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How Tapping Home Equity Can Pay the Taxes on a Roth IRA Conversion

Single Family Home with Beige Clapboard Exterior and Trees in Autumn Colors (Foliage) in Sleepy Hollow, Hudson Valley, New York. OlegAlbinsky/iStock

The benefits of incorporating a Roth IRA into your retirement strategy are often praised by financial advisers, citing the ability for money to grow tax-free for decades and provide tax-free income in retirement. While a Roth IRA conversion is one way to take advantage of this savings tool, the tax implications of converting investments from a traditional retirement account to a Roth IRA typically deter most people. Yet the effects of new legislation and persistent market volatility make a Roth IRA conversion worth considering, and paying for it doesn’t have to break the bank.

A Roth IRA conversion uses assets from a traditional or rollover IRA, 401(k), SEP or Simple IRA to fund a Roth IRA. Unlike regular contributions to a Roth IRA, which are constrained by income limitations and annual contribution caps, there are no restrictions when converting retirement assets to a Roth IRA. Any amount can be converted regardless of your age, income, or employment status. But the Roth IRA conversion doesn’t come without a cost.

When you convert pre-tax assets in a traditional retirement account to your Roth IRA, the conversion is treated as income and you must pay taxes on the assets converted. The amount you pay in taxes depends on your income tax bracket for the year. In some cases, a substantial conversion in one year could boost taxable income by multiple brackets. To help manage that liability, a series of partial conversions over several years could be planned to keep the distributions within a targeted tax bracket.

For many retirees, income from a traditional IRA or 401(k) can create a tax headache, especially when required minimum distributions (RMDs) raise their tax bracket. That’s where a Roth IRA comes in.

A Roth IRA provides the flexibility to take tax-free withdrawals in retirement when you want and in whatever amount you want. This is unlike other retirement accounts that have RMDs beginning at age 72. The RMDs are taxable income, which means that in addition to your tax bracket they can also impact your Medicare premium bracket and the taxation of your Social Security benefit, whereas distributions from the Roth IRA will not.

This year the CARES Act temporarily pauses RMDs from traditional retirement accounts. So, if you are 72 or older and you don’t take your RMD then your income will be lower. This provides a potential opportunity to make a larger conversion while maintaining the same income tax rate.

Additionally, since the Secure Act of 2020 eliminated the stretch provisions for inherited retirement plans, the Roth IRA is also a great estate planning tool. Non-spousal heirs can no longer take distributions over their life expectancy, but rather all distributions must be taken within 10 years. While this is true as well for an inherited Roth IRA, the distribution would not be a taxable event.

The cost of an IRA conversion can be daunting, but it doesn’t have to be. Conventional wisdom is to pay the resulting tax bill with non-taxable assets from outside the retirement plan. Using plan assets would defeat the purpose of the conversion as you will permanently give up a portion of the capital that is accumulating on a tax-free basis. In addition, if you’re under age 59 ½, the portion of plan assets used to pay for the conversion could also be subject to a 10% tax penalty.

If you have the cash on hand, that’s likely the best way to cover the tax implications. But depending on the size of the conversion and your tax bracket, the up-front costs could be significant. Another option is to take out a loan against your life insurance policy. While this permanently reduces the policy value if not repaid, the loan doesn’t count as taxable income so long as the policy isn’t surrendered, doesn’t lapse, and the amount owed doesn’t exceed the premiums paid. If any of these do occur then the tax implications will likely be even larger than the taxes paid on the Roth IRA conversion.

Considering a reverse mortgage

Alternatively, tapping into your home equity can provide the means to pay the taxes. You could leverage current low interest rates and get a home equity line of credit (HELOC), though many banks have stopped accepting applications for HELOCs in recent months. Additionally, a HELOC will require a monthly mortgage payment, decreasing your cash flow.

For homeowners age 62 or older, a reverse mortgage could pay the tax liabilities from the Roth IRA conversion, creating tax and cash-flow flexibility and potentially a higher net worth.

With a reverse mortgage, the available line of credit grows and compounds at a value that is tied to current interest rates. This can be particularly beneficial with a series of partial Roth IRA conversions as it provides a growing resource to pay future tax bills. The line of credit also provides flexibility to convert a greater portion of your retirement assets during market plunges, so you only pay taxes on the lower value at the time of the conversion and not on any gains in the Roth IRA when the markets recover.

Since there are no principal or interest payments required for as long as you live in your home, the line of credit from a reverse mortgage provides the liquidity to pay for the Roth IRA conversion with no impact on household cash flow or the need to sell other invested assets.

A good rule of thumb is to use a reverse mortgage if your home equity is less than or equal to the value of the retirement assets you plan to convert. If the home represents a major portion of your net worth, a reverse mortgage may not be the best option to cover the tax bill. In this case, the reverse could better serve as a tax-free source of supplemental income, or to pay for in-home care, or other retirement expenses that distributions from the smaller invested assets may not be able to cover.

Evaluating the use of a reverse mortgage also depends on the projected costs in comparison with the projected returns. For example, if interest rates on a reverse line of credit are at 3%, and your home appreciates at a 3% rate, you could borrow 50% of your home equity and still maintain a 50% retained equity position throughout the duration of the loan. Even if the home only appreciated at a 1% rate, you would still have a retained equity position.

Projected returns on the Roth IRA conversion would also need to be evaluated. For simplicity’s sake, let us assume you borrow a total of $250,000 from your reverse line of credit to pay the tax bills on $1 million conversion. If you accrue interest on the line of credit balance at a 3% rate and the Roth IRA grows at a 6% tax-free rate, the return could be quite compelling over time.

Of course, there are no guarantees on any projections, which is why you should consult a financial professional and evaluate your specific situation. A number of “what if” scenarios should be considered including changes in interest and tax rates, home and investment growth rates, and legacy desires. These considerations will help determine if using a reverse mortgage to take advantage of the benefits of a Roth IRA conversion could be a retirement strategy that makes sense for you.

The post How Tapping Home Equity Can Pay the Taxes on a Roth IRA Conversion appeared first on Real Estate News & Insights | realtor.com®.

Source: realtor.com



What Could a Second Wave of COVID-19 Mean for Housing Markets?

Will a second wave of COVID-19 mean “boom” or “bust” for the housing market? With the trends we’re seeing now, there are a couple of possibilities to expect.

The post What Could a Second Wave of COVID-19 Mean for Housing Markets? appeared first on Homes.com.

Source: homes.com



Home Buyer’s Guide: How to Purchase a Property, From Start to Finish [Free Download]

Purchasing a home is both exciting and a major milestone in your life, so you’ll want to be prepared for what to expect to avoid a stressful process. Having an in-depth look at the buyer’s journey can help you make informed and confident decisions.

From finding a real estate agent, negotiating offers to getting your keys on closing day, we’ve outlined all the steps of a home buyer’s journey in our free Buyer’s Guide, which you can download here.

The Buyer’s Guide will cover the buyer’s timeline from meeting an agent to preparing for closing day. We’ve outlined the 8 steps in a home buyer’s journey below.

1. Working With An Agent

Every city is filled with thousands of agents, but not all are equal. We believe it is important to choose an agent that you feel confident with. Before you commit to working with an agent, make sure you have a good understanding of the knowledge and experience they offer. It’s important that you ask your questions before making the decision to work with them.

2. Financing Your Purchase

Before you set a budget and start looking for a home, you’ll have to understand what costs to expect when purchasing a home. Here are some of the major costs involved:

  • Deposits
  • Down payments
  • Mortgage insurance
  • Closing costs

You’ll also want to calculate a rough estimate of the down payment that you will be expected to pay. Depending on the price of your home, your minimum down payment can range from 5% to 20%. If you’re interested in learning more about how to finance your home, you can get our free Financing Your Purchase guide here.

3. Searching For A Home

An important part of searching for a home is understanding how the home will fit with your needs and your lifestyle. You’ll want to consider home ownership as well as different types of properties and features. 

Types of Home Ownership

  • Freehold Ownership
    • You purchase the home and directly own the lot of land it sits on
  • Condominium Ownership
    • For condos, you own specific parts of one building: titled ownership of your unit, along with shared ownership in the condo corporation that owns the common spaces and amenities
  • Co-Op Ownership
    • You own an exact portion of the building as a whole and also have exclusive use of your unit

Types of Properties

  • Detached houses
  • Semi-detached houses
  • Attached houses
  • Condos and apartments
  • Multi-unit

Tip: Depending on your budget and desired location, you may need to be flexible to find a home that meets your needs. By being willing to trade some features for others, you’ll have more options to choose from.

4. Negotiating An Offer

When you are making an offer to purchase a home, the purchase agreement should include the essential components listed below. Your agent can help put together an offer that is compelling, while safeguarding your interests and puts you in a competitive position to secure your new home.

You’ll also have the opportunity to choose the conditions that you’ll want in your offer. Some of these may include a home inspection or a status certificate review.

5. Financial Due Diligence

Whenever you make an offer on a house, you need to provide a deposit to secure the offer. The deposit is in the form of a certified cheque, bank draft, or wire transfer; it’s held in trust by the selling brokerage and is applied towards your down payment if your offer is successful.

There are two types of deposits:

  • Upon acceptance
    • The deposit is provided within 24 hours of the seller choosing your offer
  • Herewith
    • The deposit is provided when the offer is made

6. Property Due Diligence

To firm up a deal or educate yourself more on the state of the property, you’ll likely want to have a home inspection if you’re purchasing a house. If you’re purchasing a condo, then your lawyer will review the building’s status certificate.

Home Inspection

A home inspector will assess elements of the home such as the walls, windows, plumbing, heating and roof to judge the condition of the home. This process is non-invasive and is essential to help provide buyers with a good idea of the home’s current condition and the confidence of putting in an offer. 

Tip: The home inspector will provide a summary of suggested work along with a minimum budget estimate for the repairs needed. 

Status Certificates

If you’re purchasing a condominium, you’ll need to obtain a status certificate from the condo board or management for your lawyer’s review. This document will include valuable information about the condo’s budget, legal issues, reserve fund, maintenance fees and future fees increases – and the lawyer can help identify potential red flags

7. Preparing For Closing

Before the big day, you’ll want to keep a checklist of what to do ahead of time. Some of these include:

  • Review your contract
  • Complete a final walkthrough of the home
  • Purchase home insurance
  • Meet with your lawyer
  • Know how much cash you’ll need
  • Secure cash required for closing

8. Closing Day

Closing Day is when you’ll finally get the keys to your new home! In addition to bringing the cash required for closing, you’ll have to sign a few more documents which will include:

  • Mortgage loan
  • Title transfer
  • Statement of adjustments
  • Tax certificates

For the full details on the home buyer’s journey including examples, advice, pictures and sample calculations, download a copy of our free Buyer’s Guide here.

The post Home Buyer’s Guide: How to Purchase a Property, From Start to Finish [Free Download] appeared first on Zoocasa Blog.

Source: zoocasa.com




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