Tax Guy: Watch out for these IRS tax benefits — and red flags — at every stage of your life

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This column covers some important age-related tax and financial planning milestones to keep in mind for both you and your loved ones as the years fly by. Here goes.

Age 0-23

The so-called Kiddie Tax rules can potentially apply to your child, or grandchild, or other young beneficiary of your largesse. The Kiddie Tax can hit a child or young adult’s unearned income until he or she reaches age 24. Specifically, a child or young adult’s unearned income (typically from investments) in excess of the annual threshold is taxed at the parent’s higher federal income tax rates instead of the more-favorable rates for individual taxpayers.

For 2020, the unearned income threshold is $2,200.

A child or young adult’s unearned income below the threshold is usually taxed at very low rates: usually 0% for long-term capital gains and dividends and 0%, 10%, or 12% for ordinary investment income and short-term capital gains.

Key Point: Between ages 19 and 23, the Kiddie Tax is only an issue if the young adult is a student. For the year the young adult turns age 24 and for all subsequent years, the Kiddie Tax ceases to be a threat. For details on the Kiddie Tax, see this previous Tax Guy.

Age 18 or 21

A custodial account set up for a minor child comes under the child’s control when he or she reaches the age of majority under applicable state law (usually age 18 or 21). If there’s a significant amount of money in the custodial account, this issue can be a big deal. Depending on the child’s maturity level and dependability, you may or may not want to take steps to ensure that the money in the custodial account is used for expenditures that you approve of, like college costs. For more on custodial accounts, see here.

Age 30

If you set up a Coverdell Education Savings Account (CESA) for a child (or grandchild), it must be liquidated within 30 days after he or she turns 30 years old. To the extent earnings included in a distribution are not used for qualified higher education expenses, they are subject to federal income tax plus a 10% penalty tax. Alternatively, the CESA account balance can be rolled over tax-free into another CESA set up for a younger family member.

Age 50

If you are age 50 or older as of the end of the year, you can make an additional catch-up contribution to your 401(k) plan (up to $6,500 for 2020), 403(b) plan (up to $6,500), 457 plan (up to $6,500), or SIMPLE-IRA (up to $3,000 for 2020), assuming the plan permits catch-up contributions.

You can also make an additional catch-up contribution (up to $1,000 for 2019 or 2020) to your traditional or Roth IRA.

Key Point: The deadline for making an IRA catch-up contribution for the 2019 tax year is 4/15/20.

Age 55

If you permanently leave your job for any reason, you can receive distributions from the former employer’s qualified retirement plan(s) without being socked with the 10% early distribution penalty tax. This is an exception to the general rule that the taxable portion of qualified retirement plan distributions received before age 59½ are hit with the 10% penalty tax.

Age 59.5

You can receive distributions from all types of tax-favored retirement plans and accounts (IRAs, 401(k) accounts, pensions, and the like) and from tax-deferred annuities without being socked with the 10% early distribution penalty tax. Before age 59½, the 10% penalty tax will hit the taxable portion of distributions unless an exception to the penalty tax applies.

Age 62

You can choose to start receiving Social Security retirement benefits. However, your benefits will be lower than if you wait until full retirement age, which is 66 for folks born between 1943 and 1954. If you are still working before reaching full retirement age, your 2020 Social Security retirement benefits will be further reduced if your income from working exceeds $18,240.

Age 66

You can start receiving full Social Security retirement benefits at age 66 if you were born in 1943-1954. You won’t lose any benefits if you work in years after the year you reach the full retirement age of 66, regardless of how much income you have in those years. However, if you will reach age 66 in 2020, your benefits may be reduced if your income from working in 2020 exceeds $48,600.

Key Point: If you were born after 1954, your full retirement age goes up by 2 months for each year before leveling out at age 67 for those born in 1960 or later.

Tax warning: Up to 85% of your Social Security benefits may be subject to federal income tax, depending on your provisional income level. Provisional income equals your gross income from other sources plus tax-exempt interest income plus 50% of your Social Security benefits.

Age 70

You can choose to postpone receiving Social Security retirement benefits until you reach age 70. If you make this choice, your benefits will be higher than if you start earlier.

Key Point: An often-overlooked issue is that you must factor in the breakeven age after which you would come out ahead by postponing benefits. For example, if your normal retirement age is 66 and you wait until age 70 to begin receiving benefits, you forego benefits for four years. It would then take 12.5 years to reach the breakeven point. Are you sure you’ll still be around and able to enjoy the higher monthly benefit at age 82½? Good question.

Tax warning: See above for the tax warning for age 66.

Age 70.5 or age 72 if you turn 70.5 in 2020 or later

You generally must begin taking annual required minimum distributions (RMDs) from tax-favored retirement accounts (traditional IRAs, SEP accounts, 401(k) accounts, and the like) and pay the resulting income taxes. However, you need not take any RMDs from Roth IRAs set up in your name.

The initial RMD is for the year you turn: (1) age 70½ or age 72 if you turn 70½ after 2019. You can postpone taking the initial RMD until as late as April 1 of the year after you reach the magic age. If you chose the April 1 deferral option, however, you must take two RMDs in the year that included the April 1 deadline: one by the April 1 (the RMD for the previous year) plus another by December 31 (the RMD for the current year). For each subsequent year, you must take another RMD by December 31. There’s one more exception: if you’re still working after reaching the magic age and you don’t own over 5% of your employer, you can postpone taking RMDs from the employer’s plan(s) until after you’ve actually retired.

Law change: Thanks to a change included in the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act), which became law last December, the age after which you must begin taking RMDs is increased from 70½ to 72. Great, but this favorable change only applies if you attain age 70½ after 2019. So, if you turned 70½ before this year, you’re unaffected. Sorry about that. But if you turn 70½ this year or later, you won’t need to start taking RMDs until after hitting age 72. Good.

Tax warning: If you turned 70½ in 2019 and have not yet taken your initial RMD for calendar year 2019, you must take your initial RMD (which is for calendar year 2019) by no later than 4/1/20 or face a 50% penalty on the shortfall. You must then take your second RMD (which is for calendar year 2020) by 12/31/20.

It’s never too early for estate planning

Regardless of age, almost all adults should do at least some estate planning — even though very few people are currently exposed to the federal estate tax. That’s because the 2020 estate tax exemption is a whopping $11.58 million or effectively $23.16 million for married couples.

In uncomplicated situations, your estate plan might consist of nothing more than a simple will and updated beneficiary designations for life insurance policies, retirement and investment accounts, and so forth. If you have a larger estate, taking steps to confront uncomfortable realities about your heirs and to reduce exposure to the federal estate tax and any state death or inheritance tax may be advisable.

Contact your adviser if you think your estate plan needs some updating. It probably does.

The bottom line

Keep these important milestones in mind for yourself and your loved ones. And if you turned 70½ last year and have not yet taken your initial RMD, watch out for the April 1 deadline. That day will be here before you know it.

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