MY BRUTALLY HONEST REVIEW OF 401(K) PLANS

 

Investment accounts like the 401(k) plan often take center stage when securing our financial future. But just like any financial tool, a spectrum of features can make them a hit or a miss for different individuals. In this brutally honest review, we'll delve into the pros and cons of 401(k) plans, highlighting their potential benefits and the pitfalls that might leave you rethinking your retirement strategy.

Pros: Ease of Investment, Tax Advantages, and Employer Match Programs

One of the most appealing aspects of a 401(k) plan is its ease of investment. You can contribute a portion of your income through automatic payroll deductions before seeing it. This "set it and forget it" approach allows your retirement savings to grow without constant intervention.

Beyond the convenience, 401(k) plans offer significant tax benefits. Contributions are made pre-tax, which means you reduce your taxable income by the amount you contribute. This lowers your current tax liability and allows your investments to grow tax-deferred until you withdraw the funds in retirement.

Employer match programs further heightened the allure of 401(k) plans. Many companies incentivize their employees to save for retirement by matching a percentage of their contributions. This essentially equates to "free money" that can significantly boost your retirement savings over the long term.

Cons: Limited Investment Options, Potential for Higher Fees, and Tax Risks

While 401(k) plans have their merits, they are not without their downsides. One notable drawback is the limited investment options they offer. Typically, these plans provide a selection of mutual funds and a few other investment choices. This lack of diversity could limit your ability to create a well-rounded and personalized investment portfolio.

Another concern is the potential for higher fees. Some 401(k) plans come with administrative and management fees that can affect your returns over time. While these fees may seem small initially, they can add up significantly over decades of saving and investing.

Tax implications also rear their head regarding 401(k) plans. While contributions are tax-deferred, withdrawals in retirement are subject to income tax. Additionally, if you need to make early withdrawals (before the age of 59½), you might face penalties and taxes on top of the regular income tax.

Furthermore, there's the looming tax risk. Tax rates could be substantially higher when you retire, potentially eroding the benefits of your pre-tax contributions. This uncertainty about future tax rates adds an element of unpredictability to your retirement planning.

My Take: A Balancing Act for Your Retirement Strategy

In conclusion, 401(k) plans can be pivotal in your retirement planning, especially if your employer offers a matching program. They provide an accessible and efficient way to save for your golden years while reducing your tax burden. The convenience and potential for employer contributions should be considered.

However, it's crucial to approach 401(k) plans with a balanced perspective. There might be better decisions than just relying on a 401(k) due to the limited investment options and the potential for higher fees. Diversification across various retirement accounts and investment vehicles can mitigate these limitations and create a more comprehensive financial strategy.

Furthermore, the tax implications and potential future tax rate uncertainties are important factors to consider. While the allure of tax-deferred growth is strong, it's essential to recognize that tax rates can change over time, potentially affecting the value of your investments.

401(k) plans should be considered a foundational piece of your retirement puzzle, not the sole solution. By understanding the benefits and drawbacks, you can make informed decisions about allocating your retirement savings to create a robust and adaptable financial plan.

Ready to build your free retirement plan? Book an appointment using the link below:

https://www.afitonline.com/appointments

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

Is Your College Student's Scholarship Taxable?

May 1 is the traditional deadline for undergraduate students to commit to their college of choice, which means tuition payments are not far behind. If you are wondering if your child's scholarships are taxable, here is what you should know.

What Is a "Scholarship?"

First, it's important to understand how a scholarship is defined. Generally, a scholarship is an amount paid or allowed to a student at an educational institution for the purpose of study. It can include both merit and need-based institutional aid.

Other types of grants include need-based grants (such as Pell Grants or state grants) and Fulbright grants. A fellowship grant is generally an amount paid or allowed to an individual for study or research.

Fulbright grants may be either scholarship/fellowship income or compensation for personal services, which is usually considered wages. If you are a U.S. citizen recipient of a Fulbright grant, you must determine which income category your grant falls into to know how the grant is taxed for U.S. Federal Income tax purposes.

Tax-Free vs. Taxable

If your child receives a scholarship, a fellowship grant, or other grant, all or part of the amounts received may be tax-free if your child meets certain conditions.

Scholarships, fellowship grants, and other grants are tax-free if:

• The student is a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities; and
• The amounts the student receives are used to pay for tuition and fees required for enrollment or attendance at the educational institution or for fees, books, supplies, and equipment required for courses at the educational institution.

However, the student must include in gross income:

• Amounts used for incidental expenses, such as room and board, travel, student health insurance, and optional equipment.
• Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. However, students do not need to include in gross income any amounts received for services that are required by the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship and Financial Assistance Program, or a comprehensive student work-learning-service program (as defined in section 448(e) of the Higher Education Act of 1965) operated by a work college.

Reporting a Taxable Scholarship on Your Tax Return

Generally, a student reports any portion of a scholarship, a fellowship grant, or other grants that must be included in gross income as follows:

• If filing Form 1040 or Form 1040-SR, include the taxable portion in the total amount reported on the "Wages, salaries, tips" line of the student’s tax return. If the taxable amount was not reported on Form W-2, enter "SCH" along with the taxable amount in the space to the left of the "Wages, salaries, tips" line.
• If filing Form 1040-NR, report the taxable amount on the "Scholarship and fellowship grants" line.

Estimated Tax Payments May Be Due

If any part of a scholarship or fellowship grant is taxable, the student may have to make estimated tax payments on the additional income. For information on estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax.

If you have any questions about whether your college student's scholarships are taxable, please call.

 

Kids' Day Camp Expenses May Qualify for a Tax Credit

 

Day camps are common during school vacations and the summer months. And their cost may count towards the child and dependent care credit.

Here are five things parents should know:

1. Care for Qualifying Persons. You may qualify for the credit whether you pay for care at home, at a daycare facility, or a day camp. Your expenses must be for the care of one or more qualifying persons, such as your dependent child under age 13.

2. Work-Related Expense. In other words, you must be paying for the care so you can work or look for work.

3. Expense Limits. The total expense you can claim in a year is limited. The limit is generally $3,000 for one qualifying person or $6,000 for two or more.

4. Credit Amount. The credit is worth between 20 and 35 percent of your allowable expenses. The percentage depends on your income.

5. Excluded Care. Certain types of care don’t qualify for the credit, including:

• Overnight camps, Summer school tutoring,
• Care provided by your spouse or child under age 19 at the end of the year, and
• Care given by a person you can claim as your dependent.

Remember that this credit is not just a school vacation or summer tax benefit. You may be able to claim it at any time during the year for qualifying care. For more information, please call the office at 816-220-2001 or visit us online at www.AFITonline.com

Tax Withholding for Seasonal and Part-Time Employees

 

Many businesses hire workers for only part of the year, especially in the summer. The IRS classifies these employees as seasonal workers, defined as employees performing labor or services on a seasonal basis (i.e., six months or less). Examples of this kind of work include retail workers employed exclusively during holiday seasons, food service and other workers at sports events, or laborers employed during the harvest or commercial fishing season.

Seasonal employees are subject to the same tax withholding rules that apply to other employees, and all employees should fill out a W-4 when starting a new job. Employers use this form to determine the amount of tax to be withheld from an employee’s paycheck. Taxpayers (including students) with multiple summer jobs will want to ensure all their employers withhold adequate taxes to cover their total income tax liability.

Using the Withholding Calculator

If you've recently started a seasonal job, now is an excellent time to perform a paycheck check-up using the Withholding Calculator, a special tool on the IRS website that can help taxpayers with part-year employment estimate their income, credits, adjustments, and deductions more accurately. It also checks to see whether a taxpayer is having the correct amount of tax withheld for their financial situation.

• First, the calculator asks about a taxpayer's employment dates and accounts for a part-year employee's shorter employment rather than assuming that their weekly tax withholding amount would be applied to a full year.
• Next, the calculator makes recommendations for part-year employees accordingly. If a taxpayer has more than one part-year job, the Withholding Calculator can also account for this.

Taxpayers should have a completed prior-year tax return and need their most recent pay stub before using the Withholding Calculator.

Calculator results depend on the accuracy of information entered. When circumstances change during the year, taxpayers should return to the calculator to check whether they should adjust their withholding. For taxpayers working for only part of the year, it's best to do a paycheck check-up early in their employment period so their tax withholding is most accurate.

The Withholding Calculator does not request personally identifiable information, such as name, Social Security number, address, or bank account numbers. The IRS does not save or record the information entered on the calculator. As always, taxpayers should watch out for tax scams, especially via email or phone, and be alert to cybercriminals impersonating the IRS. Remember, the IRS does not send emails about the calculator or the information entered.

If You Need To Adjust Your Withholding

If the calculator results indicate a change in withholding amount, taxpayers should complete a new Form W-4 and submit it to their employer as soon as possible. Employees with a change in personal circumstances that reduces the number of withholding allowances should submit a new Form W-4 with corrected withholding allowances to their employer within 10 days of the change.

As a seasonal worker, you may not be required to file a federal or state return if the wages you earn at a seasonal job are less than the standard deduction; however, if you work more than one job, you may end up owing tax.

As you can see, seasonal workers have unique tax situations. If you have any questions about your tax situation, don't hesitate to call the office today.

Saving for Education: Understanding 529 Plans

 

Many parents are looking for ways to save for their child's education, and a 529 Plan is an excellent way to do so. Even better is that, thanks to the passage of tax reform legislation in 2017, 529 plans are now available to parents wishing to save for their child's K-12 education as well as college (two and four-year programs) or vocational school.

The SECURE Act of 2019 expanded the 529 Plan to include fees, books, supplies, and equipment for apprenticeship programs and repayment of principal and interest on student loan debt for the designated beneficiary or the beneficiary's sibling, up to a lifetime limit of $10,000.

You may open a Section 529 plan in any state, and there are no income restrictions for the individual opening the account. Contributions, however, must be in cash, and the total amount must not be more than is reasonably needed for higher education (as determined initially by the state). A minimum investment may be required to open the account, such as $25 or $50.

Each 529 Plan has a designated beneficiary (the future student) and an account owner. The account owner may be a parent or another person and typically is the principal contributor to the plan. The account owner is also entitled to choose (and change) the designated beneficiary.

Neither the account owner nor beneficiary may direct investments. Still, the state may allow the owner to select a type of investment fund (e.g., fixed-income securities) and change the investment annually as well as when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalties (more about this topic below).

Unlike other tax breaks for higher education funding, such as the American Opportunity and Lifetime Learning Tax Credits, 529 plans aren’t limited to funding only tuition. Room, board, lab fees, books, and supplies can be purchased with funds from your 529 Savings Account. However, individual state programs could have a more narrow definition, so check with your particular state.

Tax-Free Distributions

Distributions from 529 plans are tax-free as long as they are used to pay qualified higher-education expenses for a designated beneficiary. Distributions are tax-free even if the student claims the American Opportunity Credit, Lifetime Learning Credit, or tax-free treatment for a Section 530 Coverdell Education Savings Account (ESA) distribution - provided the 529 plan distributions aren't covering the same specific expenses.

Qualified expenses include tuition, required fees, books, supplies, equipment, and special needs services. Room and board also qualify for someone who is at least a half-time student. Also, starting in 2018, qualified expenses include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

Qualified expenses also include computers and related equipment used by a student while enrolled at an eligible educational institution; however, software designed for sports, games, or hobbies does not qualify unless it is predominantly educational in nature.

Federal Tax Rules

Income Tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes, but many states offer deductions or credits. Earnings on contributions grow tax-free while in the plan. Distributions for a purpose other than qualified education are taxed to the one receiving the distribution. In addition, the taxable portion of the distribution will incur a 10 percent penalty, comparable to the 10 percent penalty that applies to Coverdell ESAs. Also, the account owner may change the beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them - thus, they qualify for the up-to-$17,000 annual gift tax exclusion in 2023 ($16,000 in 2022). One contributing more than $17,000 may elect to treat the gift as made in equal installments over that year and the following four years so that up to $85,000 can be given tax-free in the first year.

Estate Tax. Funds in the account at the designated beneficiary's death are included in the beneficiary's estate - another odd result since those funds may not be available to pay the tax. Funds in the account at the account owner's death are not included in the owner's estate, except for a portion where the gift tax exclusion installment election is made for gifts over $17,000 ($16,000 in 2022). Here is an example: If the account owner made the election for a gift of $85,000 ($80,000 in 2022), a part of that gift is included in the estate if the owner dies within five years.

A Section 529 plan can be an especially attractive estate-planning move for grandparents. There are no income limits for contributing, and the account owner giving up to $85,000 ($80,000 in 2022) avoids gift tax and estate tax by living five years after the gift, yet has the power to change the beneficiary.

State Tax. State tax rules are all over the map. Some reflect the federal rules, and some are quite different. For an overview of each state's 529 plan, see: College Savings Plans Network (CSPN).

Looking Ahead

Starting in 2024, 529 college savings plans maintained for at least 15 years can be rolled over to a Roth IRA. Any contributions (and earnings on those contributions) to the 529 plan made within the last five years are not eligible. The rollover must be trustee to trustee, with a lifetime limit of $35,000 per account beneficiary. Rollovers are subject to Roth IRA annual contribution limits.

Seek Professional Guidance

Considering the differences among state plans, the complexity of federal and state tax laws, and the dollar amounts at stake, please call the office and speak to a tax and accounting professional before opening a 529 plan.

PAY YOURSELF FIRST!!

 

Automate a % of your income toward savings/investments.

If you only save/invest the leftover scraps, then don’t be surprised when you only have leftover scraps to retire on!!

What To Do if You Missed the Tax Deadline

 

Tuesday, April 18, 2023, was the deadline for most taxpayers to file their tax returns. If you haven't filed a 2022 tax return yet, it's not too late.

First, gather any information related to income and deductions for the tax years for which a return is required to be filed, then call the office. If you are owed money, the sooner you file, the sooner you will get your refund. If you owe taxes, file and pay as soon as you can, which will stop the interest and penalties you owe.

Some taxpayers filing after the deadline may qualify for penalty relief. Those charged a penalty may contact the IRS by calling the number on their notice and explaining why they couldn't file and pay on time.

For 2022 tax returns due April 18, 2023, some taxpayers automatically qualify for extra time to file and pay taxes due without penalties and interest, including:

• Some disaster victims. Individuals living or working in a federally declared disaster area have more time to file and pay what they owe.
• Taxpayers outside the United States. U.S. citizens and resident aliens who live and work outside the U.S. and Puerto Rico, including military members on duty who don't qualify for the combat zone extension, may qualify for a two-month filing and payment extension.
• Members of the military who served or are currently serving in a combat zone may qualify for an additional extension of at least 180 days to file and pay taxes.
• Support personnel in combat zones or a contingency operation in support of the Armed Forces may also qualify for a filing and payment extension of at least 180 days.

The military community can also file their taxes using MilTax, a free tax resource offered through the Department of Defense. Eligible taxpayers can use MilTax to file a federal tax return electronically and up to three state returns for free.

If You Don't File, You May Miss Out on a Refund

Every year, more than 1 million taxpayers choose not to file a return and miss out on receiving a refund due to potential refundable tax credits. The most common examples of these refundable credits are the Earned Income Tax Credit and Child Tax Credit. For example, the IRS estimates nearly 1.5 million people did not file a tax return for 2019 and missed out on an estimated average median refund of $893 (i.e., half of the refunds are more than $893, and half are less).

Taxpayers usually have three years to file and claim their tax refunds. If they don't file within three years, the money becomes the property of the U.S. Treasury. However, the three-year window for 2019 unfiled returns was postponed to July 17, 2023, due to the COVID-19 pandemic emergency.

How To Make a Payment

If you owe money but cannot pay the IRS in full, pay as much as possible when you file your tax return to minimize penalties and interest. The IRS will work with taxpayers suffering financial hardship. Taxpayers with a history of filing and paying on time often qualify for administrative penalty relief. A taxpayer usually qualifies if they have filed and paid promptly for the past three years and meet other requirements. However, if you continue to ignore your tax bill, the IRS may take collection action.

There are several ways to make a payment on your taxes: credit card, electronic funds transfer, check, money order, cashier's check, or cash. If you pay your federal taxes using a major credit card or debit card, there is no IRS fee for credit or debit card payments, but processing companies may charge a convenience or flat fee. It is important to review all your options. The interest rates on a loan or credit card could be lower than the combination of penalties and interest imposed by the Internal Revenue Code.

What To Do if You Can't Pay in Full

Taxpayers who cannot pay the full amount owed on a tax bill are encouraged to pay as much as possible. By paying as much as possible now, the interest and penalties owed will be less than if you pay nothing. Based on individual circumstances, a taxpayer could qualify for an extension of time to pay, an installment agreement, a temporary delay, or an offer in compromise. Don't hesitate to call if you have questions about these options.

Direct Pay. For individuals, IRS Direct Pay is a fast and free way to pay directly from your checking or savings account. Taxpayers who need more time to pay can set up either a short-term payment extension or a monthly payment plan.

Payment Plans. Most people can set up a monthly payment plan or installment agreement that gives taxpayers more time to pay. However, penalties and interest will continue to be charged on the unpaid portion of the debt throughout the duration of the installment agreement/payment plan. You should pay as much as possible before entering into an installment agreement.

Cash Payments. Individual taxpayers who do not have a bank account or credit card and need to pay their tax bill using cash can make a cash payment at participating PayNearMe Company payment locations (places like 7-Eleven). Individuals wishing to take advantage of this payment option should visit the IRS.gov payments page, select the cash option in the "Other Ways You Can Pay" section, and follow the instructions.

What Happens if You Don't File a Past Due Return

It's important to understand the ramifications of not filing a past-due return and the steps that the IRS will take. Taxpayers who continue not to file a required return and fail to respond to IRS requests for a return may be considered for various enforcement actions, including substantial penalties and fees.

Need Help Filing Your 2022 Tax Return?

If you haven't filed a tax return yet, don't delay. Call the office today to schedule an appointment as soon as possible.