U.S. Savings Bonds...Subject to Tax Penalties

You weren’t expecting the second half of that title, were you? Well, it is sad but true. Many people are subject to income tax penalties every year because of their US savings bonds. The government runs on taxes and expects their cut from profitable investments, such as bonds. This is where the trouble starts for most people. The IRS mandates that once a bond passes its final maturity date, the accumulated interest must be reported on that year’s federal income tax return. But if you continue to hold your bond beyond its maturity, not only will you owe taxes when you cash it in, but quite possibly a penalty as well. The IRS views it as though you are holding out on them and not cashing in your bond and paying them their fair share. They frown on underreported unearned income.

So what should you do now? First, go find your bonds and check the maturity date. If they are past maturity and it’s within the first three years, you may be able to file an amended income tax return and claim the income. If it is more than three years overdue, then the sooner you cash it in and pay the corresponding taxes the better. There will be a lesser chance that you will be penalized, and if you are penalized then it will be a smaller amount. Now please do not take my word as law, and check with your CPA or tax professional.

Besides, there is no point in holding a bond past maturity since you will not earn any more interest. Please also remember that these bonds are exempt from state and local taxes, but as we have discussed, are subject to federal income tax. So when considering bonds, please choose wisely, and check your current bonds so you can stay tax penalty free.

The Hot Dog Vendor

There was a man who lived by the side of the road and sold hot dogs.
He sold very good hot dogs.
He put up signs along the highway and advertised in the newspaper telling how good they were.
He stood on the side of the road and cried: “Buy a hot dog, Mister?”
And people bought.
He increased his meat and bun orders.
He bought a bigger stove to take care of his trade.
He finally got his son home from college to help him out.
But then something happened.
His son said, “Father, haven’t you been listening to the radio and watching TV?
There’s a big depression.
The foreign situation is terrible.
The domestic situation is worse.”
Whereupon the father thought,
“Well, my son’s been to college, he listens to the radio and watches TV and he ought to know.”
So the father cut down on his meat and bun orders, took down his signs and cancelled his newspaper ads and no longer bothered to stand out on the highway to sell his hot dogs.
And his hot dog sales fell almost overnight.
“You’re right, son”, the father said to the boy.
“We certainly are in the middle of a great depression.”

401k In-Service Withdrawals

We all know that you can’t take out your 401k money while you are still working for that company…or can you? The answer is maybe. Some retirement plans allow what is called an in-service withdrawal, or non hardship in-service withdrawal. No one really publicizes this part of the plan. You have to ask your human resources or benefits person to see if your plan has this provision. For many companies the benefits person may not even know without checking, but one way or another you should check the “Summary Plan Document”. This form lists all of the provisions available in your retirement plan. If you are lucky enough to work for a company that offers these withdrawals, you still need to check the fine print. Some plans only allow 10% of your balance to be moved, while other will allow the entire balance. In general, plans limit these withdrawals to about 20-30% of your current balance. There can also be other stipulations. Many plans allow you only to pull out the money that you have contributed and not the company match money. Also, some will suspend your company match for 6-12 months if you take a withdrawal. The last provision is that you are usually limited to how often a withdrawal can be taken.

Once you cut through all of the red tape, and determine that you can take some of your money, it opens up many investments opportunities for you. One of my biggest gripes about 401k plans is there lack of choices, and poor disclosure of fees and expenses. If you can take this money out, you can decide where to invest it and what kinds of fees you are comfortable paying. 401k plans are limited in what they can offer you as far as investing, but on your own, you have unlimited choices. One common fear is that once you pull this money out, you will be subject to taxes and a penalty. Not so, if you plan properly. When your 401k people process your request for this distribution, you let them know which investment company or brokerage account custodian to make the check payable to. You never touch the money and it is moved easily into an IRA with a company of your choosing. If you take the money yourself, you have 60 days to invest the money in an IRA, and you will avoid the penalty and taxes. This second method is far more of a pain then it is worth. Just have your company cut the check to where the money is going in the first place and save yourself the hassle.

Utilizing this provision in your retirement plan, can give you and your advisor much more flexibility in designing the best plan for you. Whenever I come across a new client (especially executives) who have almost all of their investments tied up in 401k plans and company stock, I check for the in-service withdrawal. It is one of the only ways to free up some of this money and get proper diversification for the client. This little known tool may work well for you as well. Another use for this tool is to start taking income payments from your 401k while you are still working. This isn’t used often, but in-service withdrawals used in conjunction with IRS rule 72(t) can provide penalty free income payments from a portion of your 401k, while you are still working at the company and are enrolled in your 401k plan. For more advice on any of these techniques, please feel free to contact my office. Until next time, Happy Investing.