Pre-retirement Checklist for a Worry Free Retirement

 

Jane Young, CFP, EA

Retirement represents a huge change in your lifestyle and finances.  Plan and prepare ahead of time to enjoy a comfortable and rewarding retirement.  Think about what your retirement looks like – will you retire completely or will you gradually transition into retirement?  Consider transitioning from your current career to a part time job doing something you really enjoy.  Think about what you will do in retirement, where will you live and what kind of lifestyle you want.

Consider the emotional impact of retirement.  Generally, your career provides a major sense of accomplishment, meaning and significance.  Most of your social life may also come from work relationships. Seriously consider the impact retirement may have on your self-esteem and personal identity.  Explore ways to spend your time in retirement on meaningful and rewarding pursuits, in addition to the fun activities you previously had no time for.

Evaluate your current spending habits and develop a realistic retirement budget.  Remove expenses you will no longer incur such as contributions into a retirement plan and add expenses that may increase in retirement such as additional travel and insurance expenses.  Build in some flexibility, plan for unexpected expenses and maintain an emergency fund.

Discontinuation of employee benefits, upon retirement, will probably result in the need for additional health and dental insurance.  Research Medicare costs and coverage along with the cost of supplemental health insurance that may be needed.  Think about how you may cover the possibility of long term care expenses and evaluate buying long term care insurance.  As you approach retirement you may be able to reduce or discontinue life and disability insurance coverage.

Manage your debt and take care of major maintenance or remodeling projects prior to retirement.  To the extent possible, pay off credit cards, vehicle loans, student loans and your mortgage.  If you can’t pay off your mortgage but plan to refinance, do so prior to retirement.  It may be difficult to refinance after retirement when you have no earned income.

Review your Social Security and Pension benefits and make some preliminary decisions on the best time to begin taking benefits.  Consider the possibility of losing a spouse when making these and other major retirement decisions.

Run some retirement planning scenarios with a financial planner to determine when you can afford to retire and how much you can afford to spend in retirement.  Based on these scenarios develop a plan to create a tax efficient income stream to pay expenses that aren’t covered by Social Security or Pensions.

Develop and implement an investment plan to support your short term income needs while providing reasonable growth to carry you through retirement.   Your short term money should be held in safe fixed income investments.  But your long term money should be invested in a diversified portfolio to provide long term growth for the 30 to 40 years you may spend in retirement.

Small Business Owners Need a Retirement Plan

Jane Young, CFP, EA

When you leave the corporate life to become a business owner, you lose the opportunity to continue contributing to your 401k.   You can’t replace the employer match, if you received one, but you can create your own retirement plan.

In the early years, as your business is ramping up, you will incur some start-up expenses and you may experience a significant drop in personal earnings.  This can be a great time to consider a Roth IRA.     Previously, you may have earned too much and you may have been in a higher tax bracket where you needed the tax deferral on money contributed to your 401k.

With a Roth IRA, your contribution is made with after tax money and you don’t receive a current tax deduction.  However, on the bright side, you pay no taxes upon withdrawal in retirement.  This is the opposite of a traditional retirement plan, such as a 401k, where contributions are deducted from your current income and you owe regular income tax on the entir

 

e amount withdrawn in retirement.

In 2017, Roth IRAs have an income phase-out range of $118,000 to $133,000 for single filers and $186,000 to $196,000 for joint filers.  If you have maximized your Roth contribution or are ineligible for a Roth IRA, consider Investing in a traditional retirement option.  Some straight forward options, that won’t require a team of accountants, include a traditional IRA, a Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees (SIMPLE).

You may be eligible to contribute to a traditional IRA however your ability to deduct your contributions may be reduced if you or your spouse is an active participant in a qualified retirement account (401k, SEP, and SIMPLE plans).  The combined annual contribution limit on traditional and Roth IRA accounts is $5,500 plus a $1,000 catch-up if you are over 50.

If you want to increase your contributions and don’t have employees, a SEP can be a good option.   The maximum allowable contribution is 25% of income or $54,000 for 2017.  A SEP can be expensive with employees, because the entire contribution is paid by the employer.   Each year the employer decides how much to contribute and this is given to the owner and all employees who have attained age 21, have been employed for 3 of the last 5 years and have earned at least $600.

If you have employees, a SIMPLE plan may be more economical because your employees make elective tax deferred contributions.  The employer is only required to make contributions to the plan as matching contributions up to 3% of compensation or as non-elective contributions.  In 2017 the limit on the amount employees can contribute is $12,500 plus a catch-up of $3,000 for individuals over age 50.

As your company grows consider a 401k or profit sharing plan.  These can provide higher contribution limits but they are more complicated and involve more sophisticated reporting.

Taxation on the Sale of Your Home with a Focus on Depreciation – Part 2

 

Jane Young, CFP, EA

When you sell a home that has been rented there are restrictions on your ability to exclude all of your gains.  As mentioned in last week’s article, you may be able to exclude up to $250,000 in gains if you are single and up to $500,000 if married filing jointly, assuming you have lived in your home for 2 of the past 5 years.  However, after January 1, 2009, this exclusion is limited to the gain associated with the time your home was used as a primary residence.  You cannot exclude any gain that may be attributable to depreciation allowed after May 6, 1997.

When you rent your home, the IRS allows you to take a depreciation deduction. This enables you to spread the cost of your property over time and temporarily shelter some of your income from taxes.  Residential homes are usually depreciated over 27.5 years using the fair market value (FMV) of the property at the time you began renting the property.  Only the building can be depreciated so you need to subtract the value of land from your FMV before calculating depreciation.

Depreciation can be a great way to shelter taxes, at least while you are renting your home.  However, when the property is sold you cannot exclude any gain equal to the depreciation allowed or taken, even if you lived in the home for 2 of the last 5 years.  The IRS refers to this as unrecaptured Section 1250 gain or depreciation recapture and this is taxed at a maximum rate of 25% instead of capital gains rates.  You may be tempted to forego taking the depreciation deduction to avoid the 25% depreciation recapture.  However, this is not a good idea because the IRS calculates recapture on allowable depreciation not depreciation actually taken.

If you have a loss on the sale of your home you may be able to escape recapture of depreciation. When calculating the gain or loss on the sale of your home, depreciation is deducted from your adjusted basis.  If you still have a loss after deducting depreciation you will have no gain from which you need to recapture depreciation.

On the other hand, if you anticipate a substantial gain and think it may be advantageous to postpone a large tax hit, consider a 1031 exchange also known as a like-kind exchange.  The IRS rules regarding 1031 exchanges are very stringent and can be quite complex.  If you are considering a 1031 exchange it’s advisable to work with a tax professional that specializes in this area.

 

Taxation on the Sale of Your Home – Part 1

Jane Young, CFP, EA

In most situations, if you sell your personal residence that you have lived in for 2 of the last 5 years, you will qualify for an IRC Section 121 Exclusion.   Section 121 excludes gains of up to $250,000 for an individual and $500,000 for a married couple filing jointly.  You must own your home and use it as your primary residence.  Married taxpayers may exclude up to $500,000 if either spouse owned the home for 2 of the last 5 years and both spouses lived in the home for 2 of the last 5 years.   If eligible, you can use this exclusion once every two years.  Any gains in excess of the exclusion will be taxed at capital gains rates.  If your gain does not exceed the exclusion you don’t need to report the sale on your tax return.

If you own more than one home, you are only eligible for the exclusion on your primary residence.  Additionally, you are not eligible for the section 121 exclusion if you acquired your home through a like kind exchange (1031 exchange) in the last 5 years or if you claimed an exclusion over the past 2 years.  If you don’t meet the requirements because you lived in your home for less than two years and the reason for the sale is due to poor health, change of employment, death, divorce, or other unforeseen circumstances, you may be eligible for a partial exclusion.  Additionally, special rules apply to qualifying members of the Uniformed Services or the Foreign Service and employees of the intelligence community and the Peace Corps.  The exclusion of gains does not apply to gains attributable to depreciation claimed for rental or business use after May 6, 1997.
If you lived in your home for 2 of the last 5 years but failed to use the home as your primary residence at any time after January 1, 2009, some of your gain may be ineligible for exclusion.   The time during which your home was used as a rental or vacation home is considered non-qualified use.  Any gain on your home during this timeframe is not eligible for exclusion and will be taxed at capital gains rates.  This does not reduce the actual amount of your exclusion and if your gain is large enough you may be able to use your full exclusion.

To calculate the gains attributable to non-qualified use, divide the number of years of non-qualified use (years home not used as primary residence after 2008) by the total number of years the home has been owned.  For example if you rented your home for 4 years and owned your home for 20 years, gains attributed to non-qualified use are equal to 4/20ths or 20%.  Therefore, 20% of the gain will be taxable (plus any depreciation recapture) and 80% may qualify for exclusion.

Depreciation will be addressed in Part 2 of this article.

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