Max-out Retirement Savings
Maxing contributions to retirement accounts allows you to shelter your money from income taxes until you retire. Depending on the type of account, you could get a benefit right away by using ‘pre-tax’ dollars to contribute to a 401(k) at work. If you put money into a Traditional IRA you get a tax deduction in the year you contribute, restrictions apply. With the Roth IRA, you reap the benefits later at retirement when you won’t have to pay taxes on distributions, restrictions apply. The rules regarding all types of retirement accounts are intricate and complex. Generally penalties apply to retirement money taken out before retirement. A tax professional should be consulted before contributing or withdrawing funds from a retirement account to get the best benefit.
Federal Contribution Limits to Retirement Accounts for 2016
|Type of Account||2016 Contribution Limit, under age 50
||2016 Contribution Limit, age 50 plus|
|401(k), 403(b) and 457||$18,000||$24,000|
|QRP/Keogh and SEP-IRA||20% of net self-employment income
(or 25% of compensation) up to $53,000
|Individual 401(k)||20% of net self-employment income
(or 25% of compensation)
plus $18,000, up to $53,000
|Traditional IRA & Roth IRA||$5,500||$6,500|
A few things to know about contribution limits:
- Roth IRAs. Not tax deductible, but offers greater flexibility going forward. If you file as ‘single’ and your ‘modified adjusted gross income’ (MAGI) is $116,000 or less, your contribution limit is $5,500 (or $6,500 if you’re 50 or older) in 2016. The contribution limit is gradually phased-out for those with MAGIs of $117,000 to $132,000. If you file as ‘married filing jointly’ and your MAGI is $183,000 or less, your contribution limit is $5,500 ($6,500 if you’re 50 or older). That contribution limit is gradually phased-out for those with MAGIs of $184,000 to $194,000.
- Traditional IRAs. Money you put in a traditional IRA is generally tax-deductible. It’s a great way to lower your ‘taxable income’ for the year since you have until April 15 of the following year to contribute. Restrictions apply if you’re an active participant in a qualified workplace retirement plan like a 401(k) or 403(b). If you file as ‘single’ your contribution is partially deductible if your ‘modified adjusted gross income’ (MAGI) is between $61,000 and $71,000. If you file as ‘married filing jointly’ your 2016 contribution is partially deductible if your MAGI is $98,000 to $118,000. If you don’t participate in a retirement plan at work, but your spouse does and you file jointly, your contribution is partially deductible if your MAGI is $184,000 to $194,0002.
Anyone can ‘convert’ all or part of a traditional IRA to a Roth IRA regardless of income level or filing status. Converting could be advantageous if you expect to be in the same or higher tax bracket when you withdraw the money, have a reasonably long time horizon and can afford to pay the conversion tax from a source other than your IRA at the time of conversion.
Manage College Expenses
Two strategies to save for college.
- Open a ‘Coverdell Education Savings Account’. If you’re a single filer, you may make a maximum contribution of $2,000 per year per child, subject to income limitations. Be careful if accounts are established by different family members for the same child since total contributions to all accounts on behalf of a single beneficiary in any year cannot exceed $2,000.
- Shelter College Savings in a ‘529 Plan’. Earnings grow tax free. Although there’s no limit to how much you can contribute each year, each state’s plan has its own lifetime limit—typically more than $200,000 per designated beneficiary3. You can also treat a 529 contribution as being made over five years for federal gift tax purposes (see below). For example, a married couple could contribute up to $140,000 per child up front without using any of their lifetime gift tax credit.
Two tax benefits after you have spent the money.
- Tax Credits for Education. The American Opportunity Tax Credit allows a parent or student to receive up to $2,500 on eligible college expenses paid from a non-529 account, subject to income limitations. The Lifetime Learning Credit is available for those who are not attending school at least 1/2 time.
- Tax Deductions. You may be able to deduct up to $2,500/year of student loan interest, subject to income limitations. There is also a deduction for Tuition and Fees if you don’t qualify for the credits above.
$14,000 Gifts and Estate taxes
You can give up to $14,000 per person per year to as many people as you want- without those gifts being taxed. If you are married, you can give $14,000 each for a total of $28,000 to one person. You can also give unlimited amounts toward tuition or medical expenses if you pay the provider directly. If your gifting exceeds $14,000/individual/year you are required to file a Gift Tax Return and the lifetime gift and estate tax exemptions will come into play (see table below).
Estate & Gift taxes for 2016:
|Estate Tax||Gift Tax|
|Highest rate||Exemption||Highest rate||Exemption|
|40%||$5.45 million*||40%||$5.45 million*|
*Adjusted annually for inflation
1. In some instances, modified adjusted gross income (MAGI) may be used to determine eligibility for certain deductions. MAGI calculations vary, so consult your tax professional.
2. Within certain AGI (or MAGI) phase-out ranges, you receive partial deductibility (or eligibility to contribute, in some cases) for certain tax breaks. At or below the low end of the range, you can receive full deductibility (or eligibility), but at or above the high end of the range, you lose deductibility (or eligibility).
3. As with any investment, it is possible to lose money by investing in a 529 plan. Before investing, carefully consider a plan’s investment objectives, risks, charges and expenses. Additionally, if you are investing in a 529 plan outside the state in which you pay taxes, you should consider your own state’s 529 plan to determine if you can obtain any tax or other benefits offered by your own state’s plan.