Last month I covered the importance of planning real estate liquidity needs. Simple real estate – with a small checking and / or savings account, an IRA, and a house on a mortgage – are often faced with cash flow problems. One of the solutions to providing the necessary cash is to identify your trust as the beneficiary of your IRA account. This process enables the administrator of your estate to use the IRA’s funds to pay your final expenses and make your mortgage payment on time. Unused funds from the IRA account can then be transferred to beneficiary IRAs for the desired recipients.
There is also another strategy for gaining access to larger sums of money that can be used to provide liquidity in your estate, but also provide a necessary emergency cushion while you are alive. However, this requires longer term planning and requires the assistance of your tax professional and financial advisor.
Large amounts of cash are often required for unexpected pre- and post-death emergencies. Many of us have worried about possible crises with one eye wide open at night because of forest fires, trees falling in the wind, medical problems and unexpected damage in the event of prolonged power outages. In many cases, when these disasters occur and the cash savings outside of the IRA accounts are small, the helmsman smiles to the bank. If you take larger amounts off your IRA, your tax structure may also change. Both your federal and state tax rates may increase. And at higher income levels, a greater portion of your Social Security may be taxable, and your Medicare premiums may also increase in the following year. The number of unexpected whammies while trying to raise large sums of money from your IRA can be very painful without proper planning.
How do you avoid these problems? Long-term tax planning with your finance professionals. However, this strategy takes years to implement, so you can’t wait until the last minute when a crisis is imminent. Implementation takes time and thought.
According to current income tax law, income is taxed in “brackets”. If you stay in the same income bracket by carefully planning your IRA withdrawals, you can potentially get more out of your IRA than is required for annual living expenses without increasing your tax bracket. You will still have to pay the tax on all IRA withdrawals. However, if you can spread those withdrawals over the years and save the extra cash in a savings account, the emergency pillows will start to grow over time. If planned carefully, you may be able to withdraw these additional funds without increasing your tax bracket or getting stuck with increasing the taxable amount on your Social Security. Let’s look at some of the federal income tax brackets for a single person to demonstrate this point.
| The taxable income is taxed at the following marginal rates for 2020: | |
|---|---|
| Taxable Income | tax rate |
| $ 0 to $ 9,875 | 10% |
| $ 9,876- $ 40,125 | $ 987.50 + 12% of the amount over $ 9,875 |
| $ 40,126- $ 85,525 | $ 4,617.50 + 22% of the amount over $ 40,125 |
| $ 85,526- $ 163,300 | $ 14,605.50 + 24% of the amount over $ 85,525 |
| $ 163,301 – $ 207,350 | $ 33,271.50 + 32% of the amount over $ 163,300 |
| $ 207,351- $ 518,400 | $ 47,367.50 + 35% of the amount over $ 207,350 |
| $ 518,400 or more | $ 156,235 + 37% of the amount over $ 518,400 |
Graphics provided
The taxable income is taxed at the following marginal rates for 2020.
If your taxable income was $ 30,000 that year and you were cutting another $ 10,000 a year, you would have saved over $ 30,000 emergency egg in four years of federal tax without increasing your tax bracket. However, if you needed $ 30,000 net of tax from your IRA for a future emergency and were to withdraw everything within a year on top of your normal taxable income of $ 30,000, your federal tax rate would increase from 12% to 22%. Ouch! In addition to the increased tax rate, you would also increase the amount of your Social Security Pension that is included in your taxable income. You would have gone from just 50% of your social security in your taxable income (or even zero in some situations) to a whopping 85%. Double ouch! If the main source of your extra emergency money is from your IRA, the helmsman is one of the many reasons to plan your liquidity needs before a crisis hits.
I have to emphasize that taxes are complicated. Use the assistance of your tax professional to figure out your ideal method for raising emergency funds over time. These strategies are available to those over the age of 59.5 who are most likely retired and need to build an emergency reserve.
Many people have not taken the normal withdrawal from their IRA this year because of the waiver of the required 2020 minimum payouts as part of the relief package provided for COVID. If you are low on money, I strongly recommend that you contact your tax advisor to see if you should still get some cash out of your IRA this year. If your taxable income brackets are lower than normal, this may be a good year to start this emergency reserve or increase it more than normal due to tax savings opportunities in the future. Towards the end of the year, the deadline for withdrawing IRA 2020 is rapidly approaching.
We wish you a Merry Christmas and a Happy New Year. May we all have a happier and less stressful year 2021. Take care and be safe out there! See you in 2021!
Mary Owens, Founder of Owens Estate & Wealth Strategies Group, Financial Advisor, RJFS, 426 Sutton Way, Suite 110, Grass Valley, 530-272-7500. Securities offered by Raymond James Financial Services, Inc., member of FINRA / SIPC. Owens Estate and Wealth Strategies Group is not a registered broker / dealer and is independent of Raymond James Financial Services. Investment advice from Raymond James Financial Services Advisors, Inc.