Myths and Misunderstandings Undermine Retirement Tax Planning

Taxpayers Shortchange Themselves Through Assumptions and Reactive Accounting Practices

Largely feared, the IRS offers multiple avenues to manage income tax responsibilities. Taxpayers can benefit through knowledge, self-advocacy and the services of a proactive accountant or tax adviser.

Timing is everything, and nowhere more so than in financial planning. While it’s generally unwise to time the market with buy and sell orders, consumers have until December 31 to employ tax management strategies that can legally reduce their burden to Uncle Sam. To gain an appreciation for these techniques, let’s review several misperceptions:

Myth: Only top-tier taxpayers can give to charities through IRAs, and the distribution must pass through the giver as taxable to count as a deduction.
Reality: Any owner of a IRA can transfer a fully-deductible contribution directly from their retirement account to a qualifying charity, up to $100,000 per individual, or, $200,000 per couple. Better yet, the transferred amount is not taxable, and does not impact Social Security income.

Myth: Social Security, pension and qualified 401(k) distributions are tax-free.
Reality: They accumulate tax deferred, but their distributions are taxed at ordinary income rates. Up to 85% of Social Security can be taxable depending on upon the amount of the benefit and other income that meets the provisional income test.

Myth: CPAs are forward thinkers and implement “preventative maintenance.”
Reality: Perhaps some are, but many CPAs and tax preparers work from a mostly historical perspective. Their calculations are made after January 1 for the prior calendar year, and they are largely powerless to correct clients’ errors of omission or procrastination. But if any omissions and errors occur it may be possible to re-file.

Myth: An IRA left untouched can continue to accumulate without consequence for the benefit of its owner or beneficiaries.

Reality: Minimum distributions are required after age 70½. Any short fall between the RMD amount and the actual distribution could be subject to a 50% penalty. Distributions or re-allocations taken prior to age 70½ can reduce the amount of the required distribution, and reduce the risk of penalty. In some instances within the first year after age 70½, the penalty may be recoverable.