10 Mistakes to avoid with your Roth IRA

Roth IRA Mistakes

 

An individual retirement account (IRA), specifically a Roth IRA, is a great option to save for retirement.  However, there are a handful of common Roth IRA mistakes people make. 

One of the great things about a Roth IRA is that while contributions to a Roth IRA are not tax-deductible when you make them, the distributions can grow tax-free. Unlike a traditional IRA which is tax-deductible, you’ll have to pay taxes on them at your income tax rate.

Currently, a Roth IRA contribution allows investors to save up to $6,000 an additional $1,000 if over 50 years into an account that will forever be tax-free. That means if you started a Roth IRA when you were 18 years old, and you’re now 55, every single dollar including the gains are tax-free. Peter Thiel, a hedge fund manager, turned his Roth IRA into a 6 Billion Dollar tax-free account. Maybe you won’t end up with that much in a Roth IRA, but any amount that is not taxed by Uncle Sam, the better. 

Many pre-retirees want to find more ways to save for retirement. They also want to make sure they are setting themselves up for a better tax situation when they start taking money out of their accounts. A Roth IRA allows married couples over 50, to add an additional $14,000 ($7,000 each) per year, helping them build a tax-free nest egg. 

However, there are several common mistakes we see that cause people major tax issues or nullify their contributions. Below are the most common mistakes we find and how to avoid them

 

Mistake #1 – Contributing When You Don’t Qualify

 

The government wants people to save, however, they don’t want them to be able to save too much. As such, you can earn too much to contribute to a Roth IRA. Whether you’re eligible is determined by your modified adjusted gross income. Plus the income limits for Roth IRAs are adjusted periodically by the IRS. As such Roth IRA mistakes can be made. 

Find the current Roth IRA Contribution Limits can be found here. 

If you make contributions when you don’t qualify, it’s considered an excess contribution. The IRS will charge a tax penalty on the excess amount for each year it stays in your account.

 

How to avoid it:

 

If you’re close to the income limits, one way to avoid the extra tax penalty is to wait until you’re about to file your taxes. Then you can see how much if anything you can contribute. You have until the day your taxes are due to fund a Roth IRA. This way, you avoid making the mistake of contributing more than the allowable maximum. Plus, helps to avoid paying unexpected penalties. 

 

Mistake #2 – Funding more than one Roth IRA

 

Let’s say you fund a Roth IRA with Bonfire Financial, and also open another Roth IRA at Vanguard, for example, you cannot contribute $6,000 to each Roth IRA. The Roth IRA contribution maximum limit of $6,000 ($7,000 if over 50) if based on an aggregate limit. If you contribute more than you’re allowed to your Roth IRA, you’ll face the same excise tax penalties on those extra funds.

 

How to avoid it:

 

To avoid this problem, be sure to watch and manage the total amount of contributions in all of your Roth IRA accounts. If you do accidentally put in too much, you can make a withdrawal without penalty as long as it is before the tax filing deadline. You also have to withdraw any interest earned.

 

Mistake #3 – Not Funding your spouse’s Roth IRA

 

While your contributions to a Roth IRA are limited by the amount of money you’ve earned in a given year, there is an exception. Your spouse!  Even if your spouse has no earned income, they can still contribute to their own Roth IRA via the Spousal Roth IRA. You must be legally married and file a joint return to make this work.

 

How to avoid it:

 

By using a Spousal IRA, you can double up on your Roth IRA contributions. You can save an extra $7,000 per year in tax-free dollars if over 50 years old. 

Keep in mind that IRAs are individual accounts. As such, a Spousal Roth IRA is not a joint account. Rather, you each have your own IRA—but just one spouse funds them both.

 

Mistake #4 – Too large of a Roth Conversion 

 

Roth conversions are a good tool to use to make your future earnings tax-free and avoid RMDs in the future.  How these conversions work is by moving pre-existing funds in your traditional IRA or traditional 401K into a Roth or Roth 401k. The amount of money that is converted or moved from one account to the other will be taxable at whatever your current income tax bracket is.

One problem that can happen is that if you are close to the next income bracket and you convert funds over to a Roth, some of the conversion could be taxed at a higher rate. It pushes you into the next income bracket.   These conversions cannot be reversed. So, if you are not working with an advisor and your tax professional you can inadvertently pay more taxes than you need to.  

 

How to avoid it:

 

If you have large IRAs or 401k and would like to convert into a Roth, it is best to watch your income brackets and convert an amount of money that would fill your current income tax bracket but not spill over into the next.  It is best to use this strategy over multiple years.

 

Mistake #5 – Not doing a Backdoor Roth

 

Many of our clients have incomes that are above or well above the Roth IRA income phaseout.  Yet they and their spouses are funding their Roth IRA’s $7,000 each year. How? 

By using a strategy called the Backdoor Roth Conversion. A Backdoor Roth Conversion is done by funding an empty IRA up to $7,000 from your bank and then immediately converting the IRA dollars into the Roth IRA. In this way, you are funding a traditional IRA and not-deducting from your income, also known as a nondeductible IRA contribution, and then converting into the Roth IRA, which is allowed regardless of income. In this strategy, you indirectly fund the Roth IRA and can continue to do this every year going forward.

 

How to avoid it:

 

If you make too much money to contribute directly to a Roth IRA, consider doing a Backdoor Roth. There are some drawbacks to converting a traditional IRA to a Roth IRA. Since the money you put into your traditional IRA was pre-tax, you’ll need to pay income tax on it when you do the conversion. It’s possible that this additional income could even bump you up into a higher tax bracket. We highly recommend talking to a CERTIFIED FINANCIAL PLANNER™ about implementing this strategy. 

 

Mistake #6 – Doing a Backdoor Roth with Money in an IRA

 

One mistake we often see is someone funding a backdoor Roth IRA while concurrently having pre-tax dollars in other IRA accounts. The reason this is a problem is that the IRS looks at all accounts. And due to the “Pro-rata Rule” treats them as one. You cannot simply just choose to move after-tax dollars into a Roth IRA.

You have to calculate the amount of money that can be moved into a Roth without paying taxes by dividing the amount of after-tax dollars by the total amount of money in all your  IRA accounts. 

 

How to avoid it:

 

A way to avoid this common pitfall is to account for all IRAs. (SEP IRAs, Simple IRAs, and or traditional IRAs)This will help know whether you can contribute without triggering the Pro-rata rule. You could also convert all pre-tax dollars at once. Or, another option would be to roll your IRA money into a 401k so that you no longer have any money in an IRA.  

 

Mistake #7 -Not properly investing the money

 

One common mistake we see investors make is that they believe the Roth IRA is an investment when it is simply an account. Just because you contribute to a Roth IRA doesn’t mean it is invested automatically.

It is not enough just to open an account. You have to go into the account and select investments and manage them. If you just contribute to a Roth IRA without selecting an investment in the account, it could be just sitting in cash! 

 

How to avoid it:

 

Invest the money in your Roth IRA. If you are unsure of a good investment strategy, schedule a meeting with one of our CERTIFIED FINANCIAL PLANNER™ professionals. We can help make sure your Roth IRA is invested correctly for you based on your goals,  time horizon, and risk tolerance. 

 

Mistake #8 -Not optimizing your Roth Dollars 

 

Oftentimes, we see Roth IRA investors using allocations that are very conservative. Or they match other allocations in their 401(k). This is a massive oversight and not planning for a proper tax allocation strategy. A Roth IRA should be managed more aggressively than your other accounts so that you can take full advantage of the tax-free benefit. 

 

How to avoid it:

 

Leave the conservative allocation to the after-tax and tax-deferred accounts.  A Roth IRA should be as aggressive as you are willing and capable of doing. One advantage of  IRAs over 401k plans is that, while most 401k plans have limited investment options, IRAs offer the opportunity to put your money in many types of stocks and other investments.

 

Mistake #9 – Forgetting to name Beneficiaries

 

It’s important to name a primary and contingent beneficiary for your IRA accounts. Otherwise, if something happens to you, your estate will have to go through probate. And that can take more time, cost more money, and cause a lot of inconveniences.

 

How to avoid it:

 

Name your beneficiaries and be sure to review them periodically and make any changes or updates. This is especially important in the case of divorce. We see a lot of issues arise because a divorce decree won’t prevent a former spouse from getting your assets if he or she is still listed as a beneficiary on those assets. 

 

Mistake #10 -Not having a CFP® Manage your investment and tax strategy

 

There are many nuances to opening and maintaining a Roth IRA. The investments, the tax strategies, and the timing of contributions can all make or break your account’s tax-free status. This potentially could cost you additional taxes and penalties. 

 

How to avoid it

 

Work with a CERTIFIED FINANCIAL PLANNER™ to help you set up, and maintain your Roth IRA.  They can help plan for an effective retirement and tax strategy. Having a professional help you with your retirement accounts and other complicated retirement plan strategies can potentially help you avoid expensive Roth IRA mistakes.

 

To Sum it Up- Don’t make these Common Roth IRA Mistakes

 

Roth IRAs can provide a lot of great retirement benefits, but they can also be complicated. There are a lot of common mistakes with a Roth IRA. It is important to pay attention to all the regulations and rules to help you avoid these common mistakes.

Have questions about your Roth IRA? Give us a call! We are local in Colorado Spring but help clients all over the nation. We are happy to help. 

Small Changes, Big Differences in your Retirement plan

The Power of 1% 

  How Small Changes Can Make Big Differences in your Retirement Plan

We have all heard that something – something 1% more, or something-something 1% better every day will have a massive effect on your life over the long run. How small changes can make big differences. It makes sense, if you could mathematically make yourself 1% better or more each day, you will be significantly better than you were at the beginning of the month or beginning of the year. It is a worthy pursuit. But it is very hard to calculate unless you are talking about running miles or lifting weights.

The concept is that a small change over a long period of time will have a massive impact on you and your life if done for a long time. This can be applied to so many things. Even an aircraft that is 1 degree off will land in a very different location than what was scheduled. But today I want to apply it to your financial life. Specifically, your 401k or retirement plan.

The “Power of 1%” is a motivational abstraction, why would I want this idea applied to a boring, old 401k plan? Because just 1% could make a massive difference in your life. These small changes can make big differences in your retirement plan. This one concept could make your retirement and life unimaginably better, and totally change the way you grow your wealth. Just 1% can be the difference between barely scraping by, to being a comfortable millionaire.

 

Power of 1%

 

The true key is to simply increase your 401k contribution by 1% at the beginning of the year, each year.

 

Let’s talk about how.

 

You have a 401k retirement plan and let’s say you are saving a decent amount of your money at 5% of your income, and your employer is either matching your contribution or putting in a percentage of your salary, depending on where you work.

Let’s take three pilots for this example, each in different stages in their career. 1. Rookie 2. Senior FO 3. Fully Tenured Captain that was flying bi-planes back in the day (joking). Pay will remain the same for easy math.

The Rookie makes $100,000 per year and is deferring 3% of his salary each year. In 5 years he would have put away $15,000 into his 401k. 3% seems like a lot, but over 5 years, that is only $15,000 for his retirement. Now let us see what would happen if he increases his deferral by just 1% each year. If he starts at 3% and increases each year by 1%, he will be at 7% (Year 1 was 3%) and over that time he would have contributed a total of $25,000! That is an extra $10,000 or 67% more than what he was normally doing.

Small Changes Big Differences in your Retirement plan

The Senior FO makes $250,000 per year and is deferring 5% into his 401k each year. When he retires in 10 years, he would have contributed $125,000 into his 401k. Not bad! But if he plans to retire, he should definitely do more. If he increased his contribution just 1% each year for 10 years, He would add $216,500 over his time, almost twice as much if he stuck with the 5% rate. Remember, you can only max out your side of the 401k contributions up to $19,500 each year, plus another $6,500 if you’re 50 or more, which is the case here. But you can always take that money and put it somewhere else. (Hint, hint Backdoor Roth Conversions) Here is the example:

Small Changes Big Differences in your Retirement plan

The last person is a Captain that will be retiring in 3 years. He has 3 years to put away as much money as possible. His salary is $350,000. He will need to put away 8% of his salary in order to meet his max of $26,000. Since he doesn’t have a lot of time to scale up every percent, he should just try to contribute as much as possible before he retires. If he maxes out, he will have $78,000 over 3 years! The more you can contribute to your 401k the better life will be.

 

The Tale of Two Pilots

 

Now let’s look at another example of how small changes can mean big differences in your retirement plan.

David and Susan both went to Metro State University to be pilots. They both were very good students, graduated from school, both worked for a regional liner and they just started flying for the same major airline. David loves to snowboard, vacation around the world, and party. He says  “As long as I’m covering my financial bases, I can do the things I enjoy.”

Susan loves to ski, read books, and spend time with her family. Living a comfortable life is important for her and she wants to make sure she can do the things she enjoys in the future. 

On their first day, they sit down with HR, and they are asked how much they want to start deferring in their retirement plan. David, whose friend told him to defer as much as he can, announces he will start with 5% of his $150,000 salary going to his 401k. When Susan sits down with HR, she says she can’t defer any dollars into her 401k because she wants to finish paying her student loans first. But she promises next year she will start with 1% of her $150,000. And the next year, 2% and so on. 

At Year 10, they both start getting paid $250,000. And at Year 20, they are making $300,000.

25 years later, after they both have amazing and fulfilling careers, they bump into each other at the DIA breakroom! “Wow!” They say for they haven’t seen each other for a long time. After a while of catching up, they talk about their retirement accounts. 

David smiles and boasts “I’ve been saving 5% of my salary since the first day I got here, and now I have saved $282,500 of my salary” as he calculates in his Excel spreadsheet:

“Very impressive!” Says Susan, as she tabulates how much she has saved. She started saving with nothing, but she promised she would increase her contribution by just 1% each year. After she does some math, she shows David how much she has saved. Smug David leans forward and stares, mouth open, at the numbers from Susan’s tablet…

“You saved $439,500?! Wow! I thought you said you were doing none, how did you beat me? That’s almost twice as much as I’ve saved, and I’ve been doing 5% my entire career!”

“Slow and steady wins the race” Susan smiled. 

Just a small change can make a huge difference in your retirement plan. And just because you start off slow doesn’t mean you’re out. Don’t get discouraged, just try to be 1% better. Like Susan!

 

What’s Next?

 

If you are just starting out or in your mid-career, increasing your retirement plan contributions by just 1% this year will have a huge impact on your retirement accounts and life. This doesn’t even factor in the potential increased growth that your account could receive. Lastly, your salary regularly increases with inflation, usually around 2% to 3% each year. If you just took 1% from that, you would hardly notice the change in your cash flow. 

This strategy is something relatively new but is gaining more traction among plan sponsors and large companies. Many of them are automatically enrolling employees into automatically increasing their deferral, or at least strongly encouraging that their employees increase their 401k contribution each year. Hopefully, these examples have made it clear the importance of growth for your retirement. 

Do you have a financial plan? Please reach out for a complimentary discovery meeting with our CERTIFIED FINANCIAL PLANNERS™ to help give you a clear path to a successful story. Susan would 🙂

 

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United Airline Layoffs. What to do if you are laid off.

United Airline Layoffs

 

Economic downturns often hit the airline industry harder than most. Once again, the airline industry has been grounded by the pandemic and the corresponding economic conditions. As such, layoffs are looming.  United Airlines announced it will be laying off thousands of employees, estimated to be 36,000 by October 1, 2020. Additionally, United Airlines said the jobs of more than 14,000 employees are at risk when federal aid expires in the spring of 2021. These layoffs could affect everyone from customer service employees, flight attendants, to pilots. Many other airliners may follow suit.

The fallout from 9/11 and the impact of the 2008 Financial Crisis took the airline industry roughly 2-3 years to recover. It is hard to say how long the coronavirus impact will last or how it will all turn out.

If you are worried you might be one of the airline employees to be laid off or already have been, there are many concerns you may have.  From how to pay bills, to how long will this last, to how to keep medical insurance and benefits… the list goes on.

 

What should I do if I am laid off?

 

We have put together some tips, ideas, and strategies to help you get through this tough situation. 

 

Covering your living expenses

 

Being able to cover your living is by far the most important question and concern.  There are a number of strategies to help navigate this and there are also some new provisions from the CARES ACT that can help if you are a United Airline employee who has had to face the layoffs. 

 

Your emergency fund

 

An emergency fund is a savings account or separate account that is set aside for when the unexpected happens, like being laid off.  We recommend that our clients have 3-6 months of their monthly expenses saved in this kind of account. The goal is to use this money to pay for your mortgage, food, etc.  It is designed to help you bridge the gap of unemployment to your next job or getting rehired when things recover.  

One often-overlooked task is once you are employed again to refill your emergency fund. This account can help you in a tough situation but be sure to replenish it to ensure it is there for the next time something unexpected comes up. 

If you do not have an emergency fund in place, read on for some other ideas that can help. 

 

Claiming unemployment

 

If you received a WARN, it is important to start planning ahead now. You can now qualify for weekly unemployment payments from the state in which you worked.  Many people fly out of a hub that is different from the state that they live in. When applying for unemployment, use the state that you work out of. Selecting reason for unemployment: “Coronavirus” can streamline the paperwork process. A quick Google search of your state and unemployment will land you on the right page. Look for “.gov” in the address. The CARES Act is adding $600 per week into unemployment checks but is set to end on July 31st. This may be extended as the impact of the virus continues. 

 

Mortgage Forbearance

 

Mortgage Forbearance means you can postpone your mortgage payment temporarily. For 180 days you can request a forbearance from your mortgage lender. If granted it means you will not have to pay your mortgage for about 6 months.  However, this is not mortgage forgiveness. You still owe the full amount and interest still accrues on the months you do not pay.  You will need to work out the details and repayment plan with your lender as each situation is different.  Per the CARES Act, no additional fees or penalties will be applied if you require forbearance.

 

Retirement Account Withdrawals

 

Taking a distribution or withdrawal from your 401(k) should be a last resort. The money in your 401(k) is meant for your retirement. However, with the intensity and impact of the United Airline layoffs caused by COVID-19, the CARES Act has set up many relief options.

Traditionally, you could not access your retirement account before the age of 59 1/2 without having to pay a 10% penalty and income tax.  The CARES Act has waived this 10% penalty.  Since all retirement accounts (Roths excluded) are funded with pre-tax dollars and the income tax is normally due in the year of a distribution. 

The CARES act has allowed distribution in 2020 up to $100,000 be taken out and the taxes are due over the next 3 years. For example, if you take out $90,000 from your retirement account, you will have to pay tax on $30,000 in 2020, $30,000 in 2021, and $30,000 in 2022. That is much better than having to pay all $90,000 in 2020. The money will come out of your account’s investments pro-rata, so if you have half your money in large-cap stocks and half in small-cap stocks, the money will be sold in them equally to fund the distribution.

Reach out to your 401(k) provider Charles Schwab or Fidelity for details.

 

401(k) Loan

 

Taking a loan from your 401(k) is not a good idea because you will be taxed on the distribution, and you will have to repay the loan. There could potentially be many more downsides to taking a loan rather than just distributing the money.  If you are furloughed or leave the plan, you will be subjected to a faster repayment schedule.

If you take out a loan, you will be taxed on the loan amount, plus you will have to use after-tax dollars to pay back the loan. In the grand scheme of things, once you repay the 401(k) loan, you will still be subjected to income tax when you take the money out when you retire. So you will be taxed TWICE on the money, instead of just at the distribution.

 

Miscellaneous Items

 

Many car manufacturers are offering payment deferrals during this time. If you are unable to make payments comfortably on your car, be sure to reach out to your car’s manufacturer finance department to discuss payment options. Many newer cars (2018 or newer) will have more generous payment options than older vehicles.

Also, a voluntary separation could be a good idea if you are close to retirement. The benefits of the United Airlines Retirement Health Account (RHA) can help you pay for medical insurance. 

 

What about my  Benefits if I am laid off??

 

United Airline layoffs are hard enough, luckily you can retain certain benefits. For instance, health insurance, RHA, and you’re retirement accounts can still provide you benefits.

 

Health Insurance

 

COBRA is a government bill that lets you keep your medical insurance with your company for up to 3 years. You will have the same coverage and plan, except you will have to pay 100% of the premium (plus a 2% premium for administration costs for a total of 102%) Look at your most recent pay stub to see how much you and your employer were paying for medical insurance.

 

Retirement Health Account

 

Your Retirement Health Account (RHA) is a unique account granted directly to United from a private letter ruling with the IRS. The RHA is used to pay for out-of-pocket medical expenses and health insurance premiums when retired, furloughed, or separated from service. The RHA can also be used to pay for your COBRA premiums. Click here for more details on how to use your RHA.

 

401(k) and Retirement Investments

 

There are some options you can choose to do with your 401(k) when you have faced a layoff.

  1. You can keep it with the company.  Nothing will change as you will have the same investment options and access.
  2. You can withdraw the money, as we mentioned above.  However, this is not the best action to take if it can be avoided.
  3. You can roll your money into an IRA.  There are no taxes on this move, and it can give you more investment options and control of your money.

Our preference is to roll your 401(k) over into an IRA so that you have better access to your account while avoiding the administration and investment fees from United, Fidelity, or Charles Schwab. We can build you a custom portfolio based on your needs and our custom investment research for a fee typically lower than your Fidelity and Charles Schwab 401(k) options.

Our expertise is working with pilots and aircrew in providing them the best investments through our relationship with Charles Schwab. Leveraging our partnership with Charles Schwab we can build you a custom portfolio in your PCRA.

 

What’s Next?

 

We can help you navigate one of the most difficult times the airline industry has ever faced, and that is really saying a lot! We work with many pilots, crew members, and their families and help them prepare for a successful retirement and reach their financial and life goals.

Bonfire Financial is a fiduciary, fee-only,  financial advisor.  We have a staff of Certified Financial Planners™ that specialize in helping United Airline Employees and Pilots.

As a United Airline or major airline employee, we would like to offer you a free consultation to help answer any questions you may have and help you get a game plan in place. Scheduled your call now. 

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United Employee Benefits: How to Leverage Your RHA for Tax-Free Growth

United Airlines Employee Benefits: Retirement Health Account

 

Working as a United Airline Employee has more benefits than just a 401(k) plan or free flights. United provides a Retirement Health Account that gives you another resource to fund medical expenses in retirement.  When doing financial plans for our clients many of which are pilots, one important issue that often comes up is how to fund health care.  The United RHA is a great tool for that.

 

What is an RHA?  

 

The United Retirement Health Account is a health expense reimbursement account like a Health Saving Account (HSA) but one you use in retirement. United Airlines ALPA Retirement Health Account (RHA) allows retired United and legacy Continental pilots to reimburse themselves tax-free for qualified health expenses for them, their spouse, and dependents in retirement. For that reason, it truly is one of the great United Employee benefits.

 

Eligible expenses include:

  • Doctor visits
  • Co-pays
  • Dental premiums
  • Insurance premiums
  • Medicare
  • Long Term Care insurance premiums

 

The RHA is a fringe benefit provided by United and is a unique savings account that most companies do not have. United basically got the blessing of the IRS through a private letter ruling to have this plan.  Because it is more of a one-off plan the rules are more opaque and restrictive.

 

How does the RHA work?

 

Unlike other United Airlines employee benefits, the RHA is funded by United only. No employee money is ever contributed to the account. Every working hour, United contributes $1.00 to your account. More importantly, when your 401(k) limit is reached, all employer contributions will continue, but spill into the RHA. United contributes 16% of your salary into your 401(k), and once the 401(k)  limit is reached at $57,000 in 2020 (not including the employee age 50 catch-up of $6,500 in 2020), further contributions will spill into the RHA. Forfeited vacation can be contributed to either the PRAP or RHA at the employees’ discretion.

 

What can I use the RHA for?

 

The RHA is meant for medical expense reimbursement in retirement or separation of service only. The account itself is held in a pooled account with other employees and pilots at United, and cannot be moved into an individual account. As such, the benefit of the RHA is to allow you and your spouse and dependents to reimburse any health expenses and premiums tax-free.

According to a study done by Fidelity, the average 65-year old couple retiring in 2019 can expect to spend $285,000 in healthcare and medical expenses. Medical expenses increase at nearly twice the rate of inflation, and will likely continue to grow in the future. The RHA allows retired employees and pilots to maximize their retirement benefits by providing a tax-free vehicle to pay for medical expenses, without having to access taxable or tax-deferred accounts like your 401(k).

 

An example

 

Take for example, Sarah. Sarah is a retired pilot and can use her 401(k) to pay for regular retirement expenses. The issue that she runs into is that distributing from her 401(k) will recognize that income. If she is currently in the 22% tax bracket and takes out $50,000 per year to pay for expenses, she will need to pay $11,000 in tax for that year. Sarah needs surgery and will need to pay $10,000 out of pocket. She will pay that money from her checking account, and reimburse herself from the RHA for $10,000. Because she used the RHA for a qualified health expense, she will not have to pay any taxes. If Sarah made the mistake of using her 401(k) for the expense, she would need to pay an extra $2,200 to the government!

The RHA can be used to pay for Medicare premiums, co-pays, insurance premiums, dental insurance premiums and expenses, and even long-term care insurance premiums. The RHA can grow rather quickly and it can be very useful for your family. For example, if you have a balance of $0 in your RHA, and United contributes $5,000 each year for 20 years, and you expect an annual return of 6%, your ending RHA value will be $183,928 of tax-free dollars at 65! If you have contributed $10,000 per year, you would have $367,856!

 

Eligible Expenses

 

All of the following in red are covered by the RHA. The blue are non-eligible medical expenses that must be paid out-of-pocket. 

United Airline Employee Retirement RHA

(Image: Further/SelectAccount Family of Products)

 

When can I excess the money in my RHA?

 

There are a few times in which you will be able to access your RHA. The most straightforward one is in retirement. Also, if you are laid off or fired you will be able to access it. Additionally,  if you are furloughed, you can use the RHA to pay for COBRA premiums until you get back to work. Just another one of the United Employee Benefits.

 

How do I maximize my RHA?

 

If you are nearing retirement, you may be seeing that you have a very large 401(k), which can also mean a very large tax problem when you go to withdraw from it in retirement, especially with Required Minimum Distributions (RMD) beginning at 72 years old with the new SECURE retirement act. To maximize RHA funding, you can contribute more to your 401(k), up to $19,500 in 2020. Moreover, if you maximize your contribution, you will have only $37,500 ($57,000-$19,500) left for the employer to contribute. Say if you make $280,000 in 2020, United will contribute $44,800. Because there is only $37,500 left for United to fund the 401(k), the rest, $7,300, will spill into the RHA. Therefore, if you wish to save more in your RHA, you can maximize your contribution early in the year to fund the 401(k) using your employee contribution.

Further, you can also elect to move all forfeited vacation days into the RHA. You can maximize or minimize what is in your RHA by either over- or under-funding your PRAP using your employee contribution or forfeited vacation. The United Retirement & Insurance committee has an RHA spill calculator available to you, to estimate your projected RHA funding.

Here is an example of two pilots, they both make $280,000. Both pilots are 47 years old. Tom (Pilot A) maxes his 401(k) contribution up to $19,500. Bill (Pilot B) contributes $10,000 to his 401(k). Remember, the total amount allowed in the 401(k) per year is $57,000. Any amount over will spill into the RHA:

Salary United’s 16% Contribution Pilot’s Personal Contribution Total Contribution (limit of $57,000) Spill into RHA (above $57,000)
Tom (A) $280,000       $44,800     $19,500     $64,300 $7,300
Bill (B) $280,000       $44,800     $10,000 $54,800 $0

How do I limit contributions to my RHA?

 

Because United funds your RHA based on your salary, there is no way to avoid contributing to the RHA if United has maximized your 401(k) contribution. Based on the 401(k) rules, the 401(k) spill will begin once a pilot has reached a total of $57,000 contributed in his 401(K) in 2020 (not including $6,500 in catch-up at 50). All employer contributions will go to the RHA  after that. By underweighting what you contribute into the 401(k), you can limit the amount of spill into the RHA. If you have a salary of $250,000 and United contributes 16%, you will have $40,000 in your 401(k). You still have $17,000 without having any spill into the RHA ($57,000 – $40,000 = $14,000 left to fund). Regardless, you are not losing money when United contributes to the plan. It is essentially a free benefit to you.

 

What happens to my RHA if I die?

 

The RHA can be used by you, your spouse, and qualified dependents. If you are 65, and your children now support themselves, they are not considered to be your dependent. When you die, your spouse will be able to use and access the RHA. Once your spouse dies, and you have no dependents, any remaining amount in the RHA will be reverted back into the pooled investment account at the record keeper. The RHA is not able to be inherited like other accounts. Therefore, it is important to take advantage of your RHA when you are able to use it so you don’t leave any money on the table. 

 

The RHA and Tricare for Life

 

Many pilots are retired military and will use Tricare to supplement part of their medical coverage. For example, a family on Tricare for Life in retirement will still be using Medicare Part A & B, and Tricare is used in conjunction to pay for coverage outside of hospital stays (A) and doctor’s visits (B).  Similarly, Tricare is used for other coverage such as prescription drugs, and the remaining premiums from Medicare Part B. Tricare and Medicare Part A & B cover most health-related expenses, but the RHA can be used tax-free to cover other parts such as dental insurance premiums, long term care insurance premiums, vision plans, therapy, and other eligible medical expenses outside of Medicare and Tricare coverage.

 

RHA to fund long term care insurance premiums

 

According to Genworth Insurance, $51,480 in 2019 was the national annual median cost of In-Home Care. Long-term care can quickly drain older Americans’ retirement and savings. According to AARP, 52% of people turning 65 in 2017 will need long-term care at some point. The estimated cost for end-of-life care in 2016 ranged from $215,820 and $341,651 according to Alzheimer’s Association. Ultimately, the last thing you want is to drain your worth in your final years and not be able to leave anything to your estate, children, heirs, and charities.

Long-term care insurance is one way to pay for long-term care and nursing care. LTC insurance can cost up to $3,000 per year for one person and can be even more if you have a family history of dementia. Luckily, you can pay for LTC insurance premiums tax-free with the RHA. Therefore, you can have LTC insurance and leverage your RHA’s tax-free characteristics. 

The Retirement Health Account might just be one of the best United employee benefits out there. It’s employer-funded, more money without more taxes, extra money for health care expenses during retirement benefit.

 

Questions?

 

We are here to help. Bonfire Financial acts as a fiduciary financial advisor for our clients. We have a staff of Certified Financial Planners™ that specialize in helping United Airline Employees and Pilots with their retirement and benefits. Schedule a free consultation with us today. We’d love to talk to you. 

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Why you need titling, not just a will

Titling, wills and trusts

 

A will helps determine what happens to your assets after you die. In fact, it may be one of the most important documents you have in your lifetime. However, there is a lot more than just a will that you will need if you want to distribute your assets to the best of your wishes, as well as avoiding a probate court from interpreting your will and deciding who gets what. 

A will is necessary, but many people do not know that the way a property is titled actually supersedes what is written in the will. By law, whoever is the beneficiary listed on an account or property, that asset will be given to that person, no matter what the will says. 

This is an overview of estate distribution, estate vehicles, and how to properly title your accounts to make for an easy transition to your heirs and legatees (aka – the people you love). All while avoiding the headache of probate court. 

Let’s go over the basics of titling, the will, and trusts.

 

The Will and Probate Court

 

Probate court is a system that deals with the property and debts of a decedent (a person who has died). Its role is to assure that their debts are paid. In addition to ensuring any remaining assets are distributed according to the will. When a person dies, it is up to the court and the executor to distribute the assets according to the probate declaration. 

Probate court can take up to 9 – 15 months to determine and distribute assets to heirs. The costs of probate court can be up to 7-9% of the total amount of the estate. If you only have a will without titling your accounts, your estate is susceptible to the interpretations of the state. Thus, can lead to your estate being distributed against your wishes. Many people seek ways to avoid probate as the time and cost can greatly harm and inconvenience their estate and their heirs. 

There are several ways to avoid assets going through probate. They are trusts, legal titling, and beneficiaries by contract.

 

The Will and Titling

 

A valid will is extremely important to have because it will give instructions to the court about how your assets will be distributed. 

When someone dies with a valid will, they will die “Testate” meaning their assets will transfer through the probate court to their heirs and legatees. A legatee is an heir that is specifically named in the will. 

If you do not have a valid will, you will die “Intestate” which means the courts will determine who will receive your property based on closest familial relation. 

If you do not have a will or a known family, your assets will be gifted to the state! As an example of how common this is, the state of Colorado alone is holding over $400 million in unclaimed money from its residents. If your desires are to benefit someone outside of your immediate family, you would need a will to state this. 

Wills are the basic tool for estate planning, but they are susceptible to the interpretation of the courts. Wills must go through probate. Which may allow your heirs to potentially negate who you named in your will if it does not seem appropriate or valid for any reason. A will can be argued by the courts and the heirs, so it is not completely secure. If any property is left out of the will, that would also be subject to the interpretation of the court. 

 

Titles by Law

 

Titles are very useful in making a very simple statement of who is the owner of the asset and who is the beneficiary. When you title an account or asset, the person that you have listed can either be part-owner of that asset or the beneficiary. 

When a couple buys a home jointly, the couple owns an equal share of the house and they cannot do anything with it without the other’s permission. If one of the spouses were to die, the other surviving spouse would gain 100% of the value. Except for property titled as “Community Property”, all titles supersede the will.

 

Ways to title and asset

 

There are many ways to title an asset. This is how they all work and what makes each different.

  1. Fee Simple: The account is titled in your name only. It will have to pass by the will.
  2. Joint Tenants with Right of Survivorship (JTWROS): Pass by law directly to surviving account holder when the first account holder dies. This title will supersede the will.
  3. Tenants in Common: Titling is split by the amount of ownership contribution proportionally. The other holder does NOT have the ability to own your part if you decease. This titling is used for business partners that contribute to assets together but do not want their assets to pass to each other.
  4. Tenants by Entirety: Similar to JTWROS, but only for married spouses. Passes 100% to the surviving spouse by law.
  5. Community Property: If you live in a “Community Property” state, each spouse independently owns 50% of an asset and can do with it whatever they please. This does NOT necessarily transfer to the spouse as does JTWROS. You can list the heir to whoever you please. The states that use Community Property instead of JTWROS or Tenants by Entirety are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. If you live in these states, you will have to plan differently for distributing your property and assets. Seek estate counsel from an estate planner to effectively protect and direct your assets to your wishes.

 

Titles by Contract

 

There are many accounts that someone cannot list another person as the owner of the account. For example, you cannot have your spouse titled on your Individual Retirement Account (IRA) or 401(k), because it is a single-person account. However, you can add your loved ones to your account as beneficiaries.

Interestingly, only you can have access to your individual accounts even if you are married. These types of accounts are not passed by “Law” as joint accounts are, but are passed by contract; which asks who is the listed beneficiary on the account. Passing by contract avoids probate and always supersedes the will. It is crucial to not only update your will with major life changes but to review your beneficiaries as well. 

If an ex-spouse is listed as the beneficiary of your IRA, your IRA will pass to your ex-spouse. Regardless if the updated will directs your IRA to your children. There is no way for the court to interject in this mistake because it never goes to Probate Court. 

Retirement accounts such as IRA’s and 401(k)’s use beneficiaries. For bank accounts, you will need to add a Transfer on Death (TOD) to your account. A TOD will be the individual or charity that the account will transfer to. Titles by contract are used for financial accounts. For real assets, such as homes, cars, and property, these assets must be listed in the will or stated in a trust.

Here is an infographic that demonstrates assets passing through and around the probate process: 

Wills and Titling

 

Trusts

 

A trust is a vehicle that a person (grantor) makes to be held in trust by the trustee, for the benefit of the beneficiary. A trust is a useful arrangement that allows the grantor and the trust to avoid probate. It also allows the grantor to control the trust beyond the grave.

Trusts were once extremely necessary for anyone that had over $1 million in total assets. In 2002, your estate would be taxed at 50% of any amount over $1 million! Families leverage trusts to move money out of their estate and help protect their assets for their beneficiaries. 

This is no longer the case, as the current credit has been raised to $11 million. Thus, protecting most people from having to pay any “Death Tax”. Trusts are still popular and useful because they are taxed as their own entity. They are shielded from the estate’s creditors. Also, they can distribute money periodically to its heirs instead of a lump sum payout through the will. 

 

Contingencies

 

The trust can allow for contingencies such as divorces and deaths that could occur in the future. For example, if a mother was concerned that her children may spend their inheritance if she were to die, she could establish a trust that would that only distribute 10% of its assets to the heirs each year. This trust declaration would still benefit her children. However, it would make sure that they would not spend it immediately. 

Trusts are also useful to implement when a parent may be worried that their child may divorce a partner in the future. If the father wrote a will, the proceeds could be split between the spouses upon divorce. In a trust, the parent could stipulate that only their child would receive 100% of the benefit if a divorce were to occur.

This is “Controlling the Estate Beyond the Grave”.  It’s just one example of the various tools a trust can have for a person to always make sure their money is going where they intended it to go.

The trust also protects one’s assets from the claims of creditors. A probate court by law awards the estate’s creditors first and then distributes what is left to the heirs. A trust protects the assets from creditors. It also distributes them immediately to your heirs or listed charities as the trust stipulates. If a trust seems like a good tool for your specific estate plan, a lawyer or estate planner can help you build a trust as the cornerstone of your estate plan. 

 

The Bottom Line

 

There are various tools and vehicles you can use to direct your assets and estate when you die. To recap, the four ways that assets pass from the decedent’s estate to their heirs and legatees. By the will and probate, by law of titling, by contract of beneficiary, and by the terms of the trust. 

Each one has its advantages and disadvantages. For example, the will is very simple and inexpensive to create but will be subject to the probate court. A trust will have the advantage of avoiding probate, but are can be expensive and convoluted in nature. Further, real assets like your house, cars, and property typically cannot have a listed beneficiary and must pass through the will or a trust. 

The most important lesson is to review your accounts, titling, and estate documents to ensure they are all up to date and clearly represent your best wishes. Speak with an estate planner that you trust to help guide you.

 

Where a Financial Advisor comes in

 

Estate planning is an often overlooked aspect of financial planning. However, a financial advisor can help play a major role, working in conjunction with your estate planner.  First, they can help keep your beneficiaries up to date on your investment accounts. They can help advise you on how certain life changes may impact your estate plan, most specifically retirement. Finally, if you do not have a will or estate plan in place that can help you find a good one.  We knew many great estate planners that can help you get your will and titling done right.  Want to get started? Schedule a free consultation call today.

 

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Roth 401k or Traditional 401k?

Roth 401k or Traditional 401k? 

 

The 401k plan is the cornerstone to retirement. Gone are the days of big company and school district annual pensions and generous social security benefits. It’s now up to the individual to plan and save for their entire retirement. In addition to all the expenses that go with it. Luckily, a Roth 401k or Traditional 401k is a fantastic tool. One of the best that you can use to save for your retirement and goals. However, there is a lot to understand about how they work and how to use the 401k for your best outcome.

 

A little background

 

The purpose of the 401k plan is to save for retirement. Currently (as of 2019), an employee can contribute $19,000 of their own money to their account and an additional $6,000 if they are over 50 years old per year. Your company can match or add to the 401k plans. The total plan can add up to $56,000 or $62,000 (if 50) per year in 2019. Some plans also allow for you to contribute to a Roth 401k. Many people wonder if this may be a better option for them. We’ll explore the key differences between a Roth 401k or Traditional 401k so you can make a confident decision.

 

The Roth 401k

 

The Roth 401k is a relatively new concept. It was introduced in 2001 for the purpose of allowing employees to take taxes now and forever shield the gains from tax. Many people see the benefits of contributing to the Roth 401k. However, some are hesitant as to whether the traditional tax-deferred 401k will still be better for them because of its favorable tax deferral. When you elect to contribute to the Roth 401k, you can use your entire employee contribution of $19,000 (plus $6,000 if over 50) to your account each year.

The money you add to the Roth is still considered income. You will be taxed on that amount. Once your savings in the account have been taxed at your regular income level, it will grow tax-free. Then, when you take money out of it, that will also be tax-free.

This is a great option if you do not want to pay extra tax in your retirement. Also, good if you are in a lower tax bracket than you expect to be in the future.

 

Example

 

As an example, if you contribute $25,000 to your Roth 401k at the 22% tax bracket, you will still pay $5,500 as a part of your tax bill. Let’s say if you contribute $25,000 annually for 10 years at a rate of 8%, you would be the owner of an account that has $362,164 completely tax-free! The benefit of having a Roth IRA is that you will never pay taxes on the gains that you make in the account. If your account is still around for your heirs, they will not have to pay any tax either!

Having this option will allow you to grow your money . Addtionally, you will not have to worry about paying extra taxes. It is important to note that your employer does NOT match your contribution on a Roth basis if you do. They will continue to match your contribution, but it will only be in traditional tax-deferred dollars.

Let’s say your company matches you 3% of your salary. If you are in the plan and make $100,000, you will be contributing $3,000 each year into your Roth 401k. Plus, your company will contribute $3,000 to the traditional 401k. They will be in the same account but will be accounted for separately by the administrator of the company 401k plan. When you are deciding, if you can afford to do the Roth 401k, you absolutely should.

 

The Traditional 401k

 

The traditional 401k allows an employee to defer their income of what they contribute. That means if you made $100,000 and decided to contribute $25,000 to your 401k, you will only have to report $75,000 to the IRS. This is because you “deferred” your income into the account. Once you retire and withdraw that money, you will have to pay the income that you “realized” at the tax rate you are at when you withdraw.

The advantage of the traditional 401k is that you get to defer your income and save it while it grows in your account. When you retire, you may move your traditional 401k to an IRA. As an example, you made $170,000 as a married couple. At $170,000, you are pushed into the 24% tax bracket (over $168,450 Married Filing Jointly). But because you understand the 401k can defer your income, you decide to defer $15,000 into the account, dropping you out of the 24% bracket and into the 22% bracket, which saves you money!

The traditional 401k is best if your cash flow is tight. It is extremely important to save for your retirement. You should always save 10% or more of your salary as a rule of thumb. When you save on taxes, you will be saving yourself money.

 

Example

 

Here is an example that will illustrate how your contributions of $20,000 affect your cash flow.

 

Roth 401(k) or Traditional 401(k)

 

Here we can see with a salary of $100,000 we cannot defer any money from taxes if we contribute $20,000 into the Roth 401k. Our total taxes at 24% will be $24,000 for the year. If we contribute $20,000 to the traditional 401k, we will defer that money from taxes, so only $80,000 will be taxed at 24%. At the end of the year, using the traditional will save us $4,400, which is $367 per month. If that money is needed for your cash flow, do the traditional. If you can take the hit now on taxes, you should do the Roth 401k.

 

Which one is best for me?

 

You are weighing now versus later. If you are just starting out in your career and are in the lower tax brackets you should contribute to the Roth 401k. At the end of the year, you will have a bigger tax bill from Uncle Sam because you recognized all of your Roth contributions. Have no fear! Your Roth retirement account will grow tax-free all the way up until you retire. Plus, all the gains that you have made throughout those years will be tax-free as well!

If you have a good handle on your cash flow, you should contribute to the Roth 401k. If cash flow is an issue you can use the traditional 401k to lower your tax bill. You get to defer that income and save it in a tax-deferred account that will grow. Once you take money out of the account, you will have to pay income tax on it. This can be quite advantageous if you are at the top of your career and at the higher tax brackets. If you believe that you will be in a lower bracket when you retire, the traditional is your best bet.

 

The Backdoor Roth IRA

 

People want to enjoy deferring their income to save on taxes but also want the ability to have a Roth account that they can draw from tax-free in retirement. Many people close to retirement are looking at all the taxes they have saved in their accounts and now see a huge dollar sign going to the government every time they take money out for their retirement expenses.

The Backdoor Roth IRA allows a person to continue to defer their income through their 401k, but also contribute $6,000 (plus $1,000 if over 50) per spouse into a Roth IRA. A married couple can contribute up to $14,000 each year to Roth IRAs. If this planning technique is done for 5 – 10 years before retiring, this would give a retiring couple a substantial tax-free account.

 

Example

 

As an example, if a married couple were to contribute the max amount of $14,000 for 10 years. Assuming a yearly return of 8%, they would have $202,811.87 of assets that would never be taxed again! The benefit of a Roth is also that there are no Required Minimum Distributions as there are with a traditional account. If a married couple paired the backdoor Roth IRA with the 401k plan, they would have an effective diversification of their tax accounts, which would be very helpful in retirement.

This is a complex planning strategy. It is important to work with a financial advisor that understands your objectives and will help you leverage your current situation to help you meet your expectations.

 

The Bottom Line

 

If you can stomach the tighter cash flow and you are suspecting that you may be in a higher tax bracket, the 401k Roth is best for you. If you are tight on cash flow and could use the extra money while also saving for your retirement, the traditional 401k is for you. Also, if you suspect to be in a lower tax bracket in the future when you take out money, the traditional 401k is what you should choose.

The Backdoor Roth IRA is great for people that wish to save in a traditional 401k to take advantage of the tax deduction, but also want to grow a Roth IRA that will never be taxed. Using this mechanism, a single person could add $62,000 into a traditional 401k and $7,000 into a Roth IRA.

 

What’s next?

 

Interested in learning about the differences between an IRA and a 401k? Read up on that here.  Still have questions? Please feel free to contact us!  719-394-3900- We offer free 30 minute consultations that can help answer many of your questions.

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