11 Real Estate Exit Strategies for Low- or No-Tax Investment Gains

The single greatest predictor of wealth in the U.S. isn’t education level, ethnicity, gender, or any other demographic descriptor. It’s whether or not you own real estate.

In the most recent Survey of Consumer Finances, the Federal Reserve found the median net worth of homeowners to be 46 times greater than that of renters. While the median renter had a net worth of $5,000, the median homeowner owned $231,400 in net assets.

Homeowners benefit from appreciation, forced savings in the form of principal repayment toward mortgages, and often lower annual housing costs compared to local renters. Those advantages get compounded by a tax code that favors property owners. Beyond simple homeownership, real estate investors can reduce their taxes through myriad strategies and incentives.

Still, when it comes time to sell, many property owners face sticker shock at their prospective tax bill. So how can property owners reduce — or better yet, eliminate — their taxes when they go to sell?

Common Real Estate Exit Strategies

Try these low- and no-tax real estate exit strategies to keep more of your real estate profits in your pocket and out of Uncle Sam’s grasping paws.

1. The Homeowner Exclusion

To begin, homeowners get an inherent tax break when they sell their home — with certain requirements and restrictions, of course. If you’re a homeowner selling your primary residence, chances are you won’t have to pay taxes on your profits from the appreciation of the home’s value since you bought it.

Single homeowners can exclude the first $250,000 in profits from their taxable income, and the number doubles for married couples filing jointly. Sometimes called a Section 121 Exclusion, it prevents most middle-class Americans from having to pay any taxes on home sale profits.

Any profits over $250,000 ($500,000 for married couples) get taxed at the long-term capital gains tax rate. More on that shortly.

To qualify for the exclusion, however, homeowners must have owned and lived in the property for at least two out of the last five years. They don’t have to be consecutive; if you lived in the property for one year, moved out for three years, then moved back in for one more year before selling, you qualify.

If you want to sell a property you don’t currently occupy as your primary residence, and want to avoid taxes through a Section 121 Exclusion, consider moving into it for the next two years before selling.

2. Opt for Long-Term Capital Gains Over Short-Term

If you own a property — or any asset for that matter — for less than a year and sell it for a profit, you typically pay short-term capital gains tax. Short-term capital gains mirror your regular income tax level.

However, if you keep an asset for at least one year before selling, you qualify for the lower long-term capital gains tax rate. In tax year 2020, single filers with an adjusted gross income (AGI) under $40,000 pay no long-term capital gains taxes at all — the same goes for married filers with an AGI under $80,000. Single filers with incomes between $40,001 and $441,450 and married filers between $80,001 and $496,600 pay long-term capital gains at a 15% tax rate, and high earners above those thresholds pay 20%.

Keep your investment properties and vacation rentals for at least one year if you can. It can save you substantial money on taxes.

3. Increase Your Cost Basis by Documenting Improvements

If you slept through Accounting 101 in college, your cost basis is what you spent to buy an asset. For example, if you buy a property for $100,000, that makes up your cost basis, plus most of your closing costs count toward it as well. Let’s call it $105,000.

Say you live in the property for 20 months, making some home improvements while there. For the sake of this example, say you spent $15,000 on new windows and a new roof.

Then you sell the property for $160,000. Because you lived there for less than two years, you don’t qualify for the homeowner exclusion. After paying your real estate agent and other seller closing costs, you walk away from the table with $150,000.

How much do you own in capital gains taxes?

Assuming you earn enough income to have to pay them at all, you would owe the IRS for $30,000 in capital gains: $150,000 minus your $105,000 cost basis minus the additional $15,000 in capital improvements. If you can document those improvements, that is — you need to keep your receipts and invoices in case you get audited.

In this example, your capital gains tax bill would come to $4,500 (15% of $30,000) if you document the capital improvements, rather than $6,750 (15% of $45,000) if you don’t.

4. Do a 1031 Exchange

Section 1031 of the U.S. tax code allows investors to roll their profits from the sale of one property into buying a new property, deferring their capital gains tax until they sell the new property.

Known as a “like-kind exchange” or 1031 exchange, you used to be able to do this with assets other than real estate, but the Tax Cuts and Jobs Act of 2017 excluded most other assets. However, it remains an excellent way to avoid capital gains taxes on real estate — or at least to postpone them.

Real estate investors typically use 1031 exchanges to leapfrog properties, stocking their portfolio with ever-larger properties with better cash flow. All without ever paying capital gains taxes when they sell in order to trade up.

Imagine you buy your first rental property for $100,000. After expenses, you earn around $100 per month in cash flow, which is nice but you certainly won’t be retiring early on it.

You then spend the next year or two saving up more money to invest with, and set your sights on a three-unit rental property that costs $200,000. To raise money for the down payment, you sell your previous rental property, and net $20,000 in profit at settlement. Ordinarily you’d have to pay capital gains taxes on that $20,000, but because you put it toward a new rental property, you defer owing them.

Instead of $100 per month, you net $500 per month on the new property.

After another year or two of saving, you find a six-unit property for $400,000. You then sell your three-unit to raise money for it, and again use a 1031 exchange to roll your profits into the new six-unit property, again deferring your tax bill on the proceeds.

The new property yields you $1,000 per month in cash flow.

In this way, you can keep scaling your real estate portfolio to build ever-more cash flow, all the while deferring your capital gains taxes from the properties you sell. If you ever sell off these properties without a 1031 exchange, you will owe capital gains tax on the profits you’ve deferred along the way. But until then, you need not pay Uncle Sam a cent in capital gains.

5. Harvest Losses

Invest in enough assets, and you’ll end up with some poor performers. You can sit on them, hoping they’ll turn around. Or you can sell them, eat the loss, and reinvest the money elsewhere for higher returns.

It turns out that there’s a particularly good time to accept investment losses: in the same year when you sell a property for hefty capital gains. Known as harvesting losses, you can offset your gains from one asset by taking losses on another.

Say you sell a rental property and earn a tidy profit of $50,000. Slightly nauseated by the notion of paying capital gains tax on it, you turn to your stock portfolio and decide you’ve had enough of a few stocks or mutual funds that have been underperforming for years now. You sell them for a net loss of $10,000, and reinvest the money in (hopefully) better performing assets.

Instead of owing capital gains taxes on $50,000, you now owe it on $40,000, because you offset your gain with the losses realized elsewhere in your portfolio.

6. Invest Through a Self-Directed Roth IRA

Want more control over your IRA investments? You can always set up a self-directed IRA, through which you can invest in real estate if you like.

Like any other IRA, you can open it as a Roth IRA account, meaning you put in post-tax money and don’t owe taxes on returns. Your investments — in this case, a real estate portfolio — appreciate and generate rental income tax-free, which you can keep reinvesting in your self-directed Roth IRA until you reach age 59 1/2. After that, you can start pulling out rent checks and selling properties, all without owing taxes on your profits.

Just beware that setting up a self-directed IRA does involve some labor and expense on your part. I only recommend it for professional real estate investors with the experience to earn stronger returns on real estate investments than elsewhere.

Pro tip: In addition to owning physical properties through a self-directed IRA, you can also use your self-directed IRA to invest in real estate through platforms like Fundrise or Groundfloor.


Hold Properties to Pass to Your Children

“Exit strategy” doesn’t always mean “sell.” The exit could happen in the form of your estate plan.

Or, for that matter, through methods of passing ownership of properties to your children while you still draw breath. There are several ways to go about this, but consider the following options as the simplest.

7. Leave the Property in Your Will

In 2020, the first $11.58 million in assets you leave behind are exempt from estate taxes. That leaves plenty of room for you to leave real estate to your children without them getting hit with a tax bill from Uncle Sam.

And, hey, rental properties can prove an excellent source of passive income for retirement. They generate ongoing income with no sale of assets required, which means you don’t have to worry about safe withdrawal rates or sequence of returns risk with your rental properties. They also adjust for inflation, as you raise rents each year. You can delegate the labor by hiring a property manager, and once your tenants eventually pay off your mortgage, your cash flow really explodes.

Plus, you can let your kids hassle with hiring a real estate agent and selling the property after you depart this mortal plane. In the meantime, you get to enjoy the cash flow.

8. Take Out a Home Equity Loan

Imagine you buy a rental property while working, and in retirement, you finally pay off the mortgage. You can enjoy the higher cash flow of course, but you can also pull money out through a home equity loan.

In this way, you pull out almost as much money as you’d earn by selling. Except you don’t have to give up the property — you can keep earning cash flow on it as a rental. You let your tenants pay down your mortgage for you once, all while earning some cash flow. Why not let them do it a second time?

You pull out all the equity, you get to keep the asset, and you don’t owe any capital gains taxes. Win, win, win.

You can follow the same strategy with your primary residence, but in that case you incur more personal debt and living expenses. Not ideal, but you have another option when it comes to your home.

9. Take Out a Reverse Mortgage

Along similar lines, you could take out a reverse mortgage on your primary residence if you have equity you want to tap into. These vary in structure, but they either pay you a lump sum now, or ongoing monthly payments, or a combination of both, all without requiring monthly payments from you. The mortgage provider gets their money back when you sell or kick the bucket, whichever comes first.

For retirees, a reverse mortgage helps them avoid higher living expenses while pulling out home equity as an extra source of income. And, of course, you don’t pay capital gains taxes on the property, because you don’t sell it.

10. Refinance & Add Your Child to the Deed

My business partner recently went to sell a rental property to her son for him to move into with his new wife. But the plan derailed when the mortgage lender declined the son’s loan application.

So they took a more creative approach. My business partner and her husband refinanced the property to pull out as much cash as they could, and they had the title company add their son and his wife to the deed and the mortgage note. The son and daughter-in-law moved into the property, taking over the mortgage payments. My partner and her husband took the cash, and while they remain on the deed, their ownership interest will pass to the younger generation upon their death.

In this way, they also streamline the inheritance, as the property won’t need to pass through probate.

This strategy comes with two downsides for my partner and her husband, however. First, they remain liable for the mortgage — if their son defaults, they remain legally obligated to make payments. Second, mortgage lenders don’t lend the entire value of the property when they issue a refinance loan, so my partner didn’t receive as much cash as she might have if she’d sold the property retail.

Of course, she also didn’t have to pay a real estate agent to market it. And any small shortfall in cash from refinancing rather than selling outright could be collected as a “down payment” from your child, or you could just shrug and think of it as a gift.


Other Exit Strategies

11. Donate the Property to Charity

Finally, you can always avoid taxes by giving the property to your charity of choice.

No clever maneuvers or tax loopholes. Just an act of generosity to help those who need the money more than you or Uncle Sam do.

By donating real estate you not only avoid paying taxes on its gains, you also get to deduct the value — in this case the equity — from your tax return. But bear in mind that the IRS looks closely at charitable deductions, especially house-sized ones, and you may hear from them demanding more information.


Final Word

Property owners have plenty of exit strategies at their disposal to minimize capital gains taxes. But don’t assume all of these options will last forever — with an ever-widening federal budget deficit, expect tax rates to rise and investment-friendly tax rules to suffer. Your taxes may go up in retirement, not down.

Whether you own a real estate empire or simply your own home, choose the strategy that fits your needs best, and aim to keep more of your proceeds in your own pocket.

What are your exit strategies for your properties? How do you plan to minimize your tax burden?

Source: moneycrashers.com

Backdoor Roth IRA – Definition & How to Make These Contributions

Saving for retirement is important for everyone. It’s difficult to live off Social Security benefits alone, so most people will need to supplement their retirement income with their own savings.

Many people have access to retirement plans like 401(k)s through their employers. If you don’t have access to a 401(k), or simply want to save more or have more control over your retirement savings, you might consider opening an Individual Retirement Account (IRA).

An IRA is a special type of account that is designed for retirement savings. You can open IRAs at many banks and with most brokerage companies. If you put money in an IRA, you can receive tax benefits, but you also restrict your ability to withdraw that money.

One drawback of traditional IRAs and Roth IRAs is that they limit the amount that you can contribute and exclude some people from contributing based on their income. However, there are ways to get around these limits.

What Is a Roth IRA?

For Roth IRAs, you pay taxes as normal when you contribute money to the account. However, withdrawals from the account are completely tax-free. That means you don’t have to pay any tax on your investment gains or dividends you receive in the account.

This can save you a lot of money in taxes compared to investing in a taxable brokerage account.

For comparison, a traditional IRA lets you deduct your contributions from your income, reducing your income tax bill immediately. However, you have to pay income tax on all the money you withdraw, including earnings, meaning you are deferring your taxes to a later date.

Roth IRAs are designed for retirement savings, so there are rules about withdrawing from the account.

Because you’ve already paid taxes on the money you contribute to a Roth IRA, you can withdraw contributions without penalty or taxation. However, the earnings in the account — the gains from your investment activities — are subject to penalties if you withdraw them before you turn 59 ½.

If you’ve had the account open for fewer than five years, you have to pay a 10% penalty and income tax on any earnings you withdraw. If you’ve had the account open for at least five years, you may be able to avoid taxes but will have to pay the 10% penalty on early withdrawals.

In some situations, such as paying for a first-time home purchase or paying for medical expenses, you may be able to avoid these taxes and penalties.

Once you turn 59 ½, you can make withdrawals from the account freely as long as it has been open for at least five years.


Roth IRA Contribution and Income Limits

The government places limits on the amount of money that you can contribute to a Roth IRA each year. The limits are based on your age and your income.

In general, for 2020, you can contribute up to the lesser of your taxable income for the year or $6,000. If you are age 55 or older, you can contribute an additional $1,000.

If you have a high enough income, the amount that you can contribute will begin to decrease until it reaches $0. The income maximum varies depending on your filing status.

Full Roth IRA Contribution Allowed Partial Roth IRA Contribution Allowed No Roth IRA Contribution Allowed
Single or Head of Household tax filing status Earned less than $124,000 Earned $124,000 to $138,999 Earned $139,000 or more
Married, filing separately tax filing status, did not live with spouse during the year Earned less than $124,000 Earned $124,000 to $138,999 Earned $139,000 or more
Married, filing separately tax filing status, did live with spouse during the year Earned less than $10,000 N/A Earned $10,000 or more
Married, filing jointly, or qualified widower tax filing statuses Earned less than $196,000 Earned $196,000 to $205,999 Earned $206,000 or more

These income limits use your modified adjusted gross income (MAGI), which is your gross income minus certain deductions such as contributions to employer retirement plans and student loan interest.


What Is a Backdoor Roth?

A backdoor Roth is a strategy people use to get around the income limits on Roth IRA contributions by contributing to a traditional IRA and then converting the balance to a Roth IRA.

Imagine that you’re fortunate enough to have an income of $150,000 as a single person. You probably have a good amount of money to invest for retirement, but the government won’t let you contribute to a Roth IRA.

You can use a backdoor Roth to get funds into your Roth IRA without breaking the income maximum rules. Traditional IRA contributions, unlike Roth IRAs contributions, are not limited by your income.

That means that you can contribute money to a traditional IRA no matter how much you make, and then roll those funds into a Roth IRA.

Pro tip: Have you considered hiring a financial advisor but don’t want to pay the high fees? Enter Vanguard Personal Advisor Services. When you sign up, you’ll work closely with an advisor to create a custom investment plan that can help you meet your financial goals.


How to Make Backdoor Roth Contributions

Making a backdoor Roth contribution is relatively easy.

1. Contribute to a Traditional IRA

To start, contribute the amount that you want to put in your Roth IRA to a traditional IRA.

When you contribute money to a traditional IRA, you can usually deduct those contributions from your income when you file your tax return. However, like Roth IRAs, there are income maximums for deducting traditional IRA contributions.

If you make more than the maximum allowed, you can still contribute to a traditional IRA, but you cannot deduct that contribution from your income when filing your tax return.

Because you’re rolling your money into a Roth IRA anyway, you’ll have to pay taxes, meaning you don’t have to worry about making too much to take the deduction.

2. Roll Your Traditional IRA Into a Roth IRA

Once you’ve contributed to an IRA, you want to roll that money into a Roth IRA.

A rollover lets you convert some or all of your traditional IRA balance into a Roth IRA balance. In effect, you can completely dodge the income limit for Roth IRA contributions using this strategy. Your broker can typically help you with the rollover process, making it relatively easy.

When you roll your traditional IRA’s balance into a Roth IRA, you pay income taxes on the amount you roll over.

The Pro-Rata Rule

Before you make a backdoor Roth contribution, you need to keep in mind one rule surrounding traditional IRAs and rollovers: the pro-rata rule.

To understand the pro-rata rule, picture your traditional IRA as having two buckets. One bucket includes money you deducted from your income and thus haven’t paid taxes on yet. The other includes money you contributed that you could not deduct from your income, possibly because you made too much money that year.

You need to track the buckets separately because although you have to pay income tax on pre-tax contributions when you withdraw them, you don’t have to pay them on post-tax contributions. If you did, you’d be paying taxes on the same income twice.

The pro-rata rule states that you must roll a proportional amount of each bucket into a Roth IRA when performing a rollover, meaning you can’t choose which bucket of money to roll over. This can have significant tax implications depending on how much pre-tax money you already have invested.

Avoiding the Pro-Rata Rule

The only way to avoid the pro-rata rule is to roll over your entire traditional IRA balance. If you make too much to contribute to a Roth IRA in the first place, you’re in a high tax bracket, resulting in a large tax bill as part of the rollover if you already have funds in your traditional IRA.

Keep in mind, the pro-rata rule looks at all of your IRAs and other pre-tax accounts, even if you keep them at different brokerages. You can’t open accounts in different places to dodge the rule.

3. Pay the Taxes Owed

When you roll money from a traditional IRA, you have to pay income tax on the money you roll over, unless the rollover is entirely composed of nondeductible contributions. If you’re rolling a large amount, you’ll want to have some money set aside to cover this cost.

To keep costs low, it might be worth timing your rollover for a year where your income is low, which means you’ll be in a lower tax bracket when you owe the tax on the amount rolled from your traditional to your Roth IRA.

Ultimately, backdoor Roth IRA contributions work best if you have little or no money in your traditional IRA. Asking a tax professional or a financial planner is a good idea if you want help with the process.


Advantages of Backdoor Roth Contributions

There are a number of reasons to consider backdoor Roth contributions.

1. Avoid Income Limits

The obvious benefit of backdoor Roth contributions is that they let you get around the income limits imposed by the IRS.

If you make too much to contribute to a Roth IRA, you probably have some extra money to save for the future. A backdoor Roth lets you get all of the advantages of a Roth IRA despite the income limits.

2. Tax-Free Growth

Money in a Roth IRA grows tax-free. You don’t pay taxes when you take money out of the account and the money you earn from your investments isn’t taxed either.

If you’re planning to invest the money anyway, by putting it in a Roth IRA, you’re getting the benefit of tax-free growth and only losing the freedom to withdraw earnings before you turn 59 ½.


Disadvantages of Backdoor Roth Contributions

Before using a backdoor Roth, consider these drawbacks.

1. Complexity

Making backdoor Roth contributions involves a few steps. You have to put money into a traditional IRA, then initiate a rollover to a Roth IRA.

If you have your traditional and Roth IRAs at the same company, your brokerage can probably help with the process, but there are a few moving parts.

You also have to make sure you submit the correct forms when you file your taxes to indicate your contributions and rollovers.

2. Combining Pre- and Post-Tax Money Is Messy

The pro-rata rule for rollovers means that backdoor Roth contributions work best if you don’t have any money in a traditional IRA.

If you do have some funds in your traditional IRA and don’t want to move the full balance of the account to your Roth IRA, you’ll be rolling a combination of pre- and post-tax funds into your Roth and leaving a combination of both in your traditional IRA.

This means you have to be diligent with your recordkeeping to make sure you don’t pay taxes on your post-tax traditional IRA funds when you withdraw money from the account in retirement.

You also have to pay taxes on any money rolled from a traditional IRA to a Roth IRA in the year you perform the rollover, which you need to plan for.


The Mega Backdoor Roth

Related to the backdoor Roth IRA is the mega backdoor Roth IRA. In rare cases, people can use a quirk of their 401(k) plan to get past the Roth IRA contribution limit, putting tens of thousands of dollars into their Roth IRAs each year.

401(k) Contribution Limits

A 401(k) is a retirement plan provided by employers as a benefit for their employees. One of the advantages of 401(k)s is their much higher contribution limits compared to IRAs.

For 2020, the individual limit for a 401(k) is $19,500 when it comes to deducting contributions from your taxes.

However, the true limit for 401(k)s is triple that number, $58,500. This limit includes all contributions made by the individual and their employer. Employees can deduct the first $19,500 they contribute and employers can contribute another $39,000 without the employee paying taxes on those employer contributions.

A small number of employers allow their employees to make post-tax, non-Roth contributions to their 401(k)s. This is like making nondeductible contributions to a traditional IRA.

You put money into the 401(k) but still pay taxes on the contributions. If your employer allows these types of contributions, you can add your own post-tax money to the account up to the $58,500 limit.

Typically, when you leave an employer, you can roll the balance of your 401(k) into your IRA. Most employers don’t let you roll your 401(k) into an IRA or make withdrawals from the account while you’re still employed. However, a small number of employers do allow these in-service distributions.

Performing a Mega Backdoor Roth Rollover

If your employer lets you make both post-tax, non-Roth contributions and allows in-service distributions, you have access to the mega backdoor Roth IRA.

To make a mega backdoor Roth contribution, contribute post-tax, non-Roth funds to your 401(k), then perform an in-service rollover of that money from your 401(k) to your Roth IRA.

Using this strategy, you can put as much as $39,000 extra into your Roth IRA each year, increasing your tax-advantaged investments by a huge amount.

Unfortunately, 401(k) plans that allow both post-tax, non-Roth contributions, and in-service distributions are incredibly uncommon, meaning that most people won’t be able to use this strategy.

However, if you run your own business or are self-employed, there’s nothing stopping you from designing your retirement plan to offer these options.


Final Word

Roth IRAs are one of the best ways to save for retirement, but if you make too much money, the IRS won’t let you contribute to the account.

For those with incomes high enough that they can’t contribute to a Roth IRA but who want to save more toward retirement, a backdoor Roth IRA contribution can help get around the limits.

If you’d rather keep the money out of retirement accounts and easy to access, you can always consider opening a taxable brokerage account. If you’re a hands-off investor, you can also think about using a robo-advisor to manage your portfolio.

Source: moneycrashers.com

What Is a Spousal IRA – Rules, Eligibility & Benefits

In order to contribute to an individual retirement account (IRA), you must have earned income, right?

Although that’s true for most people, the IRS makes an exception for nonworking spouses. The government acknowledges that in some households, one spouse stays home with the kids while the other generates income, so they allow both spouses to contribute to IRAs based on the joint household income. To do otherwise would put these households at an unfair disadvantage in retirement planning.

Known informally as spousal IRAs, these tax-sheltered accounts help families save more money for retirement without the burden of taxes.

Eligibility for Spousal IRAs

The “spousal IRA” is just a regular IRA — the name merely refers to the fact that the working spouse can make a contribution to an IRA held in the name of a nonworking spouse. All the same rules apply, and the stay-at-home parent opens a standard IRA in their own name.

The eligibility requirements for the spousal IRA are straightforward:

  • Marital Status: Married
  • Tax Filing Status: Married, filing jointly
  • Earnings: The contributing spouse must have compensation or earned income of at least the amount annually contributed to the nonworking spouse’s IRA. If the contributing spouse also has an IRA, annual compensation or earned income must exceed the combined contributions of both IRAs.
  • Age: The nonworking spouse must be under age 72 in the year of the contribution for a traditional IRA. There are no age restrictions on a Roth IRA for a nonworking spouse.

Understand that IRAs are owned separately, not jointly. This means the nonworking spouse owns the assets in the IRA. Once your working spouse contributes to the IRA, the money becomes yours. The IRA is in your name and opened with your Social Security number, and it remains yours even if you divorce.


How It Works: Creating and Contributing to Accounts

Once you determine that you meet the eligibility requirements, you can open an IRA through your regular investment brokerage (E*Trade and SoFi are our favorites). You open the account in your name even if your working spouse is the one who contributes to it.

Once created, you or your spouse can transfer money into your spousal IRA from your checking account. At the time of transfer, you specify which year you want the contribution to count toward.

You can then invest in any assets allowed by your brokerage. You completely own and control the account, as with all IRAs.


Contribution Limits and Deadlines

Because spousal IRAs work just like any other IRA, the contribution limits are the same. They remain unchanged from 2020 to 2021 at $6,000 per year per adult. Adults 50 and over can contribute an extra $1,000 as a catch-up contribution, for a total annual contribution limit of $7,000.

Thus, a married couple under age 50 can contribute a total of $12,000, and couples over 50 can contribute up to $14,000 per year.

You can contribute to a traditional IRA, Roth IRA, or both. The combined total can’t exceed the limit, so for example a 40-year-old could contribute $2,000 to their traditional IRA and $4,000 to their Roth IRA to max out their annual contributions at a combined total of $6,000.

The IRS allows you to contribute funds to your IRA up until the tax return filing deadline for the previous year — usually April 15, but extended to May 17, 2021, for individuals for tax year 2020. So for the first several months each year, you can make IRA contributions for either the previous year or the current one.


Income Limits and Tax Benefits

Spousal IRAs offer the same tax benefits as an account in the name of a working spouse. These tax advantages come with limits that depend on your age and income, as well as the type of IRA.

Traditional IRA

The main tax benefit of traditional IRAs is that you can deduct the contribution from your taxable income. You don’t pay taxes on the earnings until you withdraw money from the account during retirement. At that point, the amount you withdraw each year is taxed as regular income. In fact, you must start taking required minimum distributions (RMDs) once you turn 72.

No matter how high your income, you can contribute to a traditional IRA. But you only get the tax benefit of deducting your contribution if the working spouse earns less than the income limits.

If the working spouse doesn’t participate in an employer-sponsored retirement plan, such as a 401(k) or SIMPLE IRA, the deductible amount phases out for incomes between $198,000 and $208,000 in tax year 2021 (up from $196,000 and $206,000 for 2020).

If the working spouse does participate in an employer-sponsored retirement account, the income limits are lower. In 2021, the ability to deduct contributions phases out between $105,000 to $125,000 (up from $104,000 to $124,000 in 2020).

Roth IRA

When you contribute to a Roth IRA, you don’t get an immediate tax deduction. Instead, your Roth IRA contributions grow and compound tax-free, and you don’t pay taxes on withdrawals in retirement.

Unlike a traditional IRA, which requires you to begin taking minimum distributions at age 72, you are never required to take minimum distributions from a Roth IRA.

The ability to contribute to a Roth IRA starts phasing out for couples earning more than $198,000 in 2021 ($196,000 in 2020), and disappears entirely for those earning more than $208,000 ($206,000 in 2020).


What Happens to IRAs When One Spouse Dies?

When you open an IRA, you name a beneficiary for the event of your death. The IRA bypasses probate and goes directly to that beneficiary, and creditors can’t touch it. If that beneficiary dies before you do, then your IRA goes into probate to be distributed as part of your estate.

Most married couples name their spouse as the designated beneficiary for their IRA. Spouses get special treatment by the IRS, with more options available to them for handling the inherited IRA.

When you inherit your spouse’s IRA, you can do any of the following with the funds.

Roll Over Funds to Your Own IRA

Unique to married couples, you can roll over funds from your deceased spouse’s IRA to your own IRA. You pay no penalties or taxes on the money at the time of rollover. The funds simply get treated as part of your own IRA from then on.

This is usually the best option for spouses from a tax planning perspective.

Leave the Money as an Inherited IRA

Inherited IRAs follow slightly different rules.

Withdrawals continue to be treated based on your deceased spouse’s age. On the plus side, you can start taking withdrawals penalty-free, even if you’re under 59 ½, as long as your deceased spouse had been over 59 ½. The downside is that you must take required minimum distributions based on your spouse’s age, even if you are under 72.

You can, however, submit a new schedule based on your age.

If you inherit a Roth IRA, you must take RMDs on it, which is not the case with your own Roth IRA (including if you had rolled over the IRA funds to your Roth IRA).

Take All the Money Now

You can just cash out the money in your deceased spouse’s IRA. The IRS doesn’t hit you with penalties, even if you’re under 59 ½. But you do have to pay income taxes on it, which may thrust you into a higher tax bracket.

Disclaim Some or All of the Money

Don’t want the money for some reason?

If you want some or all of the IRA funds to go to your spouse’s other designated beneficiaries instead of you, you can disclaim it within nine months of your spouse’s death. In effect, you take a pass on receiving it, so it goes to the other beneficiaries instead.

This may make sense from a tax planning perspective. Or maybe you just don’t need the money, and the other beneficiaries do.


Final Word

A spousal IRA is a great way to boost household retirement savings contributions and build a bigger nest egg. Plus, it gives a nonworking spouse the chance to build up assets, rather than missing out on some of his or her potential earning power due to helping out at home. Given the retirement challenges many women face in particular, spousal IRAs can create added financial security in addition to the tax benefits.

If you or your spouse stay at home, check to see if you meet the criteria for eligibility, and consider investing through a spousal IRA.

Source: moneycrashers.com

Mint Success: Transitioning from College Kid to Young Professional

Photo Credit: Lawrence Peart

“Mint is so crucial to my personal finance I honestly have no idea where I would be without it.” That’s what Austin, TX photography consultant Lawrence Peart says when reflecting about his transition from college student to young pro, financially speaking. His experience so far shows that it is possible to graduate from college without debt, and to adjust to the higher cost of living as a young professional, while also saving money for your future.

But Peart stands out from the crowd. We looked at Minters’ numbers to see how college students and recent graduates use their money or handle debt, and found that there’s a big shift in many categories from ages 18 to 25 – incomes increase, spending categories fluctuate, and debt repayment – well, you know how that goes. Student loan payback time for many!

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College Grads Make More Money…

Depending on the field that graduates enter, incomes can be across the board, but a majority of our Mint users in that age range earn between $25K and $50K annually.

Student ChartGraduate Chart

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…and Spend More Money!

The newfound earnings may seem like a lot of money to a recent grad but, when faced with the sticker shock of life outside school, the typical Mint user experiences an accompanying increase in spending on rent, entertainment, and education related expenses – mostly student loan repayment. That bill averages about $300 per month.

Most grads continue to use credit cards after graduation. In fact, their card charges increase from $1,200 to $1,900 on average. But most of them don’t pay finance charges, which means these savvy Mint users are the ones who pay their balances by the end of the month. This explains why Mint’s young users have an average credit score of 690, considerably higher than the national average of 630 for the same age group*.

Good work, Minters! But while you’re paying off your college debt and adjusting to life on the outside, don’t forget to save for your future. Only 2% of college students have significant long-term savings, and that number only goes up to 7% among college graduates 25 and under. It might seem daunting to set aside those crucial dollars, but that money will grow over time and make your older self thank your younger self.

Moving Forward

Peart is in that 7% – he follows the mantra “Save, invest early and often, reap the benefits later.” With a goal to live debt-free and retire in his 20’s (he just turned 26), Lawrence uses Mint to budget and find extra money to sock away for the future. While his income falls in the same range as the majority of recently graduated Mint users, his experience both during school and in the few years since graduation defies many of the statistics, so naturally we asked him all about it.

What kind of shift in spending did you experience between college and post-college life?

I think it might surprise most people to hear that I spend far less money now than I did in college. Once you start earning an actual income and developing a clearer sense of your relationship to money it becomes much easier to save, and feels more rewarding to do so. While in school I never had much cash, so in a way it had less value and I spent it more freely. You expect to be broke in college, which becomes a self-fulfilling prophecy, and unless you’re careful that can then extend past your college years into your working life. I even had a little saying for it: the closer I am to zero, the less I have to lose.

The average college graduate spends about $300 per month on student loan repayment. What’s your bill?

$0. My experience paying for college was a mixture of some good fortune, a little bit of privilege, and tons of hard work. I chose a public school in a reasonably cheap city, I received decent grants, I applied for every scholarship available to me every semester (and made sure I had the grades to qualify) and for all but my sophomore year I worked at least part-time to have a source of income. I graduated broke, sure, and maybe missed out on some fun things here and there, but at least I didn’t owe anything.

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What was the most shocking financial realization you experienced once you left college?

That you can save quite a bit of money not doing the stuff everyone seems to think you have to be doing. If you don’t buy fancy clothes, go out for drinks every day, feel the need to keep up with the newest phone every 6 months etc., all of that extra cash starts to add up.

What are your thoughts about retirement savings, and what do you practice?

I half-seriously tell myself that I want to retire in my 20’s. I don’t mean “retire” in the way most people would think of retirement, I always want to be creating and applying myself to something, but I’d like to have the ability to not work for long periods of time. To be able to wake up one day in the near future and say “I am comfortable not working the rest of the month, time do something creative” and not feel guilty about it. That’s the goal.

I set up a Roth IRA almost immediately upon getting sustained income and contribute the full amount each year into basic low-cost index funds. I admire my parents in a lot of ways and don’t question their decisions and what life events influenced them, but while they are both doing fine in retirement age they are doing so without any long-term retirement account holdings. It might be hard to imagine 40 years down the line, but the math regarding investing when you’re young is compelling.

How does Mint help you stay on track?

I worked for about nine months before I came across Mint, and even though I thought I was being good with my money, you truly have no idea until you see it categorized and laid out in front of you. Those little purchases each day, the subscriptions, the monthly payments, it all adds up fast. You might think you’re saving money, but you’re not. It really does take hard work. Mint makes it easy, and I’ll tell everyone who listens: it’s even made paying bills fun. The first week of each new month is like Christmas. I get paid, I pay off my recurring expenses and then allocate how much I want to save that month before organizing more flexible costs like groceries, entertainment, etc. I follow one maxim above all else: you don’t save what is left after spending, you spend what is left after saving.

You can be like Lawrence

Does the idea of watching the savings pile up get you excited? Try setting up a goal with your Mint account and making that progress bar move!Don't save what you don't spend - spend what you don't save
We would like to hear your story! Contact us at Editor_Mint@intuit.com with “Mint User Story” in the subject.

Kim Tracy Prince is a Los Angeles-based writer who is pretty jealous of Lawrence’s early progress. It took her many years to pay off her student loans. She celebrated by finally framing her diploma.

*Source: https://www.creditkarma.com/trends/age
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