Category: Retirement

August 27, 2024 | by Atherton & Associates, LLP

For many retirees, downsizing their homes isn’t just a choice—it’s a strategic move toward a more manageable and financially secure retirement. Whether it’s to reduce living expenses, adapt to a more accessible living environment, or simply adjust to a life that no longer requires as much space, the decision to downsize can be both practical and liberating. After children leave the nest and the demands of a larger home become less appealing, the lure of a simpler lifestyle grows stronger.

But there’s another aspect to consider: the capital gains presented by the equity built up in your home. According to Vanguard, home equity makes up roughly half the net worth of homeowners aged 60 and older. For those who purchased their homes decades ago, the numbers are striking. In 2000, the median-priced home was $119,600, while the median home reached nearly $418,000 in December 2023, a 350% increase. This trajectory suggests that many homeowners, especially those with more expensive homes, may have built significant equity through appreciation over the years.

This realization prompts important questions: how might your home’s appreciation impact your taxes, and what strategies can you employ to minimize the tax burden?

1 – Consider your tax Bracket

Federal capital gains tax is levied on the profit made from selling assets, such as real estate, that have been owned for more than a year. While capital gains are taxed at rates more favorable than ordinary income taxes, they can still be substantial depending on your filing status, annual income, and the amount your home has appreciated in value over time.

Long-term capital gains tax rates are tiered at 0, 15, and 20% based on your taxable income. In 2024, the capital gains rates are:

If you are facing a potential capital gain (beyond any exclusion) if you sell your home, you should consider your current and future income levels when planning a sale. If you’re still earning a significant income, waiting until you retire could place you in a lower tax bracket, potentially reducing the amount owed in capital gains tax. Of course, this is just one factor to consider when to sell your home.

2 – Plan ahead to maximize the capital gains tax exclusion

There is a capital gains tax exclusion on the sale of a primary residence if you qualify. Single filers can exclude up to $250,000 of the capital gains. Married couples filing jointly can exclude up to $500,000. To be eligible for this exemption, you must have used the property as your primary residence for at least two of the five years preceding the sale. Additionally, this exclusion cannot be claimed more than once every two years.

If the profit from selling your home exceeds the applicable exclusion limit, the surplus will be taxed as a capital gain. Understanding this threshold is crucial in planning your sale to minimize potential tax liabilities.

It’s pragmatic to acknowledge that planning for the future involves preparing for various scenarios, including those we may not wish to contemplate. If a spouse becomes widowed, the surviving spouse’s eligibility for the exclusion reduces to the single filer amount, which is half of what couples can claim. However, certain properties may qualify for a step-up in basis, potentially adjusting the property’s value for tax purposes. This adjustment depends on where the property is located and how it’s owned or titled. While some properties may not receive a step-up at all, others could see a significant reduction in taxable gains due to this rule.

Given these nuances, it’s wise to review how your real estate is titled and to what extent either spouse might benefit from a step-up in basis. Understanding these details in advance can help you estimate whether the single-filer capital gains exclusion will suffice to offset any potential gains.

3 – Keep track of your capital improvements

If you don’t qualify for the exclusion or only a portion of your gain is exempt, there may still be ways to reduce your taxes.

First, you’ll need to calculate the cost basis of your home accurately. This figure isn’t just the amount you originally paid for your property; it also includes the total of all capital improvements you’ve made over the years. To determine your cost basis, start with the original purchase price of your home, then add the cost of any significant improvements – such as remodeling a kitchen, adding a bedroom, or upgrading your heating system. Essentially, any improvements that add to the value of your home can increase its cost basis.

Suppose you bought your house for $200,000 and later invested $50,000 in a major renovation. If you haven’t already factored these improvements into your cost basis, doing so now could significantly reduce your taxable gain.

To ensure that you can take full advantage of your adjusted cost basis, maintain detailed records of all home improvements and relevant expenses. Receipts, contracts, and before-and-after photos can serve as valuable documentation if the IRS requires proof of the improvements made. This documentation is essential not only for verifying your costs but also for simplifying the process of calculating your home’s adjusted cost basis.

Professional guidance

As you consider the possibility of downsizing, it’s crucial to understand the tax implications. A tax professional can help you understand aspects of the financial landscape you might not have considered and offer strategies to optimize your position when the time comes to downsize.

This article highlights key considerations that are often overlooked in the planning stages of downsizing. By keeping these factors in mind, you can better prepare for the financial implications of such a significant life change. For a comprehensive evaluation and advice suited to your personal situation and goals, we encourage you to contact one of our expert advisers.

April 30, 2024 | by RSM US LLP

Executive summary: Distribution options

Employers establish retirement plans to provide a vehicle to set aside monies, whether funded by the employee or the employer, to be preserved for a retirement benefit. The rules related to when an employee can take a distribution from their retirement plan account are restrictive considering the goal of preserving the retirement funds. SECURE 2.0, enacted on Dec. 29, 2022, included provisions that loosen some of the restrictions on withdrawals from a retirement plan. The additional options available give plan sponsors flexibility in choosing what to offer their employees.

In general

There are a few general concepts to keep in mind as we dive deeper into some of the provisions added by SECURE 2.0.

1. A plan sponsor has discretion as to whether and how these optional plan provisions will be incorporated into the plan.
2. All the distribution provisions discussed are exempt from the 10% tax on early withdrawals (i.e., before age 59½) from a retirement plan. However, the amount withdrawn is still subject to income tax.
3. While income tax applies, there is the ability for an individual to recoup taxes, and restore their retirement savings, by re-contributing to the plan some or all the amounts withdrawn within three years of distribution.
4. The provisions can be made available to any plan participant, not just a current employee.

Domestic abuse

A survivor of domestic abuse often needs access to additional funds to assist in escaping or recovering from an unsafe situation. “Domestic abuse” for this purpose is defined in SECURE 2.0 as: “physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including by means of abuse of the victim’s child or another family member living in the household.” The survivor must certify that they experienced domestic abuse within the last year to receive a distribution that is no more than the lesser of $10,000 (for 2024, as indexed) or 50% of the survivor’s vested plan balance.

This distributable event became available, after Dec. 31, 2023, for implementation by an IRC section 401(a) defined contribution plan (including 401(k), but not money purchase pension plans), 403(a) annuity plan, 403(b) plan and a governmental 457(b) plan, as well as individual retirement accounts (IRAs).

Emergency personal expense

Unforeseen emergency situations that require immediate financial resolution are a common occurrence. This distributable event allows up to $1,000 of the participant’s plan account to be withdrawn. To receive the distribution, the participant must certify that they have an expense for themselves or a family member that is an immediate financial need. Only one such distribution can be issued in a calendar year. Another personal expense distribution cannot be issued in the three calendar years following the year of distribution unless the withdrawn amount is repaid to the plan or contributions made by the participant to the plan after the distribution are at least equal to the amount distributed.

Many plans already provide hardship distribution options for employees. However, the circumstances under which a hardship distribution can be issued are limited. For example, an employee’s car may require a $750 repair, which would not fall under one of the safe harbor reasons for hardship distribution. However, the employee could use the emergency personal expense provision to take a distribution to cover the $750 repair.

This distributable event became available, after Dec. 31, 2023, for implementation by an IRC section 401(a) defined contribution plan (including 401(k), but not money purchase pension plans), 403(a) annuity plan, 403(b) plan and a governmental 457(b) plan, as well as IRAs.

Federally declared disasters

Repeatedly, Congress has enacted legislation after disasters (e.g., hurricanes, floods, wildfires) providing individuals the opportunity to take a penalty-free distribution or loan from their retirement plan accounts to assist them as they rebuild their lives. In lieu of the disaster-by-disaster approach, Congress enacted permanent rules for distributions and loans related to federally declared disaster areas.

Key features of the new distribution provision are:

• A participant can request a distribution of up to $22,000 up to 180 days after the date of the disaster.
• The individual must have sustained an economic loss in relation to the disaster and must have a principal place of residence located in the disaster area.
• The tax effect of the amount withdrawn can be spread over three years rather than the entire amount being taxable in the year withdrawn.

Key features of the new loan provision are:

• The maximum dollar amount that can be made available is the lesser of 50% of the individual’s vested plan balance or $100,000 (increased from $50,000 under the normal loan rules).
• Loan repayments, whether on an existing loan or one taken because of the disaster, owed between the date of the disaster and up to 180 days after the disaster can be delayed for one year.

These provisions became available for disasters after Jan. 26, 2021, and can be implemented by an IRC section 401(a) defined contribution plan (including 401(k) plans), 403(a) annuity plan, 403(b) plan, and a governmental 457(b) plan, as well as IRAs.

Terminal illness

This provision was not added as a distributable event, but rather just as an exception to the early withdrawal penalty. Therefore, it only applies when a distribution is issued under another plan provision. The intention was to have this be an optional plan distributable event. There has been a technical corrections bill drafted that would address this, as well as some other SECURE 2.0 provisions, but it has not yet been finalized.

IRS Notice 2024-2 provides guidance on terminal illness distributions in the form of Q&As. The guidance confirmed the following:

• A terminally ill individual is one who has an illness or physical condition that a physician has certified is expected to result in death in 84 months or less. The 84 months is measured from the date of certification.
• Certification must be obtained prior to the distribution and contain specific information (e.g., the name and contact information of the physician, a narrative description to support the conclusion that the individual is terminally ill, the date the physician examined the individual, etc.) as outlined in Notice 2024-2.
• Only the physician’s certification must be provided to a plan administrator to support the distribution. However, the individual should retain appropriate underlying documents to support their distribution and as part of maintaining complete tax records.
• Generally, there is no limit to the amount that can be treated as a terminal illness distribution. However, distributions cannot be made solely because of a terminal illness. Therefore, the participant must qualify for a distribution based on another plan provision, and any limits applicable to the distributable event being utilized to issue the distribution would have to be considered. For example, a plan may allow in-service distributions, but it might cap such distributions to $10,000.

The provision became available after Dec. 29, 2022, for distributions from IRC section 401(a) defined benefit and defined contribution plans (including 401(k) plans), 403(a) annuity plans, and 403(b) plans, as well as IRAs.

Takeaway

Legislators see that employees have unexpected financial needs arise for which they need a source of funds. The only source, for some employees, with an amount sufficient to assist with the need is retirement plan savings. Relaxation of the distribution rules to provide an employee with a current source of funds may negatively impact the individual’s financial position in retirement overall but may also help encourage participants to contribute to their retirement plans by alleviating fears that their funds are not accessible when needed under extenuating circumstances. The opportunity is available for an employee to restore their retirement account by re-contributing the distribution taken, but how many individuals will avail themselves of this opportunity? Employees contemplating one of these distributions should consider 1) other sources of income that may be available to assist with the financial need, 2) the current tax ramifications of the withdrawal, and 3) how the reduction to their account balance will affect them in retirement.