Answers to Your Tax Questions on RMDs, AMTs and 401k Rollovers

Over the last few weeks, I have hopefully helped you gain a better understanding of taxes, why you should care about them (beyond your annual tax filing!) and how you can lower your taxable income. During this time, I’ve received lots of questions about taxes, and I am going to dedicate this week to answering the most popular questions.

Start at the Beginning

Before I do, I want to highlight the series thus far, for those just joining us now. There’s a lot of great information covered in each of them.

Understanding Your Tax Reality
I shared what is the most common tax mistake, how tax brackets work, reducing taxable income and phantom income.

How To Create a Tax Efficient Portfolio through Asset Allocation
I shared what the most common tax investment mistake is, how asset allocation can help you build a tax efficient portfolio and harvesting losses.

Retirement Plans and Taxes
I outlined the differences between Qualified and Non-Qualified Retirement Plans and gave an overview of Required Minimum Distributions (RMDs).

Your Tax Questions

Unfortunately I cannot answer every question but I chose the three that seem to cause the most confusion.

Please note: This is general information that may not be relevant to your personal situation. Please work with your personal financial advisor and/or CPA to determine the best course of action for you.

If I Don’t Need the Money from My Required Minimum Distribution (RMD), Do I Have to Take It?

The simple answer is yes. RMD is REQUIRED minimum distributions, and this is how you repay the government after they allowed you to defer taxes for many years through your Qualified Retirement Plans. This is still a benefit to you because your entire dollar was able to be invested (versus minus the taxed amount in Non-Qualified Plans) and you are likely in a lower taxable income bracket now. I discussed what RMDs were last week so please read that post to understand the penalties of not taking your RMD.

If you are fortunate enough to not need the money from your RMD to pay bills and support your retirement lifestyle, I would like to offer a couple of possible strategies for to consider.

1. First Option: A Legacy Enhancing Strategy. This strategy would be designed to use life insurance to better leverage earnings from your IRA, helping to enhance the amount your beneficiary inherits. This is done by reallocating the excess earnings from the IRA into a life insurance policy that can potentially increase the overall inheritance. Please remember, you will still pay taxes on the RMD and should consider an insurance premium that represents your after tax RMD. Don’t forget that you will need to go through underwriting, so you need to be insurable to take advantage of this strategy.
2. Second Option: A Gifting Strategy. Consider gifting the RMD to your favorite charity, avoiding taxes all together. This strategy is approved by the IRA annually, so work with your CPA and CFP® to determine if either of these strategies make sense for you.

While it may not always seem fair that you have to take a RMD if you don’t need the money now, you do have some options that can greatly benefit those you love and/or organizations you want to support. And most importantly, remember — being in the position of having excess money is not really a problem at all. You may have to pay taxes on it, but you don’t have to spent it either.

AMT? What is It and Why Do I Have to Pay It?

This is a question I am getting more and more frequently. So let’s dig in. AMT is the Alternative Minimum Tax, and it applies more often than you think. Although it was originally designed to address the problem of wealthy individuals using various strategies to reduce or eliminate their income tax liabilities by setting a limit on those benefits, more and more middle-class Americans are finding themselves subject to AMT today.

When most of us think about paying taxes, we subtract various deductions against income, then calculate how much we owe in taxes. The AMT works differently. Using the IRS Form 6251, the AMT calculation requires you to add back certain tax deductions and income exclusions to your regular taxable income to arrive at your AMT. Your tax under AMT rules may be higher than your tax under regular tax rules, and you are required to pay the higher of the two.

What Triggers the AMT?

This is not a comprehensive list but what I most commonly see triggering AMT in my clients.

• Interest deductions from home equity or refinanced mortgages that were not used to buy, build or improve your home.
• Interest from certain private-activity muni bonds.
• A large spike in income or capital gains.
• High state and local income tax deductions.
• Exercised and held incentive stock options.

Because more people are subject to AMT, I encourage you to work your CPA to determine why you had to pay AMT and how to potentially avoid it in the future.

I Just Transferred My 401k to an IRA and Received a 1099R. Do I Need to Pay Taxes on This?

I have had many panicked calls from clients on this subject, so let’s see if I can provide some clarity around this as many of you are likely to roll-over a 401k at some point. When you move a qualified plan (IRA, 401k, etc.) to another firm, you have 60 days to invest it in another qualified plan or it becomes taxable.

The firm that you transferred out of is required to issue you a 1099R for tax purposes. The firm that you “rolled over” the plan to will also issue one to the IRS stating that you have moved the money back into a qualified plan with the date attached. It is your responsibility, whether you are doing it yourself or through your financial advisor, to confirm the money has rolled over within the appropriate timeframe. Otherwise, you may be subject to taxes and penalties (if under 59 1/2). So, assuming the roll-over happened within the approved timeframe, you do not owe taxes.

Don’t Be Afraid to Seek Help

Tax code frequently changes and can be very confusing to most taxpayers. Thanks to the internet we can find lots of great information, but be sure that you’re also not following old rules either. 🙂 Don’t be afraid to seek professional help, especially if your tax situation is complicated. There are no dumb questions and a professional can make a real difference to both your tax knowledge and your tax liability.

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