Q: When I do my IRA required minimum distribution I take some extra money out and move it to a taxable account. Good idea or bad idea? Thanks – Bill Faye, Rockville, MD
A: After years of accumulating money for retirement, figuring out what to do with “extra” money withdrawn from your IRA accounts seems like a nice problem to have. But required minimum distributions, or RMDs, can be tricky.
First, a bit of background on managing RMDs. These withdrawals are a requirement under IRS rules, since Uncle Sam wants to collect the taxes you’ve deferred on contributions to your IRAs or 401(k)s. You must take your distribution by April 1st of the year you turn 70 ½; subsequent RMDs are due by December 31st each year. If you don’t take the distribution, you’ll pay a 50% tax penalty in addition to regular income tax on the amount that should have been withdrawn.
The size of your required withdrawal depends on your age and the account balance. (You can find the details on the IRS website here.) If you’re over 59 ½, you can take out higher amounts than the minimum required, but the excess withdrawals don’t count toward your future distributions. Still, by managing your IRAs the right way, you can preserve more of your portfolio and possibly reduce taxes, says Mary Pucciarelli, a financial advisor with MetLife Premier Client Group.
For those fortunate enough to hold more than one IRA, you must calculate the withdrawal amount based on all your accounts. But you can take the money out of any combination of the IRAs you hold. This flexibility means you can make strategic withdrawals. Say you have an IRA with a big exposure to stocks and the market is down. In that scenario, you might want to pull money from another account that isn’t so stock heavy, so you’re not selling investments at a low point.
You can minimize RMDs by converting one or more of your traditional IRAs to a Roth IRA. Roths don’t have minimum distribution requirements, so you can choose when and how much money you take out. More importantly, you don’t pay taxes on the withdrawals and neither will your heirs if you leave it to them. You will owe taxes on the amount you convert. To get the full benefit of the conversion, consider this move only if you can pay that bill with money outside your IRA. Many investors choose to make the move after they’ve retired and their tax bill is lower. Pucciarelli suggests doing the conversion over time so you can avoid a big tax bill in one year.
Up until this year, you could avoid paying taxes on your RMD by making a qualified charitable contribution directly from your IRA to a charity. The tax provision expired in December. It’s possible Congress will renew the tax break, though nothing is certain in Washington. Meanwhile, if you itemize on your taxes, you can deduct your charitable contribution.
As for the extra money you’ve withdrawn, it’s fine to stash it in a taxable account. If you have sufficient cash on hand for living expenses, you can opt for longer-term investments, such as bond or stock funds. But be sure your investments suit your financial goals. “You don’t want to throw your asset allocation out of whack when you move the money,” says Pucciarelli. Consider a tax-efficient option, such as an index stock fund or muni bond fund. That way, Uncle Sam won’t take another big tax bite out of your returns.
Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.
New rules let you carry over unused funds in your healthcare flexible spending account, and more employers are adding that option. So that's one less excuse for why you're not signing up for this valuable perk at work.
The U.S. Treasury Department changed a rule last October to allow employees to roll over $500 of unspent flexible spending account money, ending years of a use-it-or-lose it policy, but most workers have yet to reap its benefits.
Only 8% of U.S. companies adopted the FSA program this year, according to data from Alegeus Technologies, the largest provider of benefit administration services.
But that figure could jump to as much as 50% in 2015, predicts Alegeus executive chairman Bob Natt.
FSAs allow workers to set aside pretax money for healthcare expenses.
Employees will likely find out if their company is taking part in the rollover program when they get their open enrollment benefit information this fall.
Those offered the new option will be able to place up to $2,500, pretax, in their FSAs, and roll over as much as $500 of unspent money at the end of the year. Those who continue in traditional FSA plans will have to use all their funds by year-end, or when a grace period stipulated by their companies ends.
But the program’s participation rate is meager. About 33 million Americans contribute to an FSA each year. That number includes only a quarter of the workers eligible for it at large corporations, according to benefit consultant Mercer.
That enrollment could be boosted by the new rollover benefit, Alegeus’ Natt says, allowing both employees and employers to benefit from not paying tax on those contributions.
Indeed, there’s already some evidence of the new rule’s pulling power.
PrimePay, a third-party benefit administrator, which heavily promoted the rollover option to clients last year, saw a 30% adoption rate. The companies that participated saw a 17% increase in participants and contribution dollars.
“I was a little disappointed at first,” says Steve Jackson, PrimePay’s senior vice president for strategic development and channel sales. “But then as I saw what Alegeus was finding nationwide, it seemed better.”
FSAs can still be a hard sell to employees.
Rod Leveque, 39, who works in communications in Claremont, Calif., contributed to his FSA for the first time last year, after four years at a company that offered the option. Leveque says his decision was spurred by an impending LASIK eye surgery, for which he expected expenses.
Next year? “I doubt I will continue to participate,” he says. “I don’t think the $500 rollover would sway me, either,” he adds, because his typical medical expenses do not make it worthwhile.
If your company does adopt a rollover model, Natt’s advice is to put at least $500 in, because you are at no risk of losing it. If you leave the company and still have a balance on the books, however, you’ll need to spend that balance down.
Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.
If you want to owe less for 2014, start your year-end tax planning today.
When everyone else starts loading their backpacks and shopping the back-to-school sales, I know it is time for me to dive back into TurboTax.
That’s because fall is the perfect time to plan my approach to the tax forms I won’t file until next April. By using the next four months strategically, I may be able to reduce the amount I have to pay then.
This is a particularly easy year to do tax planning, because the rules haven’t changed much from 2013. If you do your own taxes on a program like Intuit’s TurboTax or TaxAct, you can use last year’s version to create a new return using this year’s numbers, and play some what-if games to see how different actions will affect your tax bill.
If you use a tax professional, it’s a good time to ask for a fall review and some advice.
Here are some of the actions to take now and through the end of the year to minimize your 2014 taxes.
1. Feed the tax-advantaged plans. Start by making sure you’re putting the maximum amount possible into your own health savings account, if you have one associated with a high-deductible health plan. That conveys maximum tax advantage for the long term. Also boost the amount you are contributing to your 401(k) plan and your own individual retirement account if you’re not already contributing the maximum.
2. Plan your year-end charitable giving. You probably have decent gains in some stocks or mutual funds. If you give your favorite charity shares of an investment, you can save taxes and help the charity. Instead of selling the shares, paying capital gains taxes on your profits and giving the remainder to your charity, you can transfer the shares, get a charitable deduction for their full value and let the charity—which is not required to pay income taxes—sell the shares. Start early in the year to identify the right shares and the right charity.
3. Take losses, and some gains. If you have any investment losses, you can sell the shares now and lock in the losses. They can help you offset any taxable gains as well as some ordinary income. You can re-buy the same security after 31 days, or buy something different immediately. In some cases, you may want to lock in gains, too. You might sell winners now if you want to make changes to your holdings and have the losses to offset them.
4. Be strategic about the alternative minimum tax. Did you pay it last year? Do you have a lot of children, medical expenses and mortgage interest payments? If so, you may end up subject to the alternative minimum tax, which taxes more of your income (by disallowing some deductions) at a lower tax rate. Robert Weiss, global head of J.P. Morgan Private Bank’s Advice Lab—a personal finance strategy group—says there are planning opportunities here. If you expect to be in the alternative minimum tax group, you can pull some income into this year—by exercising stock options or taking a bonus before the year ends—and have it taxed at the lower AMT rate. It’s good to get professional advice on this tactic, though. If you pull in too much money you could get kicked out of the AMT and the strategy would backfire.
5. Look at the list of deductible items and plan your approach. Many items, such as union dues, work uniforms, investment management fees and more are deductible once they surpass 2% of your adjusted gross income. Tax advisers often suggest taxpayers “bunch” those deductions into every other year to capture more of them. Check out the Internal Revenue Service’s Publication 529 to view the list, and try to determine if you want to amass your deductions this year or next. Then shop accordingly.
Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.
The bottom line is it's a solid deal
Outrage is a useful tool in a democracy, but not when it’s directed at the wrong target or ignores the facts. As the criticism of Burger King’s so-called ‘tax inversion’ deal with Canadian fast-casual restaurant and coffee chain Tim Hortons heats up in the political arena, several facts are being blatantly ignored. While it may be ideologically satisfying to label the merger as being unpatriotic because it will deprive the U.S. Treasury of tax dollars, it is also an overblown criticism.
Consider how shareholders of public corporations get taxed. Unlike investors in private companies who get taxed once on their pass-through income, public investors get a double hit.
To take a simple example, for every dollar that a public company makes in income, it has to pay 35% in federal income taxes as well as more in state and local taxes – let’s call it another 5%. The remaining 60 cents are then distributed as dividends to shareholders. Of that 60 cents, the shareholders now have to pay personal taxes in the average range of 20% to 39.6% depending on how long they have held the stock. Again, taking state and local taxes into account, in aggregate then, most shareholders pay somewhere between 55% and 67% in taxes on their investment in a public company.
This analysis, of course, ignores tax loopholes that large public companies are able to take advantage of but such loopholes rarely yield more than a 5-10% benefit, which still leaves shareholders paying an average of 50% in taxes.
Even those who believe in progressive taxation would be hard pressed to agree with this tax scheme. True, shareholders may also achieve gains through the appreciation of their stock, which is not taxed twice, but that is meant to be a bonus to incentivize people to invest, not to be an offset against dividend income. The latter could make tax incentives for investing a zero-sum game, which makes no sense.
From a political standpoint, it may be beneficial to demand that American companies not repatriate abroad for tax reasons, but the merger of Burger King with Tim Hortons has a lot more to do with the tight margins in the burger joint business and the more robust margins in the fast-casual restaurant and coffee chain trades. As Burger King struggles with hyper competition from McDonalds, Chipotle, and Starbucks, it needs to explore expansionary opportunities. The fact that Tim Hortons happens to be in Canada – in this case, at least – is incidental.
Moreover, the likely tax savings for Burger King by a tax inversion would only be around $3.4 million this year, given that Canada’s total corporate tax rate is 26.5% and Burger King paid an actual tax rate of only 27.5% last year, which would not be a lot for a company with more than $1 billion in top-line revenues and $340 million in profits on a run-rate basis for 2014. To put it another way, If the management of Burger King agreed to an $11 billion merger simply because of $3.4 million of cost savings, it would be bad management indeed. However, that is not the case here and all signs, when rationally examined, point to the fact that this deal is important for Burger King’s future growth, which will also benefit its employees, shareholders, and customers.
Questioning mergers based on anti-competitive factors is fine, but questioning the wisdom of patently good corporate deals simply because there are ancillary tax benefits is silly. It distracts from larger issues like labor relations and the pressures of global competition on the American economy, while doing nothing to benefit the discussion about tax reform.
This particular example has no real meat, except perhaps in the press.
Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius. Sanghoee sits on the Board of Davidson Media Group, a mid-market radio station operator. He has an MBA from Columbia Business School and is also the author of two thriller novels. Follow him @sanghoee.
The investor's Berkshire Hathaway is helping to finance a deal that would turn Burger King into a Canadian company for tax purposes.
Burger King and Tim Horton have made it official: They’re planning to merge, and when all is said and done the new headquarters will be in Canada, not the U.S. By using Ontario as the address for the combined company—the operational HQ for BK restaurant will remain in Miami, the company says—the company may stand to pay a lower tax rate. This has linked BK to the roiling political controversy over “inversions,” in which American companies merge with smaller firms located abroad to become foreign companies for tax purposes.
Part of the financing for the deal comes from Berkshire Hathaway, the company run by famed investor Warren Buffett. He’s long been a a critic of the way our tax code favors, in his view, super-wealthy people like him. Back during the 2012 campaign, President Obama, whom Buffett supported, loved to bring up Buffett’s observation that he actually paid a lower tax rate than his secretary. Obama even proposed a “Buffett rule” that anyone earning more than $1 million should pay at least a 30% effective federal rate.
So a critic of the tax code is taxing advantage of what looks like a loophole in the tax code. This has already prompted some to call Buffett a hypocrite. Neil Cavuto at Fox Business doesn’t go to the H-word but says of Buffett: “It sets him up essentially against himself – and his oft-repeated claim those who have more should pay more in taxes.”
No, not really. First, it’s hardly news that Buffett has always been very shrewd about investing with an eye toward keeping taxes low. A small example: As Bloomberg News pointed out in March, tax savings are one reason Buffett says he prefers to buy companies outright when he can, instead of simply holding stock.
Second, while this is a story that’s very much developing, it is not clear that the Burger King/Tim Horton’s deal is mainly about lowering taxes. As MONEY’s Paul Lim argued yesterday, it may have more to do with diversifying Burger King’s portfolio beyond the slow-growing hamburger business. (BK will still pay U.S. taxes on its U.S. earnings. Though, as Reuters explains, locating in Canada now could eventually become more valuable if the company expands abroad.)
But mainly, suggestions of hypocrisy ring false because Buffett has never, ever held himself out as person who pays more taxes than he has to. The whole point of his story about his tax rate vs. his secretary’s is that he was allowed to pay less than he thought he should. He never said he was writing a check to the Treasury to make up the difference. He just said the law didn’t make any sense, and then he actively he supported a change that would presumably cost him money.
Also, if we had a Buffett rule that captured more of the income of high earners, complex corporate deals that cut taxes would actually be a little less worrying. After all, the ultimate beneficiaries of inversions and the like are the shareholders of companies. And that means it’s wealthy households who get the biggest bang for the tax-saving buck when a U.S. company heads abroad.
Call it inversion reversion. Or, don’t bite the hand that feeds you. After considering a tax-avoidance strategy by which it would buy a United Kingdom based company and move there to lower its tax bill, Walgreens is staying put in Chicago. But America’s biggest drug store chain is still going ahead and exercising an option to buy the 55% of the U.K.’s Alliance Boots that it doesn’t already own for $15 billion.
The combined company will be called Walgreens Alliance Boots and have 11,000 stores in 10 countries, plus a pharmaceutical wholesale and distribution network.
In remaining true to its Midwestern roots, Walgreens is eschewing the latest trend in corporate tax avoidance, known as inversion. Earlier this year companies including AbbVie and Mylan, have announced mergers with European based companies and intend redomicile there—that is, more their legal residence while pretty much staying put— because the tax rates are lower than the 35% corporate statutory rate in the U.S. Although the effective tax rate that most U.S. companies actually pay is much lower, the opportunity to replant a corporate flag in, say, Ireland, where the economy sucks but the corporate tax rate is 12.5%, has been too much to resist.
The corporate migration to foreign shores has been gaining momentum, led by pharmaceutical and medical companies. In addition to AbbVie and Mylan, Salix, Horizon Pharma and Medtronic have acquired firms in the UK, the Netherlands, and Ireland. Pfizer tried to buy the U.K.’s AstraZenica but was rebuffed. For the American multinational RX firms in particular, the lure of not repatriating foreign earnings, which would be taxed at U.S. rates, is powerful. By moving to Ireland, say, companies pay a territorial tax rate—that is, they are taxed only on domestic profits. The U.S. taxes corporations on their worldwide profits, which is one reason why many American multinational hold substantial profits overseas. According to the Congressional Research Service, a Pfizer inversion would have cost the U.S. $1.4 billion in lost tax revenues annually.
Walgreens said that it had given the inversion strategy careful consideration, as some of its stockholders had demanded. But in a statement, CEO Greg Wasson said the company concluded “it was not in the best long-term interest of our shareholders to attempt to re-domicile outside the U.S.” (Translation: the lawyers said no.) But Walgreens also acknowledged that as a U.S. company that derives almost all of its sales from U.S. consumers—not to mention from reimbursement from Medicaid and other government programs—it felt a patriotic tug, too.
U.S. Treasury Department Secretary Jacob J. Lew has been howling about corporations’ lack of “economic patriotism” and talking up retroactive legislation that can effectively undo some of the deals that have already taken place. Earlier this year, Treasury suggested changing the rules that govern such transactions. Currently, a company can take advantage of the tax benefits of an inversion deal only if the original U.S. stockholders own less than 80% of the new overseas company. Treasury wants to lower that threshold to 50% to make the deals less attractive. It also proposed denying tax benefits if the new entity is “primarily managed and controlled in the United States” regardless of the new shareholding distribution.
This is the second time in the last two decades that Treasury has led the charge to stem inversion schemes. In the 1990s and 2000s, companies such as Ingersoll-Rand, Tyco, the PXRE Group, Foster Wheeler, Nabors Industries, and Coopers Industries blew town to replant themselves in other nations, some in those great manufacturing centers known as Bermuda or the Cayman Islands. Congress put a halt to that naked tax dodging with the American Jobs Creation Act of 2004.
There is no disagreement among Democrats and Republicans that the corporate tax code needs to be overhauled to make it less complex and to impose tax rates that are competitive with other countries. “We want our tax code to have incentives for investing in the United States and disincentives for taking business out of the United States,” Lew said at a CNBC conference this week. That, however, will take another act of Congress, a body more inclined to do nothing. That would not describe America’s dealmakers and tax lawyers who continue to demonstrate that they have no aversion to inversion whatever.
Q: Is rental income a good way to diversify my retirement portfolio?
A: For some people, yes. “Rental property can provide another stream of income, a hedge against inflation if rental prices rise and an asset that hopefully will appreciate over time,” says Diann McChesney, a certified financial planner at Asset Strategies Inc. in Avon, Conn. But being a landlord isn’t for everyone and not all properties are a good investment, says McChesney.
To get the most out of a rental property, be judicious about where you buy. Like most things in real estate, location is critical. Buy in a place where there is strong demand for housing so you can command a good rent and you don’t have a hard time finding tenants. You may not want the hassle of owning it in your older retirement years, If you plan to sell it down the road, it’s important to own a property that will be attractive to other investors.
A good rental property has many of the same things you look for in a home: A nice neighborhood, well-regarded schools and jobs that attract people to the area. Be careful about buying a fixer-upper. Unless you are handy or have a lot of time to handle repairs, maintenance problems will eat into the income. Today’s low interest rates make taking on a mortgage reasonable but the real key is ensuring that the rental income generates positive cash flow. If you want an income from the property, rent should more than cover your mortgage, property taxes, maintenance and repairs, says McChesney.
Keep in mind that banks require a larger down payment for—20% to 25%—and charge higher rates. It’s also an illiquid asset, so you won’t be able to tap your investment as easily as you can money in, say, an IRA. While you can get a tax break writing off expenses while you hold the property, once you sell it you’ll pay taxes on that depreciation.
The bottom line: A rental property can be a good way to diversify your retirement portfolio and provide another source of income in your later years. But “there’s a lot more to it than collecting rent,” says McChesney.
Roth 401(k)s are showing up in more workplaces, but only about 10% of eligible workers saved in one last year. That's a big mistake.
Since they were launched in 2006, Roth 401(k)s have been typecast as the ideal plan for millennials. Paying taxes on your contributions in exchange for tax-free withdrawals, the reasoning goes, is best when your tax rate is lower than it’s likely to be in retirement. It turns out Roth 401(k)s may be the better option for Gen Xers and baby boomers too.
That’s the conclusion of a recent study by T. Rowe Price, which found that Roth 401(k)s leave just about all workers, regardless of age or tax bracket, with more money to spend in retirement than pretax plans do. “The Roth 401(k) should be considered the default investment,” says T. Rowe Price senior financial planner Stuart Ritter.
Yet few workers of any age invest in Roth 401(k)s, which let you set aside $17,500 in after-tax money this year ($23,000 if you’re 50 or older), no matter your income. Just as with a Roth IRA, withdrawals are tax-free, as long as the money has been invested for five years and you are at least 59½. Some 50% of employers now offer a Roth 401(k), up from just 11% in 2007, according to benefits consultant Aon Hewitt. But only 11% of workers with access to a Roth 401(k) saved in one last year. Big mistake. Here’s why:
Higher income. Every dollar you save in a Roth 401(k) is worth more than a dollar you put in a pretax account. That’s because you’ll eventually pay income taxes on those pretax dollars, while you get to keep every penny in a Roth. Granted, you get an upfront tax break by saving in a traditional 401(k), and you can invest that savings. Even so, a Roth almost always overcomes that headstart, the T. Rowe Price study found.
The fund company’s analysis looked at savers of different ages and tax brackets, both before and after retirement. As the graphic shows, a Roth 401(k) pays more even if you face a lower tax rate in retirement than you did during your career. The only group that would do significantly better with a pretax plan: investors 55 and older whose tax rate falls by 10 percentage points or more, which would mean up to 6% less income.
Greater flexibility. With a tax-free account, you can avoid required minimum withdrawals after age 70½ (as long as you roll over your Roth 401(k) to a Roth IRA). You can also pull out a large sum in an emergency, such as sudden medical bills, without fear of rising into a higher tax bracket.
Tax diversification. Having tax-free income can keep you from hitting costly cutoffs. For every dollar of income above upper levels, 50¢ or 85¢ of your Social Security benefits may be taxable. “Many retirees in the 15% bracket actually have a marginal tax rate of 22% or 27% when Social Security taxes are added in,” says CPA Michael Piper of ObliviousInvestor.com. And if you retire before you’re eligible for Medicare and buy your own health insurance, a lower taxable income makes it more likely you’ll qualify for a government subsidy. In short, when it comes to retirement, tax-free money is a valuable tool.
The late night duo are the newest celebrities to speak out against corporate inversions.
Last night the Comedy Central dream team of Jon Stewart and Stephen Colbert each took a moment on their respective shows to attack the growing number of American corporations moving their official addresses abroad to escape U.S. taxes.
The specific kind of tax flight the duo is talking about is known as an inversion, and these maneuvers have become all the rage in recent months. As MONEY’s Pat Regnier explains, an inversion is when a U.S. company merges with a (typically smaller) foreign company in tax-friendly country. The U.S. company then claims it is now based in the foreign company’s nation and thus avoids paying U.S. taxes while continuing to enjoy many benefits of essentially remaining an American company.
“It’s like me adopting an African child, and then claiming myself as his dependent,” quipped Colbert.
This practice has been widely condemned as unpatriotic and unfair to American taxpayers who will be stuck footing the bill if the government needs to replace corporate tax dollars with new sources of revenue. The anti-inversion chorus has so far included public figures ranging from President Obama to entrepreneur and Dallas Mavericks owner Mark Cuban, who recently advised his Twitter followers to divest from inversion-happy corporations.
On Wednesday, Stewart and Colbert added their own two cents, with Colbert bringing on Fortune’s Allan Sloan, author of a recent seminal article on inversions, to talk about the problem.