That is an important question because the actual money you have to spend when you retire depends upon the after-tax sources of your retirement income. Thus it is important to understand how the various retirement vehicles are taxed. There is significant diversity in taxation since a retiree must consider both Federal and state taxes on retirement income. Of all the states one might consider retiring to, there are eight that have no state income tax. These are Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. However, to make up for no revenue from individual income taxes these states may be funded by other types of taxes, such as property taxes, sales taxes, or excise taxes.

Social Security Benefits – Social Security is probably the leading source of retirement for most retirees, and determining the federal taxation can be somewhat complicated the IRS provides a worksheet. Without using the worksheet we know that no more the 85% of Social Security benefits are subject to federal taxation and in many lower-income situations, none of the Social Security benefits are taxable. The actual calculation involves adding your other income to half of your annual Social Security benefit. If the amount is less than $32,000 for married tax filers or less than $25,000 for single filers in 2022, you will avoid federal taxes on your benefits. However, those filing Married Separate will find that 85% of their Social Security benefits are always taxable.

State Tax – Besides the states that have no state tax, there are 30 that do not tax Social Security benefits, The balance, VT, CT, RI, WV, MO, MN, ND, NE, KS, CO, UT, NM, and MT, tax Social Security benefits based on factors such as age and income or a modified amount. See the Tax Foundation Map.

Roth IRA Retirement Account – Roth IRA contributions are limited to the lesser of earned income or the annual limit which is $6,000 ($7,000 if age 50 or over). With a Roth IRA, a taxpayer gets no tax deduction when contributions are made. However, what the taxpayer gets is tax-free accumulation, and after age 59-½, all distributions are tax-free, including the account earnings, provided the 5-year holding period has been met. Since the earnings are also tax-free once the age and holding period requirements are satisfied, the sooner an individual begins making contributions, the greater the benefits at retirement. However, contributions to Roth IRA are restricted for higher-income taxpayers.

Traditional IRA Retirement Account – Like Roth IRA contributions, traditional IRA contributions are limited to the lesser of earned income or the annual limit which is $6,000 ($7,000 if age 50 or over). Unlike Roth IRAs, generally, contributions are deductible in the year of the contribution. Thus future distributions are fully taxable including the earnings. Where an individual also has a qualified retirement plan, the deductibility is phased out for those with higher incomes. However, they can still make non-deductible contributions, in which case a prorated amount of the distributions will be non-taxable. In addition, individuals can elect to make non-deductible contributions which may be appropriate when an individual intends to subsequently convert the traditional IRA to a Roth IRA as discussed next.

Spousal IRA – Generally, IRA contributions are only allowed for taxpayers who have compensation (the term “compensation” includes wages, tips, bonuses, professional fees, commissions, taxable alimony received, and net income from self-employment). Spousal IRAs are the exception to that rule and allow a non-working or low-earning spouse to contribute to his or her own IRA, otherwise known as a spousal IRA if their spouse has adequate compensation. The maximum amount that a non-working or low-earning spouse can contribute is the same as the limit for a working spouse.


Example: Tony is employed, and his W-2 is $100,000. His wife, Rosa, age 45, has a small income from a part-time job totaling $900. Since her own compensation is less than the contribution limit for the year, she can base her contribution on their combined compensation of $100,900. Thus, Rosa can contribute up to $6,000 to an IRA.


Back-Door Roth IRA – Where a high-income individual would like to contribute to a Roth IRA but cannot because of the high-income limitations, there is a workaround, commonly referred to as a back-door Roth IRA, that will allow funding of a Roth IRA for some individuals. Here is how a back-door Roth IRA works:

  1. First, an individual contributes to a traditional IRA. For higher-income taxpayers who participate in an employer-sponsored retirement plan, a traditional IRA is allowed but is not deductible. Even if all or some portion is deductible, the contribution can be designated as not deductible. 
  2. Then, since the law allows an individual to convert a traditional IRA to a Roth IRA without any income limitations, the individual can convert the non-deductible Traditional IRA to a Roth IRA. Since the Traditional IRA was non-deductible, the only tax related to the conversion would be on any appreciation in the value of the Traditional IRA before the conversion is completed.

Potential Pitfall – There is a potential pitfall to the back-door Roth IRA that is often overlooked by investment counselors and taxpayers alike that could result in an unexpected taxable event upon conversion. For distribution or conversion purposes, all IRAs (except Roth IRAs) are considered as one account and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable.

This may or not may affect the decision to use the back-door Roth IRA method but does need to be considered prior to making the conversion.

Saver’s Credit – Low- and moderate-income workers can take advantage of a special tax credit that helps them save for retirement and earn a special tax credit. This credit helps offset part of the first $2,000 workers voluntarily contribute to traditional or Roth Individual Retirement Arrangements (IRAs), SIMPLE-IRAs, SEPs, 401(k) plans, 403(b) plans for employees of public schools and certain tax-exempt organizations, 457 plans for state or local government employees, and the Thrift Savings Plan for federal employees.

Employer Pensions – Generally, since employer pension plans are fully funded by the employer, pension payments will be fully taxable.

Employee Funded Retirement Plans – These include plans such as 401(k) plans, 403(b) plans, self-employed plans, and SEP IRAs. Since these plans are funded with pre-tax dollars the individual receives a current tax deduction (income deferral); thus, the income and accumulated earnings will be taxable when withdrawn for retirement, after reaching age 59½ or later.

Health Savings Accounts (HSA) – Although the tax code refers to these plans as “health” savings accounts, an HSA can act as more than just a vehicle to pay medical expenses; it can also serve as a retirement account. For some taxpayers who have maxed out their retirement plan options, an HSA provides another resource for retirement savings—one that isn’t limited by income restrictions in the way that IRA contributions are.

Since there is no requirement that the funds be used to pay medical expenses, a taxpayer can pay medical expenses with other funds, allowing the HSA to grow (through account earnings and further tax-deductible contributions) until retirement. In addition, should the need arise, the taxpayer can still take tax-free distributions from the HSA to pay medical expenses. Unlike traditional IRAs, no minimum distributions are required from HSAs at any specific age.

Withdrawals from an HSA that aren’t used for medical expenses are taxable and subject to a 20% penalty, with one exception: an individual age 65 or older will pay income tax on non-medical related distributions from their HSA but won’t owe a penalty for using the funds for other than medical expenses.

Example: Henry, age 70, has an HSA account from which he withdraws $10,000 during the year. He also has unreimbursed medical expenses of $4,000. Of his $10,000 withdrawal, $6,000 ($10,000 – $4,000) is added to Henry’s income for the year, and the other $4,000 is both tax- and penalty-free. If Henry had been 64 years old or younger, he’d be taxed on the $6,000 and pay a penalty of $1,200 (20% of $6,000).


Brokerage Accounts – Some individuals invest in stocks and mutual funds for their future retirement. These investments, if held for more than a year, will produce long-term gains or losses. Long-term gains are taxed at zero, 15%, or 20% depending on the individual’s total income for the year. However, investments held for less than a year will be taxed as ordinary income (taxed at the individual’s regular tax rate, which could be as high as 37%). In addition, a surtax may apply to the individual’s investment income. It is 3.8% of the lesser of the taxpayer’s net investment income or the excess of their modified adjusted gross income over $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others.

Bond Investments – Those who are approaching retirement or have already retired may wish to switch their retirement investments into less uncertain investments since they may not have the longevity to stay the course for recovery. Bonds provide a safer alternative. Generally, income from municipal bonds is exempt from taxation for federal purposes. In addition, interest earned from municipal bonds issued by an individual’s home state is also exempt from state income taxes.

Home Equity – Provided a retiree has not used up their home equity, that equity can provide a source of retirement income by selling the home and taking advantage of the home gain exclusion of $500,000 for married couples ($250,000 for others). They can do this by downsizing or selling and renting. To qualify for the exclusion the individual must have owned and lived in the home for at least two out of the last five years before the sale. For married taxpayers filing jointly, both spouses must have used the home as their main residence for two of the five years before the sale, while only one spouse needs to be the owner for two of the five years.

Reverse Mortgage – As an alternative to selling the home, homeowners aged 62 and older can stay in their home while converting the home equity via a reverse mortgage. With a reverse mortgage, the lender pays the homeowner rather than the homeowner making payments. In addition, since the payments constitute home equity they are not taxable.

Whole Life Insurance Cash Value – Cash value accumulated in an insurance policy can also provide a source of income during retirement. The income will be tax-free up to the amount that was paid into the policy.

For some individuals, there may be other available sources of retirement income. Please call our office for assistance in your retirement planning.

Amber, Christopher, Maribel, and John!

Bowman & Company is happy to announce the promotions of Amber Dominguez, Christopher (Chris) Buzo, Maribel Galan, CPA, and John Normington. These four professionals will take on new their new roles as Supervisors.

Amber has been in the accounting field for four and a half years with Bowman and is in the final stages of finishing up earning her CPA license. She attributes a great deal of her success to those who have mentored her in official and unofficial capacities. In the office, Amber is most passionate about working with Non-Profits. Outside of work, Amber is passionate about cats and finding loving homes for her foster kittens. Amber is currently managing the balance of transitioning from staff on audit engagements to in charging those engagements and is looking forward to new opportunities.

Chris has been in the accounting field for five years and with Bowman for one and a half years where he has enjoyed working with the team specializing in Tax Accounting. While Chris feels there are many resources available at Bowman to support him in his professional development, he felt that the people he works with and everything he has learned from them to be his most valuable resource. Chris is a “learn by doing” individual and takes the knowledge he gains and uses it to gain proficiency. Chris is passionate about maintaining a reputation for reliability and dependability for the Firm and his colleagues. 

Maribel has been in the accounting field for over five years and has spent the past two and a half years with Bowman.  She initially began her career working in Audit before transitioning to the Tax side of the firm. She considers her transition to the Tax team to be one of her top experiences at Bowman because of the resources available and people who supported her as she gained new expertise. Maribel appreciates the example of the many Firm leaders who demonstrate a work-life balance, and she hopes to emulate this in her own career. She looks forward to broadening her technical tax skills and becoming someone at the Firm who others will view as a resource.

John started his accounting career with Bowman and has been with the firm for seven years. He attributes a great deal of his success and career development to his co-workers, who are always very helpful, and the guidance and support of the Partners. John also shared a secret to his success: consolidating questions to be respectful of other’s time and covering multiple topics at once. John currently specializes in Low-Income Housing Tax Returns and was previously focused in Audit. John recalls a time when managing the budget of each project was a challenge and how he overcame this through understanding the nuances for each project. John appreciates all of the fun activities we do at Bowman, especially night out at the ballpark.

Congratulations Amber, Christopher, Maribel, and John!

Natasha Doran and Ivan Alatorre

Bowman & Company is excited to announce the promotions of Natasha Doran and Ivan Alatorre. They will be taking on new roles and responsibilities as Senior Accountants.

Natasha has been in the accounting field for over 30 years and a member of the Bowman team for three and a half years. She remembers that prior to joining Bowman, many of her accounting questions were unanswered. When she started at Bowman, she was pleased at the many resources available to her, as well as the helpful team she worked with to gain additional knowledge and skill with higher level clients. Natasha specializes in Trusts, Tax and Client Accounting Advisory Services (CAAS). She remembers that working on Trusts was initially intimidating and now she handles them quite often. Natasha appreciates the flexibility at Bowman, which allows her to manage family needs. In her off time, you will likely find her on a beach in her favorite place, Hawaii. 

Ivan began his career in the accounting field at Bowman and has been with the firm for one and a half years with Bowman. He attributes his success and career development to his ability to ask questions and not being afraid to fail. Ivan currently works in both Audit and Tax and enjoys the dynamics of each. A naturally quiet person, Ivan has learned the benefit of overcoming this challenge because when he interacts with his coworkers and peer and asks questions, he always learns something new. His motto is “just do it” (but we won’t tell Nike).  In his new role, Ivan is looking forward to higher level tasks and responsibilities, as well as being someone his coworkers depend on. 

Congratulations Natasha and Ivan!

Whitney Kesterson

Bowman & Company is pleased to announce the promotion of Whitney Kesterson. Whitney takes on new responsibilities as a Senior Manager.  

Whitney has 10 years of private industry accounting experience and 11 years of public accounting experience, of which five of those years have been with Bowman. Whitney attributes much of her career development to being proactive, learning and absorbing as much as possible and also becoming a SME (subject matter expert) in specific areas of accounting. Whitney’s areas of accounting expertise are focused on audits of employee benefit plans, low-income housing and Title 31 (anti-money laundering) casino compliance. A career highlight for Whitney was her off-site visit with the Alliott Global Alliance and meeting professionals from all around the world.

In her new role, Whitney is looking forward to continuing to pursue learning opportunities and sharing her skill set as well as developing others and being a mentor to staff.

CONGRATULATIONS WHITNEY!

On July 27, the legislative text of the Inflation Reduction Act (IRA) was made public. The enormous bill—clocking in at 725 pages—contains a wide range of provisions and comes with an $800 billion price tag. “The bill is fighting inflation and has a whole lot of collateral benefits as well,” said former Treasury Secretary Larry Summers, who reportedly helped craft the legislation.

According to a recent article from Vox, there are three big questions when it comes to the passage of the IRA:

  1. Will Arizona senator Kyrsten Sinema support the IRA?
  2. Will Democratic House moderates support the IRA?
  3. Will a vote on the IRA occur prior to the Senate’s annual summer recess, which is scheduled to begin on August 8?

While there are many hurdles to summit before the bill becomes law, it is important to remain aware of what is potentially in the works. Read on for an overview of the key items contained in the new act.

Provisions for Funding the IRA

In order to cover the $800 billion price tag of the IRA, authors of the legislation included a variety of savings- and revenue-related provisions. Here is a breakdown of how the IRA will be funded:

  1. Savings in the Healthcare Arena – $320 Billion
    1. Repeal of a Trump-era drug rebate rule ($120 Billion)
    2. An inflation cap on drug prices ($100 Billion)
    3. An allowance for Medicare to negotiate certain drug prices ($100 Billion)
  2. New Revenue – $470 Billions
    1. A new 15% corporate minimum tax ($315 Billion)
    2. Increased revenue as a result of IRS tax enforcement funding ($125 Billion)
    3. Closure of the carried interest loophole ($15 Billion)
    4. Methane and Superfund fees ($15 billion)

How IRA Funds Will be Spent

So how will the $800 billion raised via savings and new revenue be spent? Here is a brief overview of initiatives included in the IRA:

  1. Climate & Energy Spending – $385 Billion
    1. Creation of new clean manufacturing tax credits ($40 Billion)
    2. Establishment of additional clean electricity grants and loans ($30 Billion)
    3. Creation of a new “Clean Energy Technology Accelerator” ($30 Billion)
    4. Incentivization of clean agriculture ($30 Billion)
    5. Incentivization of clean electronic vehicle manufacturing ($20 Billion)
    6. Additional energy and climate provisions ($235 Billion)
  2. Healthcare Spending – $99 Billion
    1. A three-year extension of Obamacare subsidies for health care insurance costs ($64 Billion)
    2. A redesign of Medicare Part D and additional health care provisions ($35 Billion)
  3. IRS Funding – $80 Billion
    1. Funding for increased IRS enforcement
  4. Other Spending – $305 Billion
    1. Reducing the Federal deficit

Conclusion

As with any legislation in progress, pretty much everything about the IRA remains up in the air until it is enacted by the President. Please be assured that your Bowman & Company, LLP accounting advisors are keeping a close watch on the progress of the IRA and will keep you apprised of any major developments. 

Sources

  1. https://www.washingtonpost.com/us-policy/2022/07/28/manchin-schumer-climate-deal/
  2. https://finance.yahoo.com/news/inflation-reduction-act-how-a-new-bill-would-lower-costs-for-americans-200724803.html
  3. https://www.whitehouse.gov/briefing-room/speeches-remarks/2022/07/28/remarks-by-president-biden-on-the-inflation-reduction-act-of-2022/
  4. https://www.vox.com/policy-and-politics/23282983/inflation-reduction-act-kyrsten-sinema-josh-gottheimer