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March, 2009:

4 Things to Consider About Healthcare in Retirement

Mar 29th, 2009
by jblankenship.
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heres-health-by-robert-brookAs we all are painfully aware, the costs and complexity of healthcare are skyrocketing, and nothing seems to be slowing things down.  Granted, it seems like the present administration is making overtures to give the appropriate attention to the problem, but… as we all know, paths to places we don’t want to go are paved with good intentions.  At this point I would not hold my breath for the next great proposal on healthcare costs, there are far too many other fires for this administration to fight in the meantime.

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Recent information from Fidelity suggests that a 65-year-old couple who retired in 2008 can expect lifetime healthcare costs to top $225,000 over their remaining lifetimes.  And that doesn’t include long-term care (nursing home or assisted-living) costs.

Four Things to Consider About Healthcare in Retirement

  1. It’s not solely Medicare. If you haven’t checked into it yet, and you thought Medicare would be your only insurance in retirement, you’re in for a surprise:  with the co-payments, “holes” in coverage, and coinsurance payments, it’s almost a requirement that you have a supplemental healthcare policy to help out – and it ain’t cheap.  Industry averages for a couple, aged 65, in good health start around $7,000 per year, and go up from there.
  2. Retiring early increases the costs. If you’re planning to retire early (and therefore lose employer-provided health coverage) you’ve got to replace it somehow.  These policies are even more expensive than the Medicare supplement policies discussed above – and much more variable due to the complexities of coverage.  This portion of your early retirement deserves (requires!) quite a bit of planning ahead, as healthcare costs could be a significant portion of your monthly expenses in retirement.
  3. It doesn’t help to wait. Are you just starting out to consider your options and are close to retirement?  If so, you’re quite a bit behind the curve – there are several things that could be done in the five to ten years prior to retirement that might help you with the costs.  For example, if you’re a little overweight, or a smoker, rectifying these things five or ten years before retirement can have a significant impact on your costs.
  4. Knowledge is helpful. Health insurers use a special report, called a Medical Information Bureau (MIB) report to help determine your eligibility for coverage.  Think of it like a credit report on your health.  You can order your own MIB report, in order to look things over to see if there are any red flags (much the same as reviewing your credit report).  If you have a denial of coverage on your report or any issues that could adversely impact your ability to get coverage, it’s best to know that up front and work with an agent or broker who specializes in your issues.

Although these things may seem like a lot of work, they’re excellent considerations to take into account as you plan for your healthcare in retirement.  And – most financial planners these days, myself included, can help you work through the decision-making process.  It’s not simple, and mistakes can be quite costly.

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Penalties for Changing SOSEPP

Mar 27th, 2009
by jblankenship.
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broken-bamboo-by-kimberlyfayeSo – you’ve begun your Series of Substantially Equal Periodic Payments (SOSEPP) from your IRA to satisfy your §72(t) requirement.  Allofasudden, something happens that causes you to make a change to your payment – either purposely or by accident.  What happens?

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Well – first of all, we must understand the timeline associated with an SOSEPP:  once begun (notwithstanding the “one-time change” exception which you can read about here), you have to continue those periodic payments without change for the longer of five years or until you reach age 59½.

If you make a change to your periodic payments (other than the one-time change), §72(t)(4) indicates that ALL of your payments, beginning with your first payment under the SOSEPP, will be subject to 1) ordinary income tax (should have already been assessed); 2) the 10% non-qualified withdrawal penalty; and 3) interest on any unpaid tax or penalty, calculated from the date(s) of the disbursal(s) forward to the date you “broke” the SOSEPP.

This is the Code section that should strike the most fear in the hearts of folks who are considering establishing an SOSEPP.  If you think about it, the possibilities for error are numerous – your brokerage fails to execute a disbursement the way you directed; you forget to take your withdrawal; you mistakenly take more (or less) than your SOSEPP prescribes… And if it’s been in place for several years, you’ll owe penalties back to the beginning of the plan, plus interest. 

It doesn’t take much imagination to envision a scenario where you could be in pretty deep with such an error on you plan.  And from what I read, the IRS has very little in terms of a sense of humor when dealing with these cases – not many are overturned. 

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IRA Basics

Mar 25th, 2009
by jblankenship.
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apple-study-in-bw-by-ellas-dadTo start off, let’s talk about the basics of IRAs.  The following information holds true for both traditional IRA (TIRA) and Roth IRA (RIRA) plans.

IRA accounts can be held at a variety of institutions, from banks and credit unions, to brokerages and insurance companies.  Essentially, if it is a financial institution, quite likely there is an IRA offering.  Typically, an account is established by filling out an application, identifying yourself by name, address, and social security number.  You’ll be asked to name a beneficiary – a decision not to be taken lightly, but we’ll get to that issue a bit later.  Having filled out the necessary paperwork, generally you will send off the application, along with your contribution to the account.

In any given year, there is a limit to the amount you are allowed to contribute to ALL IRAs.  This means the total of all of your contributions, whether to a TIRA or a RIRA, cannot exceed the annual limit (see here for the current year’s limit).  If you are age 50 or older, there is an additional “catch-up” contribution allowed.

It is important to understand that the term “Individual” in Individual Retirement Arrangement is taken quite literally:  IRAs are Individual instruments, not jointly held, so the limits mentioned above are per individual, not per household.

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RMD Holiday in 2009

Mar 23rd, 2009
by jblankenship.
2 comments

Late last year, as part of the bailout packages that were spinning through Congress, a provision was added to the tax law that allows for a “holiday” on Required Minimum Distributions for the year 2009.

happy-holidays-by-eye-of-einsteinWhat this means is that if you are over age 70½ and thus subject to Required Minimum Distributions (RMDs) from your IRA or other retirement plan, you are not required to take the distribution for tax year 2009.  Just to briefly run through the requirements – when you have an IRA or other retirement plan (but not a Roth IRA), once you reach age 70½ you are generally required to begin taking RMDs from your account each year.  The minimum amount required to be distributed is based upon your attained age as of January 1 of that year, as well as the balance of your account(s) as of December 31 of the prior year.  For the purposes of determining the amount, all IRA accounts are treated as one large IRA, while any other retirement accounts (401(k), 403(b), 457, etc.) are treated separately.

So – what does this mean to the person who reaches age 70½ during 2009?  Excellent question… and for the unitiated, the critical factor is that, always in your first year (the year you reach age 70½), you get an extra 3 months to take the distribution.  That is, when you reach age 70½, you have until April 1 of the following year to take the RMD for that particular year.  However, if you delay until after the end of the year in which you reach age 70½, you will effectively have to take two minimum distributions in the same tax year, as all subsequent RMDs (after your first year) must be received by December 31 of that year.

But for 2009, if you reach age 70½ during that year, you are not required to take the first RMD.  And then in 2010, unless something changes in the tax law, you will be required to take a minimum distribution before December 31, 2010, since that will effectively be your second payment (but the first one you didn’t have to take, in 2009).

And what if I turned age 70½ in 2008 and had not taken my RMD by December 31?  Unfortunately, you are still required to take your RMD by April 1, 2009 – the tax provision only allowed for changes or skipping of the RMD for tax year 2009.

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Tax Loss Harvesting: It’s Never Too Late

Mar 22nd, 2009
by jblankenship.
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We’ve discussed before on these pages the benefit of tax-loss harvesting.  Briefly, this is where you have a taxable account, holding stocks, bonds, or mutual funds, and (as was the case this past year) 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 law 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.

As an example, say you purchased a mutual fund for $10,000 in late 2007.  Over the course of the year in 2008, 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 2008, 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 in your account before you can use it to reduce ordinary income.

taxes-by-x_jamesmorrisNow, the bad news is that you can’t make this move for 2008 – you must make your sale of the holding and realize the loss before the end of the tax year.  The 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 in income for your 2009 taxes, which you’ll file a year from now.  It’ll be a nice surprise for you (if you’ve forgotten about it) when you get ready to file in 2010.

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.

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SOSEPP & How a QDRO Affects It

Mar 20th, 2009
by jblankenship.
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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).

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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.

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

Mar 19th, 2009
by jblankenship.
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An exception to the 10% penalty on distributions from a qualified plan (but not an IRA) is when the distribution is pursuant to the imposition of a Qualified Domestic Relations Order, or QDRO (cue-DRO).

love-lasts-by-foundphotoslj1A QDRO is often put into place as part of a divorce settlement, especially when one spouse has a considerably larger retirement plan balance than the other.  What happens in this case is that the court determines what amount (usually a percentage, although it could be a specific dollar amount) of 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, which 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 the 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.

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 Edwina’s 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.)

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Snake Oil Sales, 2009 Style

Mar 17th, 2009
by jblankenship.
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By now you’re probably sick to death of the conversation around the Jim Cramer vs. Jon Stewart ratings booster.  If you don’t know what I’m referring to, you can find a CNN report about the whole affair here (sorry, the video has been removed).

snake-oil by healthcare-savantAn interesting point in all of those conversations is that, in spite of what you may think, Jim Cramer, or Suze Orman, or Bob Brinker, or even (heaven forbid) Dave Ramsey, are entertainers first and foremost.  Jon Stewart was on the nose when he said that both he and Cramer are snake-oil salesmen.  It is their job to attract listeners so that advertisers can push their products.  In between these product pushing moments, these folks do their best to provide provocative responses to the issues (in this case financial issues) that are on our minds.  But it must be entertaining, or we (the consuming public) won’t watch or listen.

Granted, it is in the best interest of the host or hostess to provide correct answers and information - but often there are answers given with an air of certainty that is at least inappropriate, possibly even unwarranted.  Each individual needs to understand that with every recommendation there is a disclaimer: This probably doesn’t exactly fit your specific situation. Since the entertainment is designed to be attractive to the widest possible audience, bits and pieces of every show may fit your situation, but most likely you need to filter the information to truly meet your needs.

This is not to say that these folks don’t give good advice.  Of the four I mentioned, you could certainly do worse than listening to any one of them.  Perhaps even better, follow all four (and add some of your own to the mix) and then come up with your own blended strategy.

Because in the end, no matter how mad you may be at Jim Cramer et al, it ultimately is your own decision to make the moves you make (or choose not to make).  Hold yourself accountable – learn enough about your finances to understand what you’re hearing and make good choices.  Have a trusted advisory group (family members, friends, co-workers, me, etc.) that you can ask questions of and receive unbiased answers.

Take recommendations from expert advisors, but also understand what you’re agreeing to.  Blind faith in an advisor led to Bernie Madoff’s getting away with billions.  Question everything – a true fiduciary advisor will welcome the opportunity to explain things.  If your advisor hesitates to explain her recommendations, you need to start looking for another advisor.

It’s important to have information at your hand and in your mind when making decisions – but remember to get more than one single opinion, and to keep your trusty grain of salt handy.  This wouldn’t necessarily have saved you from the market downturn, but it may have helped.

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The March Continues…

Mar 15th, 2009
by jblankenship.
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Greetings for March… the time of year when the earth begins the awakening process, and we see that there is, in fact, an end to the darkness of the winter.

Perhaps we’re seeing a similar awakening in the markets…?  This past week we’ve seen nearly an 11% increase.  Taken by itself it is a somewhat remarkable thing since we don’t see that sort of increase in a week very often, and in the context of the carnage we’ve seen over the past 6 months or so, it’s a very welcome respite.  We’ll just have to wait and see how things work – if this is the start of a new rally, or if this is only a short-term uptick.

I found the following quote that may be helpful to you as you face the uncertainty and trials that the economy is giving us:
seven-pillars-of-wisdom1.

Trials make us think; thinking makes us wise; wisdom makes life profitable.

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.This month, our main article is about how to re-set your Social Security benefits – a method for getting the ultimate “do over”, allowing you to get back those increases that you gave up by taking an early payment.  I hope it’s of interest to you.

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The Ultimate “Do Over”

Mar 15th, 2009
by jblankenship.
3 comments

12/8/2010 update – the SSA revised the “Do Over” a bit.   See the article “SSA Revises Withdrawal Policy” for details.

We’ve talked about it before – the decision of when to begin taking your Social Security retirement benefit is very important.  (you can see my post on the subject here)  The problem is, sometimes we aren’t in a position to delay receiving the benefit… or maybe we didn’t consider what a difference it would make to delay taking payment (it’s substantial).

It’s a little-known fact that you can re-set your Social Security payout amount, even if it’s been a few years since you started.  You may have heard of this, but usually discussions have few details on how to do it.  That’s what I intend to provide for you in this article:

hunger by cliff1066Let’s say for example that you had a choice to begin your Social Security payout at your early retirement age of 62, at a reduced amount of $750 per month.  Had you waited until “normal” retirement age (66), your benefit would have been 33% greater, or $1,000 per month.   (For the purposes of simplicity of illustration, the annual cost-of-living increases have not been included in this example.)

Yes, these are real world numbers, and yes, the difference is that great.  So, by the time you have reached age 66, you have received four years’ worth of benefits at the reduced rate, or a total of $36,000.  It is possible for your to re-set your payout to begin at your attained age of 66, instead of continuing at the reduced rate for the rest of your life.

And it gets better, the longer you’ve received the reduced benefit:  From your normal retirement age to age 70, there is an 8% bonus applied for each year that you delay receiving the benefit.  If, in our example, the retiree had waited until age 70, his monthly payout (again, not counting cost-of-living adjustments) would be approximately $1,320 per month.

So how does it work?  It’s fairly simple, once you understand the details – you pay back the Social Security Administration all of the money that has been paid out since you opted to begin receiving the benefit.  That’s it, no interest, no penalties.  Then you re-apply for benefits at your current age.

So – from our example if you started your benefit at age 62 at $750/month, and then at age 66 decided you’d rather have the greater payout – for the cost of $36,000, you will increase your payout by $3,000 per year.  That’s a 8.33% return on your money.  And if the same retiree had waited to do his “do over” at age 70, the cost is $72,000 in our example, but the payout increase is even better:  $6,840 per year, or a 9.5% return on your money.

That works out to better than a 75% increase in annual benefit.  Seems like, as long as you’re planning on living a while, this is a pretty good deal.

The only problem with this whole plan is this:  you can do this once, and it’s not revokable.  So, if you sent in your $72,000 yesterday and accidentally stepped in front of a bus today, your heirs do not get the money back.  However, as is the case with each of these decisions, if you are the higher wage earner and your spouse survives you, he or she will be eligible to receive the increased benefit.

Obviously this isn’t a consideration for everyone, and it may not be an appropriate decision for many that do have the funds available to make such a move, but for some folks in specific situations it can be a pretty good move.  As we mentioned in the earlier article about this, though, as long as you are in good health, the longer you work and wait to start taking the Social Security benefit, the better.  This is especially true for the higher earning spouse.

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