Comprehensive Advisor

Credit CARD Act 2009

We’ve gotten a few questions about the Credit CARD Act signed into law by the president last week.  Our view is that the approach is generally correct and in the right direction, there will be several negative and unintended consequences.

 

The good points include more forthright disclosure of the cost of the credit card interest charges.  For example, the number of months to pay off the card at the minimum payment amount and the total amount of interest to be paid are both vital pieces of data that every card user should have.  Also, the ending of the severely unethical practice of raising interest rates retroactively will end.  Of course, taking the singing pirate off the television will be helpful, too.

 

The negative consequences include some fairly strict retributions that all of us may feel.  Inactive cards that helped our credit scores to stay high may be unilaterally cancelled.  Credit limits may be reduced, again unilaterally further hampering credit scores.  Expect fees to come back and in a big way.  Almost certainly, many card issuers will institute an ownership fee of some kind.  In other words, you may have to pay $25-$50 or more per year solely to have the pleasure of carrying a particular card.  Many free services will now cost you.  Award programs may be cutback, or eliminated altogether.

 

We generally believe the philosophy behind the bill is correct.  Most remaining credit card users will be the more responsible ones.  Unfortunately, they will shoulder higher costs as the credit card companies try to keep up their exorbitant profits at the expense of fewer card users.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

 

Penalty Exceptions Concluded (for now!)

TSP, 457 plans, and other plans can have early withdrawal penalties, too.  Early withdrawals are usually made due to financial problems.  In these cases a 72t distribution is hardly ever the best way to go, so I didn’t talk about it over the past few days and won’t now.  The big points to remember are the withdrawal will most likely be subject to taxes and penalty (see the example earlier), and the remaining balance in your retirement account could be significantly reduced.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Penalty (Usually) not Withheld by Custodian

While the custodian will often offer the choice of withholding federal and state taxes if the taxpayer chooses, the custodian will not withhold the early distribution penalty. Instead, the taxpayer must pay the penalty directly to the IRS by including the amount in the “Other Taxes” section of her or his tax return.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

How Do I Tell the IRS About My Exception?

If a distribution qualifies for the exception to the penalty, the payer (usually the custodian) is required to make that indication on IRS Form 1099-R.  Remember, this is true only in cases where the custodian is certain the exception applies. For instance, the payer is not required to indicate the exception applies if the taxpayer indicates that the distribution will be used to purchase a first time home.  In cases where they are required to indicate the exception applies, the indication is made in Box 7 of Form 1099-R, and includes the following:

• Code 2:  IRS Levy, Direct Roth Conversion
• Code 3:  disability
• Code 4:  death, and
• Code G:  direct rollovers

If the payer is unsure if the amount qualifies for an exception, Code 1 will be in Box 7. Code 1 means no exception applies to the distribution. If, in fact, the taxpayer qualifies for an exception, the taxpayer should file IRS Form 5329 and complete the required sections.  This will alert the IRS of the exception. Form 5329 should also be filed if the payer (again, the custodian) indicates that an exception applies, when one does not.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Penalty Exemptions for Both IRAs and Qualified Plans

Okay, day early, yes!  Finally, the exemptions in this table are for both qualified plans and traditional IRAs.

Distributions from inherited retirement accounts

Distributions from nontaxable amounts

Distributions due to IRS levy on the retirement account

Eligible rollover distributions that are rolled over within 60-days

Qualified reservist distributions

Unreimbursed medical expenses that are more than 7.5% of adjusted gross income

Substantially equal periodic payments (SEPP)

Roth IRA conversion amounts

Distributions while the taxpayer is disabled

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Penalty Exemptions-Qualified Plans

The following early withdrawal exceptions apply only to qualified plans, such as a 401k or defined benefit pension plan (ah, the good old days!).

Distribution is made payable to an alternate payee (ex-spouse or child support order) under a qualified domestic relations order (QDRO)

Distribution made after separation  from service in or after the year participant reaches age 55 (age 50 for qualified public safety employees)

Distribution is made from an employee stock ownership plan for dividends on employer securities held by the qualified plan

Next time (probably Tuesday after the holiday weekend), we’ll review the exceptions applying to both IRAs and qualified plans.

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Penalty Exemptions-IRAs

The following distributions from a traditional IRA should be exempt from the 10% penalty on a withdrawal taken before age 59 ½.  In each of the instances below, certain criteria must be met.

First time home buyer distribution, up to $10,000

Distributions for the taxpayers qualified higher education expenses

Distributions for the cost of the taxpayer’s medical insurance, if certain conditions are met

 

These exceptions may look straightforward, but as with everything else in the tax code, please look a little further for the good and the bad.  For example, what exactly is a first time home buyer?  It is an individual (and if married, such individual's spouse) who had no present ownership interest in a principal residence during the 2-year period ending on the date of acquisition of the principal residence to which a first-time homebuyer distribution applies.  If a participant is married, his/her spouse must also satisfy the first-time homebuyer requirement in order for it to apply.  Further, a principal residence may include a houseboat, a house trailer, or stock held by a tenant-stockholder in a cooperative housing corporation, if the dwelling which the taxpayer is entitled to occupy as such stockholder is used by him as his principal residence.  This last paragraph is thanks to the good folks at www.retirementdictionary.com.

 

Visit us again tomorrow to get a look at the exceptions relating to qualified plans.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

 

How big is that penalty? Wow, that's big!

The early distribution penalty applies to any distribution from a qualified plan, a 403b or an IRA before the owner reaches 59 and ½ years of age, unless one of several exceptions applies. Some of the exceptions apply only to IRAs.  Some exceptions apply to qualified plans and 403b plans.  Then, there are a number of exceptions that apply to both qualified plans and non-qualified plans (IRAs, for example). Taxpayers who do not qualify for one of the exceptions will definitely be surprised at how big a withdrawal they have to make to cover their financial need, the income taxes (federal, state, and local), and the 10% penalty.  Let’s say you need $7,000 to cover your expenses for the next month.  Add to that you tax bracket of 25% and the 10% penalty, your actual distribution amount required to net $7k, in this case is a whopping $10,769!  The math works like this, divide $7k by 1 minus the total tax plus penalty, or $7000/(1-(0.25+0.10))= $10,769.  As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Working longer than planned?

For many people, whether one is making an early IRA or 401k withdrawal before retirement or the recent stock market losses, either could mean working longer than planned. For those who are under the age of 59 ½ and make an early IRA or 401 k withdrawal, they could owe the IRS an additional tax of 10% plus the normal income taxes on withdrawals of any pre-tax contributions.  Taxpayers who make withdrawals from their retirement accounts before retirement often do so because of financial hardships, usually a job loss or unforeseen medical expenses. Because these withdrawals usually result in the payment of federal income taxes, state income taxes and, often, an early distribution penalty, a taxpayer is almost always forced to make a withdrawal of an amount greater than the amount required to cover the living expenses immediately in front of him or her.  The net result is while you have enough money to cover the financial need and to satisfy the taxes and penalties, you will have a substantially smaller retirement account balance. As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Eary IRA Withdrawals and Penalties

An increasing number of people are being forced to consider making early withdrawals from accounts and funds that were supposed to be for retirement.  This series of posts will deal with the penalties the laws impose on making those withdrawals before the normal distribution age of 59 and ½ years.  Many people who have lost jobs and who are facing imminent job losses, this series of posts might help shape your decisions on how to handle your money in the unfortunate event of a job loss.  As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further information and to discuss your personal situation.