Don’t Overpay Tax on Early Retirement Distributions

If you have to get your hands on IRA or 401K money before age 59 ½ , then usually you have to pay a 10% penalty. You might be able to avoid this penalty if your withdrawal is to pay for large medical bills, college expenses, the birth or adoption of a child, a first-time home purchase, or is related to a disability. Furthermore, some of these exceptions only apply to IRA withdrawals. So, for example, if you are purchasing your first home, a withdrawal from your 401K to fund it will be subject to a 10% penalty but a withdrawal from an IRA won’t be. Solution: Roll funds from your 401K to your IRA, and then withdrawal the funds from the IRA to use for your house down payment.

The child care credit is MUCH larger in 2021

You now get a tax credit of 50% of the amount paid for child care for each child under age 13. The max credit is $4K for 1 child or $8K if you have 2 children in day care. If married, both spouses need to have earned income equal-to-or-greater than the amount of child care expenses.

What does this mean for you? If you are married and have 1 child in day care that costs $8K, then you save $4K in tax only if both spouses earn at least $8K. If you only have 1 spouse working, then you get no child care credit. Thus, the first $8K that the normally-non-working-spouse earns might cause tax of $2,700 ($8K times combined FICA, Federal Income, and State Income tax of 33%), but earns the family $4K in credits….so that spouse is being paid $1,300 by the IRS to work!

Obviously, this gives the normally-non-working-spouse an incentive to at least earn the amount of the child care cost!

This credit gets a little confusing when you coordinate it with a pre-tax dependent care plan through work….it might make sense to NOT DEFER money into the pre-tax plan through work since the amount of the credit might be more than the tax saved by the deferral…ask us with questions so that we can guide you on how much to defer into your pre-tax dependent care plan through work.