MANY SENIORS needlessly incur hefty penalties or overpay their taxes. The reason: They don’t understand the strict rules that govern removing money from their tax-deferred retirement accounts.
The IRS sets the year you turn age 70½ as the deadline to begin taking RMDs, short for required minimum distributions. (For 2020 and later years, the starting age is 72.) The feds allow some leeway for the first of your RMDs. But this is a tricky exception.
DON’T GIVE INVESTING advice to clients. That’s something I’ve repeatedly learned as a tax lawyer. Still, when financial markets gyrate, many clients want advice about taxes, especially the seemingly simple rules for capital gains—and I have a longstanding fondness for eating three times a day.
Let’s start with the basics. Take an individual who sells an investment that she has owned for more than 12 months. Any increase in its value from its cost basis is taxed at her long-term capital gains rate—15% for most individuals,
IN 1934, WHEN I WAS age one, a federal income tax return was one page, and came with two pages of instructions. It was hand carried to the house by a live postman. The IRS regulations were 200 pages—though some say it was 400—all of which were memorized by the tax author J. K. Lasser.
When I was a young man in the workforce, we still got the several-page income tax form by mail,
LIKE MOST PEOPLE, I’ve made my fair share of financial blunders. I’ve also had some successes. But I definitely spend more time beating myself up over my errors than celebrating my successes.
Undoubtedly, my biggest mistake fits into the relatively obscure category of asset location. If you aren’t familiar with the term, I can explain it by way of an example. Suppose you have two investment accounts: a retirement account and a standard, taxable account.
THE FEDERAL TAX code now contains over 10 million words, so it’s no surprise that most Americans score an “F” when it comes to understanding taxes. A few years ago, I would also have flunked.
But following my divorce, I knew I needed to educate myself on financial topics. While I could tell you how much I took home each month, I didn’t have a clue how much I paid in taxes, much less what my marginal tax rate was.
AROUND THIS TIME of year financial advisors and the media start talking about taking tax losses. The notion: You sell underwater investments in your taxable account, and then use those realized capital losses to offset realized capital gains and up to $3,000 in ordinary income.
There’s nothing wrong with taking tax losses, though I think the notion is oversold. Unless you’re an active trader or a really bad investor, you probably won’t have any losses to take.
IF YOUR GOAL IS lower investment costs, the financial world has never been friendlier. Let’s say you want to buy the broad U.S. stock market. You can choose between a Schwab exchange-traded index fund that charges 0.03% of assets per year, an iShares ETF that levies 0.03% or a Vanguard mutual fund that costs 0.05%.
Those expense ratios are truly astonishing: If you had $100,000 to invest in the broad U.S. market, your annual fund expenses would be just $30 or $50.
THE FEDERAL TAX system punishes the middle class, who have earned income and fund retirement accounts. Meanwhile, it favors the wealthy, who are more likely to have substantial sums in taxable accounts and then bequeath those assets.
Okay, now I need to explain myself.
First, there’s the question of earned versus unearned income. Tax rates on wages are higher than those on long-term capital gains and qualified dividends, plus workers also have to pay Social Security payroll taxes.