Starting a Roth IRA for a Teen

Want to give your child or grandchild a financial head start? A Roth IRA might be a choice to consider. Read on to learn more about how doing this may benefit both of you.

Rules for setting up a Roth IRA. If your teen has an earned income, you may be able to set up a Roth IRA for them. For example, if your 15-year-old has earned $6,000 at a summer job, you can set up an account for them up to $6,000 (the maximum annual Roth IRA contribution). The amount cannot exceed the teen’s income. Keep in mind that money that you contribute to the Roth IRA can count as a gift within your $15,000 yearly gift tax exclusion ($30,000 for a married couple).¹

Looking ahead to the future. If money is withdrawn from a Roth IRA before age 59½, a tax 10% federal tax penalty may apply. There is, however, a notable exception. Up to $10,000 of investment earnings can be taken out of a Roth IRA at any time if the money is used to buy a first home. In this instance, the IRS may waive the early withdrawal penalty. Should your teenager become a parent someday, a portion of those Roth IRA assets might also be utilized to pay college tuition costs for themself or their child.^2,3

This article is for informational purposes only. It’s not a replacement for real-life advice, so make sure to consult your tax professional before modifying any Roth IRA strategy. Tax-free and penalty-free withdrawal also can be taken under circumstances other than first-home purchases, such as the owner’s death. The original Roth IRA owner is not required to take minimum annual withdrawals. To qualify for the tax-free and penalty-free withdrawal of earnings, the teenager must meet a five-year holding requirement and occur after age 59½.

Greater earning potential, thanks to the magic of compound interest. Setting up a Roth IRA for a teenager is a great way to introduce them to basic financial concepts, such as compound interest. Giving your teen a hands-on learning experience may help them understand the value of saving for the future. You may also be facilitating the development of your children’s or grandchildren’s financial habits.

There are a few things to consider when setting up a custodial Roth IRA. Setting up a Roth IRA for a minor is often referred to as a custodial IRA. Until the child is able to take it over, you act as the custodian of the account. Individual state laws determine when the minor child is able to take over management of the Roth IRA for themselves.

A tax professional can provide guidance that may help ensure that you and your minor child are following all federal and state regulations.

SECURE Act 2.0 Passed in Final Days of 2022

Congress spent the final days of 2022 on new reforms designed to help Americans save more for retirement.

You may hear the changes called SECURE Act 2.0, which is a follow-up to the Setting Every Community Up for Retirement Enhancement (SECURE) Act enacted into law in late 2019.¹

SECURE 2.0 contains dozens of provisions, but one key change is critical to understand. Starting January 1, 2023, the age at which owners of retirement accounts must begin taking required minimum distributions (RMDs) increases to 73 years of age. And starting in 2033, RMDs may begin at age 75.²

If you have already turned 72, you must continue taking distributions. But if you are turning 73 this year, we may want to revisit your approach.

SECURE 2.0 was tucked in the $1.7 trillion federal spending bill, so as more people become familiar with the legislation, expect more details to emerge. In the meantime, if you have any questions, don’t hesitate to call.²

Happy New Year.

Budget Check Up: Tax Time Is the Right Time

Every year, about 150 million households file their federal tax returns. For many, the process involves digging through shoe boxes or manila folders full of receipts; gathering mortgage, retirement, and investment account statements; and relying on computer software to take advantage of every tax break the code permits.¹

It seems a shame not to make the most of all that effort.

Tax preparation may be the only time of year many households gather all their financial information in one place. That makes it a perfect time to take a critical look at how much money is coming in and where it’s all going. In other words, this is a great time to give the household budget a checkup.

Six-Step Process

A thorough budget checkup involves six steps.

1. Creating Some Categories. Start by dividing expenses into useful categories. Some possibilities: home, auto, food, household, debt, clothes, pets, entertainment, and charity. Don’t forget savings and investments. It may also be helpful to create subcategories. Housing, for example, can be divided into mortgage, taxes, insurance, utilities, and maintenance.
2. Following the Money. Go through all the receipts and statements gathered to prepare taxes and get a better understanding of where the money went last year. Track everything. Be as specific as possible, and don’t forget to account for the cost of a latte on the way to the office each day.
3. Projecting Expenses Forward. Knowing how much was spent per budget category can provide a useful template for projecting future expenses. Go through each category. Are expenses likely to rise in the coming year? If so, by how much? The results of this projection will form the basis of a budget for the coming year.
4. Determining Expected Income. Add together all sources of income. Make sure to use net income.
5. Doing the Math. It’s time for the moment of truth. Subtract projected expenses from expected income. If expenses exceed income, it may be necessary to consider changes. Prioritize categories and look to reduce those with the lowest importance until the budget is balanced.
6. Sticking to It. If it’s not in the budget, don’t spend it. If it’s an emergency, make adjustments elsewhere.

Tax time can provide an excellent opportunity. You have a chance to give your household budget a thorough checkup. In taking control of your money, you may find you are able to devote more of it to the pursuit of your financial goals.

IRA Withdrawals that Escape the 10% Tax Penalty

The reason withdrawals from a Traditional Individual Retirement Account (IRA) prior to age 59½ are generally subject to a 10% tax penalty is that policymakers wanted to create a disincentive to use these savings for anything other than retirement.¹

Yet, policymakers also recognize that life can present more pressing circumstances that require access to these savings. In appreciation of this, the list of withdrawals that may be taken from a Traditional IRA without incurring a 10% early withdrawal penalty has grown over the years.

Penalty-Free Withdrawals

Outlined below are the circumstances under which individuals may withdraw from an IRA prior to age 59½ without a tax penalty. Ordinary income tax, however, generally is due on such distributions.

1. Death — If you die prior to age 59½, the beneficiary(ies) of your IRA may withdraw the assets without penalty. However, if your beneficiary decides to roll it over into his or her IRA, he or she will forfeit this exception.^2,3
   
   
2. Disability — Disability is defined as being unable to engage in any gainful employment because of a mental or physical disability, as determined by a physician.⁴
   
   
3. Substantially Equal Periodic Payments — You are permitted to take a series of substantially equal periodic payments and avoid the tax penalty, provided they continue until you turn 59½ or for five years, whichever is later. The calculation of such payments is complicated, and individuals should consider speaking with a qualified tax professional.⁴
   
   
4. Home Purchase — You may take up to $10,000 toward the purchase of your first home. (According to the Internal Revenue Service, you also qualify if you have not owned a home in the last two years). This is a lifetime limit.
   
   
5. Unreimbursed Medical Expenses — This exception covers medical expenses in excess of 7.5% of your adjusted gross income.
   
   
6. Medical Insurance — This permits the unemployed to pay for medical insurance if they meet specific criteria.
   
   
7. Higher Education Expenses — Funds may be used to cover higher education expenses for you, your spouse, children, or grandchildren. Only certain institutions and associated expenses are permitted.
   
   
8. IRS Levy — Funds may be used to pay an IRS levy.
   
   
9. Active Duty Call-Up — Funds may be used by reservists called up after 9/11/01, and whose withdrawals meet the definition of qualified reservist distributions.

Stop Wasting Money

Benjamin Franklin once said, “a penny saved is a penny earned.” One way to find the money to meet your spending or saving needs is to examine your current spending habits and consider eliminating money wasters.

Top Money Wasters

1. Bargain Shopping…and its Expensive Cousin, Impulse Buying:
   Fire sales and impulse buying (such as products sold on infomercials) can be money wasters, made worse by how often they sit idly in a closet or drawer.
2. Unused Subscription Services:
   It can be tempting to sign up for the “free trials” many subscription services offer, but don’t forget to cancel after your trial period is up. Forgotten subscription services can eat away at your wealth when you don’t value the subscription anymore. For example, three $30-per-month subscriptions don’t sound like much until you realize they total nearly $1,100 per year.
3. Cable and Cell:
   Call your provider and see if it’s possible to negotiate a new rate. Cell providers, who face stiff competition, may be responsive. Cable companies may be less so, especially if they are a single provider, but you can review your package and make sure you are not paying for service you don’t want.
4. Paying for Water:
   Switching from an essentially free product to one that may cost up to $1.50 a day or more is a real budget leak. Consider purchasing a reusable container and using that during the day.
5. Gourmet Coffee:
   $4 or $5 a day may not seem like a lot of money, but when Americans step into a gourmet coffee shop, they may often buy more than just the coffee. Consider brewing your own. It can be ready before you leave for work, and it’ll save you the wait in the drive-through line!
6. Eating Out:
   While dining out may be one of life’s pleasures, eating out is often less about socialization and more about convenience. Twice a week may not seem like much, but over time it can add up. Try tracking your dining-out expenses for a week. You may be shocked at how fast costs add up. 

Outlook 2023: What’s Next for Interest Rates

What does the bond market know that the Fed isn’t telling us?

Fed officials recently have said that short-term rates will need to climb to over 5 percent to bring inflation under control. But in the table below, you can see that the bond traders say short-term rates will top out at 4.5 percent in 2023 and then head lower.

The bond market is more dovish than the Fed. And perhaps with good reason. The November Consumer Price Index report came in below expectations, and there are more and more signs that inflation has started to trend lower, which may suggest the Fed’s work is coming to an end.

So why is the Fed talking so tough? As many of you may recall, Fed Chair Jerome Powell said inflation was “transitory” throughout much of 2021. The Fed Chair doesn’t want to mischaracterize inflation again.

I work with other financial professionals who listen to comments from Fed officials and compare them to what the bond market is saying. So if you happen to hear commentary about the Fed that’s unsettling in any way, please let me know as soon as possible so we can review what’s going on.

Find That Lost Retirement Account

Do you have a long-lost retirement account left with a former employer? Maybe it’s been so long that you can’t even remember. With over 24 million “forgotten” 401(k) accounts holding roughly $1.35 trillion in assets, even the most organized professional may be surprised to learn that they have unclaimed “found” money.¹

What Are “Forgotten” Retirement Accounts?

Considering that baby boomers alone have worked an average of 12 jobs in their lifetimes, it can be all too easy for retirement accounts to get lost in the shuffle.² Think back to your first job. Can you remember what happened to your work-sponsored retirement plan? If you’re even slightly unsure, then it’s time to go looking for your potentially forgotten funds.

Starting Your Search

One of the best ways to find lost retirement accounts is to contact your former employers. If you’re unsure where to direct your call, try the human resources or accounting department. They should be able to check their plan records to see if you’ve ever participated. However, you will most likely be asked to provide your full name, Social Security number, and the dates you worked, so be sure to come prepared.

If your former employer is no longer around, look for an old account statement. Often, these will have the contact information for the plan administrator. If you don’t have an old statement, consider reaching out to former coworkers who may have the information you need.

Even if these first steps don’t turn up much info, they can help you gather important information.

Websites to Check

Next, it’s time to take your search online. Make sure you have as much information as possible at hand and give the following resources a try.

National Registry of Unclaimed Retirement Benefits

This database uses employer and Department of Labor data to determine if you have any unpaid or lost retirement account money. Like most of these online tools, you’ll need to provide your Social Security number, but no additional information is required.³

FreeERISA

If your forgotten account was worth more than $1,000 but less than $5,000, it might have been rolled into a default traditional Individual Retirement Account (IRA). Employers create default IRAs when a former employee can’t be located or fails to respond when contacted. You can search for retirement and IRA accounts for free using this database, but registration is required.⁴

Once you reach age 72, you must begin taking required minimum distributions from a traditional IRA in most circumstances. Withdrawals from traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10 percent federal income tax penalty.

The U.S. Department of Labor

Finally, the Department of Labor tracks plans that have been abandoned or are in the process of being terminated. Try searching its database to find the qualified termination administrator (QTA) responsible for directing the shutdown of the plan.⁵

What’s Next?

Once you’ve found your retirement account, what you do with it depends on the type of plan and where it’s held. Your location also matters. Depending on where you live, the rules and regulations may differ.

No matter what you decide to do, be sure to involve your tax and financial professionals since they’ll be informed on current regulations for your state. They can also help you identify a strategy for your newfound money: travel, investment, or maybe that vacation home you’ve always wanted. You worked hard for that money, after all, so you should get to enjoy it!

While you probably already found your notice in the mail, you may be curious about the COLA increase happening for Social Security recipients in the New Year. Starting in January, beneficiaries will see an 8.7% increase to help offset inflation and its effects on day-to-day costs.

This means a $146 increase in the monthly benefit for most retirees. Meanwhile, Medicare Part B premiums will shink back about 3% to $164.90, down $5.20 from last year; since these premiums are typically taken from Social Security benefits, that also bumps up the monthly payout.

While many retirees rely on Social Security for a significant portion of their retirement income, it’s important to remember those who collect payments while still earning income from work or some other source. Those still earning such income may want to consider adjusting their tax withholding.

The financial markets are complex systems. They can move from one event to the next so quickly that it’s hard to know what’s driving prices.

For example, look at the roundtrip oil prices in the chart below.

Oil prices surged to over $120 a barrel in the first half of 2022 on concerns over how Russia’s invasion of Ukraine would influence crude supply. But in the second half, oil prices have trended lower as traders feared a global recession might reduce oil demand.

So which one is it? Or is it both? Regardless of what you believe, oil prices have made a round trip in roughly 12 months.

The critical takeaway is that markets can be turbulent. One can quickly replace the factors that push prices higher with a new set of characteristics that drive prices lower.

So ask yourself, “Will the talk about a recession be the theme for all of 2023, or will a new storyline replace it at some point?”

Will you pay higher taxes in retirement? It’s possible. But that will largely depend on how you generate income. Will it be from working? Will it be from retirement plans? And if it does come from retirement plans, it’s important to understand which types of plans will be financing your retirement.

Another factor to consider is the role Social Security will play in your retirement. When do you plan to start to take Social Security benefits? If you have a spouse, when do they plan on taking benefits? It’s critical to answer key Social Security benefits questions so you have a better understanding of how it will affect your taxable income.

What’s a pre-tax investment? Traditional IRAs and 401(k)s are examples of pre-tax investments that are designed to help you save for retirement.

You won’t pay any taxes on the contributions you make to these accounts until you start to take distributions. Pre-tax investments are also called tax-deferred investments, as the money you accumulate in these accounts can benefit from tax-deferred growth.

For individuals covered by a retirement plan at work, the tax deduction for a traditional IRA in 2021 is phased out for incomes between $105,000 and $125,000 for married couples filing jointly, and between $66,000 and $76,000 for single filers.¹

Keep in mind that once you reach age 72, you must begin taking required minimum distributions from a traditional IRA, 401(k), and other defined contribution plans in most circumstances. Withdrawals are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty.

What’s an after-tax investment? A Roth IRA is the most well known. When you put money into a Roth IRA, the contribution is made with after-tax dollars. Like a traditional IRA, contributions to a Roth IRA are limited based on income. For 2021, contributions to a Roth IRA are phased out between $198,000 and $208,000 for married couples filing jointly and between $125,000 and $140,000 for single filers.²

To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawal can also be taken under certain other circumstances, such as the owner’s death. The original Roth IRA owner is not required to take minimum annual withdrawals.

Remember, this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, or financial professionals before modifying your retirement strategy

Are you striving for greater tax efficiency? In retirement, it is especially important – and worth a discussion. A few financial adjustments may help you manage your tax liabilities.