February 2014 Newsletter

Should You Pay Off Your Mortgage During Retirement?

For many homeowners, paying off a mortgage is a financial milestone. This is especially true when you are retired. Not having the burden of a monthly mortgage payment during retirement can free up money to help you live the retirement lifestyle you’ve always wanted.

To pay off, or not to pay off: that is the question 

Some retirees are lucky enough to have paid off their mortgage before they reach retirement. For others, however, that monthly obligation continues. If you are retired, you may be wondering whether you should pay off your mortgage.  Unfortunately, there’s no one answer that’s right for everyone. Instead, the answer will depend upon a variety of factors and how they relate to your individual situation.

Return on retirement investments vs. mortgage interest rate

One way many retirees pay off their mortgage is by using funds from their retirement investments.  To determine whether this is a good option for you, you’ll need to consider the current and anticipated rate of return on your retirement investments versus your current mortgage interest rate. In other words, do you expect to earn a higher after-tax rate of return on your current retirement investments than the after-tax interest rate you currently pay on your mortgage (i.e., the interest rate that you’re paying, factoring in any mortgage interest deduction you’re entitled to)?  For example, assume you pay an after-tax mortgage interest rate of 4%. You are considering withdrawing funds from your retirement investments to pay off your mortgage balance. In general, you would need to earn an after-tax return of greater than 4% on your retirement investments to make keeping your money invested for retirement the smarter choice. On the other hand, if your retirement funds are primarily held in investments that typically offer a lower rate of return than the interest rate you pay on your mortgage, you may be better off withdrawing your retirement funds to pay off your mortgage.

Additional considerations

As you weigh your options, you’ll also want to consider these additional points:

• Effect on retirement nest egg– If you rely on your retirement savings for most of your income during retirement, you should generally avoid paying off your mortgage if it will end up depleting a significant portion of your retirement savings. Ideally, you should pay off your mortgage only if you have a small mortgage balance in comparison to your overall retirement nest egg.

• Tax consequences– Keep in mind that if you are going to withdraw funds from a retirement account to pay off your mortgage, there are some potential tax consequences you should be aware of. First, if you withdraw pretax funds from a retirement account, the amount you withdraw is generally taxable. As a result, you’ll want to be sure to account for the taxes you’ll have to pay on the amount you withdraw from pretax funds. Depending on your tax bracket, that could be a significant amount. In addition, if you take a large enough distribution from your retirement account, you could end up pushing yourself into a higher income tax bracket. Finally, unless you are 59½ or older, you may pay a penalty for early withdrawal.

• Comfort with mortgage debt– For many retirees, a monthly mortgage obligation can be a heavy burden. If no longer having a mortgage would give you greater peace of mind, give the emotional benefits of paying off your mortgage some extra consideration.


Filing Your 2013 Federal Income Tax Return

For most people, the due date for filing a 2013 federal income tax return is April 15, 2014. Here are a few things to keep in mind this filing season.

Lots of changes to consider

While most individuals will pay taxes based on the same federal income tax rate brackets that applied for 2012, a new 39.6% federal income tax rate applies for 2013 if your taxable income exceeds $400,000 ($450,000 if you’re married filing jointly, $225,000 if married filing separately). If your income crosses that threshold, you’ll also find that a new 20% maximum tax rate on long-term capital gain and qualifying dividends now generally applies (in prior years, the maximum rate was generally 15%).

You may also need to account for new taxes that took effect in 2013. If your wages exceeded $200,000 in 2013, you were subject to an additional 0.9% Medicare payroll tax–if the tax applied, you probably noticed the additional tax withheld from your paycheck. If you’re married and file a joint tax return, the additional tax kicks in once the combined wages of you and your spouse exceed $250,000 (if you’re married and file separate returns, the tax kicks in once your wages exceed $125,000). One thing to note is that the amount withheld may not accurately reflect the tax owed. That’s because your employer calculates the withholding without regard to your filing status, or any other wages or self-employment income you may have received during the year. As a result, you may end up being entitled to a credit, or owing additional tax, when you do the calculations on your return.

And, if your adjusted gross income (AGI) exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately), some or all of your net investment income may be subject to a 3.8% additional Medicare contribution tax on unearned income. Additionally, high-income taxpayers (e.g., individuals with AGIs greater than $250,000, married couples filing jointly with AGIs exceeding $300,000) may be surprised to see new limitations on itemized deductions, and a possible phaseout of personal and dependency exemptions.

New home office deduction rules

If you qualify to claim a home office deduction, starting with the 2013 tax year you can elect to use a new simplified calculation method. Under this optional method, instead of determining and allocating actual expenses, you simply multiply the square footage of your home office by $5. There’s a cap of 300 square feet, so the maximum deduction you can claim under this method is $1,500. Not everyone can use the optional method, and there are some potential disadvantages, but for many the new simplified calculation method will be a welcome alternative.

Same-sex married couples

Same-sex couples legally married in jurisdictions that recognize same-sex marriage will be treated as married for all federal income tax purposes, even if the couple lives in a state that does not recognize same-sex marriage. If this applies to you, and you were legally
married on December 31, 2013, you’ll generally have to file your 2013 federal income tax return as a married couple–either married filing jointly, or married filing separately. This affects only your federal income tax return, however–make sure you understand your state’s income tax filing requirements.

2013 IRA contributions–still time

You generally have until April 15 to contribute up to $5,500 ($6,500 if you’re age 50 or older) to a traditional or Roth IRA for 2013. With a traditional IRA, you may be able to deduct your contribution (if you or your spouse are covered by an employer plan, your ability to deduct some or all of your contribution depends on your filing status and income). If you make contributions to a Roth IRA (your ability to contribute depends on your filing status and income) there’s no immediate tax benefit, but qualified distributions you take in the future are completely free from federal income tax.

Filing for an extension

If you’re not going to be able to file your federal income tax return by the due date, file for an extension using IRS Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. Filing this extension gives you an additional six months (to October 15, 2014) to file your return. Don’t make the mistake, though, of assuming that the extension gives you additional time to pay any taxes due. If you don’t pay any taxes owed by April 15, 2014, you’ll owe interest on the tax due, and you may owe penalties as well. Note that special rules apply if you’re living outside the country or serving in the military outside the country on April 15, 2014.

2013 is the last year to take advantage of:

• Increased Internal Revenue Code (IRC) Section 179 expense limits ($500,000 maximum amount decreases to $25,000 in 2014) and “bonus” depreciation provisions
• The $250 above-the-line tax deduction for educator classroom expenses
• The ability to deduct mortgage insurance premiums as qualified residence interest
• The ability to deduct state and local sales tax in lieu of the itemized deduction for state and local income tax
• The deduction for qualified higher education expenses
• Qualified charitable distributions (QCDs), allowing individuals age 70½ or older to make distributions of up to $100,000 from an IRA directly to a qualified charity (distributions are excluded from income and count toward satisfying any
required minimum distributions (RMDs) for the year)


Married Filing Jointly or Separately? The Choice Is Yours

If you are married, you generally have a choice of filing your federal income tax return(s) as married filing jointly (MFJ) or as married filing separately (MFS). Because of a number of special rules, your combined tax will often be lower if you file married filing jointly than if you file married filing separately, but that is not always the case. You should generally calculate your tax both ways to determine which filing status results in the lower total tax.

Basic rules

You and your spouse can file as married filing jointly if you are considered married and you both agree to file a joint return. On a joint return, you and your spouse report your combined income, exemptions, deductions, and credits. You are both responsible for any tax, interest, or penalty due on a joint return. Alternatively, you and your spouse can file as married filing separately. On a separate return, you each generally report only your own income, exemptions, deductions, and credits. You each are responsible only for any tax, interest, or penalty due on your separate return.

Special rules for married filing separately

Maybe not unexpectedly, many tax items for MFS are exactly half of the amounts for MFJ:

• The tax brackets (for MFS, higher tax rates are reached at lower income levels than for MFJ)
• The phaseout thresholds for personal exemptions
• The limitation thresholds for itemized deductions
• The limits on the amount of income that can be excluded under an employer’s dependent care assistance program
• The alternative minimum tax exemptions
• The amount of capital losses you can deduct
• The income levels at which the child tax credit is reduced
• The income levels at which the retirement savings contributions credit is reduced
• The income thresholds for the additional 0.9% Medicare tax on Social Security wages and self-employment income and the 3.8% Medicare tax on net investment income

Some items are not available for MFS:

• The credit for child and dependent care expenses (in most cases)
• The earned income credit
• The exclusion or credit for adoption expenses (in most cases)
• The American Opportunity credit and the Lifetime Learning credit
• The deduction for student loan interest, and the deduction for tuition and fees
• The exclusion for interest from qualified U.S. savings bonds used for higher education expenses

Other rules that apply to MFS:

• With MFS, if your spouse itemizes deductions, you cannot claim the standard deduction, and even if you claim the standard deduction, the standard deduction for MFS is half the amount for MFJ
• The thresholds for taxation of Social Security benefits are lower for MFS than for MFJ
• The phaseout thresholds for deductible contributions to a traditional IRA (if you were covered by an employer retirement plan) or for contributions to a Roth IRA start at $0 for MFS

Something else to consider

If your adjusted gross income (AGI) for MFS is lower than for MFJ, you may be able to deduct a larger amount for certain deductions that are deductible only to the extent they exceed a percentage of your AGI (e.g., medical expenses, casualty and theft losses, and job expenses and other miscellaneous deductions) for MFS. For example, medical expenses are generally deductible only to the extent they exceed 10% of AGI. By claiming medical expenses on a separate return with a lower AGI, the amount of medical expenses that can be deducted may be increased.

New rules for same-sex marriages

In response to a 2013 Supreme Court decision invalidating a key provision of the Defense of Marriage Act, the IRS has ruled that same-sex couples who were legally married in a jurisdiction that recognizes their marriage are treated as married for federal tax purposes, regardless of whether the jurisdiction the couple lives in recognizes same-sex marriages. However, the rule does not apply to registered domestic partnerships, civil unions, or similar formal relationships recognized under state law. As a result, legally married same-sex couples generally must file their 2013 (and future) federal income tax returns as married filing jointly or married filing separately. Also, legally married same-sex couples may wish to consider filing amended returns for earlier years as married filing jointly or married filing separately. State tax treatment of same-sex couples varies widely.  Because of a number of special rules, your combined income tax will often be lower if you file married filing jointly than if you file married filing separately, but that is not always the case. It all depends on your unique circumstances. You should generally calculate your tax both ways and choose the filing status that results in the lower combined tax.


How much can I contribute to my IRA in 2014?

The amount you can contribute to your traditional or Roth IRA remains $5,500 for 2014, $6,500 if you’re 50 or older. You can contribute to an IRA in addition to an employer-sponsored retirement plan like a 401(k). But if you (or your spouse) participate in an employer-sponsored plan, the amount of traditional IRA contributions you can deduct may be reduced or eliminated (phased out), depending on your modified adjusted gross income (MAGI). Your ability to make annual Roth contributions may also be phased out, depending on your MAGI. These income limits (phaseout ranges) have increased for 2014:

Income phaseout range for deductibility of traditional IRA contributions in 2014
1. Covered by an employer-sponsored plan and filing as:

Single/Head of household $60,000 – $70,000
Married filing jointly $96,000 – $116,000
Married filing separately $0 – $10,000

2. Not covered by an employer-sponsored retirement plan, but filing joint return with a spouse who is covered by a plan $181,000 – $191,000

Income phaseout range for ability to fund a Roth IRA in 2014

Single/Head of household $114,000 – $129,000
Married filing jointly $181,000 – $191,000
Married filing separately $0 – $10,000


Are you ready to retire?

Here are some questions to ask yourself when deciding whether or not you are ready to retire.

Is your nest egg adequate?

It’s obvious, but the earlier you retire, the less time you’ll have to save, and the more years you’ll be living off of your retirement savings. The average American can expect to live past age 78. (Source: CDC, “Deaths: Preliminary Data for 2011”) With future medical breakthroughs likely, it’s not unreasonable to assume that life expectancy will continue to increase. Is your nest egg large enough to fund 20 or more years of retirement?

When will you begin receiving Social Security benefits?

You can begin receiving Social Security retirement benefits as early as age 62. However, your benefit may be 25% to 30% less than if you waited until full retirement age (66 to 67, depending on the year you were born).

How will retirement affect your IRAs and employer retirement plans?

The longer you delay retirement, the longer you can build up tax-deferred funds in your IRAs–remember that you need compensation to contribute to an IRA. You’ll also have a longer period of time to contribute to employer sponsored plans like 401(k)s–and to receive any employer match or other contributions. (If you retire early, you may forfeit any employer contributions in which you’re not yet fully vested.)

Will you need health insurance?

Keep in mind that Medicare generally doesn’t start until you’re 65. Does your employer provide post-retirement medical benefits? Are you eligible for the coverage if you retire early? If not, you may have to look into COBRA or a private individual policy–which could be an expensive proposition.

Is phasing into retirement right for you?

Retirement need not be an all-or-nothing affair. If you’re not quite ready, financially or psychologically, for full retirement, consider downshifting from full-time to part-time employment. This will allow you to retain a source of income and remain active and


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