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January, 2010:

Social Security: Average Indexed Monthly Earnings Explanation

Jan 13th, 2010
by jblankenship.
2 comments

earnings by ktylerconkOne of the key components of determining your Social Security retirement benefit is called the Average Indexed Monthly Earnings, or AIME (don’t you just love the acronym-loving Social Security Administration?  Errr… SSA.).  The AIME is calculated by taking the highest-earning (by index) 35 years of your working life while covered by Social Security, and then computing an average monthly amount based upon those indexed amounts.

Gobbledy-gook, right?  Okay, here’s another way to explain it:  as you work in a Social Security insured job, your earnings are recorded each year.  Each year the SSA applies an index to the year, based upon cost of living adjustments (COLAs) that have been put in place for the new year.  These indexes for each year of your earnings will be adjusted with each new year, reflecting the new COLA applied.

Once you are eligible for retirement (age 62, your Earliest Eligibility Age, or EEA), these years of earnings are put into a table and the indexes applied.  Listed below is an example of an earnings table with indexes applied:

Average Indexed Monthly Earnings

Age Earnings Index Indexed Earnings
22 $ 5,000.00 7.4186559 $37,093.28
23 $ 5,589.41 7.0133446 $39,200.47
24 $ 5,771.91 6.6817598 $38,566.51
25 $ 5,951.90 6.362084 $37,866.51
26 $ 6,259.69 5.794243 $36,270.16
27 $ 6,598.18 5.453047 $35,980.19
28 $ 6,724.29 5.147081 $34,610.48
29 $ 7,263.44 4.789173 $34,785.89
30 $ 7,652.52 4.480037 $34,283.57
31 $ 8,151.79 4.226722 $34,455.35
32 $ 8,771.10 3.915769 $34,345.61
33 $ 9,095.79 3.600777 $32,751.90
34 $ 9,809.52 3.303241 $32,403.21
35 $10,300.66 3.001138 $30,913.71
36 $11,796.26 2.84454 $33,554.93
37 $12,072.71 2.712404 $32,746.07
38 $13,417.50 2.561809 $34,373.08
39 $15,014.39 2.457123 $36,892.20
40 $16,488.37 2.386295 $39,346.11
41 $17,578.53 2.243234 $39,432.76
42 $19,816.33 2.137938 $42,366.08
43 $20,064.41 2.056512 $41,262.70
44 $22,795.36 1.965713 $44,809.12
45 $25,440.98 1.895091 $48,212.98
46 $26,801.49 1.802233 $48,302.53
47 $27,536.23 1.786866 $49,203.55
48 $30,992.15 1.740161 $53,931.33
49 $34,893.01 1.673097 $58,379.40
50 $36,396.83 1.595089 $58,056.18
51 $36,936.43 1.507145 $55,668.58
52 $41,035.24 1.432187 $58,770.12
53 $42,533.74 1.356586 $57,700.69
54 $45,383.43 1.285498 $58,340.33
55 $50,034.62 1.255546 $62,820.74
56 $51,454.51 1.243079 $63,962.02
57 $55,140.29 1.213416 $66,908.14
58 $61,014.02 1.159513 $70,746.57
59 $64,329.16 1.118584 $71,957.57
60 $67,170.90 1.06943 $71,834.56
61 $73,383.51 1.023004 $75,071.63
62 $82,983.83 1 $82,983.83
Average of top 35 years $49,898.35
Monthly Average $4,158.20

So what this table shows is that your wages earned in each year you were working have been indexed to compare with the current year’s earnings, then the top 35 indexed earnings years are averaged and divided by 12 to come up with the Average Indexed Monthly Earnings – your very own AIME.

With this table in mind, you can see how the AIME can increase if you continue working past age 62 – of course those earnings will be added to the table, and assuming that this knocks out one of your lower earning years, the average would increase.

And, as you might guess, this AIME isn’t the amount of retirement benefit that you can expect:  more factors need to be applied to come up with your PIA, and then your actual retirement age is applied to that.

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A Cash Flow Dilemma – Should I take distributions from my IRA or from my taxable account?

Jan 11th, 2010
by jblankenship.
2 comments

dilemme by Môsieur JI know, long title… but I wanted to fully describe the content of this article, which is to answer the following dilemma:

I have a sizable IRA and a sizable taxable account that holds appreciated stocks.  I am in need of additional funds (above any RMD required from the IRA) – so which account should I draw the additional funds from?

Taxable account!

There is one school of thought that says you should take the additional funds from the taxable account, because at today’s capital gains rates you will save a bundle in taxes.

The capital gains on your appreciated stock will at most be taxed at 15% (through the end of 2010) or 20% under present law (beginning in 2011).  When you compare this tax rate to the ordinary income tax rates, which top out at 36% for 2010 and will rise to at least 39.6% in 2011, this is a bargain.  This also assumes that you’ve held the stock for at least 12 months, otherwise your gains would be taxed at your ordinary income tax rate.

It’s a no-brainer, you should always take this extra money from the taxable account, right?  No, not always…

IRA account!

There is another school of thought that says, since appreciated stock receives a step-up in basis, you should leave those funds alone and plan to leave them to your heirs at your death.  This way the appreciated portion is never taxed.

Note – this particular school of thought loses its value at present due to the estate tax being currently eliminated, which effectively eliminates step-up provisions for 2010 (unless legislation is passed to change the law for 2010).  In 2011 the law (as presently written) brings back the step-up provision.

So when you consider the concept of paying ordinary tax on your IRA distribution and zero tax on the taxable account (assuming you never need to use those funds) versus paying capital gains on the taxable account and potentially leaving your heirs with a fully-taxable IRA (because IRA funds never receive a step-up in basis), this method seems to make a lot of sense.

Conclusion

In the circumstance where you know you’re going to need funds from both accounts, it probably doesn’t make much difference in the long run, but you would likely come out better using the taxable funds at today’s low capital gains rates first.  This will hold true until changes are made the the capital gains tax rates that might make this method less desirable.

But if your holdings are large enough in either account to cover your needs for the long term, with some planning of your distributions you might come out better with the second method.  Or rather, your heirs will come out better in the long run, since some sort of step-up rule is likely to be in place once Congress gets their act together and passes new estate tax legislation.

Photo by Môsieur J. [version 3.0b]
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IRS Guidance Regarding Filing Status

Jan 9th, 2010
by Jim.
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filing statusThe IRS recently issued Tax Tip 2010-03, which provides taxpayers with guidance on determining filing status for 2009 tax returns.  For additional information, you can review IRS Publication 501.  The text of IRS Tax Tip 2010-03 follows.

Eight Facts About Filing Status

Everyone who files a federal tax return must determine which filing status applies to them. It’s important you choose your correct filing status as it determines your standard deduction, the amount of tax you owe and ultimately, any refund owed to you.

Here are eight facts about the five filing status options the IRS wants you to know in order to choose the correct filing status for your situation.

  1. Your marital status on the last day of the year determines your marital status for the entire year.
  2. If more than one filing status applies to you, choose the one that gives you the lowest tax obligation.
  3. Single filing status generally applies to anyone who is unmarried, divorced or legally separated according to state law.
  4. A married couple may file a joint return together. The couple’s filing status would be Married Filing Jointly.
  5. If your spouse died during the year and you did not remarry during 2009, you may still file a joint return with that spouse for the year of death, provided the joint return election is not revoked by a personal representative for the deceased spouse.
  6. A married couple may elect to file their returns separately. Each person’s filing status would generally be Married Filing Separately.
  7. Head of Household generally applies to taxpayers who are unmarried. You must also have paid more than half the cost of maintaining a home for you and a qualifying person to qualify for this filing status.
  8. You may be able to choose Qualifying Widow(er) with Dependent Child as your filing status if your spouse died during 2007 or 2008, you have a dependent child and you meet certain other conditions.

There’s much more information about determining your filing status in Publication 501, Exemptions, Standard Deduction, and Filing Information. Publication 501 is available on IRS.gov or by calling 800-TAX-FORM (800-829-3676).

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Social Security Full Retirement Age – Explained

Jan 7th, 2010
by jblankenship.
2 comments

lone tree by Jule_BerlinThe Full Retirement Age, or FRA (gotta love the government for their acronyms!), is a key figure for the individual who is planning to receive Social Security retirement benefits.  Back in the olden days, when Social Security was first dreamed up, FRA was always age 65.

Then, in 1983 the Social Security Act was amended to make changes to the FRA.  Beginning with folks born in 1938, the FRA would be increased (see table below).  And for folks born in 1960 and beyond, FRA is age 67 (as of this writing!) but don’t expect this figure to remain constant.  Increasing the FRA is one way to reduce the cost of the overall program, which is a constant concern for the government since this program amounts to more than half a trillion dollars in payout every year.

What’s interesting is that, even though the FRA has been increasing, the “early” retirement and “late” retirement ages have remained the same, at 62 and 70, respectively.  I suspect at some stage those ages may be adjusted as well, all in the name of fiscal responsibility…

Year of Birth FRA
1937 or before 65
1938 65 and 2 months
1939 65 and 4 months
1940 65 and 6 months
1941 65 and 8 months
1942 65 and 10 months
1943-1954 66
1955 66 and 2 months
1956 66 and 4 months
1957 66 and 6 months
1958 66 and 8 months
1959 66 and 10 months
1960 or later 67

Note: persons born on January 1 of any year should refer to the FRA for the previous year.

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The Heartbreak of Withholding From Indirect Rollovers

Jan 5th, 2010
by jblankenship.
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heart break by NDrewCTaking early withdrawals from your retirement plans is rarely a good idea, and should only be considered when it’s the last possible option available to you, generally speaking.  But this article is more about the pain you could experience if you don’t handle a rollover correctly – bypassing the trustee-to-trustee transfer option and going with an indirect rollover.

Withholding Rule For Indirect Rollovers

In general, if you take an early withdrawal (pre-age 59½) from an IRA or a Qualified Retirement Plan (QRP) that includes pre-tax money, the custodian of the account is required to withhold and pay to the IRS 20% of the pre-tax amount withdrawn.  This can still be a tax-free transaction if you finish the indirect rollover process correctly and place the entire amount of the distribution back into an IRA or QRP within 60 days.  However, if you don’t complete the indirect rollover, you’re likely to get a tax surprise…

A transaction like this is called an “indirect rollover”, as opposed to a direct or a trustee-to-trustee rollover.  In the event that you complete the indirect rollover within 60 days, you will need to come up with the 20% that was withheld in order to have a full rollover – otherwise you’ll have to pay tax and a penalty on the amount that was not rolled over.

An Example

For example, let’s say you’re 50 years of age, and you have a 401(k) from a former employer that you’d like to roll over into your IRA account.  The 401(k) is worth $50,000.  For whatever reason, you opted to have the 401(k) custodian send you a check for the amount, which you then plan on sending to the IRA custodian for deposit (within the allowable 60 day period, as an indirect rollover).

Lo and behold, when the check arrives, it’s only made out for $40,000!  This is because the custodian was required to withhold 20%… and so now, since you don’t have any savings to speak of, you can only send the $40,000 over to the IRA custodian.  Guess what?  Come tax time, you will have to include that “lost” $10,000 as income, plus you’ll get to pay a 10% early withdrawal penalty as well.  So if you’re in the 25% tax bracket, you get to pay $3,500 in tax and penalties (25% times $10,000 plus 10% times $10,000).

Now, the original 401(k) that was worth $50,000 is reduced to an IRA worth $40,000 and a tax refund of $6,500 (since $10,000 was withheld and your tax and penalties were only $3,500).  This swift little maneuver has cost you 7% of your retirement plan!  Plus, you’ve lost tax-deferral on $10,000…

ALWAYS Do the Direct Rollover

It is for this reason that, whenever possible, you always should do a direct, or trustee-to-trustee transfer when rolling over IRA and QRP funds to a new account.  When you do a trustee-to-trustee rollover, no withholding applies, so you don’t have to make up any difference, and your tax-deferred amount remains intact.

It’s important to note that in our example above, if you had the $10,000 available to you in savings or elsewhere to make up the difference for the withholding, you could still complete the indirect rollover without tax or penalty by sending a total of $50,000 to the IRA custodian within 60 days.  Then when you file your taxes for the year, that $10,000 withheld would amount to either a refund to you or a reduction in the amount of tax that you had to pay for the year.

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What’s Up With Medicare Premiums? How Increases Are Determined

Jan 3rd, 2010
by jblankenship.
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canal reflections by Zadok the PriestIf you are collecting Social Security and covered by Medicare, you may be wondering why your Medicare premium didn’t increase for 2010 or 2011… or if it did increase, why did it – since it didn’t increase for so many?

To understand this quandry, we need to look at the system for determining increases to Social Security benefits first.

Social Security – No COLA Increase for 2010 or 2011

For the year 2010 (and 2011), there is no Cost-Of-Living Adjustment (COLA) in Social Security benefits.  This is reflected by the fact that the Consumer Price Index (CPI) had not increased for the year (as of May, when the figures are determined).  While the COLA figures don’t parallel the CPI exactly, the CPI is a rough guide to follow when determining increases.

This is the first time in over 30 years that there will not be a COLA – there has been an automatic increase in benefits every year since 1975.  The 2009 increase was larger than average, at 5.9%.

Impact to Medicare

So what does this mean for Medicare costs?  Well, for most folks (about 75%) receiving Social Security, part of the news isn’t all bad:  since you already receive Medicare Part A for no premium, this will not change; and your Part B premium is linked to the COLA for Social Security, so it will remain unchanged for 2010 at $96.40 per month.  What isn’t linked to COLA is Part D drug coverage, so this will likely increase for most all beneficiaries, by a factor of approximately 7% – the average monthly premium will increase by $2 a month, from $28 to $30.

The Other 25%

How can you know if you’re in the 75% that will have unchanged Medicare Part B premiums or the “other” 25%?  One of the following three circumstances puts you into the “other” 25%:

  • You don’t have Medicare Part B premiums withheld from your Social Security checks;
  • You just started receiving Medicare benefits in 2010; or
  • You make too much money.

So, what’s too much money?  Medicare Part B premiums start to increase when your income is $85,000 for single filers, or $170,000 for joint tax filers.  At this level, your Part B premium will increase to $110.50 per month, an increase of roughly 15% over 2009’s cost.  Incidentally, this is the same premium that you can expect to pay if your income is not the factor but rather one of the first two circumstances applies to you.

As your income increases, the Part B premium increases as well, up to $353.60 per month if your income is above $214,000 for single or $428,000 for joint filers.

Summary

All in all, this isn’t a terrible thing – of course it’s not welcome, but it could be much worse.  The decision to bypass the COLA was made in May of 2009, and inflation has been pretty much benign since then.  For the majority of Social Security recipients, the overall impact should be minimal.

This is not to downplay the significance, especially to low-income seniors who rely almost exclusively on Social Security benefits, as many other costs (energy costs, food, housing, etc.) have increased, plus the value of home real estate has decreased dramatically.  These factors taken together can have a devastating impact on folks who have no other “safety net” available to them.  If you’re not presently in the position to have these concerns, you should take this information as a warning:  it is critical to develop additional resources to be ready and available in the case that subsidized sources of income are not available or are limited when in retirement.

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2010 IRA MAGI Limits for a Filing Status of Married Filing Separately

Jan 1st, 2010
by jblankenship.
1 comment

elegant tern by mikebaird2010 IRA MAGI Limits for a Filing Status of Married Filing Separately

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Separately):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at your job and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 50% for every dollar (or 60% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2010.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan but your spouse is, and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2010.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Separately):

If your MAGI is less than $10,000, your contribution to a Roth IRA is reduced ratably by every dollar, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $10,000 or more, you can not contribute to a Roth IRA.

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2010 IRA MAGI Limits for IRAs – Single or Head of Household

Jan 1st, 2010
by jblankenship.
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alone with my friend by Jody McNary2010 IRA MAGI Limits for a Filing Status of Single or Head of Household

 

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on this page to determine eligibility.

 

For a Traditional IRA (Filing Status Single or Head of Household):

If you are not covered by a retirement plan at your job, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, if your MAGI is $56,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $56,000 but less than $66,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $66,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2010.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status Single or Head of Household):

If your MAGI is less than $105,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $105,000 and $120,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $120,000 or more, you can not contribute to a Roth IRA.

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Current Year MAGI Limits for IRAs – Married Filing Jointly or Qualifying Widow(er)

Jan 1st, 2010
by jblankenship.
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knee joint by mikebaird2010 IRA MAGI Limits for a Filing Status of Married Filing Jointly or Qualifying Widow(er)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Jointly or Qualifying Widow(er)):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, and your MAGI is $89,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $89,000 but less than $109,000, you are entitled to a partial deduction, reduced by 25% for every dollar over the lower limit (or 30% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $109,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2010.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan at your job, but your spouse IS covered by a retirement plan, and your MAGI is less than $167,000, you can deduct the full amount of your IRA contributions.

If you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $167,000 but less than $177,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $177,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2010.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Jointly or Qualifying Widow(er)):

If your MAGI is less than $167,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $167,000 and $177,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $177,000 or more, you can not contribute to a Roth IRA.

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