Laura answers tax questions from readers, listeners, followers, and group members that will help you understand how to pay less tax, defer it, or to boost your tax refund and save more money every year.
Question #4: Mike says, “I recently changed jobs and my new employer doesn’t offer health insurance for 90 days. Besides putting myself in financial risk, are there tax consequences if I don’t have coverage during the waiting period?”
The Affordable Care Act, known as Obamacare, requires every American to have health insurance no matter your age, income, or employment situation.
If you don’t have coverage, you typically have to pay a penalty that’s collected by the IRS. It’s calculated in 2 ways: a percentage of income and a flat fee. You have to pay whichever is higher.
The penalty rates have increased by set amounts over the past few years and will be adjusted for inflation in the future. For 2016, the Obamacare penalty is 2.5% of annual household taxable income or a flat rate of $695 per person.
However, there are some exemptions and hardships that allow you to legally avoid the penalty. One of them is having a short lapse of coverage that's no more than 2 consecutive months. You're considered covered even if you had a qualifying health plan for 1 day during a month.
For example, if you didn't have coverage from January 2 to April 15, your coverage gap was only two months, February and March. You'd qualify for the exemption and not have to pay a healthcare penalty.
But if Mike's gap is a full 3 months or more, he'll have to pay a penalty for every day that he's uninsured. And, as he mentioned, going without a health plan is dangerous for your physical and financial well-being.
To know how the Obamacare penalty will affect your taxes and if you qualify for an exemption, check out the H&R Block ACA Tax Calculator at hrblock.com. You can shop and compare health plans by starting at healthcare.gov.
Question #5: Tammy says, “I recently inherited $25,000 and want to invest it in a 401k. What are the tax consequences of doing that?”
In order to have a 401k, you must be employed by a company that offers it or be self-employed and set up a solo 401k for yourself.
In order to have a 401k, you must be employed by a company that offers it or be self-employed and set up a solo 401k for yourself. Since Tammy didn’t mention her employment status, I’ll cover both options.
If you can participate in a 401k at work, your contributions can only come through payroll deductions. In other words, you can’t just make a lump sum deposit directly into a workplace plan, like you can with many other types retirement accounts.
Once you’re enrolled in an employer’s 401k, you can typically contribute as much as 90% of your paycheck to the plan. For instance, if your gross pay is $1,000 you could elect to contribute $900 to your 401k.
For 2016, the most you can contribute to a 401k is $18,000 or $24,000 if you’re over age 50. So depending on her age, Tammy could invest $25,000 through payroll deductions over a year or two. She would contribute as much as possible from her paycheck and then use her inheritance to pay the monthly bills.
If Tammy doesn’t have a job that offers a 401k, she could invest her inheritance in a traditional or a Roth IRA. However, for 2016, the most you can contribute is $5,500 (or $6,500 if you’re over age 50). So it would take her a few years to fully invest the entire $25,000.
The other option I mentioned is called a solo 401k, which is a plan Tammy can use if she’s self-employed (on a full-time or part-time basis) and has no employees other than a spouse. If she does have employees, a good option would be to invest through a SEP-IRA.
The tax consequences of investing through a 401k, or any type of retirement account, are terrific because you cut the amount of tax you have to pay and save money. Traditional accounts give you an upfront tax deduction in the current year and allow you to avoid all taxes until you take withdrawals in retirement.
On the other hand, Roth accounts require you to pay tax on your contributions in the current year, but allow you to take withdrawals of contributions and earnings in retirement that are completely tax free.
The only downside is that if you want to take money out of a retirement account before reaching the official retirement age of 59½, you may have to pay income tax plus a 10% early withdrawal penalty.