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Tax Talk with George Saenz

Ask the tax adviser

Maximizing IRA withdrawals while minimizing taxes

Dear Tax Talk:
I have a significant amount being rolled into IRA accounts as part of a divorce settlement. I want to know how to make annual withdrawals to pay for a home loan without losing so much to taxes and early withdrawal penalties.

Ideally, I'd like to make annual withdrawals from my interest earnings for the next eight years to pay my home loan expenses until I reach age 59-1/2. How can this be done?
Phyl

Dear Phyl:
Most people are under the impression that they cannot withdraw from an IRA before age 59-1/2 without incurring the 10 percent penalty for early withdrawal. Your question provides a perfect example of when an early withdrawal method can be utilized without incurring the penalty.

Page 19 of Internal Revenue Service Publication 590 provides the general exceptions to the imposition of a penalty on withdrawals prior to age 59-1/2. The exception of interest to you would be the one that states you are receiving distributions in the form of an annuity. It's important to note here that the IRA assets do not have to be used to purchase an annuity contract with an insurer, but rather that you make annual withdrawals from your IRA account(s) based on your life expectancy at the time that you commence the withdrawals.

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Page 24 of the publication discusses selecting applicable life expectancy. I would recommend that you use the single life expectancy either refigured every year (smaller withdrawals over a longer period) or single life expectancy reduced by 1 year (larger withdrawals).

In your question you state that you are approximately 51 years of age in 2000. Comparing the two methods with an assumed 6 percent annual growth, your withdrawals would be as follows assuming $150,000 in IRA balances at the beginning:

Single life expectancy refigured every year
Age
Beginning balance with annual growth
Single life refigured
Withdrawal
Ending balance
51
150,000.00
32.2
4,658.39
145,341.61
52
154,062.11
31.3
4,922.11
149,140.00
53
158,088.40
30.4
5,200.28
152,888.12
54
162,061.41
29.5
5,493.61
156,567.80
55
165,961.87
28.6
5,802.86
160,159.01
56
169,768.55
27.7
6,128.83
163,639.72
57
173,458.10
26.8
6,472.32
166,985.79
58
177,004.93
25.9
6,834.17
170,170.77
59
180,381.01
25.0
7,215.24
173,165.77

Single life expectancy reduced by 1 year

Age

Beginning balance with annual growth

Single life reduced by 1

Withdrawal

Ending balance

51

150,000.00
32.2
4,658.39
145,341.61

52

154,062.11
31.2
4,937.89
149,124.22

53

158,071.68
30.2
5,234.16
152,837.52

54

162,007.77
29.2
5,548.21
156,459.56

55

165,847.13
28.2
5,881.10
159,966.02

56

169,563.99
27.2
6,233.97
163,330.02

57

173,129.82
26.2
6,608.01
166,521.81

58

176,513.12
25.2
7,004.49
169,508.63

59

179,679.15
24.2
7,424.76
172,254.39

The withdrawals from the IRA balances are subject to income tax but not penalty. The tax income effect is partially offset by the deduction for home mortgage interest.

When a bigger vehicle means more depreciation

Dear Tax Talk:
I am self-employed. On depreciation of a vehicle, if the vehicle weighs over 6,000 pounds and is used for business, can I depreciate 50 percent the first year?

Thanks,
Lewis

Dear Lewis:
Your question refers to the limitation on depreciation for luxury automobiles. It used to be that a rich fat-cat businessman could go out and buy a $70,000 Mercedes and write off the cost through depreciation over three years. Then Congress got smart and said this is wholly unfair, and thereby imposed meager depreciation limits on passenger automobiles.

The same Mercedes under the new rules that started in 1984 could end up being depreciated over 20 years or more based on today's limits. The problem with the law in 1984 was that most passenger vehicles had an unloaded gross vehicle weight (GVW) of less than 6,000 pounds, or in the case of a truck or van, a GVW of less than 6,000 pounds, and that's what Congress used to define a passenger vehicle.

Many of today's SUVs exceed GVW of 6,000 pounds and therefore are not considered passenger vehicles for purposes of the limitations on depreciation of luxury autos. This is good news for a fat-cat SUV owner who uses the truck in business.

The standard depreciation rules apply to a truck with a GVW of 6,000 pounds or more. The standard depreciation rules assign the truck a five-year useful life, which means the first year's depreciation is 20 percent of the cost and the second year is 32 percent. In addition, in the first year you can claim Internal Revenue Code Section 179 expense on the truck.

As explained on page 16 of IRS Publication 463, up to $20,000 of the vehicle can qualify for immediate deduction provided you meet the other rules that qualify you to claim Section 179 expense. On a luxury auto the first year depreciation and Section 179 limit combined is $3,060. On a $65,000 Lexus jeep, assuming it weighs more than 6,000 pounds, the deduction would be $29,000 ($20,000 section 179 plus 20 percent of the remaining $45,000 cost). The amounts in the two preceding sentences are reduced by the personal use percentage of the vehicles.

Forgetting the personal use, the difference in deduction of $26,000 at a 43 percent combined self-employment and income tax rate produces a savings of over $11,000. This may be enough to justify the fat-cat SUV to the doubting missus and if you're a few pounds short, load up on some options.

 

-- Posted: Dec. 8, 2000

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