Age-related Milestones

Dear Clients and Friends:

In an era filled with uncertainty, you can count on one thing for sure: Time marches on! This letter covers some important age-related tax and financial planning milestones that you should keep in mind for yourself and loved ones. 

Age 0–23: The so-called Kiddie Tax rules can potentially apply to your child’s (or grandchild’s) investment income until the year he or she reaches age 24. Specifically, a child’s investment income in excess of the applicable annual threshold is taxed at the parent’s marginal federal income tax rates (typically 15% on long-term capital gains and dividends and up to 35% on ordinary income). For 2011, the investment income threshold is $1,900 (same as for 2010). A child’s investment income below the threshold is taxed at very favorable rates (typically 0% on long-term capital gains and dividends and only 10% or 15% on ordinary income). Note that between ages 19 and 23, the Kiddie Tax is only an issue if the child is a student. For the year the child turns age 24 and for all subsequent years, the Kiddie Tax ceases to be a threat.

Age 18 or 21: A custodial account set up for a minor child comes under the child’s control when he or she reaches the age of majority under applicable state law (usually age 18 or 21). If there’s a significant amount of money in the custodial account, this issue can be a big deal. Depending on the child’s maturity level and dependability, you may or may not want to take steps to ensure that the money in the custodial account is used for expenditures you approve of (like college costs).

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 distribution are not used for qualified higher education expenses, they are subject to federal income tax plus a 10% penalty tax. Alternatively, the CESA balance can be rolled over tax-free into another CESA set up for a younger family member.

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 $5,500 for 2011), Section 403(b) plan (up to $5,500 for 2011), Section 457 plan (up to $5,500 for 2011), or SIMPLE plan (up to $2,500 for 2011), assuming the plan permits catch-up contributions. You can also make an additional catch-up contribution (up to $1,000 for 2010 and 2011) to your traditional or Roth IRA (the deadline for making IRA catch-up contributions for the 2010 tax year is 4/15/11).

Age 55: If you permanently leave your job for any reason, you can receive distributions from the former employer’s qualified retirement plan(s) without being hit with the 10% premature withdrawal penalty tax. This is an exception to the general rule that the taxable portion of qualified retirement plan distributions received before age 59½ are hit with the 10% penalty tax.

Age 59½: You can receive distributions from all types of tax-favored retirement plans and accounts (IRAs, 401(k) accounts, pensions, and the like) and from tax-deferred annuities without being hit with the 10% premature withdrawal penalty tax. Before age 59½, the 10% penalty tax will hit the taxable portion of distributions unless an exception to the penalty tax applies.