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New Rules for File and Suspend

file and suspendSo the heyday is over, file and suspend under the old rules is gone forever as of April 30, 2016. Those were the days, my friend. We thought they’d never end. We’d file and suspend forever and a day. But not any more…

Or, may we still file and suspend?

Of course we can still file and suspend, the rules are just more restrictive now. When you suspend your benefits these days, all benefits that are payable based upon your record are suspended as well. For example, if you have a child who is eligible for benefits based on your record, when you suspend your benefits the child’s benefits will be suspended as well.  The same goes for spousal benefits based on your record.

To be clear, the rules about suspending benefits are:

  • You must be at least Full Retirement Age
  • When you suspend benefits, your own benefit will not be paid to you
  • Since you are not receiving benefits, you will earn delay credits at the rate of 8% for every year of delay
  • ALL OTHER BENEFITS based on your record will also be suspended, including spousal benefits and child’s benefits

File and Suspend

Before the rules changed, it was common to file and suspend at the same time. Now, with the new rules, it would likely not make much sense to file and suspend at the same time.

The action of filing for benefits is enough to enable benefits for others (spouse or child) to receive benefits based on your record. Under the old rules, if you suspended your benefits, these auxiliary benefits could continue – so, file and suspend at the same time made a lot of sense. By doing so, you would enable others to receive the auxiliary benefits, while at the same time delaying your own actual filing to some later date, receiving the delay credits for the delay.

With today’s rules, file and suspend at the same time doesn’t actually accomplish anything for you, other than establish a filing date.

What you might do though, is file for benefits at one point, and then later suspend them. For example, if you are 62 years old and you have a child who is under 18 (for example’s sake we’ll say 12 years old), you could file for your own benefits and enable your child to receive benefits based on your record. When the child reaches age 18, he will no longer be eligible to receive the benefits – so you could suspend your benefits at this point (you’d be 68 by now) and receive an 8% increase to your benefits for each year that you delay.

The strategy above would be important to you to provide some benefits to the auxiliary dependents (such as a child or spouse) for a short period of time, while allowing you to then enhance your benefits later by suspending.

If the concept isn’t thrilling to you, you’re not alone. Suspending benefits just isn’t what it used to be.

401k Loan versus Early Withdrawal

loaned motorcycleWhen you have a 401k and you need some money from the account, you have a couple of options. Depending upon your 401k plan’s options, you may be able to take a 401k loan. With some plans you also have the option to take an early, in-service withdrawal from the plan.

These two options have very different outcomes for you, in terms of taxes and possible penalties. Let’s explore the differences.

401k Loan

If your plan allows for a 401k loan, this can be a good option to get access to the money, for virtually any purpose. Being a loan, there is no tax impact when you take out a 401k loan. Plus you can use the money for any purpose that you need, at any age.

As a loan, it must be paid back over the a five-year period (at most). You’ll pay interest on the loan, but since it is from your own account, you’re paying interest to yourself.

There is a limit of $50,000 for a 401k loan, or 50% of your account balance if that amount is less.

If you leave the employer (retirement or otherwise) and there is still a balance outstanding on your 401k loan, the outstanding balance will be considered a withdrawal from the 401k account – which is taxable as ordinary income and possibly subject to the 10% early withdrawal penalty (unless you meet one of the exceptions, see below).

If you are not currently employed by the sponsoring employer, a 401k loan is generally not available.

401k Withdrawal

If you’re still employed by the company and want to take a withdrawal from your 401k, the 401k plan must have an option to allow for in-service withdrawals. Often there are restrictions on the availability of an in-service withdrawal. For many plans it’s necessary to be above a certain age (such as 59½ years of age), or that a particular requirement is met, such as hardship by the employee, defined by the plan administrator.

In addition, if you’re taking a withdrawal from the plan instead of a 401k loan, the money withdrawn from the 401k plan will be taxable to you as ordinary income. Plus if you’re under age 59½ your withdrawal could be subject to an early withdrawal penalty unless you meet one of the exceptions. See the article 16 Ways to Withdraw Money From Your 401k Without Penalty to see the exceptions to the 10% penalty.

The good news is that you won’t have to pay the money back to the plan when you make a withdrawal as you would with a 401k loan.

Focus on the Things You Can Control

Left a good job in the city, workin’ for the man every night and day. But I never lost one minute of sleepin’ worryin’ ’bout the way things might have been.

— John Fogerty

heathrowSometimes the answer to our stresses in life is to get back to basics and figure out what’s important to us, as well as what things we can control in our life. In the song quoted above, Fogerty’s writing was most likely tempered by his recent discharge from the Army Reserve (1967), after which the protagonist explores an awakening to a simpler side of life, and what turns out to be important to him.

We are often faced with similar situations – maybe we’ve been laid off or some financial calamity strikes us, and from that perspective we often discover what’s really important to us. Other times we just come to realize that our life seems out of control, and we’re searching for a way to get our comfort level back. Most importantly we can learn to not “worry ’bout the way things might have been”, and instead focus on the things about our lives that we can control.

At times we worry about interest rates, inflation, overseas unrest, the current political cycle, whether stocks are going up or down, and the baggage retrieval system they’ve got at Heathrow*. None of these things are items that you can control – for example, stocks are going to go either up or down, and no amount of worry on your part will affect the end result. The same goes with obsessing over the interest rate or inflation. Nothing you can do will change the course of these things. It’s best just to let them go, and don’t worry about them.

Now, I’m not advocating a “don’t worry, be happy” attitude, at least not completely. But there is something to be said for not letting things get you down. This can be more easily understood if you think about your life resources that you have available to you as similar in that there is a finite amount of each that is yours to use as you please:

  1. Money
  2. Time
  3. Talent
  4. Energy

In our lives we’re always making choices about how to “spend” these resources. Setting aside money for the moment, the other three (time, talent and energy) can be exchanged for money, and you can use the money to provide yourself with more time (sometimes) and more talent. Energy is one that can’t be expanded easily – and this one is where you lose out by worrying too much.

You only have so much energy available to accomplish things in your life. Whatever amount of that energy that you spend worrying about whatever is on the business news channel, then you have that much less energy to teach your son to play catch. And the end result for your financial well-being is likely to be the same whether you’re playing catch or watching the business news circus.

In addition, we often allow “the way things might have been” to dig at us over time. This stress that we put upon ourselves has no purpose – as the saying goes, “don’t cry over spilled milk”. Learn from the bad things that have happened to you, for sure. But don’t let the bad things that happened to you in the past define your future.

You have control over certain things, and it’s different for everyone. Instead of worrying about the stock market, shut off the tv, play catch with your son (or daughter), and then use your extra energy to figure out a way to maximize your IRA contributions. You’ll be far better off in the long run.

* That line is from a Monty Python routine called I’m So Worried – not their best work, but if you’re amused by the Python, I recommend giving it a listen.

Changing Your SOSEPP – Once, just once

sosepp-carIf you’re taking (or planning to take) early distributions from an IRA using the 72(t) provision with a Series of Substantially Equal Periodic Payments, also known as a SOSEPP, you need to know a few things about this arrangement. For more information on SOSEPPs in general, see the article Early Withdrawal of an IRA or 401(k) – SOSEPP for more details.

Generally when you establish a SOSEPP you have to stick with your plan for the longer of five years or until you reach age 59½ years of age. However, the IRS allows changing your SOSEPP one time, and only one time. And then, the rules only allow changing your SOSEPP from either the fixed annuitization method or the fixed amortization method to the Required Minimum Distribution method.

This is the only exception allowed for changing your SOSEPP during its enforcement period, which is the later of five years after you started the SOSEPP or when you turn age 59½. The exception is documented in Rev. Ruling 2002-62, 2.03(b).

If you’re planning on changing your SOSEPP in a manner other than the above-described methods, you will effectively “break” the plan, meaning that the SOSEPP is no longer in place. Doesn’t sound like such a bad thing, right? That’s where you’re wrong though… because if you break a SOSEPP, there are some very nasty ways that the IRS will get back at you.

This can be as simple as increasing or decreasing the amount you withdraw slightly, or forgetting to make a withdrawal altogether, or possibly taking two distributions (a double-dip) in one year. There’s not much room for “forgive and forget” on this from the IRS. For more on the consequences of breaking a SOSEPP, see the article Penalties for Changing a SOSEPP.

There is no specific provision in the Internal Revenue Code for relief from the penalty if you have broken your SOSEPP.  On the other hand, the IRS has in some cases granted relief in several private letter rulings by determining that a change in the series of payments did not materially modify the series for purposes of the rules.

If the series is broken due to an error by an advisor (for example), some prior PLRs have been issued in favor of the taxpayer.  PLR 201051025 and PLR 200503036 each address the situation of an advisor making an error and the distributions were allowed to be made up in the subsequent year.  Bear in mind that PLRs are not valid for any other circumstances other than the specific one in the ruling, and cannot be used to establish precedence for subsequent cases.

But in reality, the likelihood of your getting a favorable PLR for your case of a broken SOSEPP is small – unfortunately, breaking the series usually results in application of the penalty for previous payments received, and the SOSEPP is eliminated.  If you wish to restart the series you can do so, but you are starting with a new five-year calendar (the series must exist for at least five years, or until you reach age 59½, whichever is later).

Don’t Forget to Make Your IRA Contribution by April 18!

forgetmenotsWhen filling out your tax return, it’s allowable to deduct the amount of your regular IRA contribution when filing even though you may not have already made the contribution.

You’re allowed to make an IRA contribution for tax year 2015 up to the original filing deadline of your tax return. This year, that date is April 18, 2016.

The problem is that sometimes we file the tax return way early in the year, and then we forget about the IRA contribution. As of the posting of this article, you have 1 week to make your contribution to your IRA to have it counted for tax year 2015.

What To Do If You Miss the Deadline

If you don’t make the contribution on time, you’re in for some nasty surprises unless you take some corrective actions.

If you find yourself on April 19, 2016 without having made your IRA contribution and you had deducted one from your taxes for 2015, you need to amend your return. This means that you’ll fill out a Form 1040X and eliminate the IRA contribution that you originally deducted from your income. This will (most likely) result in additional taxes that you’ll owe, so when you send in the amendment you’ll have to send an additional tax payment.

Failure to amend your return in a timely fashion will result in the IRS contacting you later, requiring you to pay the additional tax plus interest. In addition, since your tax return was erroneous, the IRS will consider this to be “under-reporting of income” and “under payment of tax” – both of which carry penalties. Even if it was an honest mistake, you’ll owe these penalties.

You may even owe some penalties and interest if you file your amendment right away, since technically you’ve under-reported and underpaid. But if you amend as soon as you can, these penalties and interest should be minimized.

Taxes and Your Child

childrenWhen a child has unearned income from investments in his or her own name, taxes can be a bit tricky. Depending on how much the unearned income is, part of it may be taxed at the child’s parent’s tax rate, for example.

Recently the IRS published their Tax Tip 2016-52, which details What You Should Know about Children with Investment Income. The text of the Tip is below:

What You Should Know about Children with Investment Income

Special tax rules may apply to some children who receive investment income. The rules may affect the amount of tax and how to report the income. Here are five important points to keep in mind if your child has investment income:

  1. Investment Income. Investment income generally includes interest, dividends and capital gains. It also includes other unearned income, such as from a trust.
  2. Parent’s Tax Rate. If your child’s total investment income is more than $2,100 then your tax rate may apply to part of that income instead of your child’s tax rate. See the instructions for Form 8615, Tax for Certain Children Who Have Unearned Income.
  3. Parent’s Return. You may be able to include your child’s investment income on your tax return if it was less than $10,500 for the year. If you make this choice, then your child will not have to file his or her own return. See Form 8814, Parents’ Election to Report Child’s Interest and Dividends, for more.
  4. Child’s Return. If your child’s investment income was $10,500 or more in 2015 then the child must file their own return. File Form 8615 with the child’s federal tax return.
  5. Net Investment Income Tax. Your child may be subject to the Net Investment Income Tax if they must file Form 8615. Use Form 8960, Net Investment Income Tax, to figure this tax.

Refer to IRS Publication 929, Tax Rules for Children and Dependents. You can get related forms and publications on IRS.gov.

Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.

Break Even Points for Social Security Filing Ages

break evenLast week my article 3 Myths About Social Security Filing Age included some information about year-to-year break even points for the various Social Security filing ages. This prompted some questions about the break even points between all filing ages, not just the following year.

So for example, what are the break even points between choosing to file at age 62 versus age 66 or age 70?

This article shows the approximate break even points between all of the various filing ages. The first chart shows the break even points when your Full Retirement Age is 66. To use the chart, select your first filing age decision on the left, then move right to the second filing age you’re considering:

image

So, for the decision between filing at age 62 versus age 66, you can see that the break even point is at the age of 78. Comparing filing at age 66 with age 70, the break even point is at age 82.

It should be noted that these break even points are the age you will be when cumulative benefits received at the later filing age becomes greater than the cumulative benefits received based on the earlier filing age. The specific break even points occur sometime during the year indicated, as the analysis is done on an annual basis (not month-to-month). In other words, the actual break even month might be any month during that year. With this difference in mind, the prior article has been updated to reflect the same. Previously the analysis showed the first full year that the later filing age was superior to the earlier filing age.

This second chart shows the break even points for when your FRA is 67. It is used exactly the same as the chart above.

image

As before, choose the first filing age in the left column, and then move to the right for the break even points for the various filing ages. If you were choosing between age 63 and 66, for example, the break even point is age 77. Between age 65 and age 70, the break even point is 82.

3 Myths About Social Security Filing Age

myth-myth-yethWe hear all kinds of things about Social Security filing age – that we should always delay as long as possible, that we will gain 8% every year that we delay, and that the “break even” point is 80 years of age.

This article takes a long hard look at these three “facts” about Social Security filing age and shows the real math behind them. All three are only true to a point – and as you’re planning your Social Security filing age, you should understand the real truth behind these three items.

First, let’s look at the concept of delay.

You Should Always Delay Your Social Security Filing Age to 70

This one is the easiest to understand why it’s wrong – but the component of truth in it can be important because it could work in your favor to delay. Of course an absolute like this is going to be proven incorrect in some circumstances.

If you happen to be able to delay your Social Security filing age and you live a long time after age 70, over your lifetime you will receive more from Social Security than if you file early. However, if you need the cash flow earlier due to lack of other sources of income, filing early may be your only choice.

Filing earlier can provide income earlier, but depending on your circumstances you may be short-changing your family by filing early. When you file early, you are permanently reducing the amount of benefit that can be paid based on your earnings record. Your surviving spouse’s benefits will be tied to the amount that you receive when you file, and so if you delay to maximize your own benefit and your spouse survives you, you’re also maximizing the benefit available to him or her. This is to assume that your surviving spouse’s own benefit is something less than your benefit.

John has a benefit of$1,500 available to him if he files at age 66, his Full Retirement Age (FRA). His wife Sadie has a benefit of $500 available at her FRA. If John files at his age 62, his benefit is reduced permanently to $1,125 per month. When John dies, assuming Sadie is at least at FRA, Sadie’s benefit will be stepped up to $1,237 (the minimum survivor benefit is 82.5% of the decedent’s FRA benefit amount).

On the other hand, if John delayed his benefit to age 68, he would receive $1,740 per month since he has accrued delay credits of 16%. Upon John’s death, Sadie will receive $1,740 in survivor benefits. By delaying his benefit 6 years, John has improved his surviving spouse’s lot in life by over $500 per month. Of course this has required him to come up with the funds to get by in life in the meantime, and so if he has the funds available this makes a lot of sense. If he doesn’t have other funds available, one thing that can help matters out is if Sadie files for her own benefit at age 62 – this will provide them with $375 per month while John delays his benefits.

The key here is that it’s often wise for the member of a couple that has the larger benefit to delay benefits for the longest period of time that they can afford, in order to increase the survivor benefit available to the surviving spouse. But it’s also often necessary for household cash flow to file earlier. As we’ll see a bit later, only the question of surviving benefits makes this delay a truism. Otherwise, it could be more beneficial to file earlier.

Increase Your Benefits by 8% Every Year You Delay Filing

This one again comes from a truth: for every year after FRA that you delay your Social Security filing age, you will add 8% to your benefit. But the year-over-year benefit differences are not always 8%, and often the difference is much less.

It is true that if you compare the benefit you’d receive at age 66 to the benefit you’d receive at age 67, it will have increased by 8%. However, if you compare your age 67 benefit to your age 68 benefit, it will have increased by 7.41%. This age 68 benefit is 16% more than the age 66 benefit, but only 7.41% more than the age 67 benefit.

The table below shows the differences across the spectrum of filing ages when your FRA is age 66:

Filing Age Difference
62
63 6.67%
64 8.33%
65 7.69%
66 7.14%
67 8.00%
68 7.41%
69 6.90%
70 6.45%

And this table shows what the differences are year-over-year if your FRA is age 67:

Filing Age Difference
62
63 7.14%
64 6.67%
65 8.33%
66 7.69%
67 7.14%
68 8.00%
69 7.41%
70 6.90%

So as you can see, only from one specific year, your FRA, to the following year, is the increase 8%. Otherwise, with only the exception of one filing age (the difference between 3 years before FRA and 2 years before), the year-over-year increase is less than 8%, and sometimes it’s less than 7%.

The Break Even Point is 80 Years of Age

I’ve often quoted this as a fact – rarely pinning it down to a specific year, but giving the range of around 80 years old. It’s not that simple though when you consider all of the different ages that an individual can file.

For example, when deciding between a Social Security filing age of 62 versus filing at age 63, your break even point occurs at age 77 (when your FRA is age 66).  But when deciding between age 63 and age 64 (with FRA at 66), the break even occurs at age 78.

On the other end of the spectrum, when choosing between filing at age 69 versus filing at age 70 (FRA of 66), the break even occurs at age 84 – considerably later than age 80. The break even for the decision to file at age 68 versus age 69 occurs at age 82.

The two tables below illustrate the ages at which the break even occurs between the various filing ages. This first table is when your FRA is 66:

Filing Age Break Even
62
63 77
64 78
65 76
66 79
67 80
68 80
69 82
70 84

And this table shows what the differences are year-over-year if your FRA is age 67:

Filing Age Break Even
62
63 77
64 75
65 78
66 79
67 79
68 81
69 83
70 85

So the year-over-year break even point ranges, depending on which Social Security filing age you’re considering. If the two options are earlier (before FRA) the break even point occurs before age 80. If at or around FRA, then the break even occurs right around age 80. But if the Social Security filing age you’re considering is near age 70, count on the break even being much later, as late as age 85.

IRS Reports 9 Common Tax Prep Errors

errorsUnless you’ve been under a rock for the past several years, you know that this time of year is tax season. If you haven’t already filed your 2015 income tax return, of course you’ve got some work ahead of you. Unfortunately filing your tax return often results in errors – and these can be quite costly in terms of delays in processing as well as potential penalties and interest if your error results in underpayment of tax.

In addition, an error on your return could result in missing out on refunds or credits that you are entitled to.

Recently the IRS issued Tax Tip 2016-42, which lists out 9 common filing errors that they see, and tips to avoid the errors. The actual text of the Tip follows:

Avoid Errors; File an Accurate Return

The IRS encourages you to file an accurate tax return. Take extra time if you need it. If you make an error on your return then it will likely take longer for the IRS to process it. That could delay your refund. You can avoid many common errors by filing electronically. IRS e-file is the most accurate way to file your tax return. Seven out of ten taxpayers can use IRS Free File software at no cost.

Here are nine common tax-filing errors to avoid:

1. Wrong or Missing Social Security Numbers.  Be sure you enter all SSNs on your tax return exactly as they are on the Social Security cards.

2. Wrong Names.  Be sure you spell the names of everyone on your tax return exactly as they are on their Social Security cards.

3. Filing Status Errors. Some people use the wrong filing status, such as Head of Household instead of Single. The Interactive Tax Assistant on IRS.gov can help you choose the right status. If you e-file, tax software helps you choose.

4. Math Mistakes. Math errors are common. Tax preparation software does the math for e-filers.

5. Errors in Figuring Tax Credits or Deductions. Many filers make mistakes figuring their Earned Income Tax Credit, Child and Dependent Care Credit, and the standard deduction. If you’re not e-filing, follow the instructions carefully when figuring credits and deductions. For example, if you’re age 65 or older or blind, be sure you claim the correct, higher standard deduction.

6. Incorrect Bank Account Numbers. Choose direct deposit for your refund. It’s easy and convenient.  However, be sure to use the right routing and account numbers on your return. The fastest and safest way to get your tax refund is to combine e-file with direct deposit.

7. Forms Not Signed.  An unsigned tax return is like an unsigned check – it’s not valid. Both spouses must sign a joint return. You can avoid this error by e-filing your taxes since you must digitally sign your tax return before you send it to the IRS.

8. Electronic Filing PIN Errors.  When you e-file, you sign your return electronically with a Personal Identification Number. If you know last year’s e-file PIN, you can use that. If you don’t know it, enter the Adjusted Gross Income from the 2014 tax return that you originally filed with the IRS. Do not use the AGI amount from an amended return or a return that the IRS corrected.

9. Health Care Reporting Errors. The most common health care reporting errors that taxpayers make involve failing to claim a coverage exemption and not reconciling advance payments of the premium tax credit. If you don’t have qualifying health care coverage but meet certain criteria, you might be eligible to claim an exemption from coverage and avoid an unnecessary payment when you file your tax return. If you enrolled in health coverage through the Health Insurance Marketplace and received advance credit payments, you must file a tax return to reconcile the advance payments made on your behalf with the amount of your actual premium tax credit.

Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.

Additional IRS Resources:

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Taxes and the 401k Withdrawal

401k withdrawalIf you take a 401k withdrawal and the money in the 401k was deducted from your taxable income, you’ll be taxed on the funds you withdraw. Depending on the circumstances, you may also be subject to a penalty. There’s a lot of confusion about how the taxation works – and the taxation and penalties can be different depending upon the circumstances.

Taxation of the 401k Withdrawal

When you take a distribution of pre-tax money from a 401k plan, the amount of the 401k withdrawal that is pre-tax will be included in your income and will be taxed at your marginal income tax rate in that year.

Unless you meet one of the exceptions noted in the article 16 Ways to Withdraw Money From Your 401k Without Penalty, your 401k withdrawal will also be subject to a 10% early withdrawal penalty.

For example – if you have a 401k plan at a former employer and you are 45 years of age, unless your 401k withdrawal meets one of the exceptions, taxation would work like this for a $50,000 401k withdrawal:

Taxable Income before withdrawal $60,000
Tax (assumes MFJ) $8,072.50
Effective Tax Rate 13.45%
401k Withdrawal $50,000
Other taxable income $60,000
Total taxable income $110,000
Tax (assumes MFJ) $23,836.75
Effective Tax Rate 21.67%
Penalty (10%) $5,000
Total Tax and Penalty $28,836.75
Total Effective Tax Rate 26.22%

Nothing really dramatic about the first part, it’s just more taxable income and you’ve likely grown to understand the effect of the graduated tax schedule. But what will likely open your eyes is the fact that this $50,000 was actually taxed at a rate of 41.53%! Your 401k withdrawal of $50,000 resulted in $20,764.25 in taxes and penalties, so in effect you only “net” $29.235.75 from this withdrawal. Almost makes a payday loan look cheap by comparison.

On the other hand, if you met one of the exceptions (such as being age 59½ or older, the penalty would not apply. The effective tax rate on the 401k withdrawal is 10% less, at only 31.53%.

Mandatory Withholding

Another thing you need to understand about your 401k withdrawal is the mandatory withholding. Unless your 401k withdrawal is a direct rollover to another plan (such as an IRA), part of a Series of Substantially Equal Periodic Payments (SOSEPP, or 72t option), is a Required Minimum Distribution or a hardship distribution, there is a requirement for the administrator to withhold 20% from the 401k withdrawal.

This 20% is sent to the IRS and will be included as part of your withholding and estimated tax payments that will apply against your tax when you file. If the withholding was too much, you’ll get a refund of the extra withholding, just as you do from extra withholding or estimated payments.

Here’s a continuation of the previous example to illustrate withholding:

401k Withdrawal $50,000
Mandatory Withholding (20%) $10,000
Other Withholding (from W4 wages) $9,000
Total Withholding $19,000
Total Tax and Penalty (from prior) $28,836.75
Amount You Owe $9,836.75

As you can see, even though the mandatory withholding from the 401k withdrawal is substantial, it’s not enough in many cases to cover the tax and penalties from the withdrawal.

Restricted Application – the Definitive Guide

this fellow didn't file a restricted applicationMuch has been written and discussed regarding the option to file a Restricted Application for Social Security spousal benefits, but there are still many, many questions. This article is an attempt at covering all of the bases for you with regard to restricted application.

The topic of restricted application is so popular these days because it’s being eliminated as a result of the Bipartisan Budget Act of 2015 (BBA15). In fact, if you were born on or after January 2, 1954, the changes to the rules have eliminated the option to file a restricted application for you altogether.

So – unless you were born on or before January 1, 1954, you might as well stop reading, because restricted application is not available to you. Period.

Restricted Application Rules

Okay, if you’re continuing to read, you (or your client, if you’re an advisor) must have been born early enough to be eligible for a restricted application. There are a few rules that you must be aware of for filing a restricted application:

  1. THERE IS NO DEADLINE FOR FILING A RESTRICTED APPLICATION OTHER THAN YOUR AGE 70. In other words, the upcoming deadline of April 30, 2016 has nothing to do with restricted application eligibility.
  2. You must be at or older than Full Retirement Age (FRA) to file a restricted application.
  3. You must not have filed for your own Social Security benefit previously. This includes File & Suspend.
  4. You may have previously received Social Security benefits as a young parent of a child under age 16, or as a child yourself under age 18. These benefits do not eliminate your eligibility for a restricted application.
  5. You cannot be actively receiving disability benefits. If you previously received disability benefits that were terminated some time in the past because the disability (or your eligibility) ceased, you may still be eligible for a restricted application.
  6. Your spouse must have filed for his or her own benefits. May also have suspended benefits, if the suspense was completed before April 30, 2016. But if the suspense was after April 30, 2016 you will not be eligible for spousal benefits until the suspense is lifted.
  7. If you are divorced and the divorce was finalized more than 2 years prior, your ex-spouse must only be at or older than 62 years of age, and is not required have filed for benefits. (*This is the exception to the rule in #6.)
  8. Only one member of a married couple may file a restricted application (doesn’t include ex-spouses).

Why Would You Want to File a Restricted Application?

A restricted application allows you to receive spousal benefits while delaying your own benefit, in order to accrue the delayed retirement credits (DRCs).

For example, Jeff and Cindy are both at FRA, age 66 this year. Jeff has filed for his benefits, in the amount of $2,000 per month. Cindy’s own benefit could be $900 if she filed now, but she wants to delay her benefit until age 70, when the DRCs will have increased her benefit to $1,188 (DRCs are 8% per year of delay).

Since Jeff has already filed for his benefit, and Cindy is at FRA in 2016 (therefore having been born before January 2, 1954), Cindy is eligible to file a restricted application for spousal benefits. She’ll receive a spousal benefit of $1,000 (50% of Jeff’s benefit at his age 66) and then her own benefit will accrue the DRCs since she has not filed for her own benefit.

For another example, Simon is 67 years of age and his wife Patty is 63 this year. Simon’s age 66 benefit would have been $1,500, and Patty’s would be $1,000. Patty has just retired from her job, and is filing for her own Social Security benefit. She’ll receive a reduced benefit in the amount of $800 since she filed early. Simon has not filed for Social Security benefits prior to this, as he intends to delay his filing until age 70.

Since Patty has filed for her own benefit and Simon is older than FRA in 2016 (therefore having been born before January 2, 1954), he is eligible to file a restricted application for spousal benefits. Simon will receive $500 per month for the coming three years, and then at age 70 he will file for his own benefit, which has increased to $1,980 with the DRCs.

So you can see, there may be much to be gained by filing a restricted application in the right circumstances.

How to File a Restricted Application

In order to accomplish the filing of a restricted application, you have four options to choose from. These options are listed below:

  1. Go to www.SocialSecurity.gov and apply using the online application. When you do this, fill out the application as if you will be receiving ordinary benefits, and there’s a question on the application which asks: If you are eligible for both retirement benefits and spouse’s benefits, do you want to delay receipt of retirement benefits? Answer this question “Yes”, and continue to complete the application. You have now filed a restricted application.
  2. You can file a paper application (Form SSA-1-BK is available online as well). Fill it out as if you were going to receive benefits, and then indicate in the REMARKS section “I want to restrict the scope of this application to spousal benefits only. I wish to delay filing for my own benefit to age 70.”
  3. Call 1-800-772-1213 to apply by phone. Tell the representative that you wish to file for benefits and restrict the application to spousal benefits only, and that you wish to delay filing for your own benefits to age 70 in order to earn the delay credits.
  4. Visit your local Social Security Administration office. Tell your representative that you wish to file for benefits and restrict the application to spousal benefits only, and that you wish to delay filing for your own benefits to age 70 in order to earn the delay credits.

That’s it. You don’t need to do anything else. It’s not necessary for your spouse to file & suspend (only to file), so the April 30, 2016 deadline for file & suspend doesn’t necessarily have anything to do with this.

And whoever is filing the restricted application definitely does not file & suspend – see the 3rd rule earlier in this article. File & suspend would actually derail your plan to file a restricted application.

Mutual Funds vs. 529 Plans

collegeSaving for college is a tough job – on par with saving for retirement, and often in direct conflict with that goal as well. Adding to the difficulty of the task is the fact that there are so many different options out there (in terms of investment vehicles) that really muddy the waters for the individual college saver.

One question that comes up very often is whether it is just as effective to utilize tax-effficient mutual funds instead of 529 plans as we save for college. The idea is that the mutual fund can generate a higher overall return than the 529 plan due to the additional costs associated with the administration of the 529 plan.

It is a fact that most 529 plans charge management fees that have a direct impact on the overall return of the account, and it is also a fact that many tax-efficient mutual funds (such as index funds) can produce higher returns at a lower cost than most other investments. But here are a few reasons why a 529 plan is nearly always the superior choice when it comes to college savings activities:

A. Taxing Matters – with a 529 plan, you pay no tax at all (when the funds are used for Qualified Higher Education Expenses, QHEE), while with any other type of account, you’ll likely pay some tax. In my book, no tax is always better than some tax, no matter how little.

In addition, while today’s tax rates on capital gains (the tax you’d pay on an indexed mutual fund) are at the lowest they’ve historically ever been, at either 0% or 15%, depending upon your tax bracket – these rates are liable to sunset soon, increasing the rates to 10% or 20% or even ordinary income tax rates. So, the question becomes: will your student be finished with college before the rise in rates?

The third taxing matter has to do with the Kiddie Tax. Recently there have been some changes made to this portion of the tax code, with detrimental effects for parents who have counted on a strategy of repositioning funds to the child’s name in order to benefit from a lower tax rate. The child’s investment income above a minimum of $1,700 can be taxed at the parent’s highest rate all the way up to age 23!

B. Financial Aid Impact – any income that is reported on your form 1040 (which includes capital gains) is considered as a part of the calculation for financial aid for the following year. As you begin drawing monies from the mutual funds, it is possible that you will be increasing your income to the detriment of available need-based financial aid. If, on the other hand, these funds were in a 529 plan and withdrawn for use in paying QHEE, there will be no taxable income reported on your 1040, thereby having no impact on the financial aid calculation.

C. Inherent Costs – with the 529 plans, there are administrative and manager fees, but, as shown with the recent changes to the BrightStart plan in Illinois, these fees are beginning to come down. Plus, most 529 plans (Illinois’ BrightStart and Bright Directions included) have very low-cost investment options available, reducing the expense ratio of the funds themselves. Analysis of 529 plans versus mutual funds has consistently shown that, when considering the tax benefits and the costs of the two options, there are very few instances where a low-cost mutual fund performs better than a 529 plan, and then only when the 529 plan in question is one where the administrative expenses are relatively high and the taxpayer is in the lowest possible tax bracket.

In addition to the internal costs of the various options, mutual funds quite often make certain investment decisions that have tax consequences, such as distributing capital gains and dividends. 529 plans do not have to make this sort of decision, and therefore decisions can be based entirely on investment considerations.

All in all, while non-529 investments may provide additional investment options over those available in the 529 plans, unless for some reason you do not have the option of choosing a 529 plan for specific college savings, the 529 plan is the better choice across the board.

What Must I Do Before April 30, 2016?

April 30 CalendarThere is a great deal of confusion surrounding the new Social Security rules that were put into place with the Bipartisan Budget Act of 2015 (BBA15). The part that is bothering folks the most right now is the deadline that is coming up, on April 30, 2016.

What’s important about April 30, 2016? What must I do before April 30, 2016?

The rule changes in BBA15 indicated that the suspension of Social Security benefits would be treated differently beginning 180 days after passage of the law. The law was passed on or about November 2, 2015, and so 180 days after that is April 30, 2016.

What’s the change?

First of all, in order to suspend your benefits, you must be at or older than Full Retirement Age (FRA). For folks who will be eligible to take advantage of the old suspend rule, that means you must be 66 before April 30, 2016, so you must have been born before April 30, 1950.

Previously, when someone suspended his or her Social Security benefits, his or her spouse or children could receive benefits based upon his or her record. This is still the case if you suspend your benefit prior to April 30, 2016.

After April 30, 2016, when someone suspends his or her Social Security benefits, all benefits based on his or her record will also be suspended. This means that his or her spouse or child cannot receive benefits based on his or her record while suspended.

Why would you want to suspend benefits in the first place?

For every month after your FRA that you delay receiving Social Security benefits, you accrue a delay credit of 2/3% – a total of 8% for every year of delay. This only happens if you are not receiving benefits, and it only happens after your FRA.

You can earn these delay credits by doing nothing – there is no requirement for you to do anything at all. The simple fact that you are not receiving benefits allows you to accrue this credit. You can accrue the delay credit up until the age of 70 – at that point your Social Security benefit is maximized.

On the other hand, if you file for your benefits, your dependents can receive benefits based on your record. Your spouse can receive up to 50% of your benefit amount, and your children under age 18 (19 if a full-time student, or any age if disabled) can also be eligible for 50% of your benefit amount.

“File & Suspend” gives you the ability to do both things – earn the delay credits AND provide benefits for your spouse or children. But this is only available if you file and suspend prior to April 30, 2016.

So what has to happen before April 30, 2016?

There is only one thing that must happen before April 30, 2016 if you want to take advantage of this rule before it changes: If you’re at or older than age 66 (your FRA) you must file and suspend your benefits at some point before April 30.

To do this, you have 4 choices:

  1. Go online to www.SocialSecurity.gov and apply online. When you do this, you fill out the application as if you will be receiving benefits, and then in the “Comment” section at the end of the application, write: I wish to immediately suspend my benefit to earn delay credits.
  2. You can file a paper application (form available online as well). Do the exact same thing as #1 above – fill it out as if you were going to receive benefits, and then indicate that you wish to suspend.
  3. Call 1-800-772-1213 to apply by phone. Tell the representative that you wish to file for benefits and immediately suspend them to earn the delay credits.
  4. Visit your local Social Security Administration office. Tell your representative that you wish to file for benefits and immediately suspend them to earn delay credits.

That’s all you have to do. Nothing else needs to be done before April 30.

Your dependent doesn’t have to start taking spousal or dependent’s benefits immediately or even before April 30. Since you have filed for benefits, your dependent (spouse or child) is eligible to take benefits based on your record, whenever they happen to file.

Why You’re Getting Form 1095

healthcare workersMany taxpayers are receiving a new form in the mail this tax season – Form 1095, either A, B, or C. This is because of the Obamacare law which requires that taxpayers have healthcare coverage. Form 1095 provides documentation of the taxpayer’s coverage by healthcare insurance. Depending upon the type of coverage you have, you will receive a certain type of form. And what should you do with this form?

Form 1095 A

If you have coverage through the Health Insurance Marketplace (established as a result of Obamacare), you’ll receive Form 1095-A. This form is used when you fill out your income tax return for the year, so that your tax credit for the healthcare premium can be reconciled, especially if you received the premium credit in advance.

Form 8962 is filled out and filed with your tax return, using the information in Form 1095 A. If your advance payments are more than what your income supports, you will owe some of these advance payments back – or the amount will reduce your refund. On the other hand, if your advance payments are less than what your income supports or if you didn’t receive advance payments, you’ll get the credit on your tax return.

Form 1095 B

If you had health insurance coverage via a self-insured employer or insurance that you purchased through some other means besides an employer or the Health Insurance Marketplace (including Medicare, Medicaid, or CHIP), you will receive Form 1095 B. This form is used to indicate that you had health insurance coverage as required throughout the tax year.

You (or your tax preparer) will use this form to show whether or not you had insurance coverage in the tax year on Form 8962. If you did not have coverage for any month of the year and you don’t meet one of the exceptions, you will owe the individual shared responsibility payment.

Form 1095 C

If you had health insurance coverage by way of your employer, you will receive Form 1095 C. Just the same as Form 1095 B, this form is used to prepare Form 8962, determining whether or not you had coverage, and subsequently whether or not a shared responsibility payment is due.

If you haven’t received a Form 1095 and you’re expecting one, you should wait until you receive it before filing your tax return. In a practical sense, as long as you definitely had coverage (Medicare, employer benefits, etc.) for the entire year, you can probably go ahead and file without receiving the form, but if you receive a form later and it indicates that you didn’t have coverage, you’ll need to file an amended return to correct the issue.

New Deemed Filing Rules

deemed filingWhen the Bipartisan Budget Act of 2015 was passed, there were a few changes made to Social Security rules. One of the rules that changed significantly is the deemed filing rule.

The old deemed filing rule

The current or old deemed filing rule works as follows:

When an individual who is under Full Retirement Age (FRA) is eligible for a spousal benefit in addition to a benefit based upon his or her own record files for either benefit, he or she is deemed to have filed for all benefits that he or she is eligible for at that time.

At any other time (other than the time of application for benefits) deemed filing does not apply.

For example, Anna and John are both nearing 62 years of age. Anna has a PIA (FRA benefit) of $800, and John has a PIA of $2,000. Anna is planning to file for her own benefit when she reaches 62. If John files for his benefit before Anna, deemed filing will require Anna to file not only for her own benefit but also for the spousal benefit, since she’s under FRA and she’s eligible for the spousal benefit.

On the other hand, if John had not already filed for his benefit, Anna can only file for her own benefit. Later, when John files for his own benefit, Anna has the option to file for spousal benefits, but is not required to. Deemed filing only applies upon the first month of entitlement, the month that your benefit first begins. If Anna wishes, she can delay filing for the spousal benefit in order to increase the amount of spousal benefits she can receive.

It may seem trivial, but in the example above where Anna has the choice to delay, it can mean a difference of $100 per month. If deemed filing applies, Anna will have $700 per month in benefits from her filing date through the rest of her life; if she delays filing for the spousal benefit, beginning at FRA she could receive $800 per month.

In addition, if Anna delayed filing for any benefit until she was at least FRA, then deemed filing would not apply to her at all, regardless of whether John had filed for his benefits. This would allow Anna to, at FRA, file an application for spousal benefits only, which is known as a Restricted Application. In doing so, she could receive spousal benefits while accruing delay credits on her own benefit.

The new deemed filing rule

The law in the Bipartisan Budget Act of 2015 (BBA15) changed the deemed filing so that it applies at any age, including after FRA. This means that the Restricted Application option is no longer available. The new deemed filing rule applies to anyone born on or after January 2, 1954.

So back to our example – assuming that Anna and John were born after January 2, 1954 – Anna can still file for her own benefit at age 62. If John has already filed, deemed filing applies as it did in the past. But if John has not filed for his benefit and then he files for his benefit, say 3 months later, Anna will be forced to take the spousal benefit at that time. This is due to the fact that she 1) has filed for benefits, and 2) she’s eligible for a spousal benefit, by virtue of the fact that John has filed for his benefit.

This takes away the planning strategy detailed earlier which would allow Anna to choose between receiving $700 now or $800 at FRA. She can only take the $700 now.

More significantly, if Anna had delayed until her FRA, under the new deemed filing rule, if she wants to file for benefits at FRA (or any age) she must file for all benefits which she is eligible for – in other words, no Restricted Application is allowed.

Exceptions to the new deemed filing rule

There are a few exceptions to the deemed filing rule, listed below:

  • If Anna (from our example above) is under FRA and is receiving a spousal benefit based upon the child-in-care rule, meaning that she and John have child who is under age 16 and John has applied for benefits. If this is the way that Anna is receiving spousal benefits, deemed filing does not apply to Anna. When she reaches FRA or the child reaches age 16, Anna is no longer eligible for the child-in-care benefit; any benefit that she applies for will be subject to deemed filing.
  • Likewise, if Anna was receiving a disability benefit (under FRA), deemed filing would not apply. Upon reaching FRA, Anna’s disability benefit will automatically switch over to a retirement benefit, and if she’s eligible for spousal benefits at that time, deemed filing will require her to receive the spousal benefit at that time.
  • Deemed filing also doesn’t apply to survivor benefits. If John had died before Anna reached age 62, Anna could still file for her own benefit at 62 and then delay receiving survivor benefits until they are maximized at her FRA.

IRS Warns of Surge in Email Scams in 2016

scamRecently the IRS issued a memo regarding the recent uptick in the occurrence of email phishing scams this year. Below is the text of the warning memo (IR-2016-28):

Consumers Warned of New Surge in IRS E-mail Schemes during 2016 Tax Season; Tax Industry Also Targeted

WASHINGTON – The Internal Revenue Service renewed a consumer alert for e-mail schemes after seeing an approximate 400 percent surge in phishing and malware incidents so far this tax season.

The emails are designed to trick taxpayers into thinking these are official communications from the IRS or others in the tax industry, including tax software companies. The phishing schemes can ask taxpayers about a wide range of topics. E-mails can seek information related to refunds, filing status, confirming personal information, ordering transcripts and verifying PIN information.

Variations of these scams can be seen via text messages, and the communications are being reported in every section of the country.

“This dramatic jump in these scams comes at the busiest time of tax season,” said IRS Commissioner John Koskinen. “Watch out for fraudsters slipping these official-looking emails into inboxes, trying to confuse people at the very time they work on their taxes. We urge people not to click on these emails.”

This tax season the IRS has observed fraudsters more frequently asking for personal tax information, which could be used to help file false tax returns.

When people click on these email links, they are taken to sites designed to imitate an official-looking website, such as IRS.gov. The sites ask for Social Security numbers and other personal information. The sites also may carry malware, which can infect people’s computers and allow criminals to access your files or track your keystrokes to gain information.

The IRS has seen an increase in reported phishing and malware schemes, including:

  • There were 1,026 incidents reported in January, up from 254 from a year earlier.
  • The trend continued in February, nearly doubling the reported number of incidents compared to a year ago. In all, 363 incidents were reported from Feb. 1-16, compared to the 201 incidents reported for the entire month of February 2015.
  • This year’s 1,389 incidents have already topped the 2014 yearly total of 1,361, and they are halfway to matching the 2015 total of 2,748.

“While more attention has focused on the continuing IRS phone scams, we are deeply worried this increase in email schemes threatens more taxpayers,” Koskinen said. “We continue to work cooperatively with our partners on this issue, and we have taken steps to strengthen our processing systems and fraud filters to watch for scam artists trying to use stolen information to file bogus tax returns.”

As the email scams increase, the IRS is working on this issue through the Security Summit initiative with state revenue departments and the tax industry. Many software companies, tax professionals and state revenue departments have seen variations in the schemes.

For example, tax professionals are also reporting phishing scams that are seeking their online credentials to IRS services, for example the IRS Tax Professional PTIN System. Tax professionals are also reporting that many of their clients are seeing the e-mail schemes.

As part of the effort to protect taxpayers, the IRS has teamed up with state revenue departments and the tax industry to make sure taxpayers understand the dangers to their personal and financial data as part of the “Taxes. Security. Together” campaign.

If a taxpayer receives an unsolicited email that appears to be from either the IRS e-services portal or an organization closely linked to the IRS, report it by sending it to phishing@irs.gov.  Learn more by going to the Report Phishing and Online Scams page.

It is important to keep in mind the IRS generally does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS has information online that can help protect taxpayers from email scams.

Phishing and malware schemes again made the IRS “Dirty Dozen” tax scam list this year. Check out the last IRS Phishing Scam news release for more info.

What to look for in these scams

Taxpayers receive an official-looking email from what appears to be an official source, whether the IRS or someone in the tax industry.

The underlying messages frequently ask taxpayers to update important information by clicking on a web link. The links may be masked to appear to go to official pages, but they can go to a scam page designed to look like the official page. The IRS urges people not to click on these links but instead send the email to phishing@irs.gov.

Recent email examples the IRS has seen include subject lines and underlying text referencing:

  • Numerous variations about people’s tax refund.
  • Update your filing details, which can include references to W-2.
  • Confirm your personal information.
  • Get my IP Pin.
  • Get my E-file Pin.
  • Order a transcript.
  • Complete your tax return information.

Numbers provided are for phishing and malware incidents combined.

SSA Updates File & Suspend Guidance

suspended

You can listen to this article by using the podcast player below if you’re on the blog; if you’re reading this via RSS, there should be a “Play Now” link just below the title to access the audio. If you’re receiving this article via email, there should be a “Download Now” link within the text of the message to retrieve the audio file.

Recently the Social Security Administration provided some guidance regarding how the end of file & suspend will be handled, in light of the changes that were brought about by the passage of the Bipartisan Budget Act of 2015 (BBA15).

If you’ll recall, the option to suspend your Social Security benefit (part of File & Suspend) allowed one member of a couple to establish a filing date which would then provide the other member of the couple with the eligibility to file for a spousal benefit. The first member of the couple (who suspended benefits) is allowing his or her benefit to accrue the delay credits while the second member receives benefits. This provision was eliminated 180 days after the passage of BBA15.

Below is how the Social Security Administration will handle the suspension of benefits going forward:

  • For individuals who are FRA or older, if a request for suspension of benefits has been submitted before April 30, 2016:
    • The suspension will be treated as in the past (even if it has not been processed by that date, as long as it was submitted timely). This means that auxiliary benefits (such as spousal or dependent’s benefits) can continue to be paid based upon that suspended record while it is suspended.
    • In addition, the numberholder (NH) who requests a suspension prior to April 30, 2016 can in the future ask that benefits are reinstated as of any date after the suspension request, up to the present date (this is known as a lump-sum retroactive payment).
    • During the period that the NH benefit is suspended, he or she can collect excess spousal benefits based on a spouse’s record. An excess spousal benefit is the amount of spousal benefit that is “excess”, or greater, than the NH own benefit.
  • For individuals who submit a request for suspension of benefits on or after April 30, 2016:
    • No auxiliary benefits (spousal, child’s, or other, including benefits that have been received in the past) can be paid on the NH record while the benefit is suspended – EXCEPT for ex-spouse benefits. This is a significant exception, as had the rules been applied exactly as written, a NH could control benefits to an ex-spouse. With this exception, that is not going to be the case.
    • In addition, when removing the suspension, benefits will resume in the month following the month that the request was received (or later). In other words, no lump-sum retroactive benefits will be available.
    • No excess spousal benefits can be paid to the NH while the primary benefit is suspended.

The other significant item is that the date has been set at April 30, 2016 – but it’s not as significant as it seems. Anyone born on or before April 30, 1950 (actually May 1, 1950) is considered to be FRA during the entire month of April, 2016, so even if born on May 1, 1950 the NH should be in good shape if they want to use this provision.

If you would like to see the actual message from SSA, follow this link.

Ready, Set, Go! When To Start A Pension Payout?

decisionsThe question comes up often: I’m ready to retire at age 55, and I can begin collecting my pension right away. Should I? The amount of the pension increases to almost double if I wait to start collecting at age 62, and two-and-a-half times if I wait until age 65. What’s the best way to do this?

Obviously, there are a lot of factors that will go into the answer to such a question, so right off, it’s hard to say for sure, but here are the basics of making this decision:

These types of pensions are based on the employer’s assumption about your life expectancy. If you live to exactly the expected age, the cost to the employer will be roughly the same no matter which option you choose. You just need to do the math – bigger payments later are made for (expected) fewer years.

It goes without saying that if you were sure you’d die at age 60, you would be much better off starting your pension payout as early as possible. On the other hand, if you live longer than expected, starting your payout as late as possible will likely make up for the late start. But at what projected life span does this make sense?

An Example

Let’s start with an example: Say at age 55 you could begin a pension paying $1,229 per month, or at age 62, $1,990 per month, or you could begin receiving $2,263 per month if you wait to age 65 to begin collecting. For the purpose of simplicity, the example will not factor in taxes or any cost-of-living adjustments.

At age 70, your first option is still ahead of the other two. So, if you were to die before age 71, the first option, collecting at age 55, works the best, because you would have collected a total of $221,220 by that point, versus $214,920 for the age 62 option and only $162,936 with the age 65 option.

However (and isn’t there always a however in life?) – if you lived beyond that age, the other options begin to take the lead. If you lived to at least 71 but not to age 85, the age 62 option would work out the best. Anything from age 85 on up, you’re best off to wait until age 65 to get started.

What about spouse benefits?

The above example considered only a single life – what about if you have a spouse who may be dependent on your pension in retirement? In those cases, you have the option of choosing a “joint & survivor” pension option. These are often presented in terms of the original pension amount and an amount to be paid to your surviving spouse. The amounts here are based on your age as well as your spouse’s age, since the actuarial calculations have to account for two lives receiving the money instead of just one.

As we’ve discussed in other articles, for a couple who are both age 65, there is a 72% chance that one of them will live to at least age 85, and a 45% chance that one will live to age 90. These factors cause a further reduction in the pension amounts.

So here is a sample table illustrating the benefit amounts for some example options using Joint & Survivor (J&S) pension amounts, as well as a 10-year certain annuity:

Age 55 62 65
Single Life $1229 $1990 $2263
25% J&S $1202 $1921 $2174
50% J&S $1190 $1887 $2125
75% J&S $1150 $1797 $2015
100% J&S $1126 $1741 $1944
10-year Certain $1219 $1944 $2126

As you can see, the more pension that is available to the surviving spouse, the lower the overall pension payment. This is due to the fact mentioned earlier that when considering the lives of a couple the actuarial chance of one spouse living longer is increased.

The various benefit level differentials are offered in order to allow the pension recipient to provide a benefit for his or her surviving spouse, depending upon the perceived future need for benefits. The single life option provides no further benefits after the death of the pension recipient, while the 100% J&S option continues to provide the same benefit to the surviving spouse after the death of the pension recipient. The other percentages provide a benefit to the surviving spouse, but in a limited amount.

The 10-year Certain option provides a level benefit for the greater of 10 years or the life of the pension recipient. So if the pension recipient died the day after he or she started the pension, it would be paid to his surviving beneficiary or his estate for 10 years. If the recipient lived longer than 10 years after starting the pension, it will be paid to him or her until death but no surviving spouse benefits would be paid.

The title of this article is “When” to start your pension payout, so we won’t reflect on the reasons why you might choose one type of benefit over another, we’ll just run some numbers to see what timeline provides the best benefit amounts for the various payout options.

We covered the crossover points for the Single Life option above. If we look at the 100% J&S option next, we see that the outcome is very similar to the Single Life option, but delayed a bit. If the pension recipient chooses to start his or her pension at age 55, this will provide the most benefits if either member of the couple lives to age 71. This is because the benefit paid out is exactly the same before and after the death of the recipient. After age 71, the age 62 option pays the greatest amount of benefits up to the point where either member of the couple lives to at least age 89. This is a bit later than the Single Life option – and a statistically significant period of time. From that point forward the age 65 starting point pays the best.

So, according to averages, the age 62 option is an attractive choice for this payout level, since the chance of one member of the couple living beyond age 90 is (as we noted above) approximately 45%. But still, the age 65 option will provide the most benefits from age 90 onward, so it still may be the best option for your situation.

Looking at the other J&S options – at this point we need to start thinking about when the first (recipient) spouse will die, because after his or her death the benefit amounts are reduced, often dramatically. In all cases if the recipient spouse lives beyond age 90, waiting to age 65 to start is superior. But if the recipient dies earlier, the results start to favor other options.

If the recipient spouse dies at age 73 for example, the age 62 option provides the greatest benefit for all 3 of the J&S options (other than the 100% option). Any age between 75 to 85 produces (essentially) the same outcome – the crossover point is around age 100 for a death age of 85 at the 75% survivor benefit level. Any earlier death (before age 73) results in the age 55 start age being the best choice.

And The Point of This Is…?

The point of all this, well actually there are two points: First – the answer to the question of when to take the pension depends on what you’ll do with it, and whether or not you need those funds right away. Couple those factors with how long you’ll live, as well as how long your spouse will live (if you have one). If you’ll need a larger amount to live on, such as if you don’t have any other retirement savings, the longer you can wait before starting your pension payouts the better, especially if you’re in good health and expect to live beyond age 80.

The second point is that, even if you have a pension available to you, it is definitely in your best interest to develop a savings strategy in addition to the pension. And this is doubly important if your pension is fixed (no cost-of-living adjustments) as in our example.

The best way to answer this question is to gather all of these factors, along with considerations regarding investment risk tolerance, tax implications, family longevity and your own health, as well as your lifestyle costs, healthcare costs, and propensity to continue working after your official “retirement” – at whatever age that might be – and then run the calculations.

Dependents and Exemptions

A young child

When filling out your tax return this year, you may have questions about dependents – such as who can be claimed on your return.  Claiming a dependent can have a significant impact on your return, including increasing exemptions and possibly increasing certain credits like the Earned Income Credit and various others.

The IRS recently published Tax Tip 2016-08, which lists ten facts about dependents and exemptions.  Below is the list of facts, along with some additional information that I’ve included (my comments are in italics):

Exemptions and Dependents: TopTen Tax Facts

Most people can claim an exemption on their tax return. It can lower your taxable income. In most cases, that reduces the amount of tax you owe for the year. Here are the top 10 tax facts about exemptions to help you file your tax return.

  1. E-file Your Tax Return.  Easy does it! Use IRS E-file to file a complete and accurate tax return. The software will help you determine the number of exemptions that you can claim. E-file options include free Volunteer AssistanceIRS Free File, commercial software and professional assistance.
  2. Exemptions Cut Income.  There are two types of exemptions. The first type is a personal exemption. The second type is an exemption for a dependent. You can usually deduct $4,000 for each exemption you claim on your 2015 tax return. (So a family of four can claim exemptions of up to $16,000!)
  3. Personal Exemptions.  You can usually claim an exemption for yourself. If you’re married and file a joint return, you can claim one for your spouse, too. If you file a separate return, you can claim an exemption for your spouse only if your spouse:
    • Had no gross income,
    • Is not filing a tax return, and
    • Was not the dependent of another taxpayer.
  4. Exemptions for Dependents.  You can usually claim an exemption for each of your dependents. A dependent is either your child or a relative who meets a set of tests. You can’t claim your spouse as a dependent. You must list the Social Security number of each dependent you claim on your tax return. For more on these rules, see IRS Publication 501, Exemptions, Standard Deduction, and Filing Information. Get Publication 501 on IRS.gov. Just click on the Forms & Pubs tab on the home page.Essentially, the dependent must either be a qualifying child or a qualifying relative. To be a qualifying child, the following tests must be met:
    • The child must be your son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.
    • The child must be (a) under age 19 at the end of the year and younger than you (or your spouse if filing jointly), (b) under age 24 at the end of the year, a student, and younger than you (or your spouse if filing jointly), or (c) any age if permanently and totally disabled.
    • The child must have lived with you for more than half of the year. There are exceptions for temporary absences, children who were born or died during the year, children of divorced or separated parents (or parents who live apart), and kidnapped children.
    • The child must not have provided more than half of his or her own support for the year.
    • The child must not be filing a joint return for the year (unless that joint return is filed only to claim a refund of withheld income tax or estimated tax paid).

    If the child meets the rules to be a qualifying child of more than one person, only one person can actually treat the child as a qualifying child. See Qualifying Child of More Than One Person to find out which person is the person entitled to claim the child as a qualifying child.

    To be a qualifying relative, the following tests must be met:

    • The person can’t be your qualifying child or the qualifying child of any other taxpayer.
    • The person either (a) must be related to you in one of the ways listed under Relatives who don’t have to live with you, or (b) must live with you all year as a member of your household (and your relationship must not violate local law). There are exceptions for temporary absences, children who were born or died during the year, children of divorced or separated parents (or parents who live apart), and kidnapped children.
    • The person’s gross income for the year must be less than $4,000. There is an exception if the person is disabled and has income from a sheltered workshop.
    • You must provide more than half of the person’s total support for the year. There are exceptions for multiple support agreements, children of divorced or separated parents (or parents who live apart), and kidnapped children.

    See Publication 501 for more details on dependents if you have additional questions.

  5. Report Health Care Coverage. The health care law requires you to report certain health insurance information for you and your family. The individual shared responsibility provision requires you and each member of your family to either:

    Visit IRS.gov/ACA for more on these rules.

  6. Some People Don’t Qualify. You normally may not claim married persons as dependents if they file a joint return with their spouse. There are some exceptions to this rule.
  7. Dependents May Have to File.  A person who you can claim as your dependent may have to file their own tax return. This depends on certain factors, like total income, whether they are married and if they owe certain taxes.
  8. No Exemption on Dependent’s Return.  If you can claim a person as a dependent, that person can’t claim a personal exemption on his or her own tax return. This is true even if you don’t actually claim that person on your tax return. This rule applies because you can claim that person as your dependent.
  9. Exemption Phase-Out.  The $4,000 per exemption is subject to income limits. This rule may reduce or eliminate the amount you can claim based on the amount of your income. See Publication 501 for details.
  10. Try the IRS Online Tool.  Use the Interactive Tax Assistant tool on IRS.gov to see if a person qualifies as your dependent.

Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.

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What to do with an extra 1,000 dollars

One Thousand Dollars!

One Thousand Dollars! (Photo credit: The Consumerist)

I occasionally get this question – especially around the time of tax refunds.  When someone comes up with an extra $1,000, they often want to know how to best use that money wisely to help out their overall financial condition.

Of course this question has different answers for different situations.  I’ll run through several different sets of conditions that a person might find him or herself in, and some suggestions for how you might use an extra $1,000 to best improve your financial standing.  (It’s important to note that you don’t have to have an extra $1,000 lying around to use this advice – you could have an extra ten or twenty or fifty bucks a week and put it to work with the same principles.)  The point is to find money that isn’t being spent on something critical, and put it to work for you!  Even small steps amount to wonders.

Debt

If you have consumer debt, including credit card debt, auto loans, student loans and the like, it makes the most sense to use this money to bring down your overall debt balance or eliminate it if you can.

If the interest rate on your debt is greater than about 3% or 4%, you aren’t likely to find a better way to invest an extra $1,000 than to eliminate some of your interest costs.  This is because debt is a negative investment – when you have debt that carries an interest rate of 8%, year over year while the debt balance is there, you are “earning” a –8% return on that money.

Some folks recommend eliminating all debt, but that’s a bit impractical in today’s world.  Low-cost mortgage debt and auto loans can be good uses of leverage – especially mortgage debt at the rates we’ve seen of late.  I suggest that you focus on the highest rate consumer debt first and foremost, eliminating this drag on your financial state.  Once you’ve eliminated every debt except for mortgage debt, you can move on to other pursuits.  Eliminating consumer debt at high interest rates is the best move you can make to  improve your financial self.

Emergency Fund

An emergency fund is an amount of money set aside that can be used to cover all of the unexpected expenses that come up and surprise you: new tires for the car, roof replacement, or medical expenses not covered by insurance, for example.  The other thing that an emergency fund is for is to give you some “cushion” if you find yourself unemployed for an extended period of time.  It’s for this reason that an emergency fund is typically referred to as a certain number of months’ worth of expenses – such as 3-6 months’ worth of expenses.  You should have an emergency fund of an amount that would provide for your living expenses for several months should you be unexpectedly laid off.

If you don’t have an emergency fund, or if your emergency fund is smaller than you should have set aside, this is another great place to put an extra $1,000.  Typically an emergency fund is in a place that’s a bit difficult to get at – such as a bank savings account without debit card or ATM access.  This way you’re not tempted to invade this money for non-emergency purposes.  Sometimes folks use a Roth IRA as a dual-purpose account until they can establish separate accounts for retirement and emergency funds.

A Roth IRA could be used as your emergency fund, since you can withdraw your contributions to your Roth IRA at any time for any purpose without tax or penalty.  I don’t recommend this option for long-term use, because if you have to get at the funds for an emergency purpose and you’re not able to replace them in the account within 60 days, you’ll lose the Roth treatment of those contributions forever.  You can always put more into the Roth IRA at a later time, but once you’ve got the money in there, you shouldn’t take it out before retirement without a very, very good reason.

Knowledge

The most important tool for achieving financial success is knowledge.  For this reason, I suggest that you use some of your new-found riches to improve your financial knowledge.  There are many good books out there that will help you to better understand your finances and how you can improve things.

I wouldn’t suggest spending an extra $1,000 totally on education – maybe as much as $50 or $100 for several good books.  This will help you to make good decisions with your remaining windfall.

Retirement Savings

If you haven’t maxed out all of your retirement savings for the year, such as 401(k) plans and IRAs, this is another good place to put an extra $1,000 to work.  For an IRA or Roth IRA (if you’re eligible by your income level) it’s simply a matter of making the contribution to the account and investing it appropriately.

If on the other hand you haven’t maxed out your 401(k) plan, you can defer an extra $1,000 by your paychecks throughout the remainder of the year and earmark an extra $1,000 to make up the difference in reduced take-home pay.  If you started in July and you have 13 more pays left in the year, you’d set aside around $75 per paycheck (if paid every two weeks) and your income will be reduced by a little less than that, since the money you deferred isn’t taxed.

Charitable Donations

Consider making a donation with your extra money. There are many deserving charities (I’m sure you can come up with a list of several without much difficulty) that would LOVE to have a donation of $1,000. And you can take a deduction on your tax return for the donation (assuming that you itemize your deductions).

Who Does Each Option Work Best For?

Folks who are just starting out in improving your financial situation quite often need to focus on all of the options I mentioned above – debt reduction, emergency fund, knowledge and retirement savings.   The list was put together in priority order, so you should focus on debt reduction first, then emergency funds, and so on.

If you’re a little farther down the timeline and have eliminated all consumer debt and have established an emergency fund, improve your knowledge first, and then add more to your retirement savings.  I mentioned before that the most important tool that you have is your knowledge.  The most important action you can take to improve your financial standing is to increase your bottom line.  We did this first when we eliminated all debt.  The next step is to add to savings.  Both moves will increase your net worth – your assets (savings and possessions) minus your liabilities (loans and other debts) equals your net worth.  The key to financial success is to make moves that will have a positive impact on your net worth.

Students who don’t have any debt accumulated should focus first on the emergency fund, and then on retirement savings.  In some cases it makes good sense here to put the money into a Roth IRA, since money in a Roth IRA won’t be counted on your financial aid forms, since it’s a retirement account.

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