We are continuing our series of online free webinars for anyone who needs help during this pandemic and beyond. The next one is March 25 at 5:30pm, and all you need to do is send in a question in advance. We’ll then send the link to the Zoom webinar.

We heard that some people are shy or simply embarrassed to ask financial questions publicly on Zoom. So to include more people, Maura will answer questions that people send in ahead of time.
The audience will not have to show themselves. You don’t even have to dress up!

We want to be able to take down the barriers – whatever they are – that prevent greater financial literacy.

All Are Welcome

Everyone is invited: clients, friends, students, anyone you know who might have a question. Just send in the question ahead of time to postoffice@bluesparkfinancial.com.

Sample Questions

Here are some questions that have been sent in so far:

• How do I improve my credit score?
• What is a stock split?
• If I took money out of my IRA while I was laid off, can I put it back in?
• Are stimulus payments taxable?

The Roth “five-year rule” – often misunderstood – in part governs when you can take tax-free distributions of earnings from your Roth accounts (IRAs, Roth 401k, or other work-based Roth accounts). Your Roth contributions can be withdrawn tax-free at any time. But the for the account’s earnings: The rule says that to take a tax-free distribution of earnings you must wait five years after your first contribution, the distribution must take place after you turn 59½. There are other provisions for when you become disabled, or when your beneficiaries inherit the assets after your death. Roth IRAs (but not workplace plans) also allow up to a $10,000 tax-free withdrawal of earnings after five years for a first-time home purchase, no matter your age.

While this seems straightforward, several nuances may impact your distribution’s tax status. Here are four things to think about.

When does the clock start ticking?

In some cases, the five-year waiting period may be shorter. The countdown begins on January 1 of the tax year for which you make your first contribution. For example, if you open a Roth IRA on December 31, 2020, the clock starts on January 1, 2020, and ends on January 1, 2025 — four years and one day after making your first contribution. Even if you wait until April 15, 2021, to make your contribution for tax year 2020, the clock starts on January 1, 2020.

Does the five-year rule apply to every account?

For Roth IRAs, the five-year clock starts when you make your first contribution to any Roth IRA. With employer plans, each account you own is subject to a separate five-year rule. However, if you roll assets from a former employer’s 401k plan into your current Roth 401k, the clock depends on when you made the first contribution to your former account. For instance, if you first contributed to your former Roth 401k in 2014, and in 2020 you rolled those assets into your new plan, the new account meets the five-year requirement.

What if you roll from a Roth 401k to a Roth IRA?

If you have never previously contributed to a Roth IRA, the clock resets when you roll money into the Roth IRA, regardless of how long the money has been in your Roth 401k. So use caution. If you think you might do a Roth 401k rollover sometime in the future, consider opening a Roth IRA account for it to go into as soon as possible. The five-year clock starts ticking as soon as you make your first contribution, even if it’s just a minimum amount and you don’t contribute again until you roll over the assets.

What if you convert from an IRA to a Roth IRA?

In this case, a different five-year rule applies. When you convert funds in a traditional IRA to a Roth IRA, you will have to pay income taxes on deductible contributions and tax-deferred earnings in the year of the conversion. If you withdraw any of the converted assets within five years, a 10% early-distribution penalty may apply, unless you have reached age 59½ or qualify for another exception. This rule also applies to conversions from employer plans.
 

Financial Literacy for the Pandemic

**NOTE: Our “Financial Literacy for the Pandemic” Zoom calls, which were held weekly during the first few months of the pandemic, will move to monthly as the questions have subsided but many people still need help with financial issues as a result of COVID-19. We will be sending the usual invitation with dates to clients, so you can pass on the link.

Anyone — especially first-responders, nurses, doctors, grocery workers, and delivery people —  who have questions can send them in to postoffice (at) bluesparkfinancial.com and we will address it on the next Zoom Financial Literacy call.

The CARES Act

By now you know that Congress has passed a multi-trillion-dollar relief bill to help keep individuals and businesses afloat during these difficult times. The Coronavirus Aid, Relief, and Economic Security (CARES) Act includes many provisions that could be beneficial to you.

Here are some of the highlights of the CARES Act:

Retirement Plan Distributions

There are no RMDs for 2020. Required minimum distributions from IRAs and employer-sponsored retirement plans will not apply for the 2020 calendar year. That is for regular IRAs as well as inherited IRAs. In addition, the 10% penalty for “premature distribution” that would normally apply for distributions made before age 59½ (unless an exception applied) will be waived for Coronavirus-related retirement plan distributions of up to $100,000. The tax obligation may be spread over three years, with up to three years to reinvest the money.

Federal Student Loan Deferrals

For all borrowers of federal student loans, payments of principal and interest will be automatically suspended for six months, through September 30, without penalty to the borrower. Federal student loans include Direct Loans (which includes PLUS Loans), as well as Federal Perkins Loans and Federal Family Education Loan (FFEL) Program loans held by the Department of Education.
But be careful, private student loans are not eligible for the deferral. Some private lenders are extending their own versions of the CARES Act.

Help for Businesses

The CARES Act included several provisions designed to help self-employed individuals and small businesses weather the financial slam of the COVID-19 crisis.

Self-employed individuals and small businesses with fewer than 500 employees can get a Paycheck Protection Loan through a Small Business Association (SBA) lender. Businesses can borrow up to 2.5 times their average monthly payroll costs, up to $10 million. There has been a lot of fraud already, and many businesses are returning their loans. This loan can become a grant if an employer continues to pay employees during the eight weeks following the origination of the loan – so the employees are not taking unemployment — and uses the money for payroll costs (including health benefits), rent or mortgage interest, and utility costs. These loans have kept millions of businesses solvent during these tough times.

Also available are the emergency grants of up to $10,000 (that do not need to be repaid if certain conditions are met), SBA disaster loans, and relief for business owners with existing SBA loans. I have not heard of any businesses getting one of these emergency grants so far.

Businesses of all sizes may qualify for a refundable payroll tax credit of 50% of wages paid to employees during the crisis, up to $10,000 per employee. The credit is applied against the employer’s share of Social Security payroll taxes. You cannot use both the refundable payroll tax credit and the PPP loan, you have to choose one.

Recovery Checks

Many people will receive a one-time cash payment of $1,200. Each U.S. resident or citizen with an adjusted gross income (AGI) under $75,000 ($150,000 for married couples filing jointly) who are not the dependent of another taxpayer and have a Social Security number, should get the full rebate. Parents also receive an additional $500 for each dependent child who is 16 years old or younger.

These payments are not taxable income.

The $1,200 rebate amount will decrease by $5 for every $100 in excess of the AGI thresholds until it completely phases out. For example, the $1,200 rebate completely phases out at an AGI of $99,000 for an individual taxpayer and the $2,400 rebate phases out at $198,000 for a married couple filing a joint return.

The payments will be based on 2019 income tax returns (or 2018 if no 2019 return has been filed) and is being sent by the IRS via direct deposit or mail. People who didn’t qualify for the rebate based on 2018 or 2019 income might still receive a full or partial rebate when they file a 2020 tax return.

Extra Unemployment Benefits

The federal government will provide an extra $600 per week to those getting unemployment benefits as a result of COVID-19, on top of any state unemployment benefits an individual receives. This additional benefit is for up to four months (through July 31.) The federal government will also fund up to an additional 13 weeks of unemployment benefits for those who have exhausted their state benefits (for up to 39 weeks of benefits) through the end of 2020.

The CARES Act also provides assistance to workers who have been affected by the pandemic but who normally wouldn’t be eligible for unemployment benefits, including self-employed, part-time workers, freelancers, independent contractors, and gig workers. Those who had to leave work for coronavirus-related reasons also might be eligible for benefits.
 
 
 

The government left some retirement numbers unchanged and increased some for 2020. The maximum you can contribute to a traditional IRA or a Roth IRA in 2020 is $6,000 if under 50 and $7,000 if 50 or older (or up to 100% of your earned income, if that is less), the same as last year. You can split your contribution between a traditional IRA and a Roth IRA, but it can’t be more than $6,000/$7,000.

Traditional IRA income limits

To have your contribution be fully deductible, your income (modified adjusted gross or MAGI) must be $65,000 or less (if single), up from $64,000 in 2019. If you’re married and filing a joint return, you can fully deduct in 2020 if your MAGI is $104,000 or less, which is up from $103,000 in 2019.

If you are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. If you are not covered by an employer plan but your spouse is, and you file a joint return, your deduction is limited if your MAGI is $196,000 to $206,000 (up from $193,000 to $203,000 in 2019), and eliminated if your MAGI exceeds $206,000 (up from $203,000 in 2019).

Roth IRA income limits

The income limits for determining how much you can contribute to a Roth IRA have also increased for 2020. You can contribute the full amount to a Roth IRA if your MAGI is $124,000 or less (if single), up from $122,000 in 2019. If you’re married and filing a joint return, you can make a full contribution if your MAGI is $196,000 or less, up from $193,000 in 2019).

Employer retirement plans

Most of the employer retirement plan limits for 2020 have increased. The maximum amount you can contribute as your “elective deferral” to a 401k plan is $19,500 in 2020 (up from $19,000 in 2019). This limit also applies to 403b and 457b plans, as well as the Federal Thrift Plan. If you’re 50 or older, you can also make catch-up contributions of up to $6,500 (up from $6,000 in 2019) for a total of $26,000. Special catch-up limits apply to certain participants in 403b and 457b plans.

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit. Deferrals to 401k plans, 403b plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457b plans are not. For example, if you participate in both a 403b plan and a 457b plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2020 (plus catch-up contributions).

The most you can contribute to a SIMPLE IRA or SIMPLE 401k is $13,500 in 2020 (up from $13,000 in 2019), and the catch-up limit for age 50 or older remains $3,000.

The maximum that can be allocated to your account in a defined contribution plan (for example, a 401k plan or profit-sharing plan) in 2020 is $57,000 (up from $56,000 in 2019) plus age 50 catch-up contributions. (This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.)

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2020 is $285,000 (up from $280,000 in 2019), and the dollar threshold for determining highly compensated employees (when 2020 is the look-back year) is $130,000 (up from $125,000 when 2019 is the look-back year).
 

Employer retirement plans

• Employees in 401(k), 403(b), and most 457 plans can defer up to $19,000 of their compensation in 2019 (up from $18,500 in 2018). Those age 50 and older can defer up to an additional $6,000 in 2019 (the same as last year).
• Employees in a SIMPLE retirement plan can defer up to $13,000 in 2019 (up from $12,500 in 2018), and those older than 50 can defer up to an additional $3,000 in 2019 (the same as in 2018).

IRAs

The annual limit on contributions to traditional and Roth IRAs increased to $6,000 in 2019 (up from $5,500 in 2018), and people older than 50 can contribute an additional $1,000. That can be contributed to one or both, but cannot exceed those limits.

For people covered by a workplace retirement plan, the deduction for contributions to a traditional IRA is phased out for the following modified adjusted gross income (AGI) ranges:

Note that the 2019 phaseout range is $193,000 – $203,000 (up from $189,000 – $199,000 in 2018) when the person making the IRA contribution is not covered by a workplace retirement plan but is filing jointly with a spouse who is covered.

Roth IRAs

The threshold ranges of modified AGI phaseout ranges for individuals to make contributions to a Roth IRA are:

Gift taxes

The annual gift tax exclusion for 2019 remains $15,000 per person, the same as in 2018. The amount not subject to gift and estate taxes (the basic exclusion amount) for 2019 rose to $11.4 million, up from $11.18 million in 2018.

Kiddie tax

Under the kiddie tax rules, unearned income above $2,200 in 2019 (up from $2,100 in 2018) is taxed using the trust and estate income tax brackets. The kiddie tax rules apply to: (1) those under age 18, (2) those age 18 whose earned income doesn’t exceed one-half of their support, and (3) those age 19 – 23 who are full-time students and whose earned income doesn’t exceed half of their support.

Standard tax deductions

And finally, new AMT levels:

The inherited IRA is not really yours

While you keep many of the IRA benefits, you are generally not considered the “owner” of an IRA when you inherit it. That is why you can’t mix inherited IRA funds with your own IRA or make 60-day rollovers to and from the inherited IRA. You also need to calculate the taxable portion of any payment from the inherited IRA separately from your own IRAs, and you need to determine the amount of any required annual minimum distributions (RMDs) from the inherited IRA separately from your own IRAs.

However, if you inherited the IRA from your spouse, you have more options. You can take ownership of the IRA funds by rolling them into your own IRA. If you’re the sole beneficiary, you can also leave the funds in the inherited IRA and treat it as your own IRA. In either case, the IRA will be yours and no longer treated as a beneficiary IRA. As the new IRA owner (as opposed to beneficiary), you won’t need to begin taking RMDs from a traditional IRA until you reach age 70½, and you won’t be forced to take RMDs from a Roth IRA during your lifetime at all. And as the IRA owner, you can also name new beneficiaries of your choice.

Required minimum distributions

As beneficiary of an inherited IRA – whether traditional or Roth – you must begin taking RMDs after the owner’s death. In general, you must take payments from the IRA annually, over your life expectancy, starting no later than December 31 of the year following the year the IRA owner died. But if you are a spousal beneficiary, you can usually delay payments until the year your spouse would have reached 70½.

In some cases, you can satisfy the RMD rules by withdrawing the entire balance of the inherited IRA by the fifth anniversary of the owner’s death. In nearly every situation, though, it makes sense to use the life expectancy method instead – to stretch payments out as long as possible and take maximum advantage of the IRA’s tax-deferral benefit.

You can elect to receive more than the required amount in any given year, but if you receive less than the required amount you’ll be subject to a federal penalty tax of 50% of the difference between the required distribution and the amount actually distributed.

More stretching for inherited IRAs …

What happens if you elect to take distributions over your life expectancy but you die with money still in the inherited IRA? This is where your IRA custodial/trustee agreement becomes crucial. If, as is sometimes the case, your IRA language doesn’t address what happens when you die, then the IRA balance is typically paid to your estate – thus ending the IRA tax deferral.

Many providers, though, allow you to name a successor beneficiary. In this case, when you die, your successor beneficiary steps into the role of owner and can continue to take RMDs over your remaining distribution schedule, maintaining the tax benefits over time.

Federal income taxes

Distributions from inherited IRAs are subject to federal income taxes, except for Roth or nondeductible contributions the owner made. But distributions are never subject to the 10% early-distribution penalty, even if you haven’t yet reached age 59½. (This is one reason why a surviving spouse may elect to remain a beneficiary rather than taking ownership.)

When you take a distribution from an inherited Roth IRA, the owner’s nontaxable Roth contributions are deemed to come out first, followed by any earnings. Earnings are tax-free if made after a five-calendar-year holding period, starting with the year the IRA owner first contributed to any Roth IRA. For example, if the IRA owner first contributed to a Roth IRA in 2014 and died in 2016, any earnings distributed from the IRA after 2018 will be tax-free. Once this five-year period is over, you are in the tax-free category.

Creditor protections for inherited IRAs

Traditional and Roth IRAs are protected under federal law if you declare bankruptcy. The IRA bankruptcy exemption was originally an inflation-adjusted $1 million, which has since grown to a total of $1,283,025. Unfortunately, the U.S. Supreme Court has ruled that inherited IRAs are not covered by this exemption. (If you inherit an IRA from your spouse and elect to treat that IRA as your own, it is possible that the IRA won’t be considered an inherited IRA for bankruptcy purposes, but this was not specifically addressed by the Court.) This means that your inherited IRA won’t receive protection under federal law if you declare bankruptcy. However, the laws of your state may still protect those assets, in full or in part, and may provide protection from creditors outside of bankruptcy as well.