The Health IRA

Health savings accounts (HSAs) are tax-deductible savings plans that allow you to put aside savings for future health care expenses. HSAs were introduced in 2004 as part of the Medicare Prescription Drug, Improvement, and Modernization Act, which was signed into law by President George W. Bush. Since their creation, advancements in technology and popularity have allowed investors to not only access their HSAs more efficiently but also grow their accounts considerably.

While HSAs are primarily known as a tax-advantage plan for paying medical expenses, they can also help you save for retirement. Although it has become common practice that we income earners should contribute to our respective company-sponsored retirement plans or similar workplace defined contribution plans and other IRAs as the best way to save or invest our way towards retirement, recent developments in HSAs have created new strategies to help work towards financial independence and retirement expenses.

Before getting into potential strategies for Health Savings Accounts, let’s first look at who is eligible to open a Health Savings Account:

  • Must be 18 years of age or older
  • Must be covered under a qualified high-deductible health plan (HDHP). For 2020, the IRS defines an HDHP as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family.
  • May not be covered under any health plan that is not a qualified HDHP
  • May not be claimed as a dependent on another individual’s tax return
  • Cannot be over the age of 65

Now, if you meet the criteria listed above, you are eligible to set up a Health Savings Account. Here is where the fun begins. HSA holders in 2020 can choose to contribute up to $3,500 for an individual and $7,000 for a family (HSA holders 55 and older get to save an extra $1,000). HSAs are considered ‘triple tax-free’ assets. 1) All contributions to your HSA account are tax-deductible. 2) All funds in your account grow tax-free. 3) Withdrawals to pay for qualified medical expenses are tax-free. Unlike a 401(k) or IRA, an HSA does not require the account-holder to begin withdrawing funds at a certain age. However, funds taken out for non-qualified expenses are both taxed and incur a 20% penalty if made before age 65. After age 65, non-qualified withdrawals are still taxed but have no penalty.

As the popularity of these accounts has increased over the years, we have seen more and more HSA providers include investment options as an added benefit to their services, which gives investors all the more reason to take advantage of the benefits of HSAs. What we suggest as a long-term strategy to turn your HSA from a healthcare plan to a retirement strategy is:

  1. To max out your contribution every year.
  2. Don’t spend it! This may sound counterintuitive, but we’re looking at an HSA primarily as an investment tool and tax-exempt future bucket of money. Let it grow!
  3. Keep all of your medical receipts. That $900 invoice for physical therapy in 2019 can be used anytime in the future; for example, you can pull that $900 out in 2059 tax-free!
  4. The key to maximizing your unspent contributions, of course, is to invest them wisely. Don’t leave your HSA account in cash!
  5. It may be wise to set up a separate savings account for unplanned future medical expenses so that you aren’t scrambling to find funds to pay for these expenses out of pocket.

In golf, we are all familiar with the main clubs in our bag. Our woods, irons, and (eventually) the putter. However, every once in a while we need a little extra help getting our ball to the green. That’s where the rescue club comes into play. If your woods and irons are your 401(k) and IRAs, then the HSA is kind of like your rescue club to give you that extra push towards the green. The HSA can be a great addition to your long-term planning.

Do you still have questions about HSAs and how they fit into your overall plan? Please do not hesitate to reach out to your dedicated DWM team members to learn about new developments in this area, and how an HSA may fit into your overall planning.

Traditional or Roth IRA…Which is best for you?

PICIf given the option, would you rather defer taxes or pay them now? That seems like a fairly straightforward question with a no-brainer answer. In fact, most of us would probably take advantage of the chance to defer any type of payment. People work hard for their money and want to hold onto it for as long as possible. Unfortunately, the answer to that question isn’t as simple when determining which type of Individual Retirement Account (IRA), traditional or Roth, to use for retirement.

There are a handful of differences between traditional IRA’s and Roth IRA’s, but the core differences are in how the accounts are funded and how the contributions and earnings are taxed upon withdrawal. Traditional accounts are funded using pre-taxed dollars, which allows for a current year deferral of taxes by reducing your taxable income. Later, when the funds are withdrawn in retirement, the accumulated contributions and earnings are subject to income tax. On the other hand, Roth accounts are funded using after-tax dollars. Although no current tax break is received, the accumulated earnings and contributions are not subject to tax in retirement.  There is also an annual Required Minimum Distribution (RMD) that the traditional account owner must adhere to upon reaching age 70.5.  Roth accounts do not require any scheduled distributions and can be withdrawn at any time in retirement without a tax penalty.

Choosing a traditional or Roth account depends on many factors, most of which relate to an individual’s current and expected future income tax rates. A key question to consider is whether or not an individual’s income tax rates will be lower or higher in retirement. If income tax rates are higher now than in retirement, the individual is generally better off in a traditional account. Conversely, if income tax rates are lower now than in retirement, the individual is generally better off in a Roth account. Furthermore, if income tax rates are expected to be the same in retirement as they are now, both a traditional and a Roth account will result in the same purchasing power. In addition, another key factor is whether or not a legacy will be left for descendants, as Roth accounts can be “stretched” for decades for children and grandchildren without taxes being incurred.

So, for many, the decision may seem rather simple – just calculate future income. However, predicting future income is difficult, much less guessing whether or not Congress will increase tax rates within the next 10, 20 or 30 years. Instead of trying to predict the future, consider other factors that are more easily determined. Individuals are more likely to earn larger salaries and bonuses as they progress through their career. For a young professional or even a child, their tax rate is likely to be lower than when they would retire. Perhaps a Roth account would be more beneficial initially. It’s important to keep in mind income levels as a person progresses through their career as it may become advantageous to change to a traditional retirement account.

Another factor to consider is where does the individual plan to live upon retirement. States, like New York, have significantly high state tax rates, whereas states like South Carolina and Illinois offer deductions for retirees or even excluded retirement income from state taxes. Better yet, you can choose to retire in states like Florida or Texas, which do not have any state income taxes.

Just because a person is projecting a certain tax rate in retirement or plans to live in a state with minimal or no taxes, an individual can never make a completely wrong decision. Couples often times will look at other factors when choosing the right account for them. If an older couple would like to give a tax-free inheritance to their children, even if it means paying a higher tax rate for the contributions, a Roth account or back-door Roth may be the right fit for them. Or if a young couple is just starting a family and could use the extra tax savings now rather than later, a traditional account may be their best fit.

Whether a person or a couple chooses to defer current taxes using a traditional IRA or waits to receive a benefit upon retirement using a Roth IRA, they can’t go wrong. In either case, they are contributing to their future in an account designed to help them achieve long-term growth of retirement savings. In addition, funds can be converted from traditional to Roth in the future, especially in years of a lower tax bracket. Here at DWM, we strive to give our clients the information they need to make the best decisions for themselves and their family. If you are having trouble deciding which type of account to use or want to review your current strategy, we would be glad to assist.

Retirement Strategies You Shouldn’t Overlook: Back-Door Roths & QCDs

irarotheggsWithin the last several days, President Obama released his 2017 budget proposal to the public. Included in the proposal were many provisions that targeted retirement income. Between this proposal targeting retirement income and the Bipartisan Budget signed last year that eliminated Social Security claiming strategies, it sure seems retirement strategies are being picked on quite a bit lately. But let’s remember, the President’s proposal shouldn’t be seen as anything more than a “wish-list”. While the “wish-list” provides a good indication of where the administration may be heading, it could take years before any of the provisions gain traction. In the meantime, it’s important to take advantage of the retirement strategies available to us.

One strategy that the President’s proposal would eliminate but is still available this year is known as a “backdoor” Roth. A Roth IRA is funded with after-tax dollars which allows the funds to grow tax-free. In addition, Roth IRAs do not require a minimum distribution to be taken. The limitation with Roth IRAs is that higher earners are not allowed to contribute to these accounts. In the spirit of the law, this would only give these individuals access to a traditional IRA. Traditional IRAs are funded with pre-tax dollars which are then taxed upon withdrawal. These accounts also require a person to take a minimum distribution starting at age 70 ½. By using a “backdoor” approach, these higher earners can have the benefit of contributing money to a Roth IRA. The sequence of action would be for the person to contribute to a nondeductible IRA, then convert to a Roth immediately afterwards. If the taxpayer does not have any pre-tax funds in their IRA, the conversion can be made without tax.

Late in 2015, Congress made permanent a few tax provisions that were set to expire at year-end. One in particular allows individuals to make charitable donations directly from their traditional IRA without treating the distribution as taxable income. As mentioned above, distributions from a traditional IRA are generally taxable and are required when a person reaches age 70 1/2. This transaction, known as a Qualified Charitable Distribution (QCD), will count towards the required minimum distribution but will not be treated as taxable income. To be considered a QCD, the individual must be age 70 ½ or older, the distribution must be paid to a public charity, the full payment must qualify as a charitable contribution and the distributions must be a direct transfer from the IRA trustee to the charity.

Being that the QCD is excluded from taxable income, the charitable donation itself cannot be deducted on an individual’s tax return. At first glance, this may seem to provide no real tax benefit. Why not just include the distribution as income and take the deduction? For many people, this may be the right strategy. For those individuals that are subject to itemized deduction phaseouts and the 3.8% Medicare tax on investment income, a QCD can help minimize or avoid these consequences. In addition, excluding IRA distributions from income will lower adjusted gross income (AGI) and may make it easier to deduct medical expenses and miscellaneous expenses subject to 2% of AGI, reduce the taxability of social security benefits and minimize the Medicare Part B insurance premiums.

It’s typically best practice to make your Roth or Traditional IRA contributions early in the year, so they can grow tax-free or tax deferred all year. Most of you will be meeting with your CPA or financial advisor within the next several weeks. This will be a good time to discuss these two strategies and see if they will work for you. Here at DWM, we are always happy and available to have these discussions with our clients, during tax season or not. Please let us know how we can help.

Turning Uncle Sam into Santa Claus

uncle sam santa clausWe hope everyone had a great Thanksgiving holiday. We certainly did. Now starts the final countdown for 2014. Only twenty-some days to Christmas, and less than 30 days left before 2015 arrives. Hard to believe. Certainly, most everyone’s calendar is packed full for the next four weeks. We just wanted to make sure that tax planning is on your list of “must do” items before year-end. Of course, tax planning doesn’t rank in the same category as giving my mother a Christmas kiss, being with my family or watching Dickens’ “A Christmas Carol” for the fiftieth time, but it is important.

Two good reasons: none of us likes surprises and most everyone wants to take advantage of every legal way to reduce taxes. By reviewing your taxes before year-end (hopefully with your CPA), you not only see roughly where you are for the year, but also learn what you might be able to do before year-end to reduce Uncle Sam’s share of your income.

Congress is making it tough on all of us this year. They have delayed action on more than 50 business and individual tax breaks that expired on December 31, 2013. These so-called “tax extenders” include provisions that allow businesses to write off the cost of substantial equipment at a faster rate, tax credits to weatherize homes and some higher education expenses to be deducted.

The tax extenders have commonly been renewed each year, often right after elections or even retroactively at the beginning of the next year. As we go to press, the jury is still out on renewal. Even so, there are some tax breaks you should consider for 2014:

  • Consider upping your charitable contributions. This could be writing a few more or larger checks and/or giving non-cash items, like clothing, furniture and even an old car.
  • Consider giving appreciated stock to charity this year. You get a deduction for the value of the stock given, not the cost. And, you don’t pay capital gain taxes on the money if you have held the security for 12 months. If you aren’t sure of the charity you want to give the funds, you can make the gift to a donor-advised fund, such as Schwab’s, which allows you to get a deduction this year and then advise on the recipient next year.
  • Consider gifts to your family. No, there is no tax deduction for gifts. But, you can give up to $14,000 ($28,000 if you are married) to as many individuals as you like before December 31 without anyone incurring any tax. And, if you would like to, you can do it all over again on January 1, 2015.
  • Consider harvesting tax losses within your portfolio. DWM clients know that we already did this for our clients last month. It was tough again this year, as most positions for our clients are showing unrealized gains. Furthermore, remember that you can’t sell a loss position and buy it back within 30 days. That’s a “wash sale” and the IRS bars you from claiming this loss.
  • Consider paying certain items before year-end. These could include items such as real estate taxes, state income taxes, college costs, and mortgage payments.
  • Consider funding your IRA or Roth early. Yes, you have until April 15th to make the contribution for 2014, but why not get it working for you as early as possible. And, consider making 2015 contributions in early 2015.
  • Consider a Roth conversion for part of your IRA funds. Pay the tax once and allow the funds to grow tax-free forever; for your lifetime and that of your descendants. Furthermore, there are no required minimum distributions from Roth accounts starting at age 70 ½. You and your tax adviser will need to look at current and expected future tax rates to determine if this makes sense for you.
  • Check your withholding. Compare your estimated taxes to how much you have withheld. If you are way under, consider taking extra withholding in your final paychecks. And, if you are way under or way over, consider revising your withholding allowances for 2015.

So, between all the holiday festivities in December, you’ve got some homework to do. Get with your CPA and review your 2014 taxes and see if you can lower them. Let’s try to make Uncle Sam start to look like Santa Claus. Cheers!

Obama’s MyRA: A Short Recap

myRAIn his recent State of the Union speech, President Obama introduced a new program of retirement saving for the 50% of Americans that do not currently have employer-funded retirement plans. This MyRA, as it is called for “My IRA”, allows workers to contribute up to $15,000 in a starter-saving plan that exclusively uses government Treasury Bonds. The accounts offer guaranteed principal, tax-free withdrawals of principal and no fees. Couples with an adjusted income of $191,000 or less and individuals with $129,000 or less may contribute after-tax a maximum per-year of $5,500 or $6,500, if older than 50. Once the account reaches $15,000, principal can be transferred to a traditional IRA or withdrawn without penalty for other uses. Any growth earned in the account will face a 10% withdrawal penalty if taken before age 59.5. Self-employed workers are not candidates for these accounts.

As a way to encourage saving for those workers who currently are not offered another vehicle, the rates of return on the bonds are running at an average of 3.6%, which is superior to standard bank savings accounts or CD’s. Other incentives for using the MyRA as a short-term saving plan include the fact that the principal is guaranteed, there are no fees and no withdrawal penalties on principal. This could  encourage workers to get in the habit of automatically deducting contributions directly from a paycheck for savings or used as a potential way to accrue a home down-payment or emergency fund. It requires little to get started – $25 initial minimum, and then allows deductions of as little as $5 per paycheck. Also, because the Treasury Bonds are the only investment, there is no education or decision-making required. Workers can easily transfer their account from employer to employer, either for full-time or part-time jobs.

The detractors maintain that this is simply a new market for buying Government bonds to fund overspending and to unload the Treasury Bonds purchased under the Obama administration’s recent policy of “quantitative easing”,  where the Fed  has purchased large amounts of Treasury bonds to help contain interest rates and encourage growth. Also, rising interest rates would have a major negative effect on the value of 30 year bonds. Others point out that this program is inadequate to overcome the estimated $6-8 trillion in retirement saving shortfalls and that concentration should instead be on fixing Social Security. There are no tax deductions for these contributions and the government gets to use your money and keep it from being invested in higher-earning choices. Also, employers are not required to offer this plan and it is unclear how the program will launch at its predicted start-date at the end of 2014.

There appear to be some benefits to using this as a short-term savings plan and it may act as an incentive to encourage personal savings, but it falls far short of the intended fix for under-funded retirement accounts and is an unlikely fit for most DWM clients. It provides little tax benefits and the only investment option, long-term treasury bonds, is not a good one. Further, it can certainly be argued that the spotlight should be on fixing the other government-sponsored and non-voluntary retirement savings program – Social Security.