 Income tax 2022-2023, pensions and annuities. Let's do some wealth preservation with some tax preparation. Most of this information comes from the Form 1040 Instructions Tax Year 2022 Line Instructions. You can find the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're still focused on Line 1, that being income. Remembering that the first half of the income tax formula is in essence an income statement. A strange one, however, where we have income up top. We've got the equivalent of expenses being deductions to get down to the equivalent of net income, that being taxable income. Our goal to get taxable income as low as possible, and therefore when focused on the income line, we're looking at different things and seeing whether or not it is income. And if it is, is it something that we have to include as taxable income? When we look at the actual tax form, we're focused down here on Line 5, where we have the pension and annuities. We have the taxable amount and the A and B on the form. We'll take a look at the forms in more detail in a future presentation. When we look at the form given to us to report the income, it'll typically be a 1099R. Now remember, this is similar to what we saw with the IRA site. Support accounting instruction by clicking the link below, giving you a free membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it of things in that the government's going to be trying to incentivize. This is why it's important to kind of understand the rationale for the law, because it'll be easier to memorize what is going on if you can think about what the government is basically trying to do. And that is they're trying to incentivize us to say for retirement, the idea being that people are usually good at short term decision making, but not so good at the long term decision making. And therefore the IRS is going to try to nudge us through the tax code to get us to behave the way they want us to, basically, because and that means they're going to try to get us to give a tax benefit at the point in time. We put the money in to some kind of retirement plan. And then when we take it out, we might have a taxable event at that point in time. Now they often have the leverage on the employers, remember, because they're the people that are going to be paying the employees and they have the deduction side of the transaction. So oftentimes in this situation, it would be a benefit kind of program. They could have tax implications for us if we are, say, an employee. So the employer might have a 401k plan or a 403B plan or something like that. And we're going to take our money and put it into that plan. And in so doing, when we put the money in, there's going to be a reduction to the line one on the W2 form, typically. And therefore we will not be paying taxes on it because it was basically removed from income on the W2 form when we put the money in. If we don't have a 401k plan with the work, then we might go to the IRA. That's when we go to the IRA. And that's when we can't reduce the income line on the W2, but rather we take kind of a similar kind of technique with an above the line deduction. So we'll talk more about that in future presentations. Right now we're focusing in on the distribution, taking the money out of the retirement plan. Now note that a retirement plan is not something that the government like invented some new tool that you use for investments. The government isn't good at creating investment tools, right? What the government's going to do is say, we're not going to hit you when you put the money into the investment tools, meaning we're going to give you a tax break. If you use your investment tools, the normal tools, putting money into like a mutual fund, stocks and bonds typically. But it's going to go under the umbrella of an IRA. So all they're doing to say, now I put it under the umbrella of an IRA using the same investment tools, you probably would have invested in anyways, even if there wasn't any kind of incentive to do so that would be tax incentive. And then they're going to give you this tax benefit when you put the money in, and then when you take the money out, that's when you're going to get hit possibly with the tax and possibly with the penalties and interest. Now remember, the only reason you would put it under the umbrella of a 401k plan is because of the tax benefit, because you are restricting your money by putting it in there, because that means that you can't take the money out unless you want to get hit with a penalty. No penalty! So you can only take the money out under certain conditions that typically being once you're in retirement age so that you're not going to be hit with the penalty. So we would expect older people to typically have more of these Form 1099Rs representing their income because they're past their working years. We would expect then to have the amounts be taxable but have a distribution code that would be a normal distribution so we wouldn't be penalized. If it was taken out early, then you might have a distribution code indicating that you're going to be penalized for taking it out. The distribution codes are here, which you can see on the actual form of the 1099R and the instructions related to it, or the back of the form typically, where you can look it up the IRS website when you look at the form. Okay, given that, lines 5A and 5B, pension and annuities. So you should receive a Form 1099R showing the total amount of your pension and annuity payments before income tax or other deductions were withheld. This amount should be shown in box 1 of Form 1099R. Pension and annuity payments include distributions from 401K plan, 403B plan. The 401K is a typical plan for a business and the 403B often for government type of entities, public sector areas. Government 457 plans as well. So rollover lump sum distributions are explained later. So in other words, what if, for example, you were at one job and you had a 401K plan and then you went to another job? Well, then you have this issue of do I want to keep my money in that 401K plan or do I need to pull it out? I don't want to pull it out because I'm going to get hit with penalties. Therefore you might roll it over in which case you would have something in box 1 typically and then not something in box 2. And the distribution code, I believe would be a G indicating a rollover of some kind. So that would be very important otherwise. And this happens to some people. They just pull the money out because they're going to a new job and they just pull out all this money and then get hit not only with taxes on it, but a 10% like penalty as well. So you want to avoid doing that. So rollovers and lump sum distributions are explained later. Don't include the following payments online 5A and 5B instead report them online 1H. Disability pension received before you reach the minimum retirement age set by your employer. Corrective distributions including any earnings of excess elective deferrals or other excess contributions to retirement plans. The plan must advise you of the years the distributions are includeable in income. So when we look at the distributions, it's going to become important in terms of which year the distributions should be allocated to in terms of the income for the proper year getting the cutoff dates correct. Tip, attach forms 1099R to form 1040 or 1040SR. So the 1040 the normal form 1040SR when you're over like in the retirement years. So if any federal income tax was withheld. State tax, federal tax, social security tax. Note that these forms are kind of similar to the W-2s and that well with it when you're working years the W-2 forms going to be the one that likely you're going to have the withholdings with. If you're beyond the working years, a lot of your income that you're living on is going to be from investments, but they're usually oftentimes still subject to tax because they're coming out of a 401K or IRA. And therefore you might set up withholdings when you get those distributions in a similar way as you do with the with like the W-2 kind of withholdings or you can make estimated payments in your retirement years. Fully taxable pension and annuities. Your payments are fully taxable. If A, you don't contribute to the cost, C cost later of your pension or annuity or B, you got your entire cost back tax free before 2022. But C, insurance premium for retired public safety officers later. If your pension or annuity is fully taxable, enter the total pension or annuity payment from forms 1099R box 1 on line 5B. Don't make an entry on line 5A. Fully taxable pensions and annuities also include military retirement pay showing on form 1099R. For details on military disability pension, see Publication 525. If you received a form RRB 1099R, you can see Publication 575 to find out how to report your benefits. You can go to the IRS website and find those there. Partially taxable pension and annuities. So now you're saying you got a pension or annuity, but only part of it is taxed. So now you're going to have a taxable amount non-taxable. So enter the total pension or annuity payments from form 1099R box 1 on line 5A. So if your form 1099R doesn't show the taxable amount, you must use the general rule explained in Publication 939 to figure the taxable part to enter on line 5B. That's kind of an unusual situation because usually you would think and hope that it does show the taxable amount, but if it doesn't, you can go to that publication. But if your annuity starting date defined later was after July 1st, 1986, see simplified method later to find out if you must use that method to figure the taxable part. So you can ask the IRS to figure the taxable part for you for a $1,000 fee. That doesn't sound like very worth it. For details, you can see publication 939. So if form 1099R shows a taxable amount, you can report that amount on line 5B. But you may be able to report a lower taxable amount by using the general rule or the simplified method or if the exclusion for retired public safety officers discussed next applies. Insurance premiums for retired public safety officers. So kind of a specialties type of area here. If you are an eligible retired public safety officer, law enforcement officer, firefighter, chaplain or member of rescue squad or ambulance crew. You can elect to exclude from income distributions made from your eligible retirement plan that are used to pay the premiums for coverage by an accident or health plan or a long term care insurance contract. You can do this only if you retired because of disability or because you reached normal retirement age. The premiums can be for coverage for you, your styles or dependents. The distribution must be from a plan maintained by the employer from which you retired as a public safety officer. Also, the distributions must be made directly from the plan to the provider of the accident or health plan or long term care insurance contract. You can exclude from income the smaller of the amount of the premiums or $3000. You can make this election only for amounts that would otherwise be included in your income. An eligible retirement plan is a government plan that is qualified trust or section 403A, 403B or 457B plan. If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. The amount shown on box 2A of form 1099R doesn't reflect the exclusion. Report your total distributions on line 5A and the taxable amount on line 5B enter PSO next to line 5B. If you are retired or retired on disability or reporting your disability pension on line 1H, include only the taxable amount on that line and enter PSO and the amount excluded on the dotted line next to line 1H. So again, somewhat of an unusual type of situation there. So payments when you are disabled. So now we've got a once again a kind of a more of a bit of an unusual situation here. Payments when you are disabled. So if you receive payments from a retirement or profit sharing plan that does not provide for disability retirement, do not treat those payments as disability payments. The payments must be reported as a pension or annuity. You must include in your income any amounts that you received that you would have received in retirement had you not become disabled as a result of a terrorist attack. Include in your income any payments you received from a 401K pension or other retirement plan to the extent that you would have received the amount at the same or later time regardless of whether you had become disabled. Alright, let's look at an example of that. So taxpayer J, a contractor, was disabled as a direct result of participating in efforts to clean up the World Trade Center. J is eligible for compensation by the September 11th Victim Compensation Fund. J began receiving a disability pension at age 55 when J could no longer continue working because of J's disability. Under J's pension plan at age 55, J is entitled to an early retirement benefit of $2,500. If J waits until age 62, normal retirement age under the plan, J would be entitled to a normal retirement benefit of $3,000 a month. The pension plan provides that a participant who retires early on account of disability is entitled to receive the participant's normal retirement benefit, which in J's case equals $3,000 per month. Until J turns 62, J can exclude $500 of the monthly retirement benefit from income, the difference between the early retirement benefit and the normal retirement benefit, that being $3,000 minus the $2,500 received on account of disability. J must report the remaining $2,500 of monthly pension benefits as taxable for each month after J turns age 62. J must report the full amount of the monthly pension benefit, that's the $3 a month as taxable. Okay, simplified method. You must use the simplified method if either of the following applies. Number one, your annuity starting date was after July 1, 1986, and you used this method last year to figure the taxable part. Number two, your annuity starting date was after November 18, 1996, and both of the following apply. A, the payments are from a qualified employee plan, a qualified employee annuity, or a tax shelter annuity B on your annuity starting date. Either you were under age 75 or the number of years of guaranteed payments was fewer than five. See publication 575 for the definition of guaranteed payments. If you must use the simplified method, complete the simplified method worksheet in this instructions to figure the taxable portion of your pension or annuity for more details on the simplified method. You can see publication 575 or publication 721 for U.S. Civil Service Retirement Benefits. Caution, if you receive U.S. Civil Service Retirement Benefits and you chose the alternative annuity option, you can see publication 721 to figure the taxable part of your annuity. Do not use the simplified method in these instructions. So annuity starting date. Your annuity starting date is the later of the first day of the first period for which you received a payment or the date the plan's obligations became fixed. So when we talk about a kind of annuity, when we think about our retirement type of benefits, usually we think about like a 401k plan, some kind of retirement plan that you're going to get payments from or an IRA type of plan. And then you can also imagine an annuity type of situation. The technical definition of an annuity is basically that you're going to be, you know, you're putting money in and you're going to get a fixed amount of payments out into the future. So the technical definition of an annuity is a series of fixed payments that are provided on fixed intervals for some timeframe. Now, oftentimes when we're talking about a retirement type of annuities, then the timeframe might not be completely fixed because it might go until death, right? So you might have a fixed amount of payment that's going to be received as your kind of retirement payments that are set up in the structure of an annuity until the point of death. And then how do they figure out how much the value of that annuity will be? Well, it's an estimate depending on the actuarial value of how long someone is going to live. And that's how you kind of try to value what that series of payments would be if you were trying to discount it and value how much it would be in like today's dollars, right? That's how we value the investment. And we can do that by thinking about a series of payments out into the future up until some fixed point, which will be dependent on the life expectancy. And then we can use a discounting value to calculate the present value of the annuities, general idea, okay? So age or combined ages and annuity starting date. So if you are the retiree, use your age or the annuity starting date. If you are the survivor of a retiree, use the retiree's age on their annuity starting date. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, use your combined ages on the annuity starting date. If you are the beneficiary of the employee who died, see Publication 575. If there is more than one beneficiary, see Publication 575 or Publication 721 to figure each beneficiary's taxable amount. So here's a simplified worksheet method that you could dive into if applicable. You can find that on the instructions as well or on the form 1040 line instructions for 2022. So the cost of your cost is generally your net investment in the plan as the annuity starting date. So it doesn't include pre-tax contributions. Your net investment may be shown in box 9B of form 1099R. Rollovers as we saw, an important component here generally. A rollover is a tax-free distribution of cash or other assets from one retirement plan that is contributed to another plan within 60 days of receiving the distribution. So that sounds quite complicated but just remember that if you are working at one place and then you go work somewhere else, they're not going to have the same retirement plan structure set up with the same financial institution. You might need to rollover, put the money from the one financial institution into another one. Remember they're really only in mutual funds. It's usually a kind of mutual fund or something like that. You don't really want to take the money out in such a way that you're going to be subject to taxes and penalties but rather you want to make sure that you're going to the new retirement plan, the new financial institution and having them most likely talk to the prior financial institution to make sure that they facilitate the transfer in the format of a rollover. So the 1099R will have indicated on it, I believe with the G in box 7, that it's a direct rollover or at least some kind of rollover not subject to taxes because you didn't actually pull the money out to use but just want to put it into another financial kind of institution. So that's important to tell people when they're changing jobs and stuff too because, again, people sometimes they just take the money out. They'll just take the money out and then, well, yeah, you're going to get hit with taxes and interest pretty heavily. Don't do that, don't do that. Because however, a rollover to a Roth IRA or a designated Roth account is generally not a tax-free distribution. So use lines 5A and 5B to report a rollover including a direct rollover from a qualified employer's plan to another or to an IRA or CEP. So they kind of threw in a Roth IRA here. Remember that normally when you put money into some kind of retirement type of plan, my lifestyle is my retirement plan, then it's going to be the idea being that you're going to get a tax benefit at the point in time that you put it in and then you're going to have to pay taxes at the point in time that you distribute it. Now, if you think that like your tax rates are going to be higher at the point in time that you retire possibly because you're going to be living good and pulling a lot more money out of the plans or because you think that the government's going to have to increase taxes because they're overspending these days and it's going to hit the fan at some point. They're going to increase the rates or whatever. Then you might say, well, that doesn't help me. What I'm going to do instead is try to get the benefit of at the end where I'm not going to get the tax benefit on a Roth IRA or a Roth kind of plan when I put the money in now, but I will get the benefit because it's going to be tax-free when I pull it out. Therefore, the growth dividends and income that have accumulated, I get the tax benefit of not having to pay taxes on that and that would be the general benefit of a Roth IRA. Then there's all kinds of questions in terms of, well, what if I was able to convert a standard IRA to a Roth IRA and you get into complex weeds on the conversion kind of process. Obviously, that's different than if you were to just try to roll money over from a normal kind of retirement account to another normal retirement account because the Roth IRA and the standard kind of IRA or retirement plans are opposites of each other. So putting something from a normal to a Roth, there could be tax benefits from it, but you got to make sure that you're kind of thinking that through and make sure that you're doing that transfer properly. So enter on line 5A, the distribution from form 1099R box 1. From this amount, subtract any contributions usually shown in box 5 that were taxable to you when made. From that result, subtract the amount of the rollover, enter the remaining amount on line 5B. If the remaining amount is zero and you have no other distributions to report on line 5B, enter zero on line 5B, also enter rollover next to line 5B. We'll show some examples possibly of this in our example software example. So see publication 575 for more details on rollovers, including special rules that apply to rollovers for designated Roth accounts, partial rollovers of property, and distributions under qualified domestic relations orders. Lump sum distribution. So if you received a lump sum distribution from a profit sharing or retirement plan, your form 1099R should have the quote, total distribution in quote box, in box to be checked. You may owe an additional tax if you received an early distribution from a qualified retirement plan and the total amount wasn't rollover. So that's where you want to be careful again. I won't go into it again, but be careful. For details, see the instructions for schedule 2, line 8. So enter the total distribution on line 5A and the taxable part on line 5B. For details, you can see publication 575 if you want more information on that.