Most make the connection between taxes and financial planning. However, too many times someone will receive financial advice without considering the tax consequences. Therefore, it is best to seek advice from a financial planner who is also a tax professional.
Here is a very common example: Jack age 39 leaves his current employer and has $100,000 in a 401(k) account. He decides to do an IRA rollover.
Without tax planning – Jack arranges to receive the 401(k) plan check made out in his name. When he gets his check he is shocked to discover it is for only $80,000 instead of the expected $100,000. Why? Because the 20 percent was automatically withheld for federal income tax per [IRC §3405(c)(1)]. As a result, Jack cannot possibly accomplish a completely tax-free rollover unless he somehow comes up with the missing $20,000 and deposits that amount – along with the $80,000 he has in hand, into a rollover IRA within 60 days. If Jack fails to raise the $20,000 and deposits the $80,000, he is taxed on the entire amount. Plus he owes the 10 percent federal penalty tax, on a premature retirement account withdrawal per [IRC §72(t). Also in California he will owe state tax plus a 2.5 percent penalty for early withdrawal. This could all add up to a total tax hit of $50,000 or a 50 percent loss in account value.
With tax planning – Jack arranges to receive from the 401(k) plan a check made out in the name of the trustee for his rollover IRA. This is a direct or trustee-to-trustee rollover. This rollover is exempt from the 20 percent withholding and the federal and state penalty tax. As a result Jack’s rollover IRA receives the full $100,000 balance from his 401(k) and he successfully accomplishes a totally tax-free rollover. His $100,000 will continue to grow tax deferred.
Ignoring tax considerations and proper planning can cost you lots of money. Tax planning and financial planning should be coordinated. So don’t forget about the taxes.
For more information contact Rebecca Robins, CPA/PFS, CFP®, at 661-702-9680. The office is located at 25001 The Old Road in Stevenson Ranch. Insurance Lic#0D75745.
Securities offered through H.D. Vest Investment ServicesSM, Advisory Services offered through HD Vest Advisory ServicesSM, a non-bank subsidiary of Wells Fargo & Company, Member SIPC, 6333 North State Highway 161, Fourth Floor, Irving, TX 75038, 1-972-870-6000.