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Federal Employees News Digest : Feb. 18, 2013
February 18, 2013 Vol. 62, No. 29 7 Visit us on the Internet at www.FederalDaily.com The Feb. 4 Informed Investor discussed new Medicare taxes that resulted from passage of the Patient Protection and Affordable Care Act of 2010. These taxes, which took effect Jan. 1, 2013, include an additional 0.9 percent Medicare hos- pital insurance (HI) tax on earned income and a 3.8 percent Medicare surtax that is imposed on net investment (NI) income. NI income includes taxable interest, dividends, capital gains, rental income and royalties that are generated within a non-retirement account such as a savings account held at a bank or at a credit union. The 3.8 percent surtax is in addition to the regular tax paid on NI income. This column dis- cusses what employees---particularly those with high incomes---should do to avoid the 3.8 percent surtax during 2013 and in future years. The 3.8 percent surtax affects only single individuals with modified adjusted gross incomes (MAGI) exceeding $200,000 and married individuals filing jointly with MAGI exceeding $250,000 ($125,000 for married individuals filing separate). MAGI is one's adjusted gross income plus any excluded foreign earned income. The 3.8 percent surtax is imposed on the lesser of NI income or the amount of MAGI exceeding the applicable MAGI threshold. Individuals with MAGIs below the MAGI thresholds will therefore not be subject to the 3.8 percent surtax. Employees may anticipate that their income will never approach the $200,000/$250,000 MAGI thresholds and they will not be affected by the surtax. But included in one's MAGI are capital gains, the transfer of traditional Thrift Savings Plan (TSP) funds to a Roth IRA and traditional TSP distributions. Also included is income resulting from Roth IRA conversions. Consider the fol- lowing three examples to illustrate how certain financial transac- tions could increase one's MAGI past the MAGI thresholds. Example 1. Jeff is a single employee with a total income dur- ing 2012 of $140,000. The $140,000 total income includes Jeff 's salary, taxable interest, dividends and rental income. Jeff does not anticipate any change in his income during 2013. Jeff 's invest- ments include 1,000 shares of XYZ stock that was gifted to Jeff by his father. The cost basis of the 1,000 shares is $3,000. The current value of the XYZ stock is $75,000. At the urging of Jeff 's financial advisor, Jeff sells all of the XYZ stock and incurs a capital gain equal to $75,000 less $3,000, or $72,000. Jeff 's total income for 2013 will now increase to $212,000 and Jeff 's NI income will be subject to the 3.8 percent surtax. Example 2. Joan is a married federal employee. During 2013, Joan and her husband John will have a total income of $220,000, including $20,000 of NI income. Since Joan and John's total income is $30,000 below the threshold of $250,000, they are not concerned about the 3.8 percent Medicare surtax. But suppose Joan owns a $100,000 traditional IRA that she converts to a Roth IRA during 2013. Even though their NI income is unchanged, Joan and John now have $320,000 of total income resulting in their exceeding the MAGI threshold by $70,000. This cre- ates a surtax of 3.8 percent of $20,000 or $760. Example 3. Frank, age 68, is a single employee with a combined $900,000 in his traditional TSP and other pension plans, including traditional IRAs. By the time Frank reaches age 70.5 and has retired from federal service, his combined pension plan and IRA balances are expected to be $1.2 million. At that time, Frank will be required to make minimum required distributions (MRDs) from his pension plans and IRAs equal to $1.2 million divided by his life expectancy of 27.4 years, or $43,796. This means that Frank will need to with- draw and add to his income $43,796. If Frank's other income is more than $156,204, his NI will be subject to the Medicare surtax. To avoid being subject to the surtax, Frank can convert his pension plan and traditional IRA to Roth IRAs and transfer his traditional TSP to a Roth IRA when he retires from federal service, prior to reaching age 70.5. In this way, Frank will avoid having to take MRDs from his traditional TSP, other pension plans and tradi- tional IRAs starting when he is age 70.5. One potential problem associated with converting a tradition- al IRA to a Roth IRA is the reluctance of the IRA owner to "pay the tax sooner than later." For example, converting a $400,000 traditional IRA to a Roth IRA would result in a $140,000 federal income tax liability for an IRA owner in a 35 percent tax bracket. Of course, a Roth IRA conversion may not be suitable for every employee. But it is something any employee with a large tradi- tional IRA or TSP account who in the future may be close to the $200,000/$250,000 MAGI thresholds should consider. Planning to avoid the Medicare surtax is particularly impor- tant for employees who expect to retire during the next five to 10 years and who will be receiving CSRS or FERS annuities, tradi- tional TSP distributions or Social Security benefits, and who may be selling capital assets held outside of retirement accounts, all of which could significantly increase their MAGI. Edward A. Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, MD. He is also a registered representative with FSC Securities Corporation, branch address: 833 Bromley St. - Suite A, Silver Spring, MD 20902. Phone: (301) 681-1652. Securities offered through FSC Securities Corporation,member FINRA/SIPC. EZ Accounting and Financial Services and FSC are independent companies. Informed Investor Strategies to avoid the new Medicare surtax
Feb. 11, 2013
Feb. 25, 2013