Happy Birthday -But watch out!
Watch Out for Age-Sensitive Tax Rules
CERTAIN AGES ARE milestones in the trajectory of one's life. There's age 16 (driver's license); age 21 (legal drinking age); age 50 (senior discount card from AARP) and so on. Now, chances are you don't view your progressing age in terms of tax milestones. (If you do, you may want to seek some help, or consider an exciting career as a CPA.) But fact is, as you get older there are certain tax code provisions you should be aware of.
Here's an overview of age-sensitive tax issues:
Age 18: The Kiddie Tax rules cease to apply to a dependent child's unearned income (typically meaning investment income), starting with the year the child turns 18. For earlier years, a dependent child's unearned income in excess of the applicable annual threshold is taxed at the parent's marginal federal rate (which can be as high as 35%). For 2007, the threshold is $1,700 (same as for 2006). The good news is that a dependent child's unearned income below the threshold is taxed at more favorable rates (usually no more than 10% or 15%). For more on the Kiddie Tax, click here.
Age 18 or 21: A custodial account set up for your minor child will come under the child's control when he or she reaches the local age of majority (generally, 18 or 21 depending on your state of residence). Custodial accounts are also known as UGMA (Uniform Gifts to Minors) accounts and UTMA (Uniform Transfers to Minors) accounts.
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 CESA distribution are not used for qualified education expenses, they are subject to federal income tax plus a 10% penalty. Alternatively, you can roll over the CESA account balance into another CESA account set up for a younger family member. For more on these accounts, click here.
Age 50: If you're 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 $5,000 for 2007), Section 403(b) tax deferred annuity plan (up to $5,000 for 2007), governmental Section 457 plan (up to $5,000 for 2007), or SIMPLE plan (up to $2,500 for 2007). This assumes your plan permits catch-up contributions. You can also make an additional catch-up contribution (up to $1,000 for 2007; ditto for 2006) to a traditional IRA or Roth IRA. For more on 401(k)s and IRAs, see our retirement section.
Age 55: If you permanently leave your job for any reason, you can receive distributions from your former employer's qualified retirement plan(s) without being socked with the 10% premature withdrawal penalty tax. This is an exception to the general rule that distributions received before age 59 1/2 are hit with a 10% penalty.
Age 59 1/2: You can receive distributions from all types of tax-favored retirement plans and accounts (IRAs, 401(k)s, pensions, and the like) and from tax-deferred annuities without being socked with the 10% premature withdrawal penalty tax.
Age 62: You can start receiving Social Security benefits. However, your benefits will be lower than if you wait until reaching full retirement age (see immediately below). If you also work before reaching full retirement age, your Social Security benefits will be further reduced if your income from working exceeds $12,960 (for 2007). In the year you reach full retirement age, a higher earnings threshold applies. For instance, if you reach full retirement age in 2007, your benefits will be reduced only if this year's earnings exceed $34,440. Beware: Depending on your income from other sources, up to 85% of your Social Security benefits may be taxed.
Age 65 and Change: You can start receiving full Social Security benefits. If you were born in 1941, the magic age is 65 years and eight months. If you were born in 1942, it's 65 years and 10 months. If you were born in 1943-1954, it's an even 66. You won't lose any benefits if you work in years after the year you reach full retirement age, regardless of how much money you make in those years. Beware: Depending on your income from other sources, up to 85% of your Social Security benefits may be taxed.
Age 70: You can choose to postpone receiving Social Security benefits until after reaching age 70. If you make this choice, your benefit payments will be higher than if you start earlier. Beware: Depending on your income from other sources, up to 85% of your Social Security benefits may be taxed (you get no break under the tax rules just because you're well-seasoned).
Age 70 1/2: You generally must begin taking annual required minimum withdrawals from your 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 such mandatory withdrawals from your Roth IRA.)
The initial required minimum withdrawal is for the year you turn 70 1/2, but you can postpone taking that payout until as late as April 1 of the following year. If you chose that option, however, you must take two required minimum withdrawals in that following year (one by April 1, which is the one for the previous year) plus another by Dec. 31 (which is the one for the current year). Beware: If you turned 70 1/2 last year and did not take your initial required minimum withdrawal last year, you face the April 1 deadline this year. For each subsequent year, you must take your required minimum withdrawal by Dec. 31. There's one more exception. If you're still working after reaching age 70 1/2, and you don't own over 5% of the business that employs you, the tax law allows you to postpone taking any required minimum withdrawals from that employer's plan(s) until you after you've retired.
Please don't think you can choose to ignore the required minimum withdrawal rules without dire consequences. The IRS can assess a penalty tax equal to 50% of the shortfall between the amount that you should have withdrawn for the year and the amount that you actually took out.