What is an IRA?

Everyone keeps telling you that you need to save for your retirement, but your company does not have a 401(k).  What are you supposed to do?  You can contribute to an Individual Retirement Account (IRA)!

 

The advice that everyone is giving you is right, you need to make sure you save for your own retirement.  One estimate projected that the Social Security trust fund will be exhausted by 2037 if not sooner.  I discussed this and provided advice for your retirement savings plan in Plan for Your Retirement: No One Else Will.

 

If your employer does not provide a company 401(k) plan, you will want to talk to your financial advisor about establishing an IRA.  But what is an IRA?

There are 2 basic types of IRAs:

 

1) Traditional IRA

 

Qualified contributions to a Traditional IRA help to reduce your taxes because they are tax-deductible.  Contributions to a Traditional IRA are one the few ways in which you can actually reduce your tax bill after the year ends.  The governments allows you to make a contribution up until April 15th of the following year, and to take the deduction in the preceding year.

 

The amount you are allowed to contribute to a Traditional IRA changes frequently as it is adjusted for inflation, but in 2013 you are allowed to make a contribution up to $5,500, or $6,500 if you are age 50 or over.

 

Once invested into a Traditional IRA, all of the funds grow without being taxed.  You will not be taxed until you withdraw the funds! 

 

There are a few basic requirements in order to make a contribution to a Traditional IRA:

• The contributor must be an individual (not a trust, company, etc.)
• You must be under the age of 70.5
• You must have sufficient earned income or compensation (at least as much as you contribute to your IRA)

 

Be careful though.  The ability to make a tax-deductible contribution phases out based upon whether or not your employer provides a company retirement plan, your tax filing status, and your income level. 

 

2) Roth IRA

 

The principal difference between Traditional IRAs and Roth IRAs are that with Traditional IRAs the contributions are tax-free while with Roth IRAs the distributions are tax-free.

 

In 2013, you are allowed to make a contribution up to $5,500 or $6,500 if you are age 50 or over.  However, the contribution limitation changes based upon your tax filing status and your income level.

 

Once invested into a Roth IRA, all the funds grow tax-free.  Furthermore, all of the distributions are tax-free provided that you are over the age of 59 1/2 and have had the Roth IRA account for at least 5 years.

 

Again, there are a few basic requirements in order to make a contribution to a Roth IRA:

• The contributor must be an individual (not a trust, company, etc.)
• You must have sufficient earned income or compensation (at least as much as you contribute to your IRA).

 

You will notice that unlike with Traditional IRAs, there is no age restriction on being able to contribute to a Roth IRA.

 

Of course these are only the 2 most basic types of IRAs.  You may want to discuss non-deductible IRAs, SEP IRAs, and SIMPLE IRAs with a financial advisor to determine what type of IRA makes the most sense for your situation.  If you need a referral to a great financial advisor, please do not hesitate to ask me.

 

If you have any tax questions that I can answer, please send me an e-mail.

 

Please feel free to leave your feedback below.

 

Business Networking

Want to grow your business?

There are a number of ways that you can promote yourself and your business.  In my opinion, one of the most effective methods is to network.

By going to a networking event, you are likely to meet someone who is either interested in your services or who knows someone who would be interested in your services.  Of course it is difficult to get a new customer/client based on one meeting, but it can be the first step to creating a new relationship.  I have met a number of professionals at various local events, and have followed up with them through e-mails and meetings in order to find out how we both can help each other.  You never know what chance encounter you may have at a networking event that can be a major benefit to your business.

So why I am talking about business networking in a tax blog? 

It is because the costs of business networking are tax deductible.  Like other forms of advertising, the IRS treats networking as an ordinary and necessary business expense and allows you to deduct it on your tax return.

The cost of admission to a networking event...deductible.

The cost of taking someone you met at a networking event to lunch to talk business... 50% deductible.

The dues paid to a business referral group...deductible.

The cost of traveling to a networking event or business referral group... deductible.

The requirements to claim these deductions are very simple.  First, you have to be able to prove you spent the amount you are deducting (save your receipts).  Second, you have to have had a valid business purpose.  For example, if you take someone you met at a networking event out to lunch you have to talk business with that person.  You cannot simply talk about sports and the weather.

If you have any tax questions, please do not hesitate to send me an e-mail.

What are some of your favorite networking events?  Please let me know in the comment section below.

Paying for College

College is expensive.  There is no getting around that one simple fact.  In one survey, it was determined that for the 2012-2013 school year, the average cost for an in-state public college was $22,261, and the average cost for a private college was $43,289.  Keep in mind that is a per-year cost, and included is the cost of tuition, fees, book, and housing.

Who thinks that the cost of higher education is going to go down?  Yeah, I don't either.

So what can you do to make college more affordable?

Of course there are academic and athletic scholarships.  If you can get any type of scholarship that is of course the ideal situation.  Not only is it "free" money, but it is non-taxable to the extent that it is used to pay for your tuition, fees, books, and other course-related supplies.

It is also very common to take out student loans.  There are a variety of types of student loans, but a common feature for tax purposes is that the interest paid on student loans is deductible.  This deduction phases out for single individuals with income over $75,000 and married couples with income over $155,000.

Already paying for college?  There are several federal tax credits that you can take advantage of.

• The American Opportunity Credit. This credit is worth up to $2,500 per year per eligible student.  This credit is available for the first 4 years of higher education at an eligible school.  You are able to claim the credit to cover the costs of tuition and required fees, books, and other course-related materials.   An added bonus with this tax credit is that it is partially refundable.  This means that you can get a tax refund of up to $1,000 even if you do not owe taxes.
   
• The Lifetime Learning Credit.  This credit is worth up to $2,000 per year per tax return.  The credit is available even after the first 4 years of higher education.

There are also several ways to help to save for college that have tax advantages.

• Savings Bond Interest Exclusion.  All of the interest income from Series I and Series EE bonds issued after 1989 are tax-free.  To qualify, the bond owner must have been at least 24 years old when the bond was issued, and the money must be used to pay qualified education expenses for yourself, your spouse, or a dependent.  This tax benefit phases out based upon your income level.
• 529 Savings Plans.  Your investment into a 529 Savings Plan grows tax-deferred, and the distributions from the plan that are used to pay for the beneficiary's college costs are tax-free.  With a 529 Savings Plan, the full value of your account can be used at any accredited college or university in the country.  Any non-qualified distributions are subject to a 10% penalty on the earnings and will be taxed.
• 529 Prepaid Plans.  Prepaid tuition plans are guaranteed to increase in value at the same rate as college tuition.  This means that tuition rates are locked in, offering peace of mind if you expect college tuition to rise. If the student attends an in-state public college, the plan pays the tuition and the required fees.  If the student decides to attend a private or out-of-state college, the plans typically pay the average of in-state public college tuition.  If a student decides not to attend college, the plan can be transferred to another member of the family.  529 Prepaid Plans are exempt from federal income taxation.  If no member of your family attends college, any non-qualified distributions are subject to a 10% penalty on the earnings and will be taxed.
• Education Savings Account.  Up to $2,000 can be contributed to a Coverdell Education Savings Account in any year.  The amounts deposited into the account grow tax-free until distributed, and the distributions are tax-free as long as they are used for qualified education expenses.  If a distribution exceeds qualified education expenses, the portion attributable to earnings will be subject to a 10% penalty and will be taxed.

If you have any questions, please do not hesitate to ask in the comment section below or send me an e-mail.

Do you know a high school athlete who is hoping to earn an athletic scholarship for college?  I can refer you to someone who will evaluate that athlete and help him or her get a scholarship.

I would also be happy to refer you to a great financial advisor who can discuss strategies for saving for your or your children's education.

I appreciate your feedback.  Please feel free to leave a comment below.

Why Have a 401(k)?

What financial advice have you been given?

Throughout my life I received 2 main pieces of financial advice.  1) Save for my own retirement.  2) Contribute enough to a 401(k) plan to maximize the employer match.

Every 401(k) plan is different as businesses set them up in order to best meet their needs and the needs of their employees.  However, a typical arrangement is for employers to match their employees contributions to their 401(k) plans $0.50 on the dollar, up to 3% of the employees gross salary.

If that is how your 401(k) plan works, you should contribute at least 6% of your gross salary to your 401(k) plan.  That effectively increases your salary by 3%! Why would you want to leave money on the table?

I would encourage you to actually contribute more than that to your 401(k) plan, as long as you can afford to do so.  In a previous blog post, Plan For Your Retirement: No One Else Will, I discussed why you should contribute to your own retirement and the significant advantages to doing so.  Please read that post and see why you should contribute what you can afford to your qualified retirement plan.

But what is in it for employers?  As an employer, why should you set up a 401(k) plan and put your money into your employee's retirement fund?

• $1,500 Tax Credit. Employers are entitled to claim a tax credit equal to 50% of the cost to set up and administer the plan, and to educate employees about the plan.  The credit is worth a maximum of $500 per year for each of the first 3 years of the plan.  If you are unable to use this credit in any given year, the unused portion can be carried back or forward to other tax years.  There are a few basic requirements that you should discuss with a CPA.
• Tax Deduction.  Every penny that an employer contributes to a 401(k) plan, including to his or her own, is a tax deduction.  As an employer, you are also able to deduct the cost of administering the plan and educating your employees about the plan.  This is because the IRS considers the operation of a 401(k) plan to be an ordinary and necessary business expense.
• Better Employee Recruitment and Retention.  For any business, having great employees is essential.  They represent you, so it is important that you are able to recruit the best possible employees and retain them once you have them.  All else being equal, I would choose to work for a company that has a 401(k) plan over one that doesn't.  It shows employees that you care about them and their retirement.  It helps to build loyalty to your company.

If you would like to discuss the tax benefits of establishing and operating a 401(k) plan, or you have any questions, please send me an e-mail.

I would also be happy to refer you to a great financial advisor who can discuss all the non-tax aspects of your existing 401(k) plan or help you to establish a new 401(k) plan.

I appreciate your feedback.  Please feel free to leave a comment below.

Is Working From Home an Option for You?

Because of advances in technology, it is increasingly easy for people to work from home and save money doing so.

Having a home office means that you do not have to spend hours every month sitting in traffic trying to get to work, and you do not have to spend as much on fuel for your car.  It also means, if you own your own business, that you can save thousands of dollars in rent.  But it also is a tax deduction.  By claiming the home office deduction, you are allowed to deduct a portion of your living expenses such as utilities, that would otherwise be non-deductible.

This deduction is available to you whether you own your own business or work for someone else.  But if you are an employee, you must be working from home for your employer's convenience and not your own.  If your employer requires that you work from home, then that test is met.

Unfortunately, this deduction has been greatly abused by taxpayers and now the IRS is very strict in ensuring that your home office meets all of the requirements for the tax deduction.

The home office deduction is only permitted if the home office is used exclusively on a regular basis either: 1) as the principal place of business for any trade or business of the taxpayer; 2) as a place of business that is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his or her trade or business; or 3) in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer's trade or business.

To qualify under the "regular use" test, the home office must be used on a regular basis.  Working from home once a month does not count.

To qualify under the "exclusive use" test, you must use a specific area of your home exclusively for your business.  Even after "business hours," you cannot use the space for non-business purposes.  Something as simple as your children "hanging out" in that room when you are not conducting business disqualifies the whole deduction.

However, if your home office meets these tests, the deduction can be substantial.  Under a new safe-harbor, the deduction is $5 for every allowable square foot, up to 300 square feet.  The deduction can be even greater if you keep track of all of your actual expenses, such as your mortgage, property taxes, and utilities.

If you have a home office, or are thinking about having one, and you want to make sure that it qualifies for the tax deduction, please send me an e-mail.  I will walk you through what qualifies, explain how the deduction is calculated, and answer any other questions you have about this deduction.

I can also recommend a great IT consultant.  It is improved technology that is allowing so many more people the opportunity to work from home, so you need to make sure that you are properly set up to do so.

I would love to get your feedback through the comment section below.