Boeing Pension and Lump Sum Comparison – Should I Retire Early?

Boeing Pension and Lump Sum Comparison – Should I Retire Early?

 

Boeing Employee – Should I Retire Early?

Boeing employees nearing retirement age are facing a financial decision that will need to be made by November 30—one that could have a significant impact on their lifestyle in retirement.

 

Higher Interest Rates and the Lump Sum Pension Benefit

Boeing offers many employees the option at retirement to either receive a pension, providing monthly income for life, or to have a single lump sum deposited into a retirement account that can be invested and withdrawn as desired.

The amount of the pension benefit is based on several factors, including years of service with Boeing and average salary while employed.

When determining the lump sum benefit, the underlying interest rates are an additional factor to take into consideration. Higher interest rates will create a lower lump sum benefit, and lower interest rates will create a higher lump sum benefit. Boeing resets the interest rate used in the calculation once per year in November.

With the significantly higher interest rates we’ve seen in 2022, an engineer who may currently qualify to choose either a $5,000 monthly pension or a $1 million lump sum benefit may be looking at only $800,000 in lump sum benefit if they retire after November 30, 2022. The exact numbers will vary for each employee.

That $200,000 reduced benefit can be a significant incentive for employees who are planning to retire in the next few years to adjust their plans and retire early.

 

To Whom Does This Apply?

Not all Boeing employees have a pension as part of their benefits. Also, some employees are covered by unions that only offer the monthly pension and do not have a lump sum option.

Boeing engineers who are members of the SPEEA (Society of Professional Engineering Employees in Aerospace) union usually have a generous lump sum benefit compared with the monthly pension and may benefit significantly from comparing their options.

 

Financial Planning to Compare Options

The decision to take either the lump sum in retirement or the monthly pension is a significant one, and both contain risks.

With the lump sum, the employee is accepting the risk of the market and managing the money.

With the monthly pension, the guaranteed income provided to the employee will not increase with inflation. This year has been a good reminder that inflation can significantly reduce the purchasing power of that income.

Also, does it make sense for an employee who originally planned to retire in two years to give up on the years of additional earnings and savings? Can the employee afford to do so?

We help employees compare how a monthly pension or lump sum benefit will interact with other resources (Social Security, retirement accounts, real estate) to determine the ability to meet goals in retirement. We can also compare retiring in 2022 with delaying retirement and possibly receiving a reduced benefit in the future.

 

Deadline and Next Steps

Boeing employees wanting to claim the lump sum before rising interest rates potentially reduce benefits will have to retire and submit the request for a lump sum benefit by November 30, 2022.

If you’re feeling overwhelmed by assessing the pros and cons of this decision, reach out to us for your complementary personalized analysis. We can help you determine whether retiring now would provide you with a sustainable retirement that meets your lifestyle needs.

 

 

 

Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.  Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. As always please remember investing involves risk and possible loss of principal capital and past performance does not guarantee future returns; please seek advice from a licensed professional.

 

 

 

 

Washington Capital Gains Tax and Long-Term Care Payroll Tax – New Taxes and Planning Opportunities in 2022

Washington Capital Gains Tax and Long-Term Care Payroll Tax – New Taxes and Planning Opportunities in 2022

 

The start of the new year is often a time when tax changes go into effect. At the Federal level, the Build Back Better Act, which had some significant tax changes, has not passed. For now, it is unclear if the legislation will pass in 2022. It is also unclear if any of the changes would apply in 2022 or would only apply to future years if it does pass.

In Washington State, 2022 brings the scheduled implementation of two new taxes that have the potential to impact many Merriman clients: the capital gains tax and the long-term care payroll tax.

 

Washington State Capital Gains Tax

Starting in 2022, Washington will apply a 7% tax on realized capital gains above $250,000. The most common assets that will generate income subject to this tax include:

  • Sales of stocks and bonds (and mutual funds, ETFs, and other pooled investments)
  • The sale of a business above a certain size

 

Other assets are specifically exempt from the capital gains tax, including:

  • All real estate
  • Sale of small businesses below a certain size
  • Investments inside retirement accounts
  • Restricted stock units (RSUs) at the time they vest (though their later sale could result in taxable capital gain income)

 

How the tax is calculated

This 7% tax is applied only on capital gains above the $250,000 threshold. It is not impacted by other income. The same threshold applies to married and unmarried households.

Example 1: John sold $500,000 of Microsoft stock in his taxable investment account that was acquired for $240,000. He has no other income in 2022. This results in $260,000 of capital gains. Since $260,000 – $250,000 exemption = $10,000, John would owe ($10,000 x .07 = $700) in capital gains tax.

 

Example 2: Sally has $800,000 of income from her job. She sold $500,000 of Amazon stock that was acquired for $300,000. Because the $200,000 of realized capital gain is less than the $250,000 exemption, she does not owe the capital gains tax. Her other income is irrelevant to this calculation.

 

Example 3: Matt and Molly are married taxpayers filing a joint tax return. Matt sells stock in his individual taxable account that realizes $150,000 of capital gains. Molly sells stock in her individual account that realizes $120,000 of capital gains. Even though they are both individually below the limit, because they are married and are filing a joint tax return, their total gains are $20,000 above the $250,000 limit; they would potentially owe $1,400 in capital gains tax.

 

When are payments made?

According to the state Department of Revenue webpage, the tax will be calculated on a capital gains tax return in early 2023. The tax payment will be due at the same time the taxpayer’s federal income tax return is due.

There does not appear to be a requirement to make estimated tax payments before the end of the year the way some taxpayers are required to do for federal income tax.

 

Potential court challenge

Opponents have challenged the law saying this capital gains tax is unconstitutional under the state constitution. A hearing is scheduled for February 2022. Any ruling is expected to go to the state supreme court later this year.

At this time, we are encouraging families who may be impacted by this new tax to plan under the assumption that it will go into effect.

 

 

Long-Term Care Payroll Tax

We have previously shared about Washington’s new long-term care payroll tax. The tax is 0.58% on all wages (including RSUs at the time they vest) and is used to pay for long-term care benefits ($580 on $100,000 of income).

Taxpayers were given the opportunity to exempt themselves from the payroll tax by securing a private long-term care insurance policy before November 1, 2021, and requesting an exemption from the state.

 

Delay in implementing the payroll tax

In December 2021, Governor Inslee asked the state legislature to delay implementing the payroll tax. That has not happened yet, and employers are technically still required to withhold the payroll tax from employee paychecks.

The requested delay was to allow time to address some concerns, including:

  • The current program is limited to Washington residents. Residents could pay in for an entire working career, move out of state in retirement, and then not be eligible for benefits.
  • The current program has no mechanism for new workers in Washington State to opt out.
  • The current program requires workers to pay into the system who may never be eligible for benefits. Since you must pay in for 10 years to qualify for benefits, older workers who retire before reaching that point will pay in but not qualify for benefits. Military spouses and other out-of-state residents who work in Washington may be in a similar situation.
  • The current program has no mechanism to ensure that individuals who opted out of the payroll tax maintain their insurance.

It is expected that implementing the payroll tax will be delayed, but it will still likely go into effect in some similar fashion in 2023 or 2024.

 

 

Planning Opportunities

The biggest planning opportunity for the capital gains tax is remaining mindful of how much capital gains income is being realized each year. Several large area employers, like Amazon and Microsoft, along with many smaller employers have seen a significant increase in stock values.

At Merriman, we believe in the benefits of diversifying investments and not remaining too concentrated. For tax purposes, it is often beneficial to realize those capital gains over multiple years to spread out the tax impact.

Since the 7% state capital gains tax is in addition to the federal capital gains tax, it likely makes sense to limit those gains to $250,000 per year where possible.

For the payroll tax, there is a bit of a holding pattern. There was a rush of activity in 2021 to qualify for the exemption, and that deadline has passed. Now that implementation has been delayed, we will wait to see what adjustments, if any, happen and what clients should do to plan for it.

We will update with further adjustments for federal and state taxes. Your financial advisor can provide additional specific guidance.

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be relied upon as such.

 

Beware of the Tax Cost of Turning Your Primary House into a Rental Property

Beware of the Tax Cost of Turning Your Primary House into a Rental Property

 

Since the financial downturn and real estate crisis in 2007–09, residential real estate in many parts of the country has seen a significant increase in value. This increase has created additional considerations for homeowners deciding if they want to sell an existing property or convert it into a rental.

 

Rental properties are taxed differently than personal residences. In some cases, these can make it tempting to move into an existing rental property for a few years to reduce the taxable income on the sale.

 

Homeowners also need to be mindful of the reverse—how the decision to turn a primary house into a rental property can be a poor tax move.

 

Tax Benefits When Selling Your Personal Residence

 

Since 1997, homeowners have been able to use the Section 121 exclusion to exclude up to $250,000 of gains from taxation ($500,000 if married filing jointly) upon the sale of a property. In order to qualify, the taxpayer must own and use the property as a primary residence for two of the past five years. Notably, these two years do not have to be the most recent two years. A taxpayer could live in a property from 2017–2019 then sell the property in 2021 and still qualify.

 

Example 1: Jolene and Max purchased their house in June 2011 for $400,000. They sell in June 2021 for $850,000. Because their total gain is less than $500,000, none of that gain needs to be reported as taxable income when they sell their property.

 

Example 2: Luke and Jenny purchased their home in June 2011 for $400,000. They sell in June 2021 for $1,050,000. Because their gain is $650,000, they will need to include the $150,000 above the $500,000 exclusion in their income. This $150,000 will be taxed at long-term capital gains rates. (NOTE: If Luke and Jenny did significant renovations, those costs can potentially be added to the $400,000 purchase price, reducing the taxable income.)

 

Understanding the Tax Impact of Turning Your Primary House into a Rental Property

 

When deciding to move into a new house, homeowners often have two options for their existing property: they can sell it or turn it into a rental property. While turning a primary residence can offer the appeal of receiving monthly rental income, turning your house into a rental property can have a significant tax hit come tax time if you decide to sell.

 

Example 3: Jolene and Max from Example 1 decide in June 2021 to turn their house into a rental property rather than sell. After 2 years, they decide they would rather not be landlords and sell the property in June 2023 for $850,000. Because they lived in the house as their primary residence for at least two of the last five years, they still qualify for the Section 121 exclusion. In fact, because the rental period happened after they lived in the house as their primary residence, they don’t even need to prorate the gain between periods of qualifying and non-qualifying use as they would if they moved back into the rental property. The only income to be reported is the recapture of any depreciation that was taken during the rental period.

 

Example 4: Jolene and Max from Example 1 decide in June 2021 to turn their house into a rental property rather than sell. In this case, they keep it as a rental property for four years before selling the property in June 2025 for $850,000.

When they sell their house in June 2025, it was only used as a personal residence for one of the past five years. They no longer qualify for the Section 121 exclusion. The entire $450,000 gain will be included in their taxable income. They will also have to recapture any depreciation that was taken during the rental period.

 

Jolene and Max’s decision in Example 4 to rent their house for four years before selling it has resulted in a significantly higher tax bill than they would have had if they sold it immediately or if they had sold it after only a few years of renting out the property.

 

Planning Opportunities for Real Estate that Was Converted into a Rental Property

 

There are several planning opportunities that owners might consider if they are in Jolene and Max’s situation described in example 4. These include:

 

  1. Moving back into the property to re-gain the exclusion
  2. Continue renting out the property until qualifying for a step-up in cost basis
  3. Consider a Section 1031 exchange into a different rental property
  4. Sell the principal residence and purchase a different rental property

 

Move Back into the Property to Re-Gain the Exclusion

 

Individuals can move back into the rental property to regain some of the exclusion.

 

Example 5: Tina and Troy purchased their house in June 2011 for $400,000. They turned it into a rental property in June 2015. In June 2019, they want to sell the house. Because it was a rental property for the past four years, all gains will be included in taxable income.

They decide to move back into their house in June 2019 and sell it in June 2021 for $850,000. They now qualify for the Section 121 exclusion because it was their primary house for at least two of the last five years.

 

When they sell their house in 2021, it had six years of qualified use as a personal residence and four years of non-qualified use as a rental property. The $450,000 of gains will be prorated between $450,000 x 60% = $270,000 that can be excluded and $450,000 x 40% = $180,000 that cannot be excluded.

 

Also, all depreciation that was taken during the four years as a rental property will be included in taxable income when the house is sold.

 

By moving back into their rental property for two years, Tina and Troy were able to exclude some, but not all, of the gains from the years they owned the property.

 

Continue Renting Out the Property Until Qualifying for a Step-Up in Cost Basis

 

Currently, when the owner of an asset dies, that asset gets a complete step-up in cost basis. Any gains that might otherwise have been included in taxable income are erased, and the cost basis is “reset” as if the taxpayer purchased the asset on the date of death.

 

Example 6: Tina and Troy from Example 5 don’t move back into the house in 2019, but they instead continue to rent it out. They live in Washington, and Troy is in bad health. Troy dies in June 2021 when the rental house is worth $850,000.

 

Tina receives a complete step-up in cost basis. It is now treated as if she purchased the house for $850,000. If she sells the house for $850,000, there is no taxable income, regardless of whether it is a personal or a rental property.

 

The example above assumes Troy and Tina live in a community property state like Washington (or California, Texas, or several others). If they live in a common law state, they likely would not receive the full step-up in cost basis described. Also, owners of rental properties receive a step-up in any depreciation taken in addition to the capital gains, providing an even more powerful tax benefit.

 

Consider a Section 1031 Exchange into a Different Rental Property

 

If a taxpayer no longer wants to rent out their current property, but they are willing to have a rental property, they can defer taxes with a Section 1031 exchange into a new rental property. The taxpayer can sell one rental property, purchase a new rental property, and transfer the cost basis. This will delay any taxes until the new rental is ultimately sold.

 

This 1031 exchange is a complicated process that requires working with a broker who specializes in it. This exchange can only be done with rental properties. It cannot be used to turn a rental property into a new primary house.

 

Sell the Principal Residence and Purchase a Different Rental Property

 

The final strategy to consider is to sidestep the issue altogether. If the taxpayer is moving out of a principal house and wants to own a rental property, it may be more tax efficient to sell the principal residence then purchase a different rental property.

 

By selling the principal residence before turning it into a rental property, the taxpayer can exclude all gains up to the $250,000 or $500,000 maximum of the Section 121 exclusion. Then the new rental property can be purchased and managed with a “reset” higher cost basis.

 

Conclusion

 

When moving out of a house, it may be tempting to turn that house into a rental property. There may be benefits to receiving increased cashflow that a rental can provide.

 

However, if you have a property with significant appreciation, consider carefully any decision to rent it out when you leave. This decision to rent out the property may give up far more in tax benefits than are received in new rental income.

 

If you’d like to understand the right approach for you, contact the Merriman team to strategize the decision to rent or sell your property while remaining mindful of the big picture.

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.

How to Report Your 2020 RMD Rollover on Your Tax Return

How to Report Your 2020 RMD Rollover on Your Tax Return

 

Following the stock market decline early in 2020, Congress passed the CARES Act on March 27, providing relief for individuals and businesses impacted by the pandemic. One of the provisions was a suspension of 2020 Required Minimum Distributions (RMDs). Individuals who hadn’t taken a distribution yet were no longer required to do so.

For individuals who took a distribution early in 2020, they were given the opportunity to “undo” part or all of that distribution by returning funds to their IRA by August 31, 2020.

 

Tax Forms for IRA Rollovers

Some taxpayers who took advantage of this rollover to undo that RMD may be surprised to get tax forms reporting the withdrawal.

Example 1: Kendra turned 75 in 2020 and had a $30,000 RMD at the start of the year. She took her distribution on February 1, 2020, with 10% tax withholding ($27,000 net distribution and $3,000 for taxes). She didn’t “need” the distribution as Social Security and other income covered her entire cost of living. Because she didn’t need the money, she returned the full $30,000 to her IRA on June 15, 2020.

In January 2021, Kendra was surprised to receive a Form 1099-R since she returned the entire amount and knew she shouldn’t owe taxes on it. The Form 1099-R reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports code 7 for a “normal distribution.”

 

How to Report the 2020 Rollover

Since Kendra returned the entire $30,000 withdrawal listed on her tax return, it won’t be included in her taxable income. However, she will need to report both the withdrawal and the rollover on her tax return.

In her case, the full $30,000 will be reported on line 4a of Form 1040, with $0 reported on Line 4b. She will also write “Rollover” next to line 4b. In her case, the $3,000 that was withheld for taxes will still be reported with other tax withholding and will impact her ultimate refund or balance due.

How to Report a Partial Rollover

Example 2: Jane turned 76 in 2020. She also had a $30,000 distribution that she took on February 1, 2020, with 10% tax withholding ($27,000 net after $3,000 for taxes). On June 15, 2020, she returned $12,000 to her IRA instead of the full $30,000.

In January 2021, she received a 1099-R that also reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports Code 7 for a “normal distribution.”

In Jane’s case, she will also report the full $30,000 on line 4a. She will report $18,000 on line 4b ($30,000 original distribution minus $12,000 returned to her IRA in 2020). She will also write “Rollover” next to line 4b. The $3,000 withheld for taxes will still be reported with other tax withholding as usual.

 

Form 5498

Taxpayers who returned some or all of their distribution in 2020 will receive Form 5498. They likely will not receive this form until May 2021—after the April 15 tax filing deadline. This form will be used to report the amount returned to the retirement account in 2020 and verify the rollover reported on the 2020 tax return. The taxpayer does not need to wait (and should not wait) for the Form 5498 before filing their taxes. This is simply an information form so the IRS can verify what was reported on the tax return.

 

Exception from the Usual Rule

It’s important to remember that all of these rollovers are a one-time exception in 2020 from the usual rule. Typically, this type of rollover can only be done once per rolling 365-day period and must be completed within 60 days of taking the withdrawal. Also, RMDs are generally specifically prohibited from this type of rollover.

 

Conclusion

Individuals who returned RMDs in 2020 to avoid having to include the withdrawal in their taxable income will still receive a tax form showing the distribution and will have to report it on their tax return. When reported correctly, the amount returned will be excluded from their income as intended.

 

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.

 

2020 Year-End Tax Moves

2020 Year-End Tax Moves

 

The Tax Cut and Jobs Act (TCJA) passed at the end of 2017, and the Setting Every Community Up for Retirement Enhancement Act (SECURE) passed at the end of 2019. These both made significant changes to annual tax-planning strategies.

The COVID-19 pandemic and the CARES Act relief package that followed created a new layer of complexity. Unfortunately, many taxpayers miss opportunities for significant tax savings.

Here are six moves to consider making before the end of the year to potentially lower your taxes both this year and in years to come.

  1. Take the Standard Deduction Later. The new tax rules nearly doubled the standard deduction and eliminated many write-offs, limiting the benefit of itemizing deductions for most taxpayers. However, you can optimize your deductions by “bunching” itemized deductions in a single year to get over the standard deduction threshold and then by taking the standard deduction in the following year.

    Example: Instead of giving $10,000 to charity annually (which will likely leave you with the standard deduction anyway), gift $50,000 every 5 years. This will give you a greater tax benefit in the first year while still claiming the standard deduction in the other years to maximize tax savings.

  2. Pre-Pay Your Medical Expenses. Have major medical-related expenses coming up? You can potentially maximize the tax deduction by paying out-of-pocket medical expenses in a single calendar year—either by pushing payments out to the next year or pulling later expenses into this year.

    A surprising number of medical expenses qualify, including unreimbursed doctor fees, long-term-care premiums, certain Medicare plans, and some home modifications.

    Note: Medical expenses are an itemized deduction, so this strategy may be best used with the “bunching” strategy described above, including possibly paying medical expenses in a year you maximize charitable donations.

  3. Give Money to Your Favorite Charity Right Now from Your IRA. If you’re over 70 ½, you can make up to $100,000 of annual Qualified Charitable Distributions (QCDs) directly from your IRA to a qualifying charity. Even better, for retirees who don’t need to take their Required Minimum Distribution (RMD) each year, these qualified charitable distributions count toward the RMD but don’t appear in taxable income.

    Even though the CARES Act allowed RMDs to be skipped in 2020, you can still make a QCD this year.

    Note: QCDs must be made by December 31 to count for this tax year.

  4. Take Advantage of Years in a Lower Tax Bracket with a Roth Conversion. A Roth conversion can permanently lower your taxable income in retirement by converting tax-deferred assets (IRA / 401k) into tax-free assets in a Roth account. It is best to do this in years where you are in a lower tax bracket than you expect to be in the future.

    Annual Roth conversions when in a lower tax bracket are a way to smooth out annual taxes and minimize the amount paid over a lifetime.

    Example: If a taxpayer at age 63 is in the 12% tax bracket, then moving $10,000 from an IRA to a Roth account will owe an additional $1,200 in taxes. That same taxpayer at age 73 may be in the 24% tax bracket due to Social Security, pension, and RMD income they didn’t have at 62. Taking that same $10,000 from an IRA will now result an in additional $2,400 in taxes.

  5. Optimize Your Investment Portfolio to Improve Expected After-Tax Return. Prior to the TCJA, you could write off some fees you pay for investment management. The TCJA did away with that deduction. There are still ways to pay fees with pre-tax dollars that may make sense depending on the types of accounts used.

    Likewise, some investments will be more tax efficient, and other investments will be less tax efficient. Where possible, move the most tax-efficient investments into a taxable investment account and the least tax-efficient investments into a tax-advantaged retirement account. The goal is to determine an ideal overall allocation, even if each individual account has a slightly different allocation.

    Both strategies above can potentially help maximize the after-tax return on investments.

  6. Optimize Your Retirement Contributions. The most important step you can take right now to reduce your taxes this year may be to review how and where you’re making retirement contributions. You may be missing out on critical tax savings (and investment growth) if you’re not optimizing your contributions.

    Potential retirement account strategies people often miss include Solo 401k for self-employed individuals, backdoor Roth contributions, or “mega” backdoor Roth contributions at certain large employers.

 

Everyone’s situation is different, and today’s retirement environment is complex. Working with a financial professional who coordinates with your CPA can help ensure you’re not missing any opportunities to optimize your portfolio and pay less in taxes.