Getting Your Financial Ducks In A Row Rotating Header Image

qrp

How Does an Early Withdrawal from a Retirement Plan Affect My Taxes?

Image courtesy of adamr at FreeDigitalPhotos.net

Image courtesy of adamr at FreeDigitalPhotos.net

Oftentimes we are faced with difficult situations in life – where we need extra money to pay for a major car repair, a new roof for the house, or just day-to-day living expenses – and our emergency funds are all tapped out.  Now your options become poor: should I go to a payday loan place, put more on my credit card?  My mortgage is upside-down so there’s no home equity loan in my future, and I can’t ask my folks for a loan, I’ve asked them for too much.  Hey, what about my retirement plan?  I’ve got some money socked away in an IRA that’s just sitting there, why don’t I take that money?

It’s really tough to be in a situation like this, but you need to understand the impacts that you’ll face if you decide to go the route of the IRA withdrawal, especially if you’re under age 59½.

Any money that you take out of a retirement plan as a withdrawal will be taxed as ordinary income – just like wages, salaries, and tips.  So if you’re in the 25% marginal tax bracket, every dollar that you withdraw from your IRA or 401(k) plan (if allowed) will cost you 25 cents right off the top.

In addition to the ordinary income tax, if you’re less than 59½ years of age you’ll also be hit with an additional 10% penalty for an early withdrawal (unless your withdrawal meets one of these 19 exceptions). So now every dollar that you withdraw costs an extra 10 cents on top of the ordinary income tax.  If you’re in the 25% bracket, that $10,000 withdrawal from your IRA can cost you as much as $3,500 in extra taxes and penalties.

Bear in mind that you may be able to take a temporary loan from your 401(k) or other qualified retirement plan (QRP) if you’re still employed by that employer.  Naturally you’ll need to repay the loan, but it might be a better option cost-wise than the other choices.  Plus, if you have an outstanding loan from your QRP and you leave the employer you’ll be required to either recognize the balance of the loan as a withdrawal or pay it back to the plan immediately.

Armed with this information makes your decision points much more clear: review all of the available options mentioned above (loans from family and friends, home equity loans, payday loans, and the like) against the cost of the taxes for taking an early withdrawal from your retirement plan.  The best option may be to see about a formal loan from family, paying them a reasonable rate of interest.  But of course, your circumstances are going to dictate the best option for you.  Just go into it with your eyes wide open.

November is “Add 1% More to Your Savings” Month

November

November (Photo credit: Cape Cod Cyclist)

That’s right, we unofficially declared November to be “Add 1% More to Your Savings” month.  So you can add that to the month-long observances like:

  • No-shave November
  • International Drum Month
  • Sweet Potato Awareness Month
  • and many more (see the list at Wikipedia)

In November we encourage folks to increase their retirement savings rate by at least 1% more than the current rate.  It’s a small step, but it will pay off for you in the long run.

Below is the list of my fellow bloggers who have written articles showing ways that you can start to increase your savings rate, as well as showing what the benefits can be.  Thanks to everyone who has participated so far – and watch for more articles in the weeks to come!

The 1 Percent Solution by John Davis, @MentorCapitalMg

Friday Financial Tidbit-What increasing your retirement contributions 1% can do for your retirement account by Jonathan White, @JWFinCoaching

THE 1% MORE BLOGGING PROJECT by Robert Flach, @rdftaxpro

A Simple Strategy to Maximize Open Enrollment by Jacob Kuebler, @Jakekuebler

Take a Small Step: Increase Your Savings by 1% by Jim Blankenship, @BlankenshipFP

Enhanced by Zemanta

What You Can Do If Your 401(k) Has High Fees

Image courtesy of anankkml at FreeDigitalPhotos.net

Image courtesy of anankkml at FreeDigitalPhotos.net

Now that we’ve all been receiving 401(k) plan statements that include information about the fees associated with our accounts, what should you do with that information?  Some 401(k) plans have fees that are upwards of 2% annually, and these fees can introduce a tremendous drag on your investment returns over a long period of time.

There are two components to the overall cost of your 401(k) plan.  The first, and the easiest to find, is the internal expense ratios of the investments in the plan.  Recent information shows that, on average, these investment fees are something on the order of 1% to 1.4% or more.  The second part of the costs is the part that has recently begun to be disclosed: the plan-level fees.  These are the fees that the plan administrator has negotiated with the brokerage or third-party administrator to manage the plan.  These fees can average from 1% up to around 1.5%.  When added together, these fees can amount to nearly 3% for some smaller 401(k) plans.  Larger employers’ plan fees average about 1% less, at approximately 2% per year.

For example, if average investment returns are 8% you should be doubling your investments (on average) every 9 years.  However, if there is just a 1% fee deducted from the average investment return (so that now you’re only earning 7% annually) the doubling will take a bit more than 10 years.  A 2% fee brings you down to a 6% net average return, and so now your account won’t be doubled until 12 years has passed.  If you started our with $10,000 in your account, this would result in a differential of more than $42,000 over the course of 30 years – at 8% your account could grow to $100,627, while at a 6% return would only grow to $57,435.

The information about fees used to be kept pretty much secret, but beginning in 2012 the plan-level fees have begun to be disclosed to participants in the plans.  Now you know more about the overall fees that are charged to your plan and thereby reduce your overall investment returns.

What Can You Do?

So, now that you know what your expenses are in your 401(k) account, there are a few things that you might do to improve the situation.  While it’s unlikely that you can have an impact on the plan-level fees, you may be able to control some of your exposure to investment fees.  Listed below are a few things you can do to reduce your overall expenses in your 401(k) account.

  1. Lobby for lower fees.  Talk to your HR representatives and request that your plan has lower-cost options made available.  Index funds can be used within a 401(k) plan to produce the same kinds of investment results as the (often) high-cost managed mutual funds, with much lower expense ratios.
  2. Take in-service distributions, if available.  If your plan allows for distributions from the plan while you’re still employed, you can rollover some or all of your account to an IRA, and then choose lower-cost investment options at that time.  Typically a 401(k) plan may offer this option only to employees who are at least 59½ years of age – but not all plans offer in-service distributions.
  3. Balance the high-fee options with lower-cost options outside the plan.  If your 401(k) plan is unusually high-cost, if available do the bulk of your retirement investing in accounts outside the 401(k) plan, such as an IRA or Roth IRA, if you are eligible to make contributions.  Review the investment options in your 401(k) plan for the “diamonds in the rough” – such as certain institutional funds with very low expenses – that can be desirable to hold.  Then complete your allocations using the open marketplace of your IRA or Roth IRA account.

Don’t forget that there are sometimes very good reasons to leave your money in a 401(k) plan, even if the expenses are high.  See the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k) for more information on why you wouldn’t want to make a move.

Did the Advent of 401(k) Plans Hurt Americans?

The 87-vehicle pile up on September 3, 1999

The 87-vehicle pile up on September 3, 1999 (Photo credit: Wikipedia)

There’s been quite a bit of press lately about the recent Economic Policy Institute study (see this article “Rise of 401(k)s Hurt More Americans Than It Helped” for more), which indicates that the 401(k) plan itself is the cause of American’s lack of retirement resources.  I think it has more to do with the fact that the 401(k) plan (and other defined contribution plans) were expected to be a replacement for the old-style defined benefit pension plans, and the fact that those administering the retirement plans did little to ensure success for the employees.

Traditional defined benefit pension plans didn’t ask the employee to make a decision about how much to set aside – this was determined by actuaries.  Then the company made sure that the money was set aside (in most cases) so that the promised benefit would be there when the employee retires.  In the world of 401(k) plans, the employee has free choice to decide how much and whether or not to fund the retirement plan at all.  Human nature kicks in, and the nearer term needs of the employee win out over long term needs – of course the long-term requirements get short shrift!

It’s the same as when we turn over the car keys car to a 16-year-old.  Up to this point, the child has just ridden along, not having to know anything about rules of the road, car maintenance, or paying attention.  You wouldn’t just toss Johnny the keys and say “You know where you want to be. Do your best to get there!”  Of course you’re going to make sure that he has all the training necessary to operate the vehicle safely, and that he knows when to put fuel in the car, as well as that he knows how to navigate to his destination on time.

If the playing field had been level – that is, if when 401(k)-type plans were introduced as replacements for pension plans that there was no choice regarding participation and funding level, we’d see a much different picture.  I don’t think education alone is the answer, because the importance of continual funding is so difficult to comprehend.  Forced participation runs counter to the “American Way”, but that would have changed our outlook dramatically.

The problem isn’t the 401(k) plan itself – it’s that when companies dropped pension plans in favor of 401(k) plans they didn’t provide employees with the correct message about the importance of participation.  Free will is a good thing, don’t get me wrong.  But I think employers could have done much, much more to emphasize the importance of participation, of making long-term investment decisions, and of providing for your future with today’s earnings.

It wasn’t the account that is the problem, it’s in the implementation.

Enhanced by Zemanta

Don’t Just Walk by That Dime on the Ground!

The Government Dime

The Government Dime (Photo credit: scismgenie)

Have you ever been walking along the street and saw a dime on the ground?  Did you just walk right by, or did you stop to pick it up?  Heck, it’s only a dime, it’s not hardly worth the effort to bend over, right?  But what if it was a dollar?  Or a hundred dollars?  You wouldn’t just walk by that, would you?  What about $1,200?

Unfortunately, many folks do this very thing with their 401(k) plan employer matching funds.  Most employers that sponsor 401(k) plans provide a matching contribution when you defer money into the plan.  Often this is expressed as a certain percentage of your own contribution, such as 50% of your first 6% of contributions to the plan.

So if you make $40,000 a year and you contribute 6% to the 401(k) plan, that means you’ll be contributing $2,400 to the plan from your own funds, pre-tax.  Since your employer contributes 50% of your first 6%, you’ll have an additional $1,200 added to the account for the year.

If you can only afford to contribute 2% (or $800) to the plan, you’re still getting an additional 50% of your contribution added by your employer for a total of $1,200 for the year.  It still makes sense to participate even if you can’t maximize the employer contributions.

However, if you choose not to participate at all, you are giving up the extra money from your employer – forever.  You can’t go back and get this money later when you think you can afford to.  You’re essentially walking by that $1,200 that’s just sitting there on the ground waiting for you to pick it up.

Arguments against

After having this conversation with several folks, I’ve heard many different excuses to not take advantage of a 401(k) plan.  The excuses usually fall into a few limited camps, which I have listed a below.

It’s my money! You’re darn right it is!  And if you don’t participate in your 401(k) plan you’re throwing some of *your* money away.  Many times people believe that when they put money into a 401(k) plan, it’s gone for good.  Nothing could be more untrue!  The 401(k) plan is your property. All of your contributions and (as long as you’re vested in the plan) the employer contributions are yours to keep.  Granted, it’s locked up behind some significant fees and penalties until you reach retirement age (59½ in most cases) – but it’s still yours.

I don’t trust my company – they’ll go bankrupt and lose my money! As noted above, the 401(k) account is yours, not the company’s.  Even if the company goes bankrupt completely, as long as you haven’t invested your entire 401(k) plan in company stock (a la Enron), you still have your 401(k) plan intact.  They can’t lose your money, in other words!  It’s not theirs to lose.

I can’t afford to put money in the plan!  These days, money can be pretty tight (but when isn’t it?).  Unfortunately, regardless of how much money you make, it’s always possible to spend up to and more than what you bring home each payday.  The reverse of this is also true.  Within limits, it’s usually possible to make do with less.  If your paycheck was a dollar less every payday you’d figure out how to get by, right?  How about $78 less?

Using our example from above, for a single person with an annual income of $40,000 per year, before you participate in the 401(k) plan, your total income tax would be approximately $4,054.  If you chose to put 6% or $2,400 in your company 401(k) plan, your income tax would work out to $3,694 – $360 less.  So your take home pay would only reduce by about $78 per paycheck (if you’re paid every other week).  In return for this annual reduction of $2,040 in take-home pay, you’d now have a 401(k) account with $3,600 in it when counting the employer contributions.

Pretty sweet deal, if you asked me (but you didn’t, I just threw this in your face!).  For a total “cost” of $78 per paycheck, you get lower taxes PLUS a retirement savings account worth 75% more than what you had to give up.  Not too shabby.

One great benefit of participating in a 401(k) plan is that once you’ve made the decision to participate, you are deferring this income before it makes it into your hands. You don’t have to (or get to) make a decision about saving, it’s done automatically.  This helps you to get past one of the real difficulties that many folks face with saving: the money always seems to find another place.  This way it automatically goes into savings, before it can find another place.

The bottom line

The best and most important way to assure success in retirement savings is to put away more money over time.  Of course your investment returns will help, but if you don’t save the money, it can’t produce returns, right?  So do yourself a favor and don’t walk past that $1,200 that’s just lying on the ground!

Enhanced by Zemanta

What to do with $1,000

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 additional $1,000 dollars, they want to know how to best use that money 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 that $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 (or a portion of your debt) is greater than about 3% or 4%, you aren’t likely to find a better way to “invest” 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 your 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 your 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 (I’ve reviewed quite a few of them, click this link for a list of financial books I’ve reviewed) that will help you to better understand your finances and how you can improve things.

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

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 your $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 this additional $1,000 by your paychecks throughout the remainder of the year and earmark this additional $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.

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.

Enhanced by Zemanta

Exceptions to the 10% Early Withdrawal Penalty from IRAs and 401(k)s

English: A clock made in Revolutionary France,...

English: A clock made in Revolutionary France, showing the 10-hour metric clock. (Photo credit: Wikipedia)

When you take money out of your IRA or 401(k) plan (or other qualified retirement plan, such as a 403(b) plan), if you’re under age 59½ in most cases your withdrawal will be subject to a penalty of 10%, in addition to any taxes owed on the distribution.  There are many exceptions to this rule though, and the exceptions are not the same for all types of plans.  IRAs have one set of rules, and 401(k)s have another set of rules.

The exceptions are always related to the purpose for which the money was withdrawn.  The exact same dollars withdrawn do not have to be used for the excepted purpose, just that the excepted expense was incurred.

IRA Exceptions

It is important to know that all distributions from your traditional IRA are subject to ordinary income tax, but some distributions are not subject to the early withdrawal penalty.  The list of exceptions for early withdrawals from IRAs is as follows:

Death of the owner of the IRA – if the owner of the IRA dies, the beneficiaries of the IRA can (in fact, must) take withdrawals from the plan without paying the 10% penalty.

Total and permanent disability of the owner of the IRA – if the owner of the IRA is deemed to be totally and permanently disabled.   You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.

SOSEPP – With a Series of Substantially Equal Periodic Payments, lasting at least five years or until age 59½ (whichever is longer), there is no 10% penalty applied.

Medical Expenses – if you have medical expenses greater than 7.5% of your Adjusted Gross Income, a distribution from your IRA to cover these expenses (the excess above 7.5% of AGI) will not be subject to the penalty.  Any amounts paid by insurance toward the medical expenses reduces the overall expense counted toward the excepted expenses.

Health Insurance Premiums – if you’re unemployed, you can take a distribution from your IRA to cover your health insurance premiums without paying the penalty.

Qualified higher education expenses – amounts withdrawn from your IRA to pay for tuition, fees, books, supplies, and equipment needed for enrollment or attendance of a student at an eligible higher education institution are not subjected to the penalty.  In addition, if the student is at least a half-time student, room and board expenses paid for with an IRA distribution would not be subject to the penalty.  The amount of education expenses is reduced by any scholarships, grants, and qualified 529 plan distributions; any amount applied to an IRA penalty exception is also not eligible to be used toward education credits, such as the American Opportunity Credit or the Lifetime Learning Credit.

First-time home purchase – amounts withdrawn from your IRA up to $10,000 that are used toward a qualified first-time home purchase are an exception to the penalty.

Qualified reservist distributions – if a reservist who is called to active duty after September 11, 2001 for a period of 179 days or more takes a distribution from an IRA (after the start of active duty and before the end of active duty) the distribution will not be subject to the 10% penalty.

Rollovers – both direct, trustee-to-trustee transfers and 60-day indirect transfers are exempted from the penalty.

Excess contributions – if you have contributed too much to your IRA, you can take out the excess contribution without penalty.  However, any growth that is attributed to the amount that you over-contributed will be subject to the 10% penalty and taxes when withdrawn.

401(k) Exceptions

As with the IRA, most withdrawals from a 401(k) or other qualified retirement plan are subject to taxation.  Early withdrawals before age 59½ are also subject to a 10% penalty, with some exceptions.  The exceptions are as follows:

Death of the participant – this is the same as the exception for an IRA above.

Total and permanent disability of the participant – same as with an IRA.

SOSEPP – same as with an IRA.

Medical Expenses – same as with an IRA.

Qualified reservist distributions – same as with an IRA.

Rollovers – same as with an IRA.  However, an indirect 60-day rollover (not a trustee-to-trustee transfer) is subject to mandatory 20% withholding.  If the withheld 20% is not transferred within 60 days, this amount may be subject to both taxation and the 20% early withdrawal penalty.

Corrective distributions – just like with an IRA, if you have contributed too much to your 401(k), you can take out the excess contribution without penalty. However, any growth that is attributed to the amount that you over-contributed will be subject to the 10% penalty and taxes when withdrawn.

Separation from service after age 55 – if you leave employment after the age of 55, you are eligible to take distributions from your 401(k) or other QRP without penalty.  This is only valid while the funds are still in the 401(k) – if you rollover the funds to an IRA, this option is no longer available.  If the participant is a public safety employee (police, fire, or emergency medical technicians), the age is 50 or older.

Qualified Domestic Relations Order (QDRO) – in the event of a divorce, if the 401(k) is to be divided or distributed to the ex-spouse of the participant, withdrawals from the plan by the ex-spouse are not subject to the 10% penalty.

Enhanced by Zemanta

Avoid Awkwardness in the Afterlife–Confirm Your Beneficiary Designations

Withholding Water

This is a topic that I cover with all clients, and one that I recommend you for everyone with retirement plans and other accounts with beneficiary designations.  Too often we think we have the beneficiary designation form filled out just the way we want it, and then (once it’s too late) it is discovered that the form hadn’t been updated recently – and the designation is not what we hoped for.

I made this recommendation to a client not long ago.  He assured me that he had all of his designations set up just the way he wanted.  His wife, sitting next to him in our meeting, asked him to make sure – talk to the IRA custodian and get a copy of the designation as it stands today.  A bit miffed about it all, he agreed to do so, and did the next day.  Guess what he found – as it stood on that day, his IRA beneficiary designation form indicated 100% of his IRA would pass to his ex-wife from 15 years ago!  Plus, he had no secondary beneficiaries named, which meant that if the ex predeceased him, HER heirs would be the primaries.  Thankfully he had checked on this to avoid this awkward and possibly devastating situation.

Know what was fixed pretty much immediately?

Take the time

You owe it to yourself and your heirs to take the time to review your beneficiary designations and keep copies of them in your “dead file”.  This includes IRAs, Roth IRAs, 401(k)/403(b)/457 plans, and other pensions or retirement plans.  You also may have POD or TOD (Pay on Death or Transfer on Death) designations on non-retirement accounts – confirm these and keep copies as well.

For your standard retirement accounts, such as IRAs, 401(k)s and the like, you typically have the option of naming a primary beneficiary (or beneficiaries) and a secondary or contingent beneficiary or beneficiaries.  It makes a huge difference on these accounts that you name a specific person (or persons) as the primary beneficiary, and a specific person (or persons) as the contingent beneficiary.  With IRAs, if you leave the designation blank, you may be taking away important options for your heirs.

If you leave the primary beneficiary designation blank you are leaving the transfer of your IRA up to the custodian’s default designation.  Quick! What’s your IRA custodian’s default beneficiary designation??  I didn’t think you’d know.

Often this default is your spouse first, and then your “issue” – meaning your children and other descendants.  Other times, the default beneficiary is your estate.  In the event that the estate is the default beneficiary, any beneficiaries of the estate will receive the IRA, but they will not be able to utilize the “stretch” option of receiving payout of the account over their remaining lifetimes.  This is because the IRS rules state that a “named beneficiary” must be in place in order to use the stretch provision.  If no “named beneficiary” exists, the stretch option is not allowed.  If the default is your spouse and your issue, these can be treated as “named beneficiary” if they are alive.

Discuss with your heirs

At face value, even though you think your intent for your beneficiary designations is clear, it might not be clear to your heirs.  For example, you may have chosen to pass along half of your IRA to your youngest child and only a quarter to the older two children because you believe the youngest child can use the money more than the other two.  Or maybe you decided to leave the entire IRA to your oldest daughter, and you want to designate your three sons to split up the farmland – which you believe is an equitable division.

Whatever you’ve decided, especially if there are perceived inequities in your division plan, you should take the time to review your plan with your heirs.  If that makes you uncomfortable, there are a couple of things to consider: First, if you’re uncomfortable discussing it with them, imagine how uncomfortable your heirs may be when the time comes to distribute your estate.  Maybe it’s not such a good idea after all if it could cause contention among your heirs.  Second, if you still believe your split is the right way to go, you should explain your plan to someone – your designated executor would be a good choice. And the designated executor should be a disinterested separate party, someone who isn’t receiving benefit from your estate plan, in order to keep the process “clean”.  Otherwise, if one of the heirs is your executor and the executor is perceived to receive preferential treatment, again you’ll have some contention among your heirs.

If there are complex instructions involved, consider making an addendum to your will.  Instructions in your will would have no impact on the beneficiary designations on your IRAs and other plans (these pass outside of your estate as long as you’ve made specific designations) but other asset divisions aside from retirement accounts may require explanation for your heirs to understand your intent.  Don’t expect that everyone will understand or agree with your thought process when you’re gone.  Explaining your thought process in advance will likely help to ensure that your division plan doesn’t result in a family rift.

Take the time to review your beneficiary designations.  Make sure that you have the primary beneficiary or beneficiaries that you want, and the percentages that you’d like each to have.  Also make sure that you have named contingent beneficiary or beneficiaries in the event that your primaries have predeceased you.  Lastly, make sure that you note how division is done after the death of the beneficiaries: per stirpes or per capita.

A Few Facts to Know About Retirement Plan Contributions

Deadline

As we near the tax filing deadline, there are a few things you need to be aware of as you consider your retirement plan contributions for tax year 2012 (or whatever the prior tax year is, if you’re reading this sometime later).

Regular IRA contributions are due by the filing deadline, with no extensions. That means April 15, 2013 for the 2012 tax year. Your contribution for 2012 is considered made “on time” if your payment is postmarked by midnight on April 15, 2013.

Perhaps you wish to make a more substantial contribution to a retirement plan – in 2012, you can contribute up to $50,000 to a Keogh plan. That amount is limited to 20% of the net self-employment income, or 25% of wage income if the individual is an employee of the business. Keogh plan contributions can be made by the extended due date of your return – in most cases this is October 15, 2013 (for tax year 2012). The downside is that you must have established the Keogh plan by December 31, 2012 in order to make contributions for the 2012 tax year. If you have not established your Keogh plan yet, it’s too late for tax year 2012.

However, you still have another option if you want to make significant retirement plan contributions (above and beyond the $5,000/$6,000 limit on traditional IRAs) – and this is to establish and fund a SEP-IRA. The funding limit for SEP-IRAs is the same as for Keogh plans, but you can establish the SEP-IRA as late as the extended filing date (October 15) and fund it for the prior tax year.

Happy saving!

Enhanced by Zemanta
%d bloggers like this: