CARES Act makes it easier for you to use your 401 (k). Do not do it
Dear Liz: You recently mentioned that a person can withdraw money from their 401 (k) and spread the taxes over three years. If 401 (k) is refunded, they can amend their tax returns to get those taxes refunded. Due to some major house repairs, I asked our accountant about this before continuing. He said he hadn’t read anything official about it. Could you please indicate where you got your information, so that we can decide if this is a route we can use?
Reply: You may have had this conversation before March 27, when the Coronavirus Aid, Relief and Economic Security Act (CARES) became law.
Otherwise, it’s pretty hard to imagine an accountant anywhere in the United States who hasn’t heard of the Emergency Relief Plan that created the stimulus checks sent to most Americans, as well as Paycheck Protection Program forgivable loans for businesses and the novel coronavirus hardship withdrawal rules for 401 (k) and IRAs.
These rules allow people who have been financially or physically affected by COVID-19, the disease caused by the novel coronavirus, to have emergency access to their retirement funds if their employers allow it.
Even if you have access to such withdrawal, you should consider other means first.
Taxes on withdrawals from a pension plan can be substantial, even if spread over three years. Perhaps more importantly, you would likely lose out on future tax-deferred returns that the money might have earned, as not many people who make such withdrawals will be able to repay the money.
A home equity loan or line of credit is usually a much better option for home repairs, if you can organize it.
Withdrawal of retirement funds after tax
Dear Liz: I have contributed to retirement accounts for many years, since the early 1980s. At the time, there were no deductions for contributions. I made about $ 50,000 in after-tax contributions, which means I have already paid taxes on that money. Later, I switched to pre-tax contributions. Now that I’m retired and approaching 65, in my weak mind I think I should be able to withdraw that $ 50,000 without having to pay tax on it. However, the things I have read indicate that it might not be that easy. Can you help me with this question, or at least point me in the right direction?
Reply: You will escape tax on a portion of any withdrawal you make from a pension plan that contains after-tax money, said Mark Luscombe, senior analyst at Wolters Kluwer Tax & Accounting. However, only Roth IRAs allow you to make completely tax-free withdrawals of your contributions at any time.
With a Roth IRA, any withdrawal is initially considered a return of contribution. For example, if you contributed $ 50,000 to an account that is now worth $ 200,000, the first $ 50,000 you withdraw would be tax and penalty free, regardless of your age, Luscombe said. If you were under 59 and a half, additional withdrawals may be subject to taxes and penalties.
With regular IRAs and 401 (k), the tax treatment is different. Withdrawals are seen as a proportional return of your after-tax money, Luscombe said. If you contributed $ 50,000 after tax and then withdrew the same amount from an account that is now worth $ 200,000, only a quarter of the money would escape tax.
Taxes when inheriting a house
Dear Liz: My sister recently passed away and I bought her house, which I am selling (she is now receivership). I was looking at state tax forms for real estate transactions, and there is nowhere to look for someone who has been given a house by death. Does that mean it is taxable? I was told that this was an inheritance that was not taxable.
Reply: Technically, you haven’t been given a house. You inherited it and you are correct that inheritances are generally not taxable. (Only six states have inheritance tax, and your state, California, is not one of them.) When you inherited the home, the property received what is known as a base tax increase, so that the appreciation that has occurred during your sister’s life is not forced upon. You only owed tax on any capital gain that has occurred since you own the property. A tax professional can help you determine what you may owe.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to him at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.