March 2013 Newsletter

Making the Most of Your 401(k) Plan:

A 401(k) plan represents one of the most powerful retirement savings opportunities available today. If your employer offers a 401(k) plan and you’re not participating in it, you should be.

Contribute as much as possible

The more you can save for retirement, the better your chances of enjoying a comfortable retirement. If you can, max out your contribution up to the legal limit ($17,500 in 2013, $23,000 if you’re age 50 or older). If you need to free up money to do that, try to cut certain expenses. (Note: some plans limit the amount you can contribute.)

Why invest your retirement dollars in a 401(k) plan instead of somewhere else? One reason is that your pretax contributions lower your taxable income for the year. This means you save money in taxes immediately when you contribute to the plan–a big advantage if you’re in a high tax bracket. For example, if you earn $100,000 a year and contribute $17,500 to a 401(k) plan, you’ll only pay federal income taxes on $82,500 instead of $100,000.

Another reason is the power of tax-deferred growth. Any investment earnings compound year after year and aren’t taxable as long as they remain in the plan. Over the long term, this gives you the opportunity to build an substantial sum in your employer’s plan. (Your pretax contributions and any earnings will be taxed when paid to you from the plan.)

Consider Roth contributions

Your 401(k) plan may also allow you to make after-tax Roth contributions. Unlike pre-tax contributions, Roth contributions don’t lower your current taxable income so there’s no immediate tax savings. But because you’ve already paid taxes on those contributions, they’re free from federal income taxes when paid from the plan. And if your distribution is “qualified” (that is, the distribution is made after you satisfy a five-year holding period, and after you reach age 59½, become disabled, or die) any earnings are also tax free. If your distribution isn’t qualified, any earnings you receive are subject to income tax. A 10% early distribution penalty may also be imposed if you haven’t reached age 59½ (unless an exception applies).

Capture the full employer match

Many employers will match all or part of your contributions. If you can’t max out your 401(k) contributions, you should at least try to contribute as much as necessary to get the full employer match. Employer matching contributions are basically free money. By capturing the full benefit of your employer’s match, you’ll be surprised how much faster your balance grows. If you don’t take advantage of your employer’s generosity, you could be passing up a significant contribution towards your retirement.

Access funds if you must

Another beneficial feature that many 401(k) plans offer is the ability to borrow against your vested balance at a reasonable interest rate. You can use a plan loan to pay off high-interest debts or meet other large expenses, like the purchase of a car. You typically won’t be taxed or penalized on amounts you borrow as long as the loan is repaid within five years. Immediate repayment may be required, however, if you leave your employer–if you can’t repay the loan, you may be treated as having taken a taxable distribution from the plan.

And remember that when you take a loan from your 401(k) plan, the funds you borrow are generally removed from your plan account until you repay the loan, so you may miss out on the opportunity for additional tax-deferred investment earnings. So loans (and withdrawals if available) should be a last resort.

Evaluate your investment choices

Choose your investments carefully. The right investment mix could be one of your keys to a comfortable retirement. That’s because over the long term, varying rates of return can make a big difference in the size of your 401(k) plan account.


Looking Backward and Forward on Entitlement Programs

Last year’s presidential election, along with the more recent fiscal cliff and debt ceiling negotiations, have put the spotlight on our nation’s tax policy, deficit, and entitlement programs. For some, entitlement programs are necessary–a social compact for America in an era of longer life spans, the decline of employer-provided pensions and health insurance in retirement, and a widening gap between the haves and the have-nots. For others, the current level of entitlement spending is jeopardizing our country’s fiscal health and creating an “entitlement lifestyle.” No matter where you stand in the debate, do you know the basic facts on our country’s largest entitlement programs?

Where the money goes

All entitlement spending isn’t created equal. The “Big Three” of Social Security, Medicare, and Medicaid account for more than two-thirds of all federal entitlement spending. Social Security and Medicare are primarily age-based programs, whereas Medicaid is based on income level. According to the U.S. Bureau of Economic Analysis, in 2010, the federal government spent a total of $2.2 trillion on entitlement programs, with the Big Three accounting for $1.6 trillion of this total. The largest expenditure was for Social Security ($690 billion), followed by Medicare ($518 billion) and Medicaid ($405 billion).

A history of growth

Alexis de Tocqueville, the famous French political thinker who traveled to the United States in the early 1830s and wrote about the uniqueness of our young nation’s individual self-reliance in his famous book, Democracy in America, would likely be surprised to observe the growth in spending on entitlement programs that has occurred in the United States over the past 50 years. According to the Bureau of Economic Analysis, in 1960, U.S. government transfers to individuals totaled about $24 billion in current dollars. By 2010, that figure was $2.2 trillion, almost 100 times as much.

Current status

Let’s look at our two main entitlement programs–Social Security and Medicare.

Social Security.

Created in 1935, Social Security is a “pay-as-you-go” system, meaning that payments to current retirees come primarily from payments into the system by current wage earners in the form of a 12.4% Social Security payroll tax (6.2% each from employee and employer). These payroll taxes are put into two Social Security Trust Funds, which also earn interest. According to projections by the Social Security Administration, the trust funds will continue to show net growth until 2022, after which, without increases in the payroll tax or cuts in benefits, fund assets are projected to decrease each year until they are fully depleted in 2033. At that time, it’s estimated that payroll taxes would only be able to cover approximately 75% of program obligations.


Created in 1965, Medicare is a national health insurance program available to all Americans age 65 and older, regardless of income or medical history. It consists of Part A (hospital care) and Part B (outpatient care)–which together make up “traditional” Medicare; Part C (Medicare Advantage, which is private insurance partly paid by the government); and Part D (outpatient prescription drugs through private plans only). Medicare Part A is primarily funded by a 2.9% Medicare payroll tax (1.45% each from employee and employer), which in 2013 is increased by 0.9% for employees with incomes above $200,000 (single filers) or $250,000 (married filing jointly). In addition, starting in 2013, a new 3.8% Medicare contribution tax on the net investment income of high-earning taxpayers will take effect.

Looking ahead, Medicare and Medicaid are expected to face the most serious financial challenges, due primarily to increasing enrollment. The Congressional Budget Office, in its report Budget and Economic Outlook: Fiscal Years 2012 to 2022, predicts that federal spending on Medicare will exceed $1 trillion by 2022, while federal spending on Medicaid will reach $605 billion (state spending for Medicaid is also expected to increase). According to the CBO, reining in the costs of Medicare and Medicaid over the coming years will be the central long-term challenge in setting federal fiscal policy.


There has been little national consensus by policymakers on how to deal with rising entitlement costs. At some point, though, reform is inevitable. That’s why it’s a good idea to make sure your financial plan offers enough flexibility to accommodate an uncertain future.


The “SEPP” Exception to the IRA Premature Distribution Tax

In these challenging economic times, you may be considering taking a withdrawal from your traditional IRA. While you’re allowed to withdraw funds from your IRAs at any time, for any reason, the question is, should you?

Why you should think twice

Taxable distributions you receive from your IRA before age 59½ are generally referred to as premature distributions, or early withdrawals. To discourage early withdrawals, they’re subject to a 10% federal penalty tax (and possibly a state penalty tax) in addition to any federal and state income taxes. This 10% penalty tax is commonly referred to as the premature distribution tax.

However, not all distributions before age 59½ are subject to the federal penalty tax. For example, the penalty tax doesn’t apply if you have a qualifying disability, or if you use the money to pay certain medical, college, or first-time homebuyer expenses.

The SEPP exception to the penalty tax

But one of the most important (and often overlooked) exceptions, from a retirement income perspective, involves taking a series of “substantially equal periodic payments” (SEPPs) from your IRA. This exception from the federal penalty tax is important because it’s available to anyone, regardless of age, and the funds can be used for any purpose.

SEPPs are amounts that are calculated to exhaust the funds in your IRA over your lifetime (or life expectancy) or the joint lives (or joint life expectancy) of you and your beneficiary. To avoid the 10% penalty, you must calculate your lifetime payments using one of three IRS-approved distribution methods, and take at least one distribution annually.

Calculating your payment

If you have more than one IRA, you can take SEPPs from just one of your IRAs or you can aggregate two or more of your IRAs and calculate the SEPPs from the total balance. It’s up to you. But you can’t use only a portion of an IRA to calculate your SEPPs.

You can also use tax-free trustee-to-trustee transfers (or rollovers) to ensure that the IRA(s) that will be the source of your periodic payments contain the exact amount necessary to generate the payment amount you want based on the IRS formulas. This makes the SEPP exception a very important and flexible retirement income planning tool.

Modifying your payments

Even though your payments must be calculated as though they’ll be paid over your lifetime (or over you and your beneficiary’s lifetimes), you don’t actually have to take distributions for that long. You can change, or stop, your SEPPs after payments from your IRA have been made for at least five years, or after you reach age 59½, whichever is later.

But be careful–if you “modify” the payments before the required waiting period ends, the IRS will apply the 10% penalty tax (plus interest) to all taxable payments you received before age 59½ (unless the modification was due to your death or disability).

For example, assume Mary began taking SEPPs from her traditional IRA account three years ago, when she was 43 years old (using one of the three IRS-approved methods). Mary does not take a distribution this year. Because Mary’s payment stream has been modified before she turned 59½, the 10% penalty (plus interest) will now apply retroactively to the taxable portion of all her previous distributions.

The five-year period begins on the date of your first withdrawal, so you can’t make any changes before the fifth anniversary of that withdrawal. This is true even if you turn age 59½ in the meantime. For example, assume John began taking SEPPs from his traditional IRA (using an IRS-approved method) on December 1, 2009, and that he also took payments on December 1 of 2010, 2011, and 2012. John turned 59½ on December 2, 2012. Even though John is over age 59½, he must take one more payment by December 1, 2013. Otherwise, he’ll be subject to the 10% penalty on the taxable portion of the distributions he took before he turned age 59½.


To ensure that your distributions will qualify for the SEPP exception to the premature distribution tax, be sure to get professional advice. The calculation of SEPPs can be complicated, and the tax penalties involved in the event of an error can be significant. Also, if your state imposes a penalty tax on early withdrawals, be sure to determine whether any similar exemption from the state tax is available to you.


I refinanced my mortgage loan last year. Can I deduct any of the costs associated with refinancing the loan?

Now more than ever, homeowners are taking advantage of historically low interest rates and refinancing their mortgage loans. Did you pay points to your lender when you refinanced your loan? If so, you may be able to deduct them.

Points are costs that a lender charges when you take out a mortgage loan or refinance an existing mortgage loan on your home. One point equals 1% of the loan amount borrowed (e.g., 2 points on a $300,000 loan equals $6,000).

In order for points to be deductible, they must have been charged by your lender as up-front interest in return for a lower interest rate on your loan. If the points were charged for services provided by the lender in preparing or processing the loan, then the points are not deductible.

When deducting points, keep in mind that unlike points paid on a loan used to purchase a home, points paid on a refinanced loan usually cannot be deducted in the year that you paid them. Instead, the points may need to be amortized over the life of the loan. For example, assume that you refinanced to a $300,000/30-year mortgage loan and paid $6,000 in points. You would be able to deduct 1/30 of those points each year over the 30-year loan period, or $200 per year.

The one exception to the amortization rule is if part of your refinanced loan is used to make improvements to your primary residence. In that case, you may be able to deduct the portion of the points that is allocable to the home improvements in the year that the points are paid. In addition, if you choose to refinance again or sell your home in the future, you can generally claim the entire unamortized deduction that remains. For more information on the deductibility of points, you can refer to IRS Publication 936.

As for other costs you may have incurred from refinancing, such as recording, title search, appraisal, and attorney’s fees, they are not deductible. Furthermore, unlike costs associated with a home purchase, costs associated with a refinance cannot be added into the cost basis (value) of your home for income tax purposes.


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