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Why Young People Need Estate Planning

2770132690_0b9558b429_m1Many young individuals and couples think that the time to start thinking about estate planning is when they’re older, or perhaps if they ever have “estates”. On other occasions, the impetus to plan may be due to a recent death of a friend or family member without an estate plan or as my friend Tom, an estate planning attorney says, “Right before they take a trip over water.”

However, many young individuals should start thinking and “doing” some estate planning right away. Before we get to specific recommendation, let us first understand what estate planning is – and, what your “estate” is.

Essentially, your estate is everything you own. This includes your home, personal property, life insurance policies, invested assets, etc. Deciding how these assets are controlled and divided in the event of your death is called estate planning. Additionally, estate planning includes who will care for your children if you die, and who may make decisions on your behalf should you become incapacitated. More complex estate planning may involve legal aspects of trusts, taxation, gifting, etc.

Dying without a will (intestate) leaves the decision of how your assets will be divided, and more importantly, the guardianship of your children in the hands of the laws of the state you’re domiciled. This can lead to individuals inheriting your assets and caring for your children that you’d rather not. To prevent this individuals and couples can take steps now in order to make sure their requests are followed.

The following documents should be considered by everyone concerning estate planning.*

  1. A Will. Executing a will ensures that your assets are distributed to those individuals you want to inherit or disinherit your assets. Additionally, a will establishes who will be guardian of your children should both parents pass away. A will also determines the executor of your estate and may establish a trust for assets in order to provide monetary support for your children.
  1. Power of Attorney for Health Care. This document names a specific individual to make health care decisions on your behalf should you become incapacitated and can no longer make those decisions on your own. Readers in the state of Illinois can find a great example of a health care POA here.
  1. Power of Attorney for Property. Similar to the health care POA, the POA for property enables an individual you appoint to make property decisions on your behalf. Such transactions include real estate, investments, banking and taxation. Again, Illinois readers can find a great example here.
  1. A Living Will. A living will states your desire to have or not to have death-delaying procedures implemented in the event of your diagnosis of a terminal condition by a health care professional (your attending physician). This document assures your wishes will be followed in the event you’re unable to actively make that decision. Another excellent example for IL readers can be found here.
  1. Beneficiary Designations. It’s important to make sure your beneficiary designations are up to date ion your life insurance policies, annuities, retirement accounts and other investment accounts.

It goes without saying that in addition to having these documents prepared and available, individuals should talk to their family or individuals they want to have these responsibilities about their wishes, requests and potential responsibilities. Personally, and as a planner, I’ve seen families argue, fight, and ultimately discontinue speaking due to lack of communication when estate planning.

*Note: We recommend consulting a competent estate planning attorney for all of the above. The documents listed are merely examples and should not be considered replacements for professional, legal advice.

2016 Retirement Plan Contribution Limits

The IRS recently published the new contribution limits for various retirement plans for 2016.  These limits are indexed to inflation, and as such sometimes they do not increase much year over year, and sometimes they don’t increase at all. This year we saw a few increases for some contribution amounts, and the income limits increased for most types of accounts after virtually no changes to the contribution amounts in 2015.


unusual contribution limitsThe annual contribution limit for IRAs (both traditional and Roth) remains at $5,500 for 2016 (second year without an increase).  The “catch up” contribution amount, for folks age 50 or over, also remains at $1,000.

The income limits for traditional (deductible) IRAs increased slightly from last year: for singles covered by a retirement plan, your Modified Adjusted Gross Income (MAGI) must be less than $61,000 for a full deduction; phased deduction is allowed up to a MAGI of $71,000.  This is the same as the limits for 2015.  For married folks filing jointly who are covered by a retirement plan by his or her employer, the MAGI limit is increased to $98,000, phased out at $118,000, also unchanged versus last year’s limits.  For married folks filing jointly who are not covered by a workplace retirement plan but are married to someone who is covered, the MAGI limit for deduction is $184,000, phased out at $194,000; this is an increase of $1,000 over 2015’s limits.

The income limits for Roth IRA contributions also increased: single folks with a MAGI less than $117,000 can make a full contribution, and this is phased out up to a MAGI of $132,000, an increase of $1,000 at each end of the range.  For married folks filing jointly, the MAGI limits are $184,000 to $194,000 for Roth contributions, up by $1,000 over 2015.

401(k), 403(b), 457 and SARSEP plans

For traditional employer-based retirement plans, the amount of deferred income allowed remains the same. For 2016, employees are allowed to defer up to $18,000 with a catch up amount of $6,000 for those over age 50.  If you happen to work for a governmental agency that offers a 457 plan in addition to a 401(k) or 403(b) plan, you can double up and defer as much as $36,000 plus catch-ups, for a total of $48,000 deferred.

The limits for contributions to Roth 401(k) and Roth 403(b) are the same as traditional plans – the limit is for all plans of that type in total.  You are allowed to contribute up to the limit for either a Roth plan or a traditional plan, or a combination of the two.


Savings Incentive Match Plans for Employees (SIMPLE) deferral limit is also unchanged at $12,500 for 2016.  The catch up amount is unchanged as well at $3,000, for folks at or older than age 50.

Saver’s Credit

The income limits for receiving the Saver’s Credit for contributing to a retirement plan increased for 2016.  The MAGI limit for married filing jointly increased from $61,000 to $61,500; for singles the new limit is $30,750 (up from $30,500); and for heads of household, the MAGI limit is $46,125, an increase from $45,750.  The saver’s credit rewards low and moderate income taxpayers who are working hard and need more help saving for retirement.  The table below provides more details on how the saver’s credit works:

Filing Status/Adjusted Gross Income for 2016
Amount of Credit Married Filing Jointly Head of Household Single/Others
50% of first $2,000 deferred $0 to $37,000 $0 to $27,750 $0 to $18,500
20% of first $2,000 deferred $37,001 to $40,000 $27,751 to $30,000 $18,501 to $20,000
10% of first $2,000 deferred $40,001 to $61,500 $30,001 to $46,125 $20,001 to $30,750

How to Tackle Debt

debt-freeeeeeeeeeeeeeeeeeee-300x300It can easily happen. Whether we’re trying to keep up with the Joneses or investing in our education, sometimes debt can add up quickly. The good news is that debt can be erased. However, sometimes what we know we need to do is different from actually doing it. Here’s a game plan to start chipping away at your outstanding debt. With time and persistence, we can eliminate debt and increase our net worth.

Let’s start with some definitions of debt. Debt is debt, but there is some that is generally better than others. Mortgage debt isn’t considered bad debt (unless you bought more house than you can afford). Additionally, student loan debt isn’t terrible (as you’re investing in human capital), but interest rates can be higher than home debt. Vehicle debt isn’t great either. Pay cash for your vehicles. Credit card debt is bad. It’s debt that has no backing, no assets. Interest on many cards is deplorable as well. Generally, it’s wise to reduce your credit card debt first (as it’s usually the highest interest) followed by student debt, vehicle debt, etc.

Start first on where you’re spending your money. With a sheet of paper, make two lists. On the left hand side, title this list “Needs”. On the right hand side, title this list “Wants”. Generally, your wants will dwarf your needs. In this step, be honest with what your needs really are. For most people the basics are going to be shelter, food (not dining out), clothing, water, and utilities.

Grab last year’s bank statement and circle or highlight all of the needs. This will be mortgage/rent, groceries, utilities such as water and electricity, insurance and needed (not excess) clothing.

Now, start on the lists of wants. But instead of making a list from the top of your head, start going through your statements and listing the “wants” as they appear from what you spent. Items such as car payment, dining out, smartphone, coffee, TV/cable, etc., should be put down on the list of wants.

From there, determine what wants you’re spending money on that can be given up in order to reduce your debt. If you find you’re spending quite a bit dining out, consider taking that money and putting it toward your debt. The key becomes prioritizing. It’s not uncommon (and in fact, it’s quite easy) to find a few hundred dollars extra every month to plow into your debt.

Doing this exercise accomplishes a few things. First, it reduces your debt and builds your net worth. It also changes your habits and priorities. It forces you to think about your spending and whether or not a contemplated purchase will add any value to your life. It also provides guaranteed, risk-free returns. By eliminating debt you are saving a ton of money in interest payments, effectively giving that return to yourself instead of a creditor.

Finally, it changes your habits. The good news is that once the debt is paid off, you can still treat the payments you were making as a bill. Only now, you’re going to pay yourself first. For example, let’s say you’ve been making an extra $400 payment to pay off your vehicle or credit cards. Once they’re paid off, take that $400 and put it in your emergency fund, IRA or 401k. And keep making the payments. The good news is that you’ve already budgeted for it, only now the money goes in your pocket.

Roth 401k – Is It Right for You?

up-to-5-people-wonder-about-roth-401k-a-dayMany employers are now offering a Roth 401k option in addition to the traditional 401k option. And with this new choice comes many questions: What is the benefit? Is a Roth 401k a good idea for me? How can I choose between the traditional 401k and the Roth?

Benefits of Roth 401k

Much like a Roth IRA, the Roth 401k can provide you with tax-free income when you retire. This benefit comes to you in exchange for no tax deduction when you contribute your funds to the Roth account.

Contributing money to a traditional 401k account results in a reduction from your income for the year. Then when you withdraw money from the account in your retirement, you will have to pay tax on the money withdrawn. This is the primary difference between the traditional 401k and the Roth.

Another benefit of the Roth 401k is that when you retire (or leave the job) you can rollover the money directly to a Roth IRA – this will eliminate RMDs from ever being required on the account, once the account has been held for 5 years.

Making the Choice Between Traditional and Roth 401k

So, knowing the benefits of a Roth 401k you may wonder if a Roth 401k is right for your situation. This is not a simple answer, as with many investing and savings activities. It all depends on two primary factors: your applicable tax rate now, and the tax rate in the future.

Your applicable tax rate now is important because if you choose a Roth 401k you’ll be paying taxes on the income you are deferring into the account. On the other hand, if this same money was going into a traditional 401k account you would avoid tax on the money deferred.

So if your current applicable tax rate is high, there is much value in deferring tax on some of your income. With a lower (or zero) applicable tax rate then the benefit of deferring tax on contributions is reduced or eliminated.

Looking into the future, if you anticipate that your tax rate in retirement is going to be lower than your tax rate today, then the traditional 401k is likely your best option. This is because you are deferring income at one rate and then paying tax another lower rate in the future.

On the other hand, if you anticipate higher taxes in the future (and who doesn’t?) then the Roth 401k might make more sense. This is due to the fact that, by using the Roth 401k you can pay taxes today at your lower rate and then later withdraw those funds at a zero tax rate.

Tax-Loss Harvesting: It’s Never Too Late

Tax-loss harvesting is a tax move that can help with your income tax burden when you’ve experienced a loss with your investments.  Briefly, this is where you have a taxable account, holding stocks, bonds, or mutual funds and the market declines leaving your holdings in a loss situation.  Once you sell the holding, you have realized the loss, which enables you to take advantage of the tax laws and deduct those losses, first against any gains in your account(s), and then at a rate of $3,000 per year against ordinary income.

This is similar to the famous move that Mr. Trump (and I would be shocked if Mrs. Clinton never took a loss against future taxes) used to avoid future income taxes. This was recently discovered in Trump’s tax records and made out to be a fatcat loophole – at least by the media – when actually anyone can take advantage of it. In fact, it’s likely that if you have non-IRA investments you’ve probably taken advantage of this rule yourself.

As an example, say you purchased a mutual fund for $10,000 last year.  Over the course of this year, your mutual fund’s value reduced to $5,000.  If you sold the holding, you would have a loss of $5,000.  Using the tax law to your benefit, you are able to reduce your ordinary income by $3,000 for the current year and carry over the remaining $2,000 for writing off against the following year’s income.

It is important to note that the loss is first used to offset any capital gains you may have realized before you can use it to reduce ordinary income. Continuing the example, if you also sold investments in the current year that had capital gains of $2,600, your net capital loss for the year would be $2,400 ($5,000 minus $2,600). This would allow you to take the capital gains with zero taxes (just like Donald!) and also reduce your ordinary (wage) income by the remaining $2,400 of net capital loss.

Tax-loss harvesting is the action of realizing a loss in order to utilize the loss as a reduction against your other gains and ordinary income. You may not have chosen to sell the losing investment at that particular time for any other reason, but the benefit of tax-loss harvesting caused you to take the action.

taxes-by-x_jamesmorrisThe good news is that you can sell any loss positions (and let’s face it, who doesn’t have a loss position?) that you currently hold and then take this reduction of up to $3,000 in ordinary income for your current year’s taxes, which you’ll file next April.  It’ll be a nice surprise for you (if you’ve forgotten about it) when you get ready to file.

Not available to an IRA

This is one of the many benefits of holding at least a portion of your investments in non-qualified or non-IRA accounts.  Because in your IRA or 401(k) plan, losses you sustain are of no tax consequence.  Likewise, gains that you experience, along with the funds that you “hid” from taxes in earlier years, will be taxed at ordinary income tax rates – which are presently higher than the capital gains rates assessed against your taxable account gains.  And I don’t expect that the ordinary income tax rates are set to decline appreciably at any time in the near future, given the deficit spending being introduced at an alarming pace these days.

Multiple Income Streams

minimize taxesThis post is primarily geared toward younger individuals just starting out after college or from graduate school. However, the information can be used by anyone looking to boost income in order to increase retirement savings, pay off debt earlier or simply to put them in a better position financially.

In financial planning we often talk about risk management as one of the bricks to the foundation of any solid financial plan. Generally, when we say risk management we think of auto, home, life, disability and other insurance coverage in addition to an emergency fund. Another area of “insurance” would be creating additional or multiple income streams as a hedge against losing an income source due to downsizing, termination, etc. If none of the aforementioned negative events occurs, then the extra income can be used to bolster retirement savings, reduce debt, or save extra for college. The point is that if one job dissolves there are other income streams providing cash flow.

The question then becomes how to find these additional income streams or “pipelines”. One of the easiest would be to simply find another part-time job, preferably doing something you enjoy. This could be working at your child’s school as an aid, waiting tables an earning extra money in tips, or simply working hourly on the evenings or weekends at a local business.

Individuals may also consider starting their own business, part-time, to generate additional income. One area to look is as an offshoot to what the individual is currently doing. For example, if the individual is a teacher, they may also find it enjoyable to do consulting to teachers and schools in a particular area of expertise. Another example would be an accountant finding extra work from January through April doing tax returns. The main idea here is to leverage an individual’s current knowledge and expertise into another income stream. The learning curve is less onerous. From a tax perspective, the IRS allows certain deductions if you have a legitimate business and expenses.

One word of caution: be careful of starting a business that relies on the individual working hard to make someone else money (i.e. multi-level or network marketing organizations). Often these types of “businesses” recruit naïve individuals to sell their products and recruit others to the sales “pyramid”. Generally, those making any substantial income are those at the top of the pyramid (i.e. the founders).

Should you consider exploring another income source, feel free to contact our office and we’d be happy to answer questions and provide insight as to the particular path you choose to take.

SOSEPP & How a QDRO Affects It

In addition to the 72(t) exception available for folks with a QDRO (see this post), there is also the question of how a QDRO impacts an established Series of Substantially Equal Periodic Payments (SOSEPP) – which, as we know, once established can only be changed one time.

separati-en-casa-near-divorce-by-mirko-macariAlthough not definitive, below are summaries of three Private Letter Rulings (PLRs) that seem to suggest first of all that making the distribution is not subject to the 10% penalty when a QDRO or divorce decree is involved, pursuant to the regulation in Code section 72(t)(4)(A)(ii).

Private Letter Rulings for SOSEPP

1) The transfer to a taxpayer’s spouse pursuant to a divorce decree of 50% of each of three separate IRAs owned by the taxpayer from which the taxpayer had already begun receiving “substantially equal periodic payments” did not result in a modification where the taxpayer’s spouse was two years younger and would commence receiving similar payments such that the total of periodic payments to the taxpayer and his spouse subsequent to the division would be substantially equal to the periodic payments received by the taxpayer prior to the division. PLR 9739044

2) In PLR 200027060, the IRS rules that a spouse after the divorce, that  received a portion of the client’s IRA accounts that were being used to fund a SEPP,  didn’t need to continue the payments since it was a transfer under Code section 408(d)(6). What about the client – did all the payments have to be continued out of what remained of his accounts?

2a) Later in PLR 200050046 (with similar facts) the IRS ruled in favor of the taxpayer. “The reduction in the annual distribution from IRA 1 to Taxpayer A beginning in calendar year 2001, prior to Taxpayer A’s attaining age 59 1/2 , and assuming Taxpayer A has not died and has not become permanently disabled, will not constitute a subsequent modification in his series of periodic payments, as the term “subsequent modification” is used in Code section 72(t)(4), and will not result in the imposition upon Taxpayer A of the 10 percent additional income tax imposed by Code section 72(t)(1) pursuant to Code section 72(t)(4)(A)(ii).

In other PLRs, it has further been ruled that the IRA owner may reduce the 72(t) payment amount by the same percentage as the reduction in the overall account by distribution to the former spouse.  This is the case for a QDRO granting a division of a qualified plan or a divorce decree granting a division of an IRA when the SOSEPP has already been set up.  In these cases, the former spouse who receives the proceeds from the IRA or qualified plan was not required to continue a 72(t) payment plan – the funds could be rolled over into an IRA, or left in the plan as is.

It is also important to note that the RMD (Required Minimum Distribution) for the year of the transfer is still dependent upon the previous end-of-year balance in the account – and could be adjusted for the following year if a favorable PLR is reached for the case.

Tax Benefits for Job Hunting

5 santasThe IRS recently published their Summertime Tax Tip 2016-24, entitled “Looking for Work May Impact Your Taxes”, with some good tips that you should know as you go about job hunting.  The text of the actual publication from the IRS follows, and at the end of the article I have added a few additional job-related tax breaks that could be useful to you.

Looking for Work May Impact Your Taxes

If you are job hunting in the same line of work, you may be able to deduct some of your job search costs. Here are some key tax facts you should know about when searching for a new job:

  • Same Occupation.  Your expenses must be for a job search in your current line of work. You can’t deduct expenses for a job search in a new occupation.
  • Résumé Costs.  You can deduct the cost of preparing and mailing your résumé.
  • Travel Expenses.  If you travel to look for a new job, you may be able to deduct the cost of the trip. To deduct the cost of the travel to and from the area, the trip must be mainly to look for a new job. You may still be able to deduct some costs if looking for a job is not the main purpose of the trip.
  • Placement Agency. You can deduct some job placement agency fees you pay to look for a job.
  • First Job.  You can’t deduct job search expenses if you’re looking for a job for the first time.
  • Time Between Jobs.  You can’t deduct job search expenses if there was a long break between the end of your last job and the time you began looking for a new one.
  • Reimbursed Costs.  Reimbursed expenses are not deductible.
  • Schedule A.  You normally deduct your job search expenses on Schedule A, Itemized Deductions. Claim them as a miscellaneous deduction. You can deduct the total miscellaneous deductions that are more than two percent of your adjusted gross income.
  • Premium Tax Credit.  If you receive advance payments of the premium tax credit, it is important that you report changes in circumstances –  such as changes in your income, a change in eligibility for other coverage, or a change of address  –  to your Health Insurance Marketplace.  Advance payments are paid directly to your insurance company and lower the out-of-pocket cost for your health insurance premiums.  Reporting changes will help you get the proper type and amount of financial assistance so you can avoid getting too much or too little in advance.

For more on job hunting refer to Publication 529, Miscellaneous Deductions. You can get IRS tax forms and publications on at any time.

In addition to all that…

It’s important to know that you have some other job-related tax breaks which you can take advantage of…

Moving Expenses – if you move to a new home for your employment, either a new job or just being transferred in your current job, you might be able to deduct your moving expenses if:

  • the move is closely related to your start of work in the new location
  • your new work location is more than 50 miles farther away from your old home than the distance from your old home to the old work location.  In other words, if your old workplace was 7 miles away from your old home, your new workplace must be at least 57 miles away from your old home.
  • you must continue to work in the new location for at least 39 weeks during the 12 months after the move.  If you’re self-employed you must also work in the new job for 78 weeks during the 24 months following the move. (There are exceptions for disability, layoff, transfers, and other situations.)

You may include the cost of transportation and storage of your household goods for up to 30 days, as well as travel and lodging from the old home to the new home (only one trip per person).

Unreimbursed Employee Business Expenses – certain expenses related to your job that are not reimbursed by your employer can be deducted.  Some examples are:

  • Dues to professional associations and chambers of commerce if work related and entertainment is not one of the main purposes of the organization.  Any part of the dues that is related to lobbying or political activities is not deductible.
  • Educational expenses related to your work.  These expenses must be required to maintain your current job, serving a business purpose of your employer, and not part of a program that will qualify the taxpayer for a new trade or business.
  • Licenses and regulatory fees.
  • Malpractice insurance premiums.
  • Office-in-home expenses (subject to quite a few qualifications)
  • Phone charges for business use (but not the cost of basic service for the first phone in a home)
  • Physical exams required by the employer
  • Protective clothing and safety equipment required for work, as well as tools and supplies required for your job
  • Uniforms required by your employer that are not suitable for ordinary wear
  • Union dues and expenses

This is not an exhaustive list – you can find more information by going to the IRS website at

Photo by Richard Croft

The Third Most Important Factor to Investing Success

out_at_thirdPreviously I wrote about the Most Important Factor and the Second Most Important Factor to Investing Success. Continuing this streak I’ll give you the third most important factor to investing success: Leave it alone.

To recap: The most important factor is to continuously save and add to your nest egg over your career; the second factor is allocation – make sure you’re investing in a diversified allocation that will grow over time.

The third most important factor to investing success: Once you’ve started investing, leave it alone. Resist the temptation to sell off the component of your allocation plan that’s lagging; the reason you have a diversified allocation is so that some pieces will lag while others flourish, and vice-versa.

Reallocate your funds from time to time (once a year at most) to match your allocation plan, but that’s all the fussing you should do with your investments. Leave it alone.

No Loans

In addition to resisting temptation to fiddle with the investments, don’t take out a loan from your account. Even though this may seem like a good alternative to other loan sources, your best option is to disregard the 401k loan as an alternative altogether. Taking a loan puts you behind the eight ball – having to pay back the loan will likely take over your ability to save consistently (Factor #1) and will have a portion of your funds allocated to a loan instead of your growth allocation (Factor #2).

How to Pay Off Students Loans and Save for Retirement

Businessman juggling fruit

Businessman juggling fruit

Very often in my classes I get asked the question “What should I do first, pay off student loans or save for retirement?” My goal is to give some perspective on approaching these two very important issues.

Generally, holding student loans and making the minimum payments can lead to an unnecessary amount of interest being paid. For example, if an individual has a student loan at 6%, then that loan is earning 6% but for the lender not for the student. Many individuals find themselves wanting to pay off their student loans as quickly as possible.

On the other hand, recent college graduates are also faced with the decision to save for retirement.  Many of them have heard that it is wise to start saving when they are young in order to let compounding work its magic. However, many individuals are confused as to which situation they should take care of first.

Here’s my take. If an individual has a 401k with employer matching, then it makes perfect sense to save to the maximum possible in order to receive the full the employer match. The employer match is essentially free money and is a guaranteed return on the employee’s deferral. If an individual does not have an employer match, they could still consider saving a percentage of their income – say 15% to start.

Once that is done, the individual can accelerate payments to their student loans. Essentially, the individual is earning a guaranteed rate of return equal to the amount of interest on the loan. I don’t know about you, but a 6% guaranteed return without risk is extremely difficult to achieve elsewhere. The beauty of this plan is that once the student loan is paid off the individual can take the money that was being allocated to the loan and reallocate to the retirement savings. Individuals finding themselves maxing out their 401k should consider contributing to an IRA once that happens.

Finally, a key to making this work is making the payments automatic.  Saving to a 401k is automated easily since the deferrals are coming directly from the paycheck. However, accelerating student loan payments is less convenient.  That being said, an individual can set up automatic payments through their bank to be made at periodic intervals (say, monthly) to their loan in order to put this on autopilot. Individuals may also consider allocating pay raises and bonuses to chip away at the loan.

This is one way an individual can take care of two priorities early in her career. The key will be to make these priorities above and beyond the temptations of everyday wants such as dining out or cable TV. More information on student loan payback options can be found here. 

401(k) & Qualified Domestic Relations Orders (QDRO)

An exception to the 10% penalty on distributions from a qualified plan (but not an IRA, an IRA is split via a transfer incident to a divorce, which is not an automatic exception) Qualified Domestic Relations Order, or QDRO (cue-DRO).  A QDRO is often put into place as part of a divorce settlement, especially when one spouse has a qualified retirement plan that is a significant asset.

qdroWhat happens in the case of a QDRO is that the court determines what amount (usually a percentage, although it could be a specific dollar amount) of the qualified retirement plan’s balance is to be presented to the non-owning spouse.  Once that amount is determined and finalized by the court, a QDRO is drafted and provided to the non-owning spouse. This document allows the non-owning spouse to direct the retirement plan custodian to distribute the funds in the amount specified.

In the case of a QDRO, the owning spouse will not be taxed or penalized on the distribution.  In addition, if the non-owning spouse chooses to roll the distribution into an IRA, there would be no tax or penalty on that distribution to her either.  If the non-owning spouse chooses to use the funds in any fashion other than rolling over into another qualified plan or IRA, there will be tax on the distribution, but no penalty.

Many times it may make sense for the non-owning spouse to leave the account with the qualified plan (rather than rolling into an IRA) if there may be a need for the funds at some point in the future.  This will be dependent upon just how “divorce friendly” the qualified plan custodian will be. Sometimes plan administrators do not look favorably on long-held accounts by non-participants. This may require a rollover of the account, eliminating your QDRO special treatment.

Of course other 72(t) exceptions could apply, but if there was a need that did not fit the exceptions and the distributee did not wish to establish a series of substantially equal payments for five years, the QDRO would still apply to the distribution from the qualified plan (as long as the funds are still in the plan that the QDRO was written to apply to).

As an example, let’s say Lester and Edwina (both age 40) are divorcing, and as a part of the divorce settlement, Edwina’s 401(k) plan is to be shared with Lester, 50/50, with a QDRO enforcing the split.  After a couple of years Lester decides he would like to use some of the funds awarded to him from the divorce to purchase a new fishing boat.  As long as the funds are still held in the 401(k) plan, Lester can request withdrawal and receive the funds without penalty, due to the existence of the QDRO.  However, had Lester rolled over the funds into an IRA (or other qualified plan), the QDRO would no longer be in effect, and he would be unable to access the funds without paying the penalty for early withdrawal.  (It is important to note that, in either case, Lester would be required to pay ordinary income tax on the distribution.)

Remember Your 2016 RMD

300px-IRS.svg_It’s hard to believe that 2016 is coming closer to an end. For some individuals that are required to take required minimum distributions (RMDs) from their retirement plans, it may be a good idea to double check to make sure that happens. If it doesn’t the penalties are harsh.

According to the IRS the penalty for not taking and RMD or not taking the full RMD is 50% of the amount not withdrawn.  This can lead to significant losses to a retiree that must take RMDs.  Generally, most financial planners and or custodians we’ll be able to help the individual and remind them that they have and RMD and how much that amount needs to be.

If an individual finds themselves in the precarious position of having forgotten to take the RMD or did not take out enough, there is a remedy.  The IRS allows an individual to file form 5329 and attach a letter explaining the reason why the distribution was not taken.

Additionally, the individual will want to correct the mistake as soon as possible.  In other words, the individual will want to call their custodian or financial advisor and instruct them to immediately distribute the amount that was required.  This shows a good faith effort on the part of the individual and the IRS may be much more likely to grant the exception.

Finally, individuals holding Roth 401ks are required to take minimum distributions at age 70 ½.  Even though the distribution is required the amount distributed will not be subject to taxation.  Individuals who would rather not take the required minimum distribution from their Roth 401k can roll their Roth 401k to their Roth IRA.  Roth IRAs do not have RMDs.  However, it is important to note that the rollover must occur from the principal amount and not the distribution.  In other words, an individual is not allowed to take an RMD and roll it into another qualified account.  Individuals that must take the distribution but do not want to spend the money can simply deposit the amount into a savings account or an after-tax non-qualified investment account.

Social Security Benefits After First Spouse Dies

spouse diesWhen your spouse dies there are a few things that happen to your Social Security benefits that you need to be aware of. These things will affect your benefits significantly if your own benefit is less than that of your late spouse’s benefit (or Primary Insurance Amount). These changes to available benefits could also result in increased benefits if your own benefit is the larger of the two.

These same impacts are apparent for ex-spouses as well. While reading the below, just replace “your spouse” with “ex-spouse” and all provisions are the same.

Spousal Benefits cease

When your spouse dies, the spousal benefits that you may have been receiving will cease. This means that your own benefit is the only retirement benefit that you will receive at this point.

For example, Jane and John, both age 64, have been receiving Social Security benefits for a couple of years. Jane’s PIA (Primary Insurance Amount) is $600 and John’s PIA is $2,000. Since both of them started benefits at age 62, both are receiving reduced benefits.

John is receiving $1,500 (75% of his PIA) and Jane is receiving a combination of her own reduced PIA ($450) and a reduced “excess” spousal benefit in the amount of $280. (For more details on the calculation of reduced spousal benefits, see the following article: Calculating the Reduced Social Security Spousal Benefit.)

When John dies at age 64, Jane’s Social Security benefit is reduced to only her own benefit – $450 per month. The spousal benefit ceases to be paid at all upon John’s death.

But all is not lost – if you were eligible for a spousal benefit, you are also eligible for a survivor’s benefit when your spouse dies.

Survivor Benefits (can) begin

After your spouse dies and the spousal benefits cease, you are eligible for a survivor benefit based on your late spouse’s record.

Using our example from above, where Jane’s total benefit had reduced to $450 upon John’s death – Jane is now eligible for a survivor benefit based on John’s record.

There is a complication to the calculation since John started his own benefit prior to his full retirement age: the minimum “basis” for calculation of the survivor benefit is 82.5% of John’s PIA. John’s benefit upon his death was 75% of his PIA, so the “basis” for the survivor benefit will be increased to 82.5% or $1,650, instead of $1,500.

In this case, Jane has a couple of options:

1) She can begin receiving the survivor benefit immediately upon John’s death. This survivor benefit will be reduced since Jane is under Full Retirement Age (FRA). Since Jane is 64, the reduction is 11.4% from the basis of $1,650 – to a total of $1,461.90.

2) Jane could delay receiving the survivor benefit to her age 66, when there would be no reduction. She would receive her own reduced benefit of $450 per month for the coming two years, and then at age 66 she’d start receiving the unreduced survivor benefit in the amount of $1,650.

There is no point in delaying the survivor benefit past Jane’s FRA – the survivor benefit will not increase beyond that unreduced basis that we described earlier.

There is no impact to the survivor benefit due to Jane’s early filing for her own benefit. So if she had not filed for her own benefit prior when her spouse dies, Jane could start her own benefits immediately upon John’s death. This would allow her a benefit in the amount of $520, having filed for the benefit at age 64 (no spousal benefit “excess” is available since John is deceased). Later upon reaching FRA she would be eligible for the survivor benefit at the unreduced amount, $1,650.

On the other hand, there is also no impact to your own benefit if you start the survivor benefit early. If the example changed and Jane dies before John, if John has not filed for his own benefit by Jane’s death, he could receive the survivor benefit based on Jane’s record until he files for his own benefit. Granted, at his age 64 this would work out to a maximum of $531.60, but it’s better than nothing at all. Later, John could file for his own benefit, either at FRA or later, to receive an increased benefit.

Survivor benefit basis updates

As we reviewed above, in the original case where John starts his benefit prior to his Full Retirement Age, the basis against which Jane’s survivor benefit is calculated can increase to the minimum of 82.5% of John’s PIA.

On the other hand, imagine if John had not started his benefits by the time of his death.  The basis against which Jane’s survivor benefit is calculated will increase to John’s full, unreduced PIA. In this case Jane, being 64 at John’s death, is eligible for John’s PIA reduced by 11.4%, or a total of $1,772. If Jane waits until her FRA she is eligible for a survivor benefit of $2,000.

On the third hand, consider if John was older than Jane. John is older than his Full Retirement Age (FRA) at his death and still has not filed for his own benefit. The resulting survivor benefit for Jane is updated differently. In this case, the delay credits (8% per year) are applied to John’s PIA to determine the basis for the survivor benefit. So if (for example) John was 67 at his death, the basis for the survivor benefit would be $2,160, and at age 64 Jane could receive $1,913. Waiting until her FRA would garner her $2,160 in survivor benefits.

WEP impact eliminated

The fourth thing that occurs when a spouse dies is that Windfall Elimination Provision (WEP) impact to the decedent spouse’s benefits is eliminated.

Considering John’s benefits, if he was subject to full WEP because of a government pension, his benefits are reduced to $1,179 (versus $1,500 without WEP). Upon John’s death, his WEP impact is eliminated, restoring his PIA to the full $2,000. Since John started benefits early, the basis for the survivor benefit reduces as above.

So regardless of the previous WEP impact to John’s benefits, Jane would still be eligible for a survivor benefit with a basis of $1,650.

Key Takeaways

Since the spousal benefit ceases when the first spouse dies, it’s important to know that total benefits will likely reduce for the surviving spouse until survivor benefits begin. This can cause significant hardship as demonstrated in the example above. Jane’s household income from Social Security reduced from $2,230 (John’s $1,500 and Jane’s total of $730) to only $450 upon John’s death. The survivor benefit will replace some of this but not all, of course.

In addition, determining when to start survivor benefits can be critical as well. Jane could start survivor benefits at this point in the amount of $1,463, or she could wait until age 66 to receive $1,650. If she waits she will receive her $450 benefit in the interim.

Timing of the higher benefit is important as well. Using our examples from above, John’s filing date has a significant impact on Jane’s potential survivor benefit. The potential increase could make a huge difference for Jane. This is why so many experts recommend delaying the filing for the larger of a couple’s two benefits as long as possible – it will impact the other spouse’s survivor benefit if she lives longer.

The last key takeaway is that you need to keep the WEP elimination in mind when planning for survivor benefits. This can make a significant difference for the surviving spouse – up to $428 a month from our example.

Should You DIY Your Financial Planning?

DIY FailMany individuals may consider doing their own financial planning over the course of their lives. Although financial planning is generally not too terribly difficult, to answer the title’s question, the answer should be “No.”

Here are some reasons why.

  1. Get a second opinion. Even if you do it yourself, it’s wise to have another professional take a look at what you’re doing. A good financial professional will confirm good decisions you’ve made and will politely tell you if there’s a gap in your plan or if you may be making mistakes or omissions here and there. Even good financial professionals have another professional look at their plans. Be wise enough to realize you don’t know everything.
  1. Time management. Although many individuals are smart enough to learn how to do their own financial plans, many aren’t willing to take the appropriate amount of time. It takes quite a bit of time to learn a skill or trade. Financial planning is no different. Although some financial planners’ recommendations may come easily, they took years to learn. And they are still learning – as any professional should.
  1. Leverage. Think of it this way. Many individuals are qualified to study and learn how to become doctors and attorneys.  However, many of us do not have the time to learn these professional skills. What we do however, is leverage these professionals’ knowledge in exchange for a payment. It is much more cost and time effective in most cases to pay a small sum out of pocket in exchange for valuable information or recommendations in return.
  1. Behavioral accountability. Although we would be the first to agree that an index investment strategy is not rocket surgery, a financial professional can add value in helping control investors’ emotions. This includes recommending an investor not sell at a market bottom nor make devastating financial decisions trying to beat the market. Additionally, in times of stress such as divorce or death a financial professional can provide an ear and a calm voice of reason to help an investor through difficult times.
  1. Work with a fiduciary. When seeking a financial professional it is imperative to work with a fiduciary. An individual doing it on their own is thus their own fiduciary. The question is, is the investor going to act in their own best interest? Many individuals would say yes however, this can be difficult to do during times of market volatility and stressful situations. Working with a fiduciary can help provide objective, fiduciary advice to help an individual stay true to their financial plan and goals.

Missed Rollover Automatic Waivers

missed rolloverWhen you rollover funds from one retirement plan to another, a missed rollover occurs if you can’t complete the rollover within 60 days. A missed rollover results in a taxable distribution. However, there have always been certain specific situations that provide for exceptions to this rule, but any reasons outside that limited list required the taxpayer to request a Private Letter Ruling (PLR) from the IRS. The PLR request process could result in some significant costs for lawyers and fees.

Rev Proc 2016-47: Missed Rollover Waivers

Recently the IRS published a new procedure for handling an expanded list of exceptions for a missed rollover. This procedure, Rev. Proc. 2016-47, outlines eleven possible exceptions to the missed rollover rule. The eleven exceptions are:

  1. an error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates;
  2. the distribution, having been made in the form of a check, was misplaced and never cashed;
  3. the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan;
  4. the taxpayer’s principal residence was severely damaged;
  5. a member of the taxpayer’s family died;
  6. the taxpayer or a member of the taxpayer’s family was seriously ill;
  7. the taxpayer was incarcerated;
  8. restrictions were imposed by a foreign country;
  9. a postal error occurred;
  10. the distribution was made on account of a levy under § 6331 and the proceeds of the levy have been returned to the taxpayer; or
  11. the party making the distribution to which the rollover relates delayed providing information that the receiving plan or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information.

There are some more rules that apply – such as, you must not have requested an exception in the past and that exception was denied – but otherwise it’s a self-certification. The IRS has even provided a sample letter that the taxpayer will use to provide this self-certification. The sample letter is provided at the bottom of the procedure notice: Rev. Proc. 2016-47.

Investing Your 401k – a 2-step plan

two-stepsIf you’re like most folks, when you look at a 401k plan’s options you’re completely overwhelmed. Where to start? Of course, the starting point is to sign up to participate – begin sending a bit of your paycheck over to the 401k plan. A good place to start on that is at least enough to get your employer’s matching funds, however much that might be. In this article though, we’re looking at investing your 401k money. It’s not as tough as you think. In fact, it can be done in just two steps – taking no more than 30-45 minutes of your time.

Step 1 – Look at your options

When you’ve signed up for the 401k plan, review your options for investing your 401k. Look at the list of investments available – and from here you can take a shortcut if you like.

If your plan has a “target date” investment option that coincides closely with your hoped-for retirement date, start with that fund as your investment choice. This is an excellent place to start, especially when you have a relatively small amount of money in the plan. Choose this and you’re done – skip down to the “Follow up” section below.

If you’ve been participating for a while and have built up some money while investing your 401k, look at your options more closely. Among your options should be a large-cap stock fund (such as an S&P 500 index). In addition, there should be a broad-based bond fund as an option as well.

If there are multiple choices that fit those two categories, look a bit closer. Somewhere in your documentation should be information about the expense ratios of the funds. Choose the large-cap stock and bond fund with the lowest expense ratio when there is a difference.

There will likely be other investment options available to you, but for simplicity’s sake, you should just stick with these two for the time being. As you build your experience investing your 401k plan, add other investment choices to the mix.

Note: if you’re still overwhelmed, look at “Follow up” below for information about advisors to help you with the process.

Step 2 – Consider your risk tolerance

Risk tolerance is a fancy term that we financial-types use to describe how much you can stand the ups and downs of the market when investing your 401k funds. If you’re a nervous investor, watching your balance every day or week, you have a low risk tolerance; if you are a “set-it-and-forget-it” type, your risk tolerance is higher. Stocks are (generally) the more risky investment versus bonds, so if you have a lower risk tolerance your stock investment should be a bit lower. Vice versa if you have a higher risk tolerance.

Generally, when choosing between the two options we outlined above (stock and bond funds), you should select a ratio of no less than 25% of either, and the remainder of your selection should be no more than 75%.

A good starting point is 50% in each of the stock fund and the bond fund. If you’re really skittish about investing your 401k, and/or there are only a few years remaining before your retirement date, you might choose to invest a bit less in the stock fund and more in the bond fund. On the other hand, if you’re okay with the market’s up and down movements and recognize that investing your 401k is a long-term activity, investing more in stocks and less in bonds may be the better choice.

If it seems like I’m vague about this part, that’s because this part is personal and can be different for each person. Without knowing your circumstances, I can’t tell you how to invest. However, as a rule, it’s better to put more in stocks than in bonds, as this will give you a better chance of experiencing growth of your 401k plan over time. If you start out skittish and become more comfortable, you can always increase your stock investment later on.

Follow up – investing your 401k

After you’ve had some experience investing your 401k funds, you may become more comfortable with the process. Even if you’re not comfortable with it, it does pay off to review your investment options again over time. Especially if you chose the target date option above, you may want to adjust your investment process over time.

Your employer may offer access to a service to guide you through the process of investing your 401k. Take advantage of this service if you have it available.

In addition, there are plenty of books that can help you with the investment process. You’ll never regret educating yourself on investing. If it’s just not your thing, you can choose to find an advisor to help you with the follow up process. There are many advisors who can help you look over the options for investing your 401k. Many do this for an hourly fee. Even if it costs you $500 to $1000 to get this advice, it’s money very well spent. The advisor will help you understand what’s going on with your 401k.

Two good options to find advisors are the Garrett Planning Network and the National Association of Personal Financial Advisors (NAPFA). Click on the link to go to each website for more information.

Perspective on Market Direction

stock-market-rising-4180159From time to time we are asked about where we think the market is heading, whether or not another crash or “correction” is imminent and whether or not investing in the stock market is a wise investment.

To give a little perspective on this, I want to share a story with you.

In January of 1995 I was starting the second semester of my senior year in high school. Like many high school seniors, I was excited for graduation and ready for my learning to be over (oh, the ignorance!). In my senior social studies class we had an assignment. We were to pick a major, recurring news theme that we could track and report on for the entire semester.

Naturally, when the time came for us to initially report on the news theme we had selected, I had completely forgotten about the assignment and the due date. In a rush, I ran over to the stack of newspapers in the back of the class room and feverishly tore through the pages to find something relevant and recurring. By that time, other students had claimed most of the fun, easy topics. Taken topics included pop culture, sports, and others.. This left the business and financial section relatively untouched.

In my haste, my eyes stumbled on a headline: Dow at 3,838.48. At the time, this boring subject (and arguably still boring) was at least something I could report on throughout the semester. Quickly, I cut out the article, taped it to a piece of tag board and voila! – Mission accomplished.

The reason why I am sharing this is to offer perspective on what has happened over the last 20 years. Today (as of this writing) the Dow stands at 18,305 – almost 5 times its value in January of 1995! Why is this important? There are many reasons.

First, it gives perspective to individuals who worry about day-to-day market fluctuations. In other words, don’t watch the market daily. Second, it also gives perspective on how the market has weathered major events such as the October 1997 mini-crash, the Dotcom bubble bursting, 9/11, the Great Recession (Financial Crisis), the May 2010 Flash Crash and 2016’s Brexit. Third, it also lets individuals know that diversification is critical to any investment portfolio. That is, during these volatile times, other asset classes aside from stocks acted differently.

Does anyone know where the market is going? I would argue the answer is no; when time horizon is measured in days or months. For our clients, and personally, that’s why we look at long-term time horizons – in this case, just over 20 years.

If your hobby makes money, read this

hobbyLots of us have a hobby – whether it’s collecting stamps, raising honeybees, restoring old Jeeps, or mounting a wild-cat – and sometimes these hobbies can produce income. If you have a hobby that makes money, you may need to claim this money as income, net of your expenses, on your tax return.

Recently the IRS published their Summertime Tax Tip with Five Tax Tips about Hobbies that Earn Income, providing useful information about income-producing hobbies. The text of the Tip is below:

Five Tax Tips about Hobbies that Earn Income

Millions of people enjoy hobbies. Hobbies can also be a source of income. Some of these types of hobbies include stamp or coin collecting, craft making and horse breeding. You must report any income you get from a hobby on your tax return. How you report the income from hobbies is different from how you report income from a business. There are special rules and limits for deductions you can claim for a hobby. Here are five basic tax tips you should know if you get income from your hobby:

  1. Business versus Hobby. There are nine factors (below) to consider to determine if you are conducting business or participating in a hobby. Make sure to base your decision on all the facts and circumstances of your situation. Refer to Publication 535, Business Expenses, to learn more. You can also visit and type “not-for-profit” in the search box.  You generally must consider these nine factors to establish that an activity is a business engaged in making a profit:
    • Whether you carry on the activity in a businesslike manner.
    • Whether the time and effort you put into the activity indicate you intend to make it profitable.
    • Whether you depend on income from the activity for your livelihood.
    • Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
    • Whether you change your methods of operation in an attempt to improve profitability.
    • Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
    • Whether you were successful in making a profit in similar activities in the past.
    • Whether the activity makes a profit in some years and how much profit it makes.
    • Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
  2. Allowable Hobby Deductions. You may be able to deduct ordinary and necessary hobby expenses. An ordinary expense is one that is common and accepted for the activity. A necessary expense is one that is helpful or appropriate. See Publication 535 for more on these rules.
  3. Limits on Expenses. As a general rule, you can only deduct your hobby expenses up to the amount of your hobby income. If your expenses are more than your income, you have a loss from the activity. You can’t deduct that loss from your other income.
  4. How to Deduct Expenses. You must itemize deductions on your tax return in order to deduct hobby expenses. Your costs may fall into three types of expenses. Special rules apply to each type. See Publication 535 for how you should report them on Schedule A, Itemized Deductions.
  5. Use IRS Free File. Hobby rules can be complex. IRS Free File can make filing your tax return easier. IRS Free File is available until Oct. 17. If you make $62,000 or less, you can use brand-name tax software. If you earn more, you can use Free File Fillable Forms, an electronic version of IRS paper forms. You can only access Free File through

IRS Tax Tips provide valuable information throughout the year. offers tax help and info on various topics including common tax scams, taxpayer rights and more.

Additional IRS Resources:

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