Author: Andrea Clark, CFP®, AFC®

Categories
Financial Planning

Side Hustle or Contractor Retirement Savings Options

You've got Retirement Savings Options. Picture of Notebook with 3 sticky notes IRA, 401K, and Roth written on them.

Side Hustle or Contractor – You have options!  Retirement savings options, that is.

Technology and post-Covid acceptance of remote work has created more opportunity than ever for military spouses to be gainfully employed.  PCS’ing to Germany?  Keep your job, work modified hours, and collect a tax-advantaged US-based salary.

Others are staying in the same industry, becoming 1099 contractors, and taking their skills and career with them when they move.  In other cases, we see transitioning service members and spouses opt for side gigs instead of traditional employment because of the flexibility it offers.  Often these “self-employed” opportunities generate very respectable income.  The additional income can fatten (early) retirement coffers, but can also leave folks hit by a surprise self-employment tax bill.

So what to do?

There are always pre-tax Traditional IRAs, but the contribution limits are so…limiting.  At certain income levels, you won’t even be able to deduct those contributions.

Enter the Individual 401k, SEP-IRA, or SIMPLE-IRA as retirement savings options.

Most know about the TSP and employer 401k tax advantages to reduce taxable income.  Contribute $22,500 ($30,000 if over 50)  and that same amount comes off your taxable income for the year.  For a two-income household, this could save $10,000+ at tax filing time.  However, if you have self-employed income, you need to know about these other plans.

What is an Independent 401k or SEP-IRA or SIMPLE-IRA?

Anyone with self-employment income (1099 contract work counts) who has no W-2 employees is eligible to open an Individual 401k.  The contribution limits for you as the employee are the same for anyone else contributing to a 401k:  100% of your earned income up to $22,500 if you are under 50, and an additional catch-up of $7,500 for a total of $30,000 if you are over 50.

Then things get interesting. As the employer, you may also contribute an additional 25% of your earned income (S Corp or LLC), or 20% of adjusted income if you are a sole proprietor. The combined total cannot exceed $66,000 if under 50 or $73,500 if over 50. You can make Roth contributions, too, if you are willing to pay the tax bill now. You can see how contributions as both the employee and the employer can add up fast.

The SEP-IRA (Self-employed Individual Retirement Account) is an alternative solution if you have W-2 employees, but it is limited to only employer contributions (see some exceptions) that must be made in equal percentages of salary for yourself and all employees.  Thanks to the Secure Act 2.0 in 2023, SEP-IRA plans will allow Roth contributions starting in 2024.  Both Individual 401k and SEP-IRA contributions can be made until your tax filing deadline.

If you own a business and have W-2 employees, you also have the option of a SIMPLE-IRA.  The rules are a little more specific for these plans.  See the link in the SIMPLE column below.

What’s the difference between the two?

The table below illustrates the major differences between the three plans mentioned above.

Individual401k SEP-IRA SIMPLE-IRA
Max employee contributions 100% of income, up to $22,500*

100% of income, up to $30,000**

 None, with some exceptions 100% of income, up to$15,500*

100% of income, up to $19,000**
Max employer contributions As much as 25% of net income up to annual additions limit The lesser of 25% of income  or $66,000 3% matching, or 2% non-elective
Max annual total contributions (employer and employee) $66,000*

$73,500**

 $66,000*

$73,500**

 See link above
ROTH contributions allowed YES Starting in 2024 Starting in 2024
Employees allowed No (exception = spouse) Yes Yes, up to 100
Deadline for opening account Dec 31 of tax filing year Tax filing deadline for your business Oct 1 of tax filing year

*under 50 years of age
**50 years of age or older

This calculator is also handy for seeing the differences in which plan to choose based on maximizing retirement contributions for your specific situation.

Retirement Savings Options Examples

Example 1 — Self-employed with no other employer-sponsored plan:

Sue is a 1099 contractor working from home for a big insurance company.  As a “sole proprietor”, she made $80,000 in 2022 and had only $2,000 in deductible expenses.  She is required to pay $11,934 in FICA payroll taxes (15.3% for SS and Medicare).

She contacts her MFAA financial planner about saving for retirement to save on taxes.  Her advisor helps her open an Individual 401k to which she contributes $22,500 (Sue is age 38) as her employee contributions, plus another $14,498 as employer contributions for a total of $36,998 in retirement savings for 2023.

She and her spouse are in the 22% federal marginal tax rate; Sue’s state tax rate is 3.5%.  The household will save $9,434 on its 2023 tax bill.

Example 2 — Having an employer-sponsored plan AND an Individual401k:

Sue’s spouse John decides to join her in the contract work after retiring from the military.  John can make contributions to the Individual401k under the same business tax ID number.  John makes $40,000 after retiring in July.  Self-employment taxes are $6,120; there are no additional deductible business expenses.

John had contributed $12,000 to his TSP account before retirement, and he is under 50 years old.  He can contribute another $10,500 to his Individual401k as the employee and approximately $7,000 as the employer.

Example 3 — Hiring employees who are 1099 contractors

Sue & John have more contract work than they want to handle after military retirement.  They hire two military spouses to work part-time virtually with them.  The two new hires are 1099 contractors for Sue & John.  Sue & John can continue to use their Individual401k.  They encourage both of their contractors to save for retirement in their own Individual401k.

Example 4 — Hiring employees who become W-2 employees

Business continues to boom.  Sue & John decide to make everyone a full-time W-2 employee.  The business now pays half the payroll taxes for both Sue & John and the two employees.  Because of this change of having W-2 employees, Sue & John can no longer contribute to their Individual401k.  They can either switch to a SEP-IRA or a SIMPLE-IRA.  Item of note:  you can offer and contribute to both a SEP-IRA and 401(k) in the same tax year, but the same is not true for a SIMPLE and another plan.  More details can be found on the IRS website.

How Do I Decide? What’s Next?

If the self-employment income is just you, or you and your spouse, the Individual401k will give you the most capacity to save for retirement.  If you need a plan for you and your employees, consider the SEP-IRA or SIMPLE-IRA.  Consult your tax professional for definitive advice for your situation.  Need more help understanding your retirement savings options and deciding which is right for you?  Reach out and connect with an advisor at the Military Financial Advisors Association!

 

Categories
Investing Taxes

New Year IRA Tips

New Year IRA Tips

New Year IRA Tips

Still want to save for retirement in 2022? You can!

Wait, what?  Did you say I can still save for retirement last year?

Maybe you arrived in January 2023 feeling like you didn’t make good on your 2022 goal to save more for retirement.  It was a rough year and keeping cash in the bank probably made a lot of sense while the economy did what it did in 2022.  Maybe you always had the cash, but you just didn’t have the discipline.  Or maybe you only just now have the cash and wish you could go back in time to contribute.  I have some good news for you:  you can still make annual retirement contributions to the 2022 bucket, in some cases even tax-deductible ones!

Am I too late to make a retirement contribution for 2022?

The good news:  you are not too late to contribute to your IRA for the 2022 tax year.  You may continue to contribute up to the annual maximum of $6,000 per year ($7,000 if over age 50) until the tax filing deadline [Monday, April 18, 2023].  This limit applies regardless of how much you have contributed to your employer-sponsored plan such as TSP, 401(k), 403(b), SIMPLE, and SEP-IRA.

The bad news:  Your employer-sponsored plan contributions for the 2022 tax year are over.  The deadline for annual contributions to your employer-sponsored retirement savings plan is always December 31 of the year.  Your employee contribution to these types of plans must come directly from your paycheck each month.  You cannot write a check or initiate a transfer from your bank account to be deposited into an employer-sponsored plan.  This means any deductions from your pay toward those accounts after January 1st of the new year are now counting toward the new year’s limit.  TSP, 401k, and 403b accounts have a new annual limit for 2023: $22,500 per person and an extra $7,500 “catch-up contribution” for those over age 50 ($30,000 total).  For a SIMPLE account, the limits are $15,500 (under 50) and $19,000 (50 & over).

How do I make sure my contribution will count for 2022 if it is already 2023?

Nearly every investment custodian has provisions for designating the tax year for your contribution during this “in-between time” when two years are possible.  When you sign-in to an online account to contribute, you should see both the 2022 and 2023 tax years listed, along with your allowable contribution based on age and the amount you have contributed so far to each of those tax years.

For instance, Captain Sue Savemore is 30-years-old and made an $800 contribution to her Roth IRA in June 2022.  When she logs in to her online account information, it says she can still contribute $5,200 for 2022 ($6,000 – $800) and the full $6,500 for 2023.

There will be a place to designate which tax year and how much she wants to contribute.   She would enter the amount she wants to contribute in the space for the 2022 tax year, up to the available remaining limit for 2022.  If she wanted to contribute more than $5,200, she would need to enter any further amount as a 2023 contribution.

So, if Captain Sue Savemore has $7,000 sitting in her bank account and wants that full sum to go to IRA contributions, she would put $5,200 in the designated space for the 2022 contribution and $1,800 in the designated space for 2023 contribution.

Why do I want to make a 2022 IRA contribution now?

You may be asking yourself why you would want to make 2022 contributions instead of 2023, especially if you are someone who does not typically “max out” their IRA each year.  Filling up the bucket whose window of opportunity is closing (2022) preserves your full capacity to save in the bucket that has the longer window of opportunity (2023).

Consider these scenarios:

  1. You or your spouse have a job where you regularly “max out” your employer’s plan (make the maximum allowable contributions as listed above).  You know and appreciate the value of saving early for retirement.  However, you do not have enough cash flow to also max out your IRA each year.  Then you find yourself leaving a job in 2022 and moving to an employer who does not have a retirement savings plan.  By contributing to the 2023 IRA right now and leaving the 2022 bucket unfilled, you have just robbed yourself of some of your capacity to save.
  2. You may find yourself in a situation with an unexpected raise or bonus or other windfall later in 2023 and want to earmark it all for playing catch-up with retirement savings.  Again, if you leave your 2022 bucket less than full and start using up the capacity in your 2023 bucket, you just shorted yourself on that opportunity.

Does it matter if the contribution is Roth or Traditional?

The remaining 2022 contribution amount can be either Roth or Traditional, no matter what you may have already contributed in 2022.  The annual limit applies only to the total IRA contributions, not the tax treatment of the contribution.  Back to our example using Captain Sue Savemore:  if she should decide she wants to make the remaining 2022 contribution of $5,200 to a Traditional IRA, that is perfectly OK.  If she did not already have a Traditional IRA account, she could open one and fund it before the tax deadline and it would still count for the 2022 tax year.  Her combined contribution for 2022 would be $800 Roth + $5,200 Traditional = $6,000 annual limit.

How do I choose between Roth to Traditional contributions?

One of the beauties of making an IRA contribution late in the tax year is that you have a better sense of your tax scenario for that year.  Choosing between Traditional or Roth tax treatment most often depends on your expected marginal tax rate.  [if you need a quick primer on this, see this video from a recent Military Saves campaign, produced by yours truly].

However, there are two more decision points to consider when making IRA contributions:  (1) whether or not you are covered by an employer’s plan, and (2) what you modified adjusted gross income (modified AGI) is expected to be.

First, let’s define “modified AGI”.  This definition can be found on the IRS website:

“For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for student loan interest.”

This means that for most military families, if your income has stayed more or less the same in 2022 as it was in 2021, look back at your 2021 tax return, line 11 and add in any amount found on Schedule 1, line 21 to get a rough guess on your modified AGI.  You can take a look at your 2022 W-2(s), add interest, and do a quick calculation of your modified AGI using this free 1040 tax calculation tool found on the Office of Financial Readiness website – a great educational resource for servicemembers on a whole host of financial topics.

If you are COVERED by an employer sponsored plan, your ability to make a tax-deductible Traditional IRA contribution is limited.  Being “covered” is not the same at “participating”.  Every servicemember is covered by an employer plan (TSP), whether they have ever contributed any money or not.  If you are covered, then these covered employee IRS limits will tell you if your contribution is deductible.

Looking back at the example of Captain Sue Savemore:  In 2022, Sue is a “single” tax filing status.  With eight years of service as an O-3, her taxable income for 2022 was $81,684.  This puts her above the limit for single taxpayer ($78,000 MAGI) and unable to make a tax-deductible Traditional IRA contribution, even if she did not contribute a single dollar to TSP.

So now you are thinking, “well, just make a Roth contribution instead, since Roth contributions are not tax deductible anyway.” This would be an equivalent tax situation, and Roth contributions are not limited by coverage under an employer plan.  The only limit on Roth contributions would be her MAGI.  Thankfully, that MAGI limit is higher for single Sue ($129,000 for 2022), and she could indeed make the full Roth contribution for 2022.

But what if Sue had gotten married and were “married filing jointly” tax status for 2022?  And what if she were marrying Barry Businessman, who separated from service in 2021 and had almost no income in his new business in 2022?  Maybe Sue and Barry could use a little more cash flow right now but still want to save for retirement.  Even though Sue is still covered by an employer plan, the deductible IRA contribution limit for married filing jointly is much higher, $109,000.  And the good news for Barry is for some time to come, he will be able to make tax-deductible contributions due to different IRS limits for those who are NOT covered by an employer plan.

But what if these IRS limits exclude us from ANY kind of IRA contribution?

Is there some loophole?  I really want to save more!  (this is music to any CFP’s ears)

Yes, there is a little loophole called a Backdoor Roth IRA.  If you are seeking to create more tax-free income in retirement but are a high-income earner with limited means of doing so, this could be a good strategy.  The simplest explanation of the process is:

  1. Make a non-deductible 2022 contribution to a Traditional IRA account.  This contribution should be reported in your 2022 tax return on Form 8606.  There is no MAGI limit or employer plan limitation for NON-DEDUCTIBLE contributions.
  2. Do a “Roth conversion” of the contribution.  A Roth conversionrefers to taking all or part of the balance of an existing traditional IRA and moving it into a Roth IRA.  This could be a taxable event if you have a balance in the Traditional IRA from previous deductible
  3. The IRA custodian will report the “recharacterization” on form 1099-R for the 2023 tax year.
  4. When you file your 2023 taxes, you will include the information from the 1099-R on good ole Form 8606 again.

NOTE:  this is an extremely simplified explanation of the Backdoor Roth.  Please discuss this option with your tax pro and/or financial planner before taking any action.

Whew, many details, lots of things to consider! If you need to talk this over with a financial professional, please check out the list of MFAA professionals on the website.

Happy savings!

Categories
GI Bill

Maximize Your Post-9/11 GI Bill Benefits

Maximize your 9-11 GI Bill Benefits

Maximize Your Post-9/11 GI Bill Benefits

The Post-9/11 GI Bill offers potentially the most valuable and flexible VA educational benefits to date. Eligibility extends across all service statuses – Active Duty, Guard, and Reserve.  Servicemembers who have already earned a college degree as part of their military service still qualify for use of the Post-9/11 benefits.  Even better, this educational opportunity can be transferred to the servicemember’s dependents, rewarding the sacrifices made by military families in supporting the mission.

The Post-9/11 Veterans Educational Assistance Act of 2008 created one of the biggest sweeping changing to military education benefits with the Post-9/11 GI Bill since the original GI Bill was created by President Franklin D. Roosevelt in 1944. The Post-9/11 GI Bill provides up to 100% of education, housing, and fees for college education over 36 months (academic months) and can also be used for certain licensing and certification tests as well.

Veterans who have served at least 90 days of active duty service after September 10, 2001 and received an honorable discharge will qualify for the Post-9/11 GI Bill. To qualify for the full benefit, a veteran must have served at least 3 years of active duty after September 10, 2001. Those who qualify for the Active Duty GI Bill or the Reserve GI Bill will have the option to choose which benefit best suits their need.

Also note that the Harry W. Colmery Veterans Educational Assistance Act of 2017, “Forever GI Bill,” changed many aspects of the Post-9/11 GI Bill, some of which went into effect immediately and others on a rolling basis.

We at MFAA want you to know and understand some of the important planning considerations surrounding the use of this military benefit.  Here are the major details of the benefit, followed by our Top 10 planning considerations when using the Post-9/11 GI Bill benefits.

Eligibility:

  • Active duty members: served at least 90 days after September 10, 2001.
  • Guard and Reserve members: served 90 days after September 10, 2001 on Title 10 orders (federal service).
  • Spouse and children: servicemember can elect to transfer credit to a spouse after six years for immediate use and to children after six years of service for use after serving another 4 years (use begins at 10 years of service).
  • Addition to Montgomery GI Bill (MGIB): Service members who have previously used 100% of entitlement under the MGIB can qualify for 12 months of Post-9/11 Benefits. If you have not exhausted your MGIB entitlement, you can switch from the MGIB benefits.

What is covered (if you are at least a half-time student):

  • Tuition and fees: up to 100% for in-state, public institution. Private and foreign school reimbursement is capped at $25,162.14 per year. Exceptions apply at Yellow Ribbon schools.  [see below]
  • Qualifying programs: 2- and 4-year colleges and universities, apprenticeships, on-the-job training programs, vocational flight training, correspondence schools, national testing programs, and licensing and certification testing. You can use this VA Institution Search Tool to verify the educational institution’s eligibility.
  • Monthly BAH: rate based on E-5 with dependents for zip code of location of institution.  This is paid directly to the beneficiary, not the educational institution.  If the program is all online If the benefits are used by the service member or the spouse while still on active duty, no BAH is paid.  In other words, no double dipping on BAH.
  • Book stipend: $1000 per academic year for 4 years, paid to the beneficiary on a quarterly basis.
  • Yellow Ribbon Programs: If the service member has 100% eligibility for the Post-9/11 benefit, a YRP school offers extended benefits.  The tuition and fees exceeding the normal maximum payment is split between the school and the VA.  Active duty servicemembers and spouses are not eligible for this program. Due to specific agreements that the VA has with each school that participates in the Yellow Ribbon Program, check with the VA for the most current criteria. You can learn more about this important boost to the Post-9/11 benefit HERE.

Example:  your child attends an out-of-state pubic institution whose tuition and fees are $8,000 per year more than your state’s public institution.  If the out-of-state school participates in the YRP, the institution will cover $4,000 of the excess tuition and the VA will cover the remaining $4,000.

  • Relocation Allowance: For servicemembers in rural areas, there is also a $500 one-time benefit if they must relocate or travel by air to the nearest school.

Determining full-time or half-time student status

Undergraduate classes training time is determined this way. If 12 credits are considered full-time, a course load of 6 credits yields a training time of 50% (6 ÷ 12 = .50), whereas a course load of 7 credits yields a training time of 58% (7 ÷ 12 = .58). In this scenario, a student would need to enroll for at least 7 credits (such as two 3-credit classes and a 1-credit lab) in order to receive the housing allowance benefits.

For graduate training, the VA will pay benefits based on what the school reports full training time to be. So, if a student is taking 3 graduate hours and the school tells the VA that is considered a full-time student, the VA will pay at the full-time rate.

Once the training time is determined, the monthly housing allowance is paid at the nearest 10% level. For instance, if a student’s training time is determined to be 58% as calculated above, that student will be paid 60% of the applicable housing allowance. If student training time is calculated to be 84%, the VA will pay 80% of the applicable housing allowance.

Earning the Full 9/11 GI Bill Eligibility

The payment rate depends on how much active duty time the servicemember has. Purple Heart recipients, regardless of length of service, are qualified for Post-9/11 benefits at the 100% level. The vast majority of servicemembers must have completed 36 months of active duty service to qualify for 100% of Post-9/11 GI Bill benefits, but there is a sliding scale shown in the chart below.

 Member ServesPercentage of Maximum Benefit Payable
At least 36 months

100%

At least 30 continuous days on active duty and must be discharged due to service-connected disability

100%

At least 30 months, but less than 36 months

90%

At least 24 months, but less than 30 months

80%

At least 18 months, but less than 24 months

70%

At least 12 months, but less than 18 months

60%

At least 06 months, but less than 12 months

50%

At least 90 days, but less than 6 months

40%

Note that time served towards earning Post-9/11 GI Bill benefits is AFTER completing military service as payback for other military education benefits like student loan repayment, ROTC scholarships, and Service Academy commitments.

To utilize the Post-9/11 GI Bill benefits for college, servicemembers must pursue an education at an accredited institution that grants college degree. It can be used for all post-graduate degrees: from an associates degree and a bachelors degree to a masters degree and doctorate degree.

Post-9/11 GI Bill Approved Training and Assistance

Servicemembers released from active duty before January 1, 2013 have a 15-year time limitation for use of benefits.  For individuals whose last discharge date is on or after January 1, 2013, the time limitation has been removed.

There are other changes associated with the Forever GI Bill that are being phased in over time so students should review updates from the VA.

GI Bill Comparison Tool

The VA offers a helpful GI Bill Comparison Tool to help show which education program and school are best based on different criteria.

 Applying for the Post-9/11 GI Bill?

Servicemembers can submit an application through the Veterans ON-line Application (VONAPP) Website. Or, call 888-GI-BILL-1 and ask to have the form (VA Form 22-1990) mailed.

Top 10 Planning Considerations:

  1. Transfer at least one credit as soon as eligible. You MUST transfer credits while on active duty before reaching 16 years of service and have 4 years of retainability.  You can always add or subtract entitlement after you get out. But, if you don’t transfer at least one month of benefit entitlement to your dependent, you are out of luck.  You won’t be able to add them later.
  2. Online-only study may be common this academic year. In this case, the BAH rate is a flat $916.50 per month regardless of location.
  3. The GI Bill is not just for the standard 4-year college degree. Many other programs are covered.  Be sure to use the institutional search tool.
  4. You may feel like you are losing part of the benefit by not receiving BAH if you are still on active duty. However, that may be the best time to use the benefit to increase earning potential for when you retire or separate from the military.
  5. If you have more than one dependent who may use the benefit, consider reimbursement rates in different states and at different institutions. One dependent may attend the less expensive local community college program vs another at the private university in high BAH zip code.  The overall value to the family may be dramatically different.
  6. BAH is paid directly to the family and can be saved and invested for the benefit of another dependent. Low interest federal loans will still be available for room and board expenses to the dependent currently using the VA benefit.  This strategy could still be an equitable distribution among siblings while requiring some “skin in the game”.
  7. Contact the financial aid office at the institution as early as possible. Very often there is a dedicated military benefits coordinator; ask when you call.  Some Yellow Ribbon schools only provide the extra benefit to a set number of students on a first-come, first-served basis.
  8. Always fill out the FASFA and other required institutional financial aid forms, even if you think you will use the VA benefits. When more than one family member is attending college at the same time, your overall family financial need will be greater and you may receive general financial aid.  It may pay to “turn off” the VA benefits during that time. Example:  Oldest child uses two years of VA benefit.  Younger sibling starts college and for two years they both qualify for greater institutional aid because the family demonstrates more “need”; benefits are turned “off”.  Oldest graduates while younger sibling finishes last two years using VA benefits.
  9. Benefit usage is counted by the day, not by the month. Breaks between terms are not counted.  If you attend a school on a trimester or quarter schedule (more term breaks), this may lead to using less of the benefit compared to traditional semesters.  In some case, the 36 months of benefits could stretch out closer to five “traditional” years of college.  The beneficiary currently using the benefit will receive the accounting statements for what is used and what remains.
  10. Use of Post-9/11 GI Bill benefits does limit the tax credits you can claim for post-secondary education. Be sure to talk with your tax professional about balancing these two tax planning scenarios.

Contact any MFAA planner to talk about how this benefit can be used to your family’s greatest advantage.

You earned it!