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Age Adjustments for Social Security

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With all the talk about how Social Security is running out of money (or will be, currently projected at 2035), one of the topics that often comes up is the age limits for benefits. As you’re probably aware, the Full Retirement Age (FRA) has been adjusted upward from the original age 65, gradually to age 67 for folks who were born in 1960 or later. This upward adjustment was put into place with the 1983 amendments, ostensibly to reduce the outflows for the system.

With that adjustment in place, and the resulting benefit that the system has received from making that change, you might wonder why some of the other age limits have not been changed. Specifically, why has the early retirement age remained at 62, and the upper limit (maximum benefit age) has also remained set at 70?

I don’t have any definitive information to back this up, but I think there may be a reason behind the lack of change in these upper and lower limits. Look at how the lower limit interplays with the FRA. When the FRA was 65, as it was for folks born prior to 1937, the maximum amount of reduction that could occur by taking benefits at the earliest age of 62 was 20%. As FRA has increased, the amount of time for reduction (the time between age 62 and the increased FRA) has also increased. This resulted in an increase in the amount of reduction for folks starting benefits at the earliest age, to 30% for those with an FRA of 67.

Since a large percentage of folks will inevitably file for benefits at the earliest possible age, leaving the early filing age at 62 results with a high percentage of people receiving benefits at a lower and lower rate. The result is a lower outflow from the system, which extends the period of time before the system starts running out of money.

At the other end of the spectrum, increasing the FRA while leaving the maximum benefit age the same results in a reduced amount of time for Delayed Retirement Credits (DRCs) to accrue. For folks with FRA of 65, the maximum amount of DRC that could accrue was 32.5%. Given changes to the formula, this amount remained fairly constant for the increase up to FRA of age 66. Once that FRA is in effect, the DRC was set at 8% per year, with no change as the FRA increased. So when the FRA increases gradually to age 67, the maximum DRC will correspondingly reduce to 24%.

As the FRA increases, the maximum reduction increases by leaving the early retirement age at 62. While at the same time, the maximum delay credit reduces by leaving the maximum age at 70. The system benefits more by leaving these ages set at 62 and 70 than if they were adjusted, at least in the short term.

I don’t think there’s anything nefarious about this, it’s just another way that the system has benefited from those changes to the FRA.

Leaving Your IRA to Your Family First, Then to Charity

Clydesdale rigged team (CRT)

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Suppose you have a situation where you’d like to leave your IRA (or at least some of it) to a family member or a group of beneficiaries, and then leave the remainder of the IRA to a charity of your choice.

One way to do this is to split the beneficiary designation between your family members and the charity. This is a simple way to make this designation, but it might not really achieve the purpose you’re hoping to. Suppose you’d like to make certain that a non-spouse family member has adequate income from your IRA for the remainder of his or her life, but you don’t want to overdo the bequest with a large appropriation (and taxes on the distribution). There’s a way to do this that may fit your needs: the Charitable Remainder Trust, or CRT.

The Charitable Remainder Trust

Using a Charitable Remainder Trust, or CRT, can be a useful way to ultimately pass your IRA or Qualified Retirement Plan (QRP) to a charity, while at the same time providing income to other beneficiaries for life. The way this works is that the CRT would receive a distribution of the IRA’s assets (within 5 years of the death of the original owner), and the beneficiaries can then receive income for the remainder of their lives. Because the remainder of the trust (at least 10% of the original value distributed at the death of the original owner) will ultimately pass to the charity, the estate receives a charitable contribution deduction for a portion of the account, actuarially-defined.

Since the funds are no longer in the IRA or QRP, the beneficiaries are not subjected to Required Minimum Distributions (RMDs) from the account – these can be tailored to the individual beneficiary’s requirements. Amounts between 5% to 50% of the IRA value can be distributed to these beneficiaries. On the downside, the amount of income will have to be pre-set, either a set amount or a set percentage of the account, and this amount cannot be changed. In other words, if the beneficiary wants more than the set amount of distribution, the distribution amount cannot be increased.

If there are multiple beneficiaries of the trust, as members of the beneficiary group die the other remaining beneficiaries will receive the income attributed to those beneficiaries, until all beneficiaries have passed on. Since there are restrictions on the CRT that require that at least 10% of the total trust value remains to be distributed to the charity, it won’t work well if the beneficiary class includes very young members. If there is a very long period of time to pay income, the remaining account value may be reduced below that restricted amount – and the distributions will slowly diminish.

This method may not be useful to everyone, but it could be useful for certain specific situations. An example would be if you had multiple IRAs, and had one in particular that you wanted to eventually pass on to a charity. At the same time you want to ensure that you don’t short-change your family or friends – maybe you have a couple of siblings that you’d like to pass along a life income to, perhaps in addition to leaving other assets these beneficiaries.

The CRT also has the benefit of passing along favorable taxation to the beneficiaries, which can include capital gains and dividends rates as well as ordinary income tax rates. Working with your tax advisor and other professionals is recommended to fully understand this potential.

Roth IRA for Youngsters

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Many times it is among the best of ideas to establish a Roth IRA for your child. This way, your child can benefit from the long-term growth in the account and have a very good head start on retirement savings for later in life. There are other benefits, including the fact that retirement funds are not included when financial aid is being calculated for college expenses, as well as providing funds for the child to use when the time comes to buy a house, for example.

One thing can cause a real problem though: if you undertake to make contributions to a Roth IRA for your child that aren’t based in fact. What’s that? How can this be? So there’s a way you can make contributions to Roth IRA that aren’t based in fact? What fact is that??

The rules for making contributions to Roth IRAs (actually, any IRA) include the fact that the person who owns the account must have earned income. This means that the individual whose account is being contributed to must have earned at least the amount that is being contributed from some sort of job – which could include self-employment or any sort of employment. In addition, scholarships or fellowships that are reported in box 1 of Form W2 are considered earnings for IRA contributions.

If your child doesn’t have income of any realistic form, it is not allowed for you to make contributions to a Roth IRA (or any IRA) on behalf of the child. And it doesn’t work for you to invent income, such as paying the child to clean up his or her room. The income has to be “real” – making contributions without some sort of real income will result in some nasty penalties. The penalty for over-contribution to a Roth IRA is 6% per year, meaning each year that the money is in the account. If several years have gone by, you’ll get hit with this penalty for each and every one of those years – which is even worse than just putting the money in a savings account the first place.

So, if your child has legitimate income, such as from mowing yards or a paper route, it’s perfectly legitimate for the child to make a contribution to a Roth IRA. You can even donate the funds to the child to make that contribution if you like. Just don’t contribute more than the child’s actual earnings.

Is It Really Allowed – Making a Non-Deductible IRA Contribution Followed By a Roth Conversion?

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I occasionally receive this question: Can I make a non-deductible IRA contribution, and then shortly after convert the IRA into a Roth IRA? My income is too high for me to make a contribution directly to a Roth IRA. (This is also known as a back-door Roth IRA contribution.)

According to the rules in place today, you can do this. Here are the applicable rules:

  • There is no income limit for an individual to make a non-deductible IRA contribution.
  • There is no income limit for an individual to make a Roth Conversion.
  • There is no time limit on how long a contribution must be in a traditional IRA before converting it to a Roth IRA.

Essentially this situation provides the individual with an income above the limits for a regular Roth Contribution with an avenue to accomplish the funding of a Roth IRA. It seems too good to be true. And even though you may feel like it’s flaunting the law, it’s really okay. Here’s why – even though you don’t realize it, the specific rule of law that could apply is called the Step Transaction Doctrine.

Step Transaction Doctrine

Wikipedia defines the step transaction doctrine as follows:

The step transaction doctrine is a judicial doctrine in the United States that combines a series of formally separate steps, resulting in tax treatment as a single integrated event. The doctrine is often used in combination with other doctrines, such as substance over form. The doctrine is applied to prevent tax abuse, such as tax shelters or bailing assets out of a corporation. The step transaction doctrine originated from a common law principle in Gregory v. Helvering, 293 U.S. 465 (1935) that allowed the court to recharacterize a tax-motivated transaction.

The doctrine states that:

interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction. By thus linking together all interdependent steps with legal or business significance, rather than taking them in isolation, federal tax liability may be based on a realistic view of the entire transaction.

There are three tests for applying the step transaction doctrine: (1) a “binding commitment”; (2) a “mutual interdependence” of steps; or (3) the intent of particular result.

Lots of legalese, I know. Let’s see how those three tests would apply to our situation with the non-deductible IRA to Roth Conversion.

Test 1

The Binding Commitment test determines that a particular action has been taken that binds the taxpayer in a commitment to later take another step in the series. Clearly, making a non-deductible IRA contribution does not bind you to take the next step in the series. Since we only have two steps in our series, we only have to apply the test to the first step.

Test 1: Pass

Test 2

The Mutual Interdependence test looks at each step in the series to determine if any of the steps along the line would have been meaningless without the overall series. Again, making a non-deductible IRA contribution can stand on its own without the series and is therefore not meaningless without the series. The same goes for the Roth Conversion – this step could occur without the non-deductible contribution step and is also not meaningless without the series.

Test 2: Pass

Test 3

The Intent test (also known as the “End Result” test) is the most likely to be applied. This test considers the series as a whole to determine if the individual steps were taken solely to achieve the end result, and not simply a group of non-related steps. So – is it likely that the only reason you’ve made the first step (non-deductible IRA contribution) is to enable the second step (Roth IRA conversion) possible so that you can achieve the end result (money in your Roth IRA account).

Test 3: Unclear

Application

The IRS has not (to date) raised any qualms against this series of transactions, although it’s possible that they could at some point. In looking at the Intent test, you could see how they might have a case. But it’s really not too likely that the IRS will undertake this position.

Since it’s a given that Roth Conversions are allowed with no restrictions by law, and it’s also a given that non-deductible IRA contributions are allowed with no restrictions by law, it’s unlikely that any law will be written to make changes to these rules in the near future. The only way it could be possible is if there were a holding period requirement within an IRA before converting the account’s holdings to a Roth IRA – and that sounds like a messy bit of law (although nowhere near as messy as some current laws are). I’d say if you are in a position to use this strategy, go ahead and do it. The worst that could happen would be a requirement to de-convert the account back into an IRA.

Keep in mind that making a non-deductible IRA contribution doesn’t automatically allow a no-tax impact conversion to Roth. If you happen to have another IRA (or IRAs) that contain deductible contributions, you will have to apply the pro rata tax rules to the conversion. This may result in additional tax on the conversion.

How PIA Relates to Your Benefit

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If you’ve been looking into your Social Security projected benefits for long, you’ve probably run across the term Primary Insurance Amount, or PIA. Click on the link to see how the PIA is calculated if you need more background information on the PIA.

What’s important to know is that the PIA is essentially the amount of your retirement benefit if you file for it exactly on your Full Retirement Age (FRA) month. But it’s quite common for an individual to file for retirement benefits either before or after FRA. If you file for your retirement benefit before or after FRA, even by a month, there is a difference between your PIA what your benefit will be.

Before FRA

If you file for benefits before the month when you reach FRA, there are two reduction rates that may apply to your benefit, reducing it from the PIA amount. The reason there are two rates is because originally the FRA for everyone was 65. This made it simple to cause a 20% reduction for anyone who started benefits at the earliest age, 62, which was 36 months before FRA. So the reduction factor for any filing up to 36 months before FRA is calculated at a rate of 5/9% (approximately 0.5556%) per month, which works out to 20% for the full 36 months.

Later, when the rules changed such that FRAs could be at ages beyond 65, the original rate of 5/9% per month was deemed too aggressive of a reduction. So a smaller value was determined for reductions beyond the first 36 months of reduction, at 5/12% per month, (approximately 0.4167%). This works out to a 5% reduction for each 12 months beyond the first 36.

Wow, that’s not complicated at all, is it? Geez. Here’s a walkthrough of the formula that you can use to help you calculate the reduction for your benefit before FRA:

1.  Enter your Full Retirement Age, years and months:
2.  Enter the age you plan to file for benefits, years and months:
3.  Subtract line 2 from line 1 in months only
4.  Subtract 36 from line 3 (if less than zero, enter zero)
5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)
6.  If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2
7.  Add line 6 to line 5
8.  Subtract line 7 from 1.0000
9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

Let’s run an example. An individual born in 1955, so his FRA is 66 years and 2 months. His PIA is $2,000, and he intends to file for benefits at age 64 years and 6 months.

1.  Enter your Full Retirement Age, years and months:

66y 2m

2.  Enter the age you plan to file for benefits, years and months:

64y 6m

3.  Subtract line 2 from line 1 in months only

20

4.  Subtract 36 from line 3 (if less than zero, enter zero)

0

5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)

6.  If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2

.11112

7.  Add line 6 to line 5

.11112

8.  Subtract line 7 from 1.0000

.88888

9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

$1,777.76

Now let’s adjust the example so that it uses the additional factor. Same individual as above, but now he plans to retire at age 62 years and 8 months.

 

1.  Enter your Full Retirement Age, years and months:

66y 2m

2.  Enter the age you plan to file for benefits, years and months:

62y 8m

3.  Subtract line 2 from line 1 in months only

40

4.  Subtract 36 from line 3 (if less than zero, enter zero)

4

5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)

.016668

6.  If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2

.200000

7.  Add line 6 to line 5

.216668

8.  Subtract line 7 from 1.0000

.783332

9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

$1,566.66

 

Now let’s look at how applying after FRA works.

After FRA

For every month after FRA that you delay applying, your benefit will grow by a factor. For folks born in 1943 and later, the factor is 2/3 of a percent, or roughly 0.6667%. If you were born in 1941 or 1942 (earlier years don’t matter at this point, you’re already 70), the factor is 15/24 of a percent, or approximately 0.625%. These factors equate to 8% per year for those born in 1943 or later, or 7.5% per year for those born earlier.

Here’s a formula to use to help calculate the delay factor and benefit amount for your situation:

 

1.  Enter your Full Retirement Age, years and months:
2.  Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):
3.  Subtract line 1 from line 2 in months only
4.  If your FRA is less than 66, multiply line 3 by 15/24% (or 0.00625); otherwise multiply line 3 by 2/3% (or 0.006667)
5.  Add 1.00000 to line 4
6.  Multiply line 5 by your PIA.  This is your increased benefit amount.

 

Let’s run through an example. The individual from above, with a FRA of 66 years and 2 months, and a PIA of $2,000, decides to file for benefits at the age of 68 years and 6 months.

1.  Enter your Full Retirement Age, years and months:

66y 2m

2.  Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):

68y 6m

3.  Subtract line 1 from line 2 in months only

28

4.  If your FRA is less than 66, multiply line 3 by 15/24% (or 0.00625); otherwise multiply line 3 by 2/3% (or 0.006667)

.186676

5.  Add 1.00000 to line 4

1.186676

6.  Multiply line 5 by your PIA.  This is your increased benefit amount.

$2,373.35

 

And that’s it.  Hope this has helped you to better understand how your PIA and your benefit are related.

2 Good Reasons to Use Direct Rollover From a 401(k) Plan

medigap

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If you have a 401(k) plan (or any Qualified Retirement Plan (QRP) such as a 403(b) plan), when you leave employment at that job you can rollover the plan funds to an IRA or another QRP at a new job. Listed below are 2 very good reasons that you should use a Direct rollover (also known as a trustee-to-trustee transfer) instead of the 60-day rollover.

A 60-day rollover is where the former plan distributes the funds from your account to you, and in order to make the rollover complete you must deposit the entire distributed amount into the new plan or IRA within 60 days.

Reasons to Use a Direct Rollover

  1. You must complete the rollover to the new account or IRA within 60 days. There is little if any leeway on this 60-day period – and though it seems as if this is a simple task to accomplish, there are many cases where well-intentioned individuals missed the bus on this one. All it takes is a lost letter in the mail, or the check falling through the cracks, or any of myriad ways to miss the deadline.
  2. When funds are distributed from a QRP to an individual, the plan administrator is required to withhold 20% of the distribution for income tax. This presents a problem if you were planning to rollover the full amount of the QRP distribution into your new plan or IRA, since you’ll now need to come up with the missing 20% from other sources. Granted, if all things remain the same you should get the withheld 20% back from the IRS when you file your taxes, but that could be a long wait if you don’t have a lot of excess cash lying around.

Using the direct rollover eliminates both of the issues listed above. When then QRP administrator enacts a direct rollover for you, most often the distribution is directly to the administrator or custodian of the new plan or IRA. Sometimes the QRP administrator will send a check to you, the plan participant, made out to the new administrator or custodian, so you’ll still need to make sure that the check gets to the new plan. You’re in a much better position to get around the 60-day window if the check is made out to the new custodian, since technically the 60-day rollover requires that you have the funds at your disposal (for use or deposit in another account).

In addition, using a direct rollover eliminates the 20% withholding requirement altogether. There’s no amount to make up later.

Spouse May Be Your Best Option for IRA Beneficiary

Since a surviving spouse gets the most flexibility and tax breaks of all possible beneficiaries (other than perhaps a charity), it seems that choosing your spouse as the beneficiary of your IRA may be the best way to go.

This is partly due to the availability of delaying taking distributions. Any other eligible designated beneficiary must begin taking Required Minimum Distributions (RMDs) by the end of the year following the year of the original IRA owner’s death. The spouse beneficiary may defer distributions to the year in which the deceased would have reached RMD age, which would be 73 or 75 these days, without taking any action.

In addition, any other eligible designated beneficiary besides the spouse is required to take the RMDs over his or her fixed-term single-life expectancy, while the spousal beneficiary can choose to take the RMDs over his or her single-life expectancy recalculated annually, so that the distributions will actually stretch out over his or her entire life. The fixed-term single-life expectancy often winds up ending sometime in the beneficiary’s 80’s.

The best part of all is that the surviving spouse beneficiary can choose to rollover the IRA to an IRA in his or her own name, which could have the effect of delaying the start of RMDs even further, if the spouse beneficiary is younger than the decedent. When this option is chosen, the surviving spouse could also choose to roll the IRA into a Qualified Retirement Plan (QRP) such as a 401(k). If the surviving spouse is still working for this employer past regular RMD age, RMDs could be delayed even further – up until the surviving spouse retires.

An added bonus to the option of the surviving spouse using a rollover, he or she can name another designated beneficiary of this rolled over IRA, providing flexibility to the overall process. Plus, with an IRA in his or her own name, when the time comes to begin RMDs, the surviving spouse can use the Uniform Lifetime Table (instead of the Single Life Table) which will allow for further stretching of the benefits, potentially far beyond his or her lifetime.

I specifically noted above that the spouse is in a superior position to other eligible designated beneficiaries. For any non-eligible designated beneficiaries, there’s not even a comparison since these beneficiaries are required to drain the inherited IRA within 10 years at the very most, no other options.

Caregiver Costs Qualify as Medical Expenses

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It’s a little known fact that certain costs for caregivers, licensed or unlicensed, may qualify as medical expenses for tax deductions. Maintenance and personal care service costs can be considered qualified medical expenses in cases where the patient receiving the care has been certified by a health-care professional as unable to perform two or more of the six activities of daily living: Bathing, Eating, Dressing, Toiletting, Continence, and Transferring (moving from bed to chair, for example).

Note: An easy way to remember these six activities is to use the first characters in the order I presented them above – B E D To C – this gives us the first five, and the entire mnemonic provides the sixth, Transferring from BED To Chair.

The health-care professional who certifies the patient as incapable of these activities can be a doctor, a nurse, or a licensed social worker, and the certifying professional is required to approve of the care program for the patient.

Another example of such qualifying expenses would be where an individual has dementia which causes serious health concerns requiring 24-hour supervision, determined by the doctor. Both licensed and unlicensed caregivers are hired to care for the individual. Payments for these caregivers are deductible as medical expenses. These expenses are considered qualified long-term care expenses.

Of course, all medical expense deductions are limited to the extent that they exceed 7.5% of the AGI of the taxpayer, and deduction is only relevant if all itemized deductions are greater than the standard deduction (if the standard deduction is available to the taxpayer).

One Way to Use IRA Funds to Invest in Your Business

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As you know, it is against all the rules to use your IRA to invest in anything which benefits you or a related party. This is one quick way to get your entire IRA disqualified, quite likely owing a big tax bill and penalties as well.

However – and there’s always a however in life, right? – there is one possible way that you could use funds from an IRA to invest in your own business. It’s a bit tricky, but it is a perfectly legal, in fact encouraged, method.

Howzat? The IRS encourages the use of IRA funds for your own business? Not exactly. There’s more to it than that. The IRS encourages by preferential law the use of 401(k) funds to invest in the business sponsoring the plan. A 401(k) is a type of qualified retirement plan that is allowed specifically to invest in the stock of the employer.

So, if you start a business and it’s incorporated (specifically a C corporation, not an S corporation), you can adopt a 401(k) and roll your IRA into the plan, then use the 401(k) funds to invest in your business. You have to make certain that the 401(k) follows all the usual rules – the plan has to be primarily designed to provide retirement benefits, it must be permanent in nature, you must make substantial and recurring contributions, and the plan must not discriminate against employees. Generally this business must be a new start up in order for the process to fit in with the rules.

Done correctly, this is a tax-free way to access your retirement savings funds to underwrite your new business. Since it’s not a loan per se, there is no requirement for lender approval or specific credit requirements, either.

This sort of use of your retirement funds comes with risks, for sure. The IRS admits that a high percentage of businesses adopting a ROBS strategy ultimately fail. And this means that a significant portion of your retirement savings will be lost as well.

This is definitely not for the faint of heart. Although all the statutes allow the method as legal, the IRS is well aware of the method and they don’t seem to like it much. They’re referring to this activity as “rollovers as business startups”, or ROBS, and they are siccing their auditors on abusers of the option. I suspect that the main reason that folks run afoul of the IRS on this is if they don’t stick with the requirements for a valid plan and abuse the privilege. I recommend getting a professional (accountant or lawyer, or both) to assist with setting up the plan so that you don’t make any mistakes.

As with many of these sorts of schemes, I don’t recommend it for regular use. It could work for special circumstances though – but you should definitely be very careful if you decide to give it a shot. The downside could be significant and painful.

Make a Long-Term Plan and Stick to It.

after 55

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In his Preface to the Fourth Edition of Benjamin Graham’s legendary book The Intelligent Investor, Warren Buffett wrote the following:

To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline.

I’ve seen the same sentiment boiled down and paraphrased a bit, also attributed to Mr. Buffett (although I couldn’t find the original source) as:

It only takes two things to make money – having a plan and sticking to it – and of those two, it’s the sticking to it that most investors struggle with.

Either way, the point is crystal clear – investing successfully, per se, is not rocket science, there are many sources you can use to develop your plan; or rather, your “intellectual framework for making decisions”. The difficult part is keeping your emotions in check when your investments have gone to extremes, high or low, so that you can stick to your plan. The whole reason for developing a plan in the first place is to help you to navigate the tough times.

The same goes for your overall financial goal plans – such as retirement plans or college savings. Developing a plan is not exactly simplicity – there are many issues to be dealt with to ensure that the plan itself is sound, including investment allocation, tax concerns, coordinating various sources (Social Security, taxable accounts, IRAs, 401(k)s, pensions, etc.), timing of contributions and withdrawals, and so on. These things are quantifiable, although the weaving together of these issues can be very complex.

The place where most financial and investing plans go awry is when difficulties arise, and you begin to question the plan. This is perfectly understandable, in part because you can often find yourself facing these difficulties in a vacuum, without any idea whether what you’re experiencing is common for all folks in your position or if you’re doing better, or if you’re doing worse. You may have no idea if the plan you’ve developed is appropriate for weathering the current storm, or if the reason you’re experiencing poor results is due to some problem in the plan itself.

This is where a good financial advisor can be worth her or his weight in gold. If the advisor you’ve chosen is properly qualified, he or she can draw upon voluminous knowledge and experience to help you understand what the plan needs to include to weather the storms. The second part, and according to Buffett the most important part, is staying with the plan even when things aren’t rosy all around. A good financial advisor, one who will operate as a fiduciary, undertakes the duty to maintain calm and to ensure that emotions are not driving the decisions.

Note: Not all financial professionals undertake this responsibility in their work with clients. Ask the questions, and if the financial pro you’re talking to won’t explicitly accept the responsibility to help you stay on track when things get rough, you need to look elsewhere for a new advisor. Try www.NAPFA.org for starters.

Most often this “sticking-to-it” part becomes the most difficult when there is great volatility on the downside in the markets. You don’t have to go very far back in time to recall some of those dark days… we saw such a dramatic downturn in the markets in 2020 and again in 2022. Those were scary times, to say the least. I remember sending out messages to my clients every few weeks during those days, repeating the mantra to stay with the plan, don’t panic. Maintaining perspective and remembering that the plan is for long term is the key – I can remember conversations where we discussed the concept that we’ve invested with the aim of using the money many years from now, and since what’s happening today is the short term, we need to maintain our positions.

That leads us to my final point on this quote: One thing that the rephrased quote above leaves out (versus the original) that I think is just as critical is where Mr. Buffett specifically refers to investing “successfully over a lifetime”. Mr. Buffett has many times stated:

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.

… meaning of course, that moving in and out of the market based upon “timing”, gut feelings, or crystal ball predictions, is not the way to be successful. Having long-term plans with solid investments, not the “get rich quick” type of investment, is the way to success.

So – here’s another rephrasing with my adjustment: Have a well-thought-out long-term plan to help you make decisions for your future (investing or otherwise), and stick to it. And hire a financial advisor to help you with both, because you’ll need the guidance, knowledge, and discipline to help you through tough times.

How Survivor Benefits are Treated

social security benefits taxedWhen you’re married to someone who has worked under the Social Security taxation system, you have two different benefits that may be available to you: Survivor Benefits, and Spousal Benefits. These two benefits may be more than the benefit you’ve earned under your own working record.

Spousal Benefits are available while your spouse (or ex-spouse) is still alive. Survivor Benefits are available after your spouse’s (or ex-spouse’s) death.

Social Security Survivor Benefits are much different from Spousal Benefits in several ways. In fact, there’s very little to compare between the two, other than that they are benefits for the spouse or ex-spouse of someone who earned a Social Security Retirement Benefit. Here are the primary things that you need to know about Survivor Benefits:

  • Survivor Benefits can be claimed as early as age 60.  Of course, as with all early claims for benefits, the amount will be reduced if you claim earlier than Full Retirement Age (FRA). At age 60 your Survivor Benefit would be reduced to 71.5% of your late spouse’s benefit amount (or PIA (Primary Insurance Amount) if he or she wasn’t at FRA). Determining the actual Survivor Benefit amount is a complex process.
  • Survivor Benefits are based upon 100% of the amount of benefit (at your FRA) that the deceased spouse was or should be receiving, whereas Spousal Benefits are based upon the PIA, and then only at a 50% maximum rate.
  • Survivor Benefits can also be applied for separately from your own retirement benefit – meaning that you can receive Survivor Benefits while delaying receipt of your own retirement benefit (if it’s higher or will be higher) in order to receive Delayed Retirement Credits up to age 70.
  • Survivor Benefits are only payable if the surviving spouse has not remarried before age 60. After age 60, the surviving spouse can remarry and still receive Survivor Benefits based upon the deceased spouse’s record.
  • A disabled surviving spouse can collect benefits as early as age 50 – at the same rate as if waiting to age 60 – 71.5% of the deceased spouse’s benefit.
  • If a surviving spouse is caring for a child under the age of 16, a different type of Survivor Benefits can be claimed until the child or children are over age 16. This benefit, known as a Mother’s Benefit or Father’s Benefit, is equal to 75% of the deceased spouse’s benefit (or PIA if the deceased spouse was not receiving benefits). This is only available to the surviving parent while the child is under age 16.
  • Survivor Benefits can also be paid to children of the decedent, provided they are under age 19 and a full time student. If the child is disabled (prior to age 22), Survivor Benefits can still be paid to the child after age 19. The child’s Survivor Benefit is at a 75% rate of the decedent’s benefit.
  • If the parents of the person who earned the Social Security benefit were dependent upon the worker, they can also receive a Survivor Benefit, known as the Parent’s Benefit, if they are age 62 or older. This benefit is 82.5% of the worker’s benefit amount if there is only one parent claiming, or if there are two dependent parents, each can claim a 75% benefit.

These Survivor Benefit rules also apply to ex-spouses who become widows or widowers, as long as the ex-spouse was married to the ex-spouse for at least ten years, and the ex-spouse did not remarry (and remain married) before age 60.

Withholding Tax Without Income?

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We’ve discussed in the past how it’s possible to eliminate quarterly estimated tax payments by using a withdrawal from your IRA. But did you know that you can put this method in motion without actually increasing your income?

Wait a minute… did you just catch that? I’m telling you that you can eliminate your withholding or quarterly estimated taxes by using a withdrawal from an IRA – and that you can do this without having to recognize income from the IRA withdrawal.

It’s a little tricky, but if you’re not too faint of heart, this could actually be a cool little maneuver. What you do is to take a withdrawal from your IRA, and on the withdrawal slip indicate that you want the entire withdrawal withheld for taxes. Then, within 60 days, replace the funds (from another, non-IRA source) into either that same IRA or another IRA – completing a sixty-day rollover. End result: taxes withheld, no income, no penalty.

While it might seem crazy to assert that you can have taxes withheld from a distribution that was negated by a 60-day rollover, but the IRS allows you to do a tax-free rollover of a distribution that has been sent to the IRS as withheld income tax, by using substitute funds (see Reg 1.402(c)-2, Q-11).

What’s so cool about this maneuver? Take these factors into account:

  • When you withhold tax from an IRA distribution, the IRS considers that it has been withheld over the course of the year, so timeliness of withholding isn’t important: you could have your entire tax burden withheld on December 31 if you wanted. If you tried this with non-IRA funds, only making one estimated tax payment (or withholding payment), the IRS would hit you with an under-withholding penalty for not sending the money to them throughout the year.
  • If you are self-employed or otherwise in complete control of your income, you can eliminate withholding and/or estimated tax payments completely, by saving up the equivalent of withholding through the year and then pulling the trick outlined above toward the end of the year.

You’d be able to very accurately calculate your tax payments, reducing the loss of income that comes along with over-withholding through the year. This way you can invest the money that you’d otherwise be sending in quarterly installments, and at the end of the year make one large payment from your IRA, and roll-in your withholding stash.

It should be noted that, while this is a valid option to consider, there are pitfalls that could really cause you problems. Just forgetting to do the IRA withdrawal (withholding the withdrawal to pay tax) on time can result in some very serious penalties. Furthermore, missing the 60-day deadline for completing the rollover could penalize you further with the 10% early withdrawal penalty. To simplify things, you should complete the rollover within the same tax year if at all possible.

In addition, keep in mind that there’s a once-per-year limit on these 60-day rollovers. So if you wanted to try this on a regular basis year after year, you’d need to time things properly to keep from hitting up against your 12-month restriction on repeated rollovers.

I would not suggest doing this maneuver on a regular basis – it should be one of those tools that you have available if you get caught in a pinch. The penalties for screwing it up are severe, and the chances of screwing it up are plenty.

Do You Need a Friend at the IRS?

As taxpayers, many of us have faced difficulties in dealing with the IRS – and it can be a daunting position to be in. One way to deal with these issues is to hire a CPA or Enrolled Agent to help you through the process. Another way is to deal with it yourself. The problem is that dealing with the IRS by yourself can be a very difficult thing to do.

The good news is that you have a friend at the IRS: The Taxpayer Advocate Service (TAS).  The purpose of the TAS is to help taxpayers:

  • whose problems with the IRS are causing financial difficulties;
  • who have tried but have not been able to resolve their problems with the IRS; and
  • who believe an IRS system or procedure is not working as it should.

The IRS has listed ten things that they believe every taxpayer should know about TAS:

  1. The Taxpayer Advocate Service (TAS) is an independent organization within the IRS and is your voice at the IRS.
  2. We help taxpayers whose problems are causing financial difficulty. This includes businesses as well as individuals.
  3. You may be eligible for our help if you’ve tried to resolve your tax problem through normal IRS channels and have gotten nowhere, or you believe an IRS procedure just isn’t working as it should.
  4. The IRS has adopted a Taxpayer Bill of Rights that includes 10 fundamental rights that every taxpayer has when interacting with the IRS:
    • The Right to Be Informed.
    • The Right to Quality Service.
    • The Right to Pay No More than the Correct Amount of Tax.
    • The Right to Challenge the IRS’s Position and Be Heard.
    • The Right to Appeal an IRS Decision in an Independent Forum.
    • The Right to Finality.
    • The Right to Privacy.
    • The Right to Confidentiality.
    • The Right to Retain Representation.
    • The Right to a Fair and Just Tax System.

      Our TAS Tax website at TaxpayerAdvocate.irs.gov can help you understand these rights and what they mean for you. The website also has examples that show how the Taxpayer Bill of Rights can apply in specific situations.

  5. If you qualify for our help, you’ll be assigned to one advocate who will be with you at every turn. And our service is always free.
  6. We have at least one local taxpayer advocate office in every state, the District of Columbia, and Puerto Rico.  You can call your advocate, whose number is in your local directory, in Publication 1546, Taxpayer Advocate Service — Your Voice at the IRS, and on our website at IRS.gov/advocate. You can also call us toll-free at 877-777-4778.
  7. The TAS website at TaxpayerAdvocate.irs.gov has basic tax information, details about tax credits (for individuals and businesses), and much more.
  8. TAS also handles large-scale or systemic problems that affect many taxpayers. If you know of one of these broad issues, please report it to us at IRS.gov/sams.
  9. You can get updates at:
  10. TAS is here to help you, because when you’re dealing with a tax problem, the worst thing you can do is to do nothing at all.

Required Minimum Distributions (RMDs) Don’t Have to Be in Cash, But…

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Here’s something that I bet you’ve never run across – when you have to begin taking Required Minimum Distributions (RMDs) from your IRA or Qualified Retirement Plan (QRP), most folks think you must take these distributions in cash.

This is not the case, you can actually take distributions of any sort, not just RMDs, from your plan (IRA or QRP) in either cash or “in kind”. By “in kind”, this means that you can take the actual securities (stocks, bonds, or other investments) from the account. These distributions in kind can be used to satisfy your RMD for the year. There can be both pros and cons to taking distributions in kind.

Pros in favor of in-kind distributions

You might want to consider using an in-kind distribution if your IRA or QRP is fully invested and you want to keep it that way. Sometimes (such as in a market downturn) it can be beneficial to maintain a cash position, but generally it’s often in your best interest to remain fully invested. Using an in-kind distribution will allow you to remain fully invested before and after your distribution.

Another reason that you might want to use an in-kind distribution is if you have a particular position in a stock or limited partnership (for example) that you consider to be undervalued, such that it will appreciate considerably after you’ve distributed it. This would put you in a position to have your gain (beginning with the date of distribution) taxed at capital gains rates rather than ordinary income tax rates.

In this second case you need to understand that you’d be taxed at ordinary income tax rates on the value of the distribution (on the day of the distribution) and your basis in the position will be set at that value. Future gains will be considered against that basis.

In addition, if you don’t have to cash out of a position in order to distribute it, you wouldn’t incur a trade commission.  Assuming that you would just re-invest in the same or a similar security, you’d then incur another trade commission when you made the new purchase. So distributing in-kind can cause a double commission to be paid, which may not be necessary.

Cons against in-kind distributions

Sometimes it can be difficult to value a security – for example if it is very thinly-traded. In a situation such as this, distributing the RMD in-kind can cause difficulties, especially if you’re hoping to minimize the distribution to only the required minimum.

With this in mind, in order to reduce confusion and ensure that you’re taking the correct amount in your RMD, it can be prudent to maintain or create a cash holding that will be sufficient for your RMD.

Taxation

It’s important to keep in mind that no matter how you take your distributions, you’ll have to pay ordinary income tax on the distribution – and the tax may be pro-rata if the IRA is partly non-deductible.

IRS Penalties – 8 Facts You Need to Know

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There are generally two ways that the IRS can assess a penalty to you – failure to file, or failure to pay; and it’s not out of the question that you could be subjected to both types of penalties. There are many other penalties, such as accuracy-related penalties, that may also apply. Listed below are some facts from the IRS about penalties.

Facts on Penalties

  1. If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty.
  2. The failure-to-file penalty is generally more than the failure-to-pay penalty. So if you cannot pay all the taxes you owe, you should still file your tax return on time and explore other payment options in the meantime. The IRS will work with you.
  3. The penalty for filing late is usually 5% of the unpaid taxes for each month or part of a month that a return is late.  This penalty will not exceed 25% of your unpaid taxes.
  4. If you file your return more than 60 days after the due date or extended due date, the minimum failure-to-file penalty is the smaller of $485 or 100% of the unpaid tax.
  5. If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½% of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid.  This penalty can be as much as 25% of your unpaid taxes.
  6. The ½% increases to 1% if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy property. If you file your return by its due date and request an installment agreement, the one-half of one percent rate decreases to one-quarter of one percent for any month in which an installment agreement is in effect.
  7. Be aware that the IRS applies payments to the tax first, then any penalty, then to interest. Any penalty amount that appears on your bill is generally the total amount of the penalty up to the date of the notice, not the penalty amount charged each month.
  8. If you timely filed a request for an extension of time to file and you paid at least 90% of your actual tax liability by the original due date, you will not be faced with a failure-to-pay penalty if the remaining balance is paid by the extended due date.
  9. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5% failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $485 or 100% of the unpaid tax.
  10. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.
  11. Generally, interest accrues on any unpaid tax from the due date of the return until the date of payment in full. The interest rate is determined quarterly and is the federal short-term rate plus 3 percent. Interest compounds daily.

Limits on Social Security Disability Coverage

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When you leave full-time employment, there is a period of time after that when you will continue to be covered by Social Security Disability Benefits. Welcome to the 20/40 Rule.

The 20/40 Rule

If you have become disabled after you’ve left employment, you may be eligible for Social Security Disability Benefits – assuming that you’re under Full Retirement Age (FRA). In a case such as this, if you have worked the required number of quarters to be eligible for Disability Benefits, the rule is that you must have worked 20 quarters out of the previous 40 quarters, earning at least the minimum.

This is the 20/40 Rule. The quarters don’t need to be consecutive, but it must be 20 out of the 40 quarters just prior to the onset of the disability. Another way to look at it is that for five years after you leave employment you will continue to be covered by Social Security Disability Benefits, again assuming that you’re under FRA.

If you work, even part-time, ($1,730 earned in a quarter for 2024), this will count as a quarter for your coverage.

The 20/40 Rule is adjusted for age, as well. If you’re under age 24 when you become disabled, you must have worked for 6 quarters out of the prior 12 quarters before you become disabled. Between ages 24 and 31, the numbers are half of the quarters after your age 21 – so if you’re 29, you would need to have 16 of the 32 quarters after your age 21. After you reach age 31, the 20/40 Rule lives up to its name – 20 quarters out of the prior 40.

Once you reach FRA, Social Security Disability Benefits are converted to Retirement Benefits, so this rule doesn’t apply any more.

How a Spouse Can Stretch an Inherited IRA

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If you or someone you know has inherited an IRA from a spouse, there are several options available for handling the account. You could transfer the IRA to an inherited IRA, properly titled, and begin taking RMDs based upon your own age; or you can transfer the IRA to an IRA titled in your own name and treat the IRA as your own. Each option has merit, you just need to determine which is best for you.

Take the IRA as an inherited IRA

If you transfer the IRA to an inherited IRA, you can immediately begin taking RMDs based upon your own age, using IRS Table I.  This will allow you to stretch out the payments you would receive from the IRA over your lifetime, without penalty. If you have need for some of the funds now but wish to defer withdrawal over a longer period of time.

You could also take withdrawals in any amount you wish (or take no withdrawals in some years), but completely drain the account by the end of the 10th year after the death of your spouse. There could be some benefit to this method – you would not have to take distributions at all for the first 9 years, and then take the entire account during the 10th. Your tax plan might fit in with this scenario, for example, if you’re still working and taking significant distributions earlier would push you into higher tax brackets.

This option, the 10-year payout, is only available if the original owner (your spouse) was not already subject to RMDs.

Take the IRA as your own

If you decide to make the IRA your own, you can treat the IRA exactly as if it were your own: you can make contributions to it, rollover other eligible funds into it, or convert it to a Roth IRA. In this case, you can delay the time to start taking RMDs until you reach age 73 – so if you are younger than your late spouse was, this method may allow you to delay RMDs the longest.

In this method, any withdrawals that you take before age 59½ could be subject to the 10% early withdrawal penalty, unless you meet one of the exceptions. You can transfer the IRA to an account in your own name at any time during the first five years, even if you’ve taken some distributions from the originally-titled account. You couldn’t take this option if you had re-titled the account as inherited (the option above), however.

Bear in mind, the above options are not every possible option for handling an inherited IRA as a spouse. For more detailed reading, check out IRS Publication 590.