholding period when you borrow money from your IRA. So, if you need money right away, you can borrow money from your IRA. How? It's called a IRA rollover.
The IRA rollover can only be done once every 12 months. You withdraw money from your current IRA and you have 60 days to deposit this money into an IRA account. Keep in mind, you don't necessarily have to open a new IRA account to do the rollover. You can put it back into your original IRA. During the 60 day period, you can use the money for whatever purpose, as long as you pay it all back by the 60th day. If you do not pay it back, you will pay income taxes on the earnings and also pay a 10% penalty as well. So, its a double taxation.
You have to be careful with the 60 day rule. The IRS does not accept any excuses or give any extensions if you can't pay the money back. If the 60th day lands on a weekend or on a holiday, it is your obligation to deposit the money before hand. Let's say you get your check from your IRA on April 1. You must deposit the money on or before May 30 (April 1 is the first day of the 60 days. There are 30 days in April and 31 days in May). If May 30 is on a Saturday or Sunday, you know the stock market doesn't do any trading on the weekends. So, you must deposit the money on the Friday before May 30.
The IRA rollover can only be done once every 12 months. You withdraw money from your current IRA and you have 60 days to deposit this money into an IRA account. Keep in mind, you don't necessarily have to open a new IRA account to do the rollover. You can put it back into your original IRA. During the 60 day period, you can use the money for whatever purpose, as long as you pay it all back by the 60th day. If you do not pay it back, you will pay income taxes on the earnings and also pay a 10% penalty as well. So, its a double taxation.
You have to be careful with the 60 day rule. The IRS does not accept any excuses or give any extensions if you can't pay the money back. If the 60th day lands on a weekend or on a holiday, it is your obligation to deposit the money before hand. Let's say you get your check from your IRA on April 1. You must deposit the money on or before May 30 (April 1 is the first day of the 60 days. There are 30 days in April and 31 days in May). If May 30 is on a Saturday or Sunday, you know the stock market doesn't do any trading on the weekends. So, you must deposit the money on the Friday before May 30.
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