My agency has just announced they will be issuing refunds for the Hall-Parker court decision on August 25th (pending any last minute changes). Since most of the visitors to this site are members of my agency I will address some of the options our Human Resources Department will be giving us. If you work for another agency you still may get something out of this as you will likely get similar options.
Human Resources is planning to give current employees a window in the month of July to make a one-time election to have this check treated differently for tax purposes and deferred compensation.
You will be able to log onto Peoplesoft to see how much your refund is and you can then choose to defer a portion of the refund or all of it. Keep in mind there are limits to how much you can defer into your 457 and 401K. I will go through some of the basics of this but a Registered Investment Advisor or Tax Accountant (CPA) can help give you more personally tailored information for your situation.
You can also change your tax withholding for the refund. Remember, as we discussed earlier if you make $80,000 and are getting a $15,000 refund and you do not defer any of the refund into your retirement account it is taxed as regular income. In other words you will be taxed on the total of $95,000. Whatever is taken out of the refund is only for tax withholdings. THIS IS NOT THE AMOUNT THE REFUND IS ACTUALLY TAXED AT.
If you decided to defer $5,000 of the refund you will have taxable income of the remaining $10,000 in this year.
The check will be issued as a separate, paper check and will not be a part of payroll or directly deposited. The refund checks will be delivered through your department to you.
As I’ve been writing about regarding taxes, you can change this one check to have more or less tax taken out by changing your withholding. Remember the scale ranges from Single with 0 Allowances (the most taken out) to Married with numerous Allowances (the least taken out).
Be careful if you change your withholding to have a small amount taken out for taxes. As I showed in my last post it is possible this large amount of money could push you into the next tax bracket.
If your income normally falls in the higher end of the 15% tax bracket for example a large portion of this refund may fall in the 25% tax bracket. This is why it may be useful to look at your tax forms (Form 1040) from last year to see what your Taxable Income was.
You may be safest to just leave the taxes alone or adjust to have more tax taken out. If too much was taken out you will get it back with your tax refund next year when you file your taxes.
Deferring Into Your 457/401k
Since we never expected this refund in the first place it should not ruin your budget if you defer at least a portion of the refund into your retirement account.
This can be especially useful if you see that the refund will push you into a higher tax bracket. Why not defer a portion of it that is in the higher tax bracket so you can avoid paying the higher rate?
Here are a few rules to keep in mind regarding how much you can put in your retirement account.
401k Contribution Limits
You can put up to $18,000 into your 401k, regardless of how much your employer contributes to it.
If you are over 50 years old you can put up to $24,000 into your 401k, also regardless of how much your employer contributes to it.
The “problem” with the 401k is you cannot withdrawal any money from it until you are 59 ½ years old. This can be problematic for Police and Firefighters because we often retire before 59. The 457 allows you to start withdrawing money once you separate from service.
457 Contribution Limits
You can put up to $18,000 into your 457, however, this includes any money your employer contributes. So, as an example, if you put $10,000 in and your employer contributes $5,000 you are at $15,000 and can only put $3,000 more in.
If you are over 50 years old you can put up to $24,000 into your 457, however, this also includes any money your employer contributes.
If you are within 3 years of retirement you can put up to $36,000 into your 457, and this also includes any money your employer contributes. This rule has an additional stipulation that I will not get into and you should speak with the plan administrator (Nationwide) about this limit.
For any of these catchup amounts that are over $18,000 you need to speak with your plan administrator to initiate the catchup.
401k And 457 Combined Limits
One benefit we have with the two retirement accounts is that we can contribute $18,000 into the 401k and the 457 for a total of $36,000. This is without even considering the higher “catchup” limits.
If you are putting this kind of money into your retirement account I wouldn’t worry about the age limit of the 401K withdrawals. If most of your retirement money goes into your 457 and you also have extra to put into your 401K, I’d be willing to bet you won’t need all of that money before you turn 59 ½.
Deferring A Percentage Or A Fixed Amount Into Your Retirement Account
I know a lot of people who put a percentage of their paycheck into their 457 instead of a fixed dollar amount. If you do this then you really don’t know exactly how much you are going to put in for the year.
This could be a problem if you defer a large amount of your refund, but don’t worry too much, and here’s why.
Let’s say you defer a large amount into your 457, and because of this you hit a total of $18,000 with four paychecks left in the year. Human Resources will recognize you have hit the limit and they will stop you from deferring into your 457. Instead, you will get the amount you usually defer as a part of your paycheck. This means it will be considered income for the year and you will pay tax on it.
To keep this from happening you may want to change your paycheck deferral to a fixed dollar amount instead of a percentage of your check so you can control exactly how much goes in. This way if you plan to max out your 457 at $18,000 you can put any extra into your 401K.
Most people probably won’t have this problem but I’m sure there are plenty that will. If you have questions about this let me know and I’ll try and clarify.
Hopefully, many of you will elect to defer at least a portion of your refund for retirement. Next week I’ll go over how to calculate your net worth and show you how to use that to determine where any extra money should go.
I’ve also had some requests to add some visuals to the tax bracket post and they will be coming soon.