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How QDRO Impacts NUA

choate buttonDon’t let the alphabet soup in the title put you off. If you’ve never come face-to-face with a QDRO you might not need to know this – but then again, the basic underlying premises are good information to understand…

First some definitions, just so we know what we’re talking about:

QDRO: Qualified Domestic Relations Order – this is a method for permitting distributions from a qualified retirement plan (not an IRA) in the event of a divorce. How a QDRO works is that, upon the decreed division of assets, if a retirement plan (such as a 401(k) or 403(b)) of one spouse is chosen as an asset to be divided and a portion given to the other spouse, a QDRO is issued. The QDRO allows the division to occur without penalty… otherwise, making a distribution from a qualified plan before age 59½ would result in penalty and possible taxation, as we all know. The QDRO provides a way (allowed by the IRS) for the receiving spouse to rollover the funds into an IRA of his or her own, without tax or penalty to either spouse.

NUA: Net Unrealized Appreciation – this is a special provision from qualified retirement plans that allows the employee to elect to treat company stock differently from all other assets in the plan when making a distribution from the plan. Essentially, you pay ordinary income tax on the basis, original cost, of the stock in your employer’s (actually former employer’s) company, and then place the stock in a taxable brokerage account. At this point, any gains on the stock are subject only to capital gains tax (rather than ordinary income tax, which is a much higher rate). The trick is that you can only do this maneuver one time, and the distribution must be in a lump sum of all your 401(k) account holdings. Everything in the account that is not company stock can be rolled over into an IRA and maintain tax deferral as usual. It’s critical to note that this can be the only distribution of funds from the account. If you were to distribute any amount, even a small amount from the employer plan in a previous year, you are no longer eligible to use the NUA provision on this employer account.


So the question comes up – if a QDRO distribution occurs for your account, and that distribution includes company stock: does this “bust” the original employee’s ability to later have the company stock treated with the NUA privilege, since the rule states that the distribution must be a one-time single lump-sum distribution?

(drum roll…) The answer is NO.  A QDRO is a division of the account, and though technically a distribution has occurred, this distribution does not impact the remaining account’s ability to take advantage of the NUA provision. The employee can go ahead and, upon separation from service, perform the lump-sum distribution of the stock and rollover the remainder into an IRA and get the NUA treatment for the stock.

Now, if you’re really astute, the last paragraph made you think of another question (it’s okay to admit it if you aren’t tax-geeky enough to have thought of this question): Can the ex-spouse (the one receiving a split of the employee’s plan) elect NUA treatment of any stock that was included in his portion of the account?

(drum roll…) The answer is a qualified YES. The qualification is this: As long as the rest of the account is eligible to be distributed (to include NUA treatment), the QDRO’d portion of the account can also take advantage of this provision.

In other words, although the ex-spouse of the employee could rollover the QDRO’d qualified retirement plan into an IRA at any time, if the account contains appreciated employer stock (stock of the former spouse’s employer) – it may be in the best interest of the receiving spouse to wait until the employee reaches age 59½ or leaves employment (termination or retirement), so that she can take advantage of the NUA provision. Otherwise, any rollover will squash this option forever.


Here’s a quick example to illustrate: Dick and Jane are divorcing.  Dick has a 401(k) plan with his employer, including some stock in his employer. Part of the divorce includes a QDRO to give Jane half of the 401(k) plan.

Once the QDRO is completed, Dick still has his original 401(k) account (albeit diminished by half), and Jane has an account in the plan of equal size. Jane can rollover those funds into an IRA at any time, if she chooses, without penalty. However, since the account holds highly appreciated company stock, in order to qualify for NUA treatment, she must maintain the account in the 401(k) plan until Dick terminates employment, retires, or reaches age 59½. At that time, she can pull the lump-sum distribution for NUA treatment and rollover the rest into an IRA. Dick can elect NUA treatment for his account when he terminates employment or retires.

Now you may be wondering about that picture… the button is the prize that a person gets when in a seminar with Natalie Choate, the renowned IRA expert – if you happen to ask a question that she is unable to answer. I asked the above questions of Mrs. Choate recently and received the button. No disrespect for her whatsoever – as an admirer of her work, I am proud of the button and wanted to share it here.

How To Turn $5,000 A Year Into a $33 Million Legacy

$5000 by AMagillWith a headline like that I bet you’re thinking this is one of those wild & crazy get rich schemes. However, it’s really just a hypothetical illustration of the great benefits of three factors that can work in your favor in building a legacy:

What follows is an example of how you can make those three factors work together to create this $33 million legacy.

How It All Started…

Once upon a time, there was this guy named Joe.  Joe is 20 years old, working part-time making decent money, finishing up college, just generally living large (by a 20-year-old’s definition). On the advice of his father (yes, some 20-year-olds do listen to their fathers!), he opened up a Roth IRA, funding it with $5,000. The account was invested in a fixed 5% yield instrument of some sort (not important what the investment is, just assume a 5% annual yield).

Using the Roth IRA is advantageous to Joe because his tax rate is very low at this stage of his life. And presumably tax rates will be increasing for him in the future. Any growth within this account is tax-deferred and most likely tax-free, as long as any future distributions are for qualified purposes.

Each year thereafter, Joe contributes an additional $5,000 to the Roth account. After he completes college, Joe starts working at an entry-level job. Not long after, he marries his high school sweetheart Jane, and Joe & Jane settle into their newlywed life. As life goes, they soon have children in their household, and even though money is tight, Joe continues to contribute the $5,000 each year into his Roth IRA. Life goes on like this for a while.

And then… 20 years pass

At age 40, Joe launches his own business. During this time in his life, tax deductibility becomes more important to him since he’s making a lot more money and is in a higher tax bracket. With this change to his tax circumstances, he stops contributing to the Roth IRA and starts investing in tax deductible retirement accounts.

All this time, his investments in the Roth account have been steadily growing at that fixed 5% rate. Now after 20 years the balance of Joe’s Roth IRA is now up to $165,329. Joe’s 20 years’ worth of $5,000 investments, makes a total of $100,000 contributed. Pretty nice, right?

Joe just sets the Roth IRA aside at this point, forgetting about it altogether for quite a while (other than those pesky quarterly statements). Not much of note happens in our story for a long, long time, other than compounding interest, time passing, and continued tax deferral.

… and another 50 years pass

Joe is now 90 years old. His business has flourished through the years, and his children are reaping the benefits of having worked there, and the children are now retiring. His grandchildren have taken over the business, and he and Jane are enjoying their great-grandchildren. A couple of years later, little Jolene is born, and this first great-granddaughter quickly becomes the apple of Joe’s eye.

It is along this time that Joe remembers that long lost Roth IRA account. To this point the Roth IRA has grown to over $2 million – from that original series of $5,000 contributions that amounted to a total of $100,000. Pretty amazing what can happen with compounding interest and time. Now, while doing his estate planning, Joe has plenty of other assets that he intends to eventually bequeath to his children: the business, other retirement and investment accounts, etc.. This Roth IRA though, he’s decided he’d like to really make a legacy out of it. So Joe decides to name his great-granddaughter Jolene, a newborn, the primary beneficiary of the Roth IRA account.

… and then, a couple of years later…

At age 95, with his family surrounding him, our protaganist Joe passes away.

little girl by ganessasLittle Jolene is now two years old, and as primary beneficiary of the Roth IRA (now worth over $2.4 million), Jolene must begin taking Required Minimum Distributions from the account, based on her age. Jolene’s Table I factor is 80.6, and so her first distribution is for just over $30,000. Her parents file the necessary paperwork and then they put this money away for Jolene’s college education fund.

And so on it goes, the account continuing to compound at 5% each year, Jolene receiving her RMD each year, and her parents putting that money away for college.

Fast forward some more…

Jolene has graduated from high school, and she’s planning to go off to college. Over the past 16 years since her beloved great-grandpa Joe passed away, she has received a total of over $650,000 in distributions from the Roth IRA that he left for her. This has made for a nice start on her college costs. (We won’t get into it now, but if we projected college costs out this far into the future, a year of college might cost more than $6 million at the 7% rate of increases we’ve seen recently.)

So Jolene finishes college, and she continues to receive the RMD payments from the wonderful gift from great-grandpa Joe throughout her life. She lives a long, full life, with a loving family and great success. At age 82, according to the original Table I factor, she has depleted the inherited Roth IRA. The total of all of the RMD distributions she received over those 80 years amounts to $33,069,557. Not too shabby for Joe’s $5,000-a-year commitment over 20 years.

Note: other than acknowledging the factors, income taxes, inflation, and other factors have not been calculated into this example. The example is only intended to illustrate the value of long-term investing, compounding of interest, and tax-deferral benefits of Roth IRAs, plus the stretch provisions. This example is not intended to represent real life situations, although it is certainly feasible. Bear in mind that this entire example’s activity takes place over the span of approximately 155 years.

Pension Payout: Annuitize or Rollover (Cash)?

cash by Franco FoliniIf you happen to be in one of those jobs (there can only be a handful left at this point, right?) that has a traditional pension plan, you may be faced with an important decision. When you’re ready to retire (did I just hear angels singing?) – you have to decide if you’ll take annuitized payments, or if you cash out the plan and roll it over to an IRA.

These “traditional” pension plans are referred to as defined benefit (or DB) plans – meaning that your benefit is defined as a determined amount. This benefit is usually based on a combination of your longevity in the job, plus your ending salary. You’re probably familiar with these computations: an example is a pension that is 2% per year of employment, multiplied by the average of your final five years of salary. So if you worked at a job for 25 years and your final five years’ salary average was $80,000, your annuity would equal $40,000 – which is $80,000 times 2% times 25 years. Often the calculations are more complicated, but that’s the gist of how they work.

In addition, your plan may also offer a cost of living adjustment, or COLA. With a COLA, each year the amount of your annuity payment is increased according to an inflation index such as the CPI, or a fixed rate such as 3%.

There are often other options to choose, such as the pension payout period. It might be for your lifetime (a “life annuity”), for you and your spouse’s lifetimes (a “joint and survivor annuity”), or over a set period of time, like 10 or 20 years (a “period certain annuity”). Quite often, unless there is a survivor option (such as a joint and survivor annuity) or a set period of time (like the period certain annuity), upon your death there will be no residual benefit from the plan. It is because of this that many folks look with favor upon the final option:  the cash-out and rollover.

Cash Out and Rollover

Most often these DB plans also offer an option to receive a cash value settlement for the plan. The amount of the settlement is a discounted value of the future cash flows (the pension payments) that you could expect to receive. For example, the pension mentioned above (the $40,000 per year payment, with no COLA) for a 62 year old retiree might have a cash-out value of $400,000. This may seem like a pretty nice amount of cash. However, this is where some folks act too quickly. (Actuaries, if you’re out there, I just picked some numbers out of the air.  I don’t know if they’re realistic or not. Forgive me!)

I get it – $400,000 in hand seems like it would be worth more than a future promise to pay $40,000 a year. Because, what happens if you die two years into the plan? As mentioned before, unless you have a survivor element in the pension plan, there will be nothing left for your heirs. There’s a lot more to consider than just the amount of the payout and your lifespan.

Things to Consider

It’s important to look at the provisions of the plan and all of the available options in order to determine what’s the best route to take. Each of the various payout options (life annuity, joint and survivor, period certain, etc.) needs to be examined to understand how the cash-out payment is calculated. (This is where it pays to know and work with a financial advisor.)

As you look at the various pension alternatives, consider them in comparison to one another. Sometimes the company subsidizes the survivor benefit to a degree, making a joint and survivor annuity more beneficial than either the single life or the cash-out option. In addition, sometimes for an early retirement option, the pension itself (over all payout options) is subsidized by the company, or “sweetened” to make retirement more attractive to the potential retiree.

As mentioned before, your health and the health of your spouse (as it impacts your lifespan), plus your other financial resources and lifestyle goals need to be considered as you look at the plan options. You also want to consider the financial strength of the company whose pension you’re considering, as well.


Going back to our example: the cash-out payment of $400,000 should be considered against the other pension payout options. The single-life payout was calculated at $40,000 per year for your life. What if the joint and survivor pension payout option was calculated at $36,000, and your spouse is also age 62? This means that you would instead receive $36,000 over your life and the life of your spouse if you predecease him or her. First of all, which option is a better deal? And secondly, is one or the other better than the lump sum cash payout?

We have to make some assumptions when calculating the values of these options. According to actuarial tables, using a joint and survivor option will statistically result in more years of payments, even if the two lives are the same age. Therefore, when comparing a single life annuity to a joint and survivor annuity, we assume that the joint and survivor annuity will be paid out for a longer period of time.

Using a 5% discount rate, the value of the joint and survivor payout is worth approximately 10.8% more (in present value) than the single life annuity. In other words, if you bypass the joint and survivor option, you’re giving up that potential 10.8% of extra value. Another way to look at it is that you’re giving your company a gift of the extra value by not choosing the J&S option.

Either of the pension options are also better than the cash payout – from a strictly financial standpoint, as long as you live to whatever the projected mortality age is for your plan (I used 82 for the example).  This is because the rate used to discount the present value of your future cash flows was 5%. This means that you’d need to get a return of something more than 5% from your lump-sum cash payout during that time frame in order to break even. Keep in mind that this 5% is a guaranteed rate – as long as you live long enough.

Of course, if your health is poor (or you have a family history of life-shortening health problems), you may benefit by taking the lump sum, for the “bird in the hand” benefit. However, if you happen to live longer than the actuarial tables project, you might be in the unenviable position of outliving your funds.

These are some of the issues you need to consider. This has been a very rough example but it should help you to understand the importance of looking before you leap.

It’s often very attractive to choose the cash-payout option since there are many inherent problems with the defined benefit pension plans. But you shouldn’t make the decision willy-nilly. It pays to examine the numbers closely, and if necessary hire someone to look at the numbers with you. You should know what you’re possibly giving up with each choice versus the alternatives.

Principles of Pollex – Saving 10% of Income

thumb xray by akeg(In case you are confused by the headline: a principle is a rule, and pollex is an obscure term for thumb.  Therefore, we’re talking about Rules of Thumb.)

I like rules of thumb, as a rule of thumb… I think we all generally want difficult issues in our lives to be boiled down to a simple, easy-to-understand statement.  These rules of thumb are everywhere, all around us. Heck, there’s even a whole website dedicated to rules of thumb, where you can find rules on all kinds of subjects, as diverse as how to outrun a crocodile to changing your answers on a test.

Save 10% of Your Income

Let’s start with one of the basics you might hear regularly: Save 10% of your income. Like most all rules of thumb, this one is very general in nature, but it provides a good starting point.

This starting point is best for someone starting the savings process at an early age – perhaps in your twenties or thirties. If you started to save 10% of your income at an early age and kept up the habit over your lifetime, you’d be bound to have a significant sum of money put aside when retirement comes. (You might be interested to note that this particular rule of thumb is one of the base recommendations in the book “The Richest Man in Babylon” which I wrote a summary of some time ago.)

The problem is that many folks don’t start early in life, and by the time they get around to saving in earnest (maybe in their forties), 10% savings will likely be woefully inadequate – 25% to 30% may be more appropriate.

The other, likely bigger problem with the 10% rule is that it doesn’t account for your timeline or the purpose or goal for the savings. The assumption of the rule of thumb is that you have a long timeline, meaning 30 or more years, and that your goal is retirement at some poorly-defined rate of income, such as 80% of pre-retirement income (see below). These two assumptions don’t fit everyone – although they could fit some people in general, your mileage may vary, quite a bit. If your timeline is shorter (say 10 to 15 years or less) or your goal is for a higher retirement income your percentage of savings should be higher, possibly much higher. If your goal is something altogether different, like a downpayment on a home (in a short timeline but of a specific, small-ish amount), 10% would be too much – although you will likely benefit on other goals by saving at least 10% starting at any time.

So, for a starting point, for someone with a relatively long timeline and a vague goal to aim for, 10% isn’t a bad place to start. Start with 10% (or however much you can afford) and adjust upward over time. It’s better than no rule at all, in my opinion.

When it Makes Sense to Take Social Security Early

fries with gravy by tweber1In this blog many times we’ve covered how beneficial it can be to delay receiving Social Security benefits as long as you can. An example of this discussion is in the article Ah, Sweet Procrastination – it makes good financial sense to delay receiving your benefit to age 70 in many cases, but of course not all.

The reason delayed filing can be such a great benefit is that this government-backed income stream is pretty much as good as you can get, in terms of longevity insurance. When you start receiving the benefit, you’ll continue to receive it through your entire life. When you start receiving your benefit impacts the amount that you will receive for your life. Plus, depending upon the amount of your spouse’s benefit, it will impact the amount that your spouse would receive as a Survivor’s Benefit as well.

But there are times when it may make more sense to begin receiving your benefit earlier…

Starting Early

Circumstances require it. If you’re in ill health, have a shortened life expectancy, or have very limited other resources, it may be necessary to start taking your Social Security benefit early. The financial calculations that we do that explain how delaying receipt of benefits is the better choice, always assume that the recipient will live to at least age 80 or beyond and can get along using other resources until filing at age 70. If one or the other (or both) of these circumstances is not the case for you, it likely makes more sense to begin taking your benefit earlier.

Spouse with a relatively small benefit. If the spouse with the lower wage base has earned a relatively small benefit and intends to switch over to a Spousal Benefit as soon as it makes financial sense, it might make more sense to start taking the smaller benefit early, even though it is reduced. In this case the financial impact of starting to take the benefit early doesn’t amount to a significant reduction in real dollars, so taking the benefit for several years is just extra “gravy on your french fries”, in a manner of speaking.

Social Security doesn’t matter to you. If you have more funds than you really need and the Social Security benefit is of very little real benefit to you – or if you consider the Social Security system a “safety net” for needy folks, you might want to start early. Or you may choose to not take the benefit at all.

Psychological impact. If you simply cannot stand the thought of leaving your Social Security benefit in the government’s hands any longer than necessary and you feel it’s to your best interest to start early (even in the face of facts to the contrary), then by all means start taking benefits early. If that’s what it takes to ease your mind, you should do it. Life’s too short to be wrought up over such matters.

Closing Thoughts

As stated before, in many cases it makes the most financial sense for the spouse with the higher earned benefit to delay benefits to age 70, but not in all cases. In order to really get a good handle on how these calculations would work for you, it may help to hire a professional advisor to run through the numbers with you.

Medicaid and Retirement Accounts

Statistics tell us that approximately 25% of us will need some sort of extended long-term nursing care during our lives – and as our life spans increase with improvements in medical care, this number is likely to increase.

Most of us have experienced family or friends needing this type of long-term nursing care. Since Medicare doesn’t provide much in the way of long-term care benefits, the individual is left with three possible sources to pay for long-term care:

  1. private payments from your savings and other sources
  2. long-term care insurance coverage (LTCI)
  3. Medicaid

old man and sheep by Kris HaamerGiven the tremendous costs for long-term care, many individuals are faced with the distinct possibility that any savings that they have amassed over their lifetimes (and that they hoped to pass along to their heirs) could be quickly wiped out or drastically reduced with a stint in a skilled-care facility. Then who will take care of the sheep?


Briefly, Medicaid was originally introduced in 1965 (alongside Medicare) as a “safety net” for healthcare, primarily to help the poverty-stricken. Along in the late ’80’s, it became clear that this safety net could be beneficial to people of modest means as well. So the laws were adjusted to allow for additional beneficiaries of the program through some simple planning. Later during the early ’90’s, the eligibility requirements were tightened up a bit, but with planning, certain beneficiaries can still receive Medicaid benefits.

Eligibility for Medicaid is based upon the assets available to the individual – only about $2,000 is allowed to remain in savings vehicles. Community (joint, owned by both members of a married couple) accounts are subject to special rules, and depending upon how your state chooses to administer the program, half of these jointly-held accounts could be considered eligible assets. Other assets, including primary residences, annuities, and life estates, receive special treatment under Medicaid eligibility rules as well.

Retirement Accounts and Medicaid Eligibility

How are your IRA, 401(k), and other accounts viewed with regard to Medicaid eligibility? As a general rule, retirement accounts are included as available assets. Even if the individual is under age 59½ and otherwise ineligible for distributions without penalty. The retirement accounts must be liquidated before the individual can be eligible for Medicaid coverage.

One way to protect assets from liquidation is if the account is in periodic payment status. This might mean the account is subject to Required Minimum Distribution (RMD) either due to age 70½ requirement or if the IRA is inherited and subject to inherited RMD. In some states, an account in periodic payment status is considered an income source rather than an asset. The circumstances might help to protect the account’s assets from being included in total for Medicaid eligibility.

For example, if an individual was in RMD status due to being over age 70½, his account would be considered in payment status. If the account was worth $200,000, this amount would not be counted against him for Medicaid eligility, but the periodic income stream would be. If he is age 72, his annual required payment from the account would be roughly $7,812, which would be considered for his income budget, approximately $651 per month. If this was his only income, that amount would be paid to the nursing home – with the balance of the cost of the nursing care paid by Medicaid.

If the individual is married and the other spouse is not applying for Medicaid, there are allowances made for monthly minimum maintenance (of the non-Medicaid spouse) as well. In 2019, the maximum monthly maintenance needs allowance is $3,160.50. This is the most in monthly income that a community spouse is allowed to have if her own income is not enough to live on and she must take some or all of the institutionalized spouse’s income. The minimum monthly maintenance needs allowance for the lower 48 states remains $2,057.50 ($2,572.50 for Alaska and $2,366.25 for Hawaii) until July 1, 2019.

Not all states utilize a minimum and maximum income allowance. Some states use just one figure that falls somewhere between the federally set minimum and maximum figures. For example, as of 2019, New York, Texas, and California all use a standard monthly figure of $3,160.50 (the maximum), and Illinois uses a standard monthly figure of $2,739.

What About a Roth IRA?

So, if you’re thinking ahead you’re wondering how this impacts a Roth IRA… since a Roth IRA is not subject to minimum distribution rules. Rightly so – the Roth IRA is never in a payment status as long as the original owner is living. As such, your own Roth IRA assets are counted toward Medicaid eligibility status. These assets would have to be spent down before the individual could become eligible for Medicaid.

Bottom line…

So the bottom line is that you need to consider lots of things as you think about Medicaid eligibility. If you have significant assets available, you could be better off to consider a Long-Term Care Insurance (LTCI) strategy, as otherwise your assets might have to be spent down and quite possibly depleted. Unfortunately there isn’t a “rule of thumb” to use in determining whether LTCI makes sense. Each individual’s situation will be a little different, taking into account medical history, family medical history, asset base, age, etc.. This is the sort of analysis that you need to do as you near retirement age in order to consider whether or not LTCI or Medicaid could be a part of your future healthcare plans.

To Gift or Inherit? Deciding When to Bequeath Assets

After beneficiaries are named and you understand how assets are distributed at death, we need to discuss the tax implications of gifted and inherited assets. The following is a description of the tax implications of non-qualified assets (those not in 401(k)s or IRAs) received by beneficiaries if gifted during lifetime or inherited after death.

Our example will use stocks in a brokerage account as the assets demonstrating the tax implications of assets gifted during lifetime or inherited at death.

Let’s assume that an individual has a brokerage account and they initially purchased $250,000 worth of stock in the account. Several years have gone by and the account as grown to $500,000. For tax purposes the basis in the account is $250,000. The individual is contemplating gifting the account to their beneficiary.

If the individual decides to gift the account during their lifetime to their beneficiary, the beneficiary receives the assets and acquires the same tax basis as the original account owner. This transfer of basis, called carryover basis, means that if the beneficiary then sells any or all the stocks in the account, the beneficiary’s tax basis is $250,000. So, if the beneficiary sold the entire account for its current value of $500,000, the taxable gain would be $250,000 – the difference between the carryover basis of $250,000 and the sales price of $500,000.

On the other hand, if the original account owner decides not to gift the account during their lifetime and instead waits until dying for the beneficiary to inherit the account, the beneficiary receives the assets and a new basis is established. This new basis, called a step-up (or step-to) in basis, means that the beneficiary’s tax basis is the fair market value of the account assets on the account owner’s date of death.

In this example, if the fair market value of the stocks is $500,000 when the account owner dies, the beneficiary’s new tax basis is $500,000. Thus, if the beneficiary sold the account for $500,000, the tax liability to the beneficiary would be zero. Any gains or losses on the inherited $500,000 would be subject to short- or long-term gains and losses, depending on the beneficiary’s holding period after inheriting the assets.

This same tax basis situation would apply to mutual funds, ETFs, real estate, and other non-qualified assets. Of course, the intentions of the individual gifting or leaving the assets after their death is entirely their prerogative – which may supersede regardless of the tax implications to the beneficiary.

How Property Transfers At Death

divorce throws a curve
Photo courtesy of Bec Brown via

When you die, the way in which your property is handled will depend on the type of documents (or lack thereof) you’ve set up before your death. The following is a summary of the ways your property transfers to heirs when you pass away.

Life Insurance. At death, life insurance proceeds are passed to your beneficiaries (and in most cases, tax free). For example, if you have a life insurance policy with a face amount of $500,000, when you die, your beneficiaries receive the $500,000 face amount tax free.

When you purchase life insurance, you name your beneficiary or beneficiaries – those who receive the death benefit when you die. Most married couples will name each other as beneficiaries on their respective polices, some will name charities, and other will name other relatives, individuals, or trusts. Life insurance contracts generally avoid probate (the legal process of validating a will and division of property), unless you name your estate beneficiary (a bad idea) or fail to name a beneficiary (also a bad idea).

Annuities. At death annuities operate the same way as life insurance regarding beneficiaries. A big difference however, is the tax treatment. Even though an annuity may pay a death benefit, in most cases it is taxable to the beneficiary. This is different from life insurance death benefits that are received tax free. Any taxable annuity death benefits are taxed as ordinary income.

Trusts. Trusts can be established either during your lifetime or at your death. They may also be revocable (changeable) or irrevocable (not changeable). Trusts are set up by a grantor (the person wanting the trust) and assets are placed in the trust, managed by a trustee, for the benefit of the trust beneficiary. When you die, the assets in the trust are still managed by the trustee for the benefit of the beneficiary. Like annuities and life insurance, trusts avoid probate.

Brokerage Accounts. When you have a brokerage account where you hold stocks, bonds, mutual funds, or ETFs it’s called a non-qualified brokerage account. The non-qualified means that it’s not a 401(k) or IRA. When you open this type of account, you are given the option to name a beneficiary on the account should you die. At death, the property passes to the beneficiary. The beneficiary also receives special tax treatment on the account. Brokerage accounts also avoid probate.

Retirement plans. When you have retirement plans such as 401(k)s and IRAs you also name beneficiaries who get the account assets when you die. The tax treatment of the assets will depend on the account (Roth or not), and what the beneficiary chooses to do with the assets (sell them all or take minimum distributions). Brokerage accounts avoid probate.

Wills. A will is a written legal document that directs how and to whom your assets are dispersed after your death. Wills also name a guardian(s) for minor children should both parents die. Wills also name an executor for your estate that helps direct where assets go, what assets to sell, and filing the final tax return for the deceased and or the estate.

As mentioned before, probate is the process of validating a will. Thus, it’s a public process, and often long and expensive. Additionally, the documents mentioned above supersede the language in a will. In other words, if your will states that your kids get your IRA assets at your death, but your IRA beneficiary is another person or entity, the IRA overrides the language in the will.

Dying without a will means dying intestate. Dying intestate means that the state determines how your assets are divided, who gets them, and if you have minor children, who becomes their guardian. Different states have different laws, but be assured, the laws may differ from what your intentions are or who you think should get your assets or be guardians. Don’t risk it. If you don’t have a will, or your beneficiaries named, consider taking care of this today.

An extremely important point not to be overlooked is the need to update your beneficiaries or documents whenever you have a life changing event. Life changes mean births, deaths, divorces, job changes, etc. For example, if you get divorced and remarry, and forget to change your beneficiary from your ex-spouse to your new spouse – and you die – your ex-spouse is still the beneficiary and gets the property. It is paramount to update your accounts, estate documents, insurance policies, and retirement plans to reflect any life changes.

Celebrating 15 years: Financial Planning 101

Original layout of Financial Ducks In a Row

On this date fifteen years ago, April 19, 2004, this blog was officially launched. The article below was the first post ever, and I’ve reposted it here in celebration of the 15 year anniversary of Financial Ducks In A Row.

I have not edited the content below, it’s exactly the same as it was originally posted back in 2004.

A lot has changed over the years, and I continue to enjoy sharing sound financial principles, information and advice through this medium, and I hope to keep it up for a long time into the future.

Nine Essential Tips for a Bright Financial Future

1. See a lawyer and make a Will. If you have a Will make sure it is current and valid in your home state. Make sure that you and your spouse have reviewed each other’s Will – ensuring that both of your wishes will be carried out. Provide for guardianship of minor children, and education and maintenance trusts.
2. Pay off your credit cards. Forty percent of Americans carry an account balance – not good. Create a systematic plan to pay down balances. Don’t fall into the “0% balance transfer game” as it will hurt your FICO score. Credit scores matter not only to credit card companies but to insurance companies as well; you can avoid an unpleasant increase in your insurance rates by managing your credit wisely.
3. Buy term life insurance equal to 6-8 times your annual income. Most consumers don’t need a permanent policy (such as whole life or universal life). Also consider purchasing disability insurance; think of it as “paycheck insurance.” Stay-at-home spouses need life insurance, too! Note: Each family’s needs are different. Some families have a need for other kinds of life insurance, so you should review your situation carefully with an insurance professional or two before making decisions in this area.
4. Build a 3 to 6 month emergency fund. Establish a home equity line of credit before you need it – this can take the place of part of your emergency fund.
5. Don’t count on social security! Fund your IRA each and every year. If you don’t fund it annually, you lose the opportunity. Fund a Roth IRA over a traditional IRA if you qualify.
6. If offered, contribute to your 401(k), 403(b) or other employer-sponsored saving plan. Use your company’s flex spending plan to leverage tax advantages. If you don’t use your flex plan or fund your retirement plan annually, you lose the opportunity – and the tax advantages – for that year.
7. Buy a home if you can afford it. Maintain it properly. Build equity in your property. You’ll have much more to show for your money spent than a box full of rental receipts!
8. Use broad market stock index funds and direct purchase government bonds to reduce risk, minimize costs and diversify your portfolio. If you have limited options, for example in your 401(k) plan, make sure that you diversify across a broad spectrum of options. Don’t over-weight in any one security, especially your employer’s stock – remember ENRON?

If you are unsure about your financial affairs or you have financial goals such as retirement planning, college funding, business succession or estate planning that you’d like help achieving, call Blankenship Financial Planning at 217/488-6473 to schedule a no-cost, no-obligation “Get Acquainted” meeting to discuss your situation.

Your Social Security Benefits Statement

statementBack in the olden days, you used to receive an annual statement from the Social Security Administration detailing your benefits projected to your potential retirement age(s). Nowadays you can go online ( and request a current statement at any time. If you haven’t gone online for your statement, you should receive a mailed copy of the statement every five years.

While the statement is designed to be pretty well self-explanatory, I thought it might be beneficial to review the statement so that you know what the statement is telling you.

First Page

This page is your basic SSA boilerplate, explaining to you some of the current details of the Social Security system, including the services and tools that they have available to you.

In addition, SSA points out that Social Security benefits should be only a part of the overall retirement resources picture. On average, Social Security will replace about 40% of your annual pre-retirement earnings.

Second Page

Now we’re into the meat of the report. At the top of the page is the detail of your Estimated Benefits. These estimates assume that your current earnings rates continue until the projected ages.  First are your Retirement Benefits – at Full Retirement Age (your FRA will be listed), at age 70, and at your early retirement age of 62 (if you’re not over this age already). These figures are helpful when planning retirement income, assuming that you expect to continue earning at your current income level until the projected age(s). You also must assume that the Social Security system will continue to pay out at the current rates to folks at your particular level of income in the future (but that’s a discussion for another time).

Next comes the section on Disability Benefits for you.  This shows the amount of Social Security Disability Benefit that you are currently eligible to receive. (If you’re looking for a rough estimate of your current Primary Insurance Amount or PIA, this figure is a good estimate to use.)

The next section is for Family and Survivor’s Benefits – indicating the amount of benefit that your Child, your Surviving Spouse caring for your child under age 16 or who has reached Full Retirement Age would receive upon your death. In addition, your Family Maximum Benefit will be listed here as well.

Lastly in this top section, the statement provides you with information about whether you have earned enough credits to qualify for Medicare at age 65, followed by your birthdate and the income estimate that Social Security is basing their projected estimates of your benefit upon.

The bottom portion of the second page details how the benefits are estimated. The explanation includes information which may change your benefit amounts (versus the projections), such as changes in earnings levels, receipt of Railroad Retirement benefits, and potential changes to the laws governing benefit amounts. Also included here is information about the WEP and GPO calculations, where they might apply to potentially reduce benefits.

Third Page

The Third Page of the statement lists out the details of your Earnings Record at the top. This section is important to review carefully… you should review the earnings listed for each year against your tax records or W2 statements, to make sure that the information the SSA has is correct. In addition to reviewing for correctness, you should look over your record and note the “zero” earnings years, as well as years that you earned considerably less than what you earned (or are earning) in later years.

As we’ve discussed in the past, your benefits are based upon your 35 highest earning years. If you have had some “zero” years in the past or some very low earnings years, you can expect for your estimated benefit to reflect any increases that the current year’s income represents over your earlier low earnings or zero years. This only becomes significant once you have a full 35 year record in the system.

Another key here is that your projected benefits listed on page 2 are based upon your earnings remaining the same until your projected retirement age(s). If you choose, for example, to retire at age 55 and have no earnings subject to Social Security withholding, your projected benefit will be reduced since those years projected at your current earning level will actually be “zero” years or much lower if you have a lower salaried job during that period. This reduction is in addition to any actuarial reductions that you would experience if you choose to take retirement benefits before FRA.

In addition, if you have gaps showing in your earnings history, you may have had a job that was not covered by Social Security, so you will be interested in knowing how the Windfall Elimination Provision (WEP) affects you, and how the Government Pension Offset (GPO) may affect your family or benefits that you may be eligible from your spouse.

The middle portion of the Third Page shows how much you have paid in to the system over the years – both the Social Security system and Medicare system. This can be an eye-opener… quite often we don’t realize how the money we’ve paid in can stack up!

Lastly on the Third Page, there are details on how to report any inaccuracies that you might find on your statement. It’s much easier to resolve things earlier in the process rather than later – when you’re possibly under the gun about applying for your benefits.

The Back Page

The Back Page of the statement is full of additional information about the Social Security system, benefit calculations, and other fun facts about your benefits. There is also a lot of information about how to find more information about your benefits as well.

Roth IRA Eligibility

JDRothThe Roth IRA is a very valuable retirement savings vehicle. There are several reasons that the Roth IRA is so valuable, including:

  • qualified withdrawals are tax free
  • withdrawal of regular contributions is available at any time for any reason
  • there is never a Required Minimum Distribution for the original account owner
  • beneficiaries can receive distributions from the account tax-free

With all of these benefits, you can see why the Roth IRA has become a very popular option for retirement savings, as well as for estate planning. So the question now becomes: Am I eligible to contribute to a Roth IRA?

Roth IRA Eligibility

The eligibility requirements for a Roth IRA are as follows:

  1. You must have earned income. This means you receive compensation in the form of wages, salaries, tips, professional fees, bonuses, commissions, self-employment income, nontaxable combat pay, and taxable alimony or maintenance. If you are married and you had no earned income (or your earned income is less than the maximum Roth IRA contribution amount), your Roth IRA contribution may be based on your spouse’s earned income.
  2. Your Modified Adjusted Gross Income (MAGI) must be less than:
    1. $193,000 (for 2019) if your filing status is Married Filing Jointly or Qualifying Widow(er); or
    2. 122,000 (for 2019) if your filing status is Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year); or
    3. $10,000 if your filing status is Married Filing Separately and you lived with your spouse at any time during the year.

And that’s it. You are not limited by participation in an employer-sponsored plan as you are with deductibility of a traditional IRA. There are a few limiting factors, though:

  1. You cannot contribute more than your earned income.
  2. A spousal contribution is allowed, as long as the total of contributions to personal and spousal IRAs doesn’t exceed the total of your own and your spouse’s earned income.
  3. You are limited by an annual amount (for 2019 it’s $6,000 plus an over age 50 “catch up” of $1,000). Your total IRA contributions (traditional and Roth added together) cannot exceed that annual limit.
  4. When your MAGI reaches a certain amount, your contribution amount will begin to be limited.  You can visit this page for more details on the MAGI limits and how they are applied.

Calculating the Spousal Benefit

Difference_engine_ScheutzThe Spousal Benefit is one of the most confusing aspects of the Social Security retirement benefit system. It may be vaguely familiar that the spouse with the lower wage base is eligible for 50% of the higher wage base spouse’s benefit, or something like that…

How is the Spousal Benefit actually calculated?

Calculating the Spousal Benefit

Here’s how the Spousal Benefit is calculated:

First of all, the Spousal Benefit is based upon a differential – between 50% of the other spouse’s Primary Insurance Amount (PIA) and his or her own PIA.

So what’s the calculation? Let’s look at an example:

Let’s say there’s a couple, both the same age with a Full Retirement Age (FRA) of 66, and the wife has a substantially lower wage base (and therefore a lower benefit) than the husband. At age 62, she files for the her own reduced benefit based on her own record, from a PIA of $800. Her benefit is reduced to $600 due to filing early.

The husband’s PIA is $2,000 per month.

Later on, when they reach age 66, the husband files for his Social Security benefits. The wife is now eligible for a Spousal Benefit, because one of the enabling factors for a Spousal Benefit is that the other spouse has filed for his or her own Social Security benefit. The Spousal Benefit is based on the differential between 50% of the husband’s PIA ($2,000 X 50% = $1,000) and her PIA ($800). The PIA is used to calculate this differential, not her benefit, even though her benefit is reduced since she filed early. The differential between those two factors is $200 ($1,000 minus $800). The differential is then added to her reduced benefit for a total benefit of $800 (reduced benefit of $600 plus the differential of $200). For simplicity, COLAs have not been included in this example.

Let’s adjust the example:  Same couple, only now the wife waits until her FRA to begin drawing her own benefit, which is the same time as the husband. Now her Spousal Benefit differential will still be $200 (the differential between 50% of his PIA and her PIA), so her total benefit will now be $1,000 (her unreduced PIA of $800 plus $200 differential).

Now, what if the wife is younger? As long as she’s at least age 62, she can begin receiving the Spousal Benefit once her husband applies for benefits. It’s important to know though, that if she decides to file for the Spousal Benefit prior to her FRA, the Spousal Benefit factor is correspondingly reduced (as would be her own benefit if she filed early).

Instead of 50% of her husband’s PIA, at her age 62 the Spousal Benefit factor would be reduced to 35% of her husband’s PIA, and then the differential calculated as explained before. At age 63 the Spousal Benefit factor would be 37.5%; at age 64, 41.7%; and at age 65 it would be 45.8%. This reduction is calculated as 25/36ths of one percent for each month before her FRA up to 36 months, plus 5/12ths of one percent for each month more than 36 before FRA. The reduction factor is then taken against the original 50% factor to determine the actual percentage of the husband’s PIA to be used in calculating the Spousal Benefit differential.

In this manner, the reduction is 25% for the closest 36 months to FRA, and then an additional 5% for each year more than 3 before FRA that the filing for Spousal Benefits is completed. If you file for Spousal Benefits exactly 4 years before your FRA, the Spousal Benefit factor is reduced by 30%, as an example. So instead of 50%, the most your Spousal benefit could be is 35% (which is a reduction of 30% applied to the original 50%).

In all cases except for someone born before 1954*, filing for a Spousal Benefit deems filing for your own benefit. Also, whenever eligible for a Spousal Benefit, if you file for your own benefit deemed filing requires that you have also filed for the Spousal benefit. This can result in unexpected reductions to both types of benefit if you weren’t prepared for this.

*If born before 1954 and you’re over FRA, it is possible to file solely for Spousal Benefit while delaying your own benefit to a later date. If you file for a Spousal benefit before reaching FRA, deemed filing applies to you no matter what your date of birth is.

Keep in mind that the examples above denoted the wife as the spouse receiving the Spousal Benefit – but the roles could be reversed, depending upon the circumstances.

I hope this clears things up a bit. It’s a very confusing component to understand, but this should have helped to clear things up – let me know if you have any questions, as always!

Let It All Go – IRS gives you 11 years…

octocostume by SappymoosetreeWhen you were a kid, did you ever dream of being able to just let it all go – not having to follow any rules, no penalties, no restrictions? What if I told you that the IRS provides you with just such an environment – where you are free to literally do (or not do) almost anything you want with your IRA? Including buying yourself that octopus costume you always wanted?

So just where is this nirvana? Where you can just go willy-nilly and do whatever suits you with your IRA? It’s not a where, but rather, when.

Between the ages of 59½ and 70½ there are no rules or restrictions regarding withdrawals from your IRA – including no required withdrawals. How ’bout them apples?? That’s a full 132 months where you can take money out of your IRA at any time, for any reason, and there are no consequences! Well, the one consequence is that you have to pay ordinary income tax on the tax-deferred withdrawals. You’re also free to not take money out of your account, if you wish – a privilege that you might yearn for after you reach the end of this free-for-all time.

And it gets better if you have a 401(k) – you have from age 55 to age 70½ with no restrictions, the only additional requirement being that you have separated from service (left your employer) on or after age 55. And many employers are stepping up and helping folks out with that lately – hardly a day goes by without hearing of someone “separating from service”.

So – when everything seems to be going against you, you can sit back and think about how the IRS has given you this wonderful span of time… eleven full years… with no restrictions.

Taxation of Social Security Benefits

taxation of social security You’d think that, after working all your life and now that you’re in a position to retire and start taking Social Security retirement benefits, that you could get a break and not have to pay income tax. But alas, Social Security retirement benefits may be taxable to you, depending upon your income level. And in truly typical bureaucratic style, it’s not a simple question to determine 1) IF your benefit is taxable; or 2) what rate or amount of your benefit is taxable; or even 3) what income is counted to determine if your benefit is taxable.

Determining Provisional Income

In order to figger out if your Social Security benefit is to be taxed at all, we first have to calculate a relatively unknown sum known as Provisional Income (PI). What this boils down to is your Adjusted Gross Income plus any tax-exempt income, plus any excluded foreign income, plus 50% of your gross Social Security benefit. If you’re interested in just which lines on the 1040 return these are, here’s a list:

  • Form 1040 Line 1, 2a, 2b, 3a, 3b, and 4b, plus Schedule 1, Line 22, plus 50% of your Social Security benefit – these income lines are all added together.
  • Subtract the deductions (Schedule 1, Line 36) from the income items – if this number is zero or less, you don’t have to calculate any more. Your Social Security benefit is not taxable.
  • IF, on the other hand, you come up with a positive number after this calculation, this number is your Provisional Income.

Once you’ve determined the Provisional Income, you’re ready to look at the “Base Amount”.

Comparing to Base Amount

So you have your Provisional Income calculated, now you need to compare that number to the Base Amount for your filing status. So, if your filing status is Married Filing Jointly, your Base Amount is $32,000. If your filing status is Single, Head of Household, Qualifying Widow(er) or Married Filing Separately and you lived apart from your spouse for the entire calendar year, your Base Amount is $25,000. (Note: if your filing status is Married Filing Separately and you lived with your spouse at any time during the calendar year, see the special section at the bottom of this article for information about your benefit’s taxability.)

Okay – so now that you know your Base Amount, you compare that number to the Provisional Income number that you came up with previously. If your Provisional Income is less than your Base Amount – you can stop, because none of your Social Security benefit is taxable.

However (and there’s always a “however” in life, right?) if your Provisional Income is greater than the Base Amount – hang in there, you have some more figgering to do. And guess what?  There’s more complexity involved! Yippee!

Incremental Amount

If you’ve determined that your Provisional Income is greater than your Base Amount. This indicates that some of your Social Security benefit is going to be taxed. This next calculation determines just how much of the benefit will be taxed. If your Base Amount is $32,000 (your filing status is Married Filing Jointly) then you have an Incremental Amount of $12,000. If your Base Amount is $25,000, then your Incremental Amount is $9,000.

When you subtract the Base Amount from your Provisional Income – is the figure you’ve come up with more or less than your Incremental Amount? If less, then 50% of the Provisional Income minus the Base Amount will be taxable, and you’re finished with calculations. (Don’t worry, we’ll work through a couple of examples to try to clear this up.) If the amount that you came up with was greater than your Incremental Amount, then at least 85% of the amount above the Incremental Amount plus the Base Amount will be taxed – but more calculations are required.

Final Calculation

If the amount of Provisional Income is in excess of your Base Amount plus the Incremental amount, which is your Excess Provisional Income, there is another calculation to complete. Take 50% of your Incremental Amount, and compare it to 50% of your overall Social Security benefit. Whichever number is smaller, add that number to 85% of your Excess Provisional Income. Then lastly, multiply your total Social Security benefit by 85%, and compare this number to the one you just came up with – whichever is smaller is the amount of Social Security benefits that is taxable.

Confusing enough? Let’s walk through a couple of examples to clarify.

Example 1 – Married Filing Jointly

1) AGI Excluding SS Benefits $30,000
2) + Tax exempt interest $1,000
3) = Modified AGI $31,000
4) + 50% of SS Benefits $10,000
5) = Provisional Income (PI) $41,000
6) – Base Amount (BA) $32,000
7) = Excess PI over BA $9,000
8) – Incremental BA $12,000
9) = Excess PI (if <0, enter zero) $0
10) Smaller of line 7 or line 8 $9,000
11) 50% of line 10 $4,500
12) smaller of line 4 or line 11 $4,500
13) 85% of line 9 $0
14) Add lines 12 and 13 $4,500
15) SS Benefits times 85% $17,000
16) Smaller of line 14 or 15 is your taxable benefit $4,500

Example 2 – Married Filing Jointly

1) AGI Excluding SS Benefits $50,000
2) + Tax exempt interest $2,000
3) = Modified AGI $52,000
4) + 50% of SS Benefits $10,000
5) = Provisional Income (PI) $62,000
6) – Base Amount (BA) $32,000
7) = Excess PI over BA $30,000
8) – Incremental BA $12,000
9) = Excess PI (if <0, enter zero) $18,000
10) Smaller of line 7 or line 8 $12,000
11) 50% of line 10 $6,000
12) smaller of line 4 or line 11 $6,000
13) 85% of line 9 $15,300
14) Add lines 12 and 13 $21,300
15) SS Benefits times 85% $17,000
16) Smaller of line 14 or 15 is your taxable benefit $17,000

Hopefully these two examples will clear things up a bit. If you are in one of the Single filing statuses, substitute your BA ($25,000) and Incremental BA ($9,000) where applicable.

Married Filing Separately, Having Lived With Your Spouse

If you have filing status of Married Filing Separately and you lived with your spouse at any time during the year, 85% of your Social Security benefit is always taxable. This is the maximum amount that can be taxed using the calculations illustrated above.

Credits and Deductions

Let’s talk a little bit about tax credits and tax deductions. Both can be used to help reduce or avoid taxation but behave differently when it comes to doing so.

Tax deductions are beneficial because help lower the amount of your income subject to taxation. Deductions may be either “above the line” or for AGI, or “below the line” or from AGI. The line in the sand in this scenario is of course, AGI (adjusted gross income).

Above the line deductions are beneficial because they reduce gross income to arrive at AGI. A lower AGI may result in being able to take advantages of other benefits in the Internal Revenue Code (IRC) such as being able to contribute to a Roth IRA and qualifying for additional tax credits (discussed below).

Common above the line deductions include pre-tax 401(k) contributions, student loan interest, deductible contributions to a traditional IRA, HSA contributions, and self-employed business expenses (Schedule C).

Once AGI is reached, below the line deductions can be applied. Below the line deductions lower AGI further, to arrive at taxable income. Below the line deductions are going to come from either itemized deductions (Schedule A) or the standard deduction – a deduction everyone qualifies for and varies in amount based on filing status. You may either itemize or take the standard deduction, but you cannot do both.

If you itemize, you’ll use Schedule A. Common deductions on Schedule A include medical and dental expenses, home mortgage interest, state and local taxes, and charitable contributions. Some deductions on Schedule A (such as medical and dental) are subject to a floor of AGI. An AGI floor means that the expenses may be deducted once they’re higher than the floor. For example, if your AGI is $100,000 and the deduction has a floor of 10%, then any expenses above $10,000 would be deductible.

Once all deductions have been taken, you arrive at your taxable income. It’s here where the applicable tax rates are applied, and your tax is calculated. However, you may still benefit from tax credits.

Tax credits reduce the amount of tax owed on a dollar-for-dollar basis. Whereas deductions reduce taxable income, credits lower the amount of taxed owed. For example, if you owe $2,000 in taxes but have $1,500 worth of credits, then your net taxed owed would be $500. In some instances, your tax credits may eliminate any taxes owed. In fact, you may even qualify for a refund based on your credits exceeding the tax you owe (called refundable or partially refundable credits).

Naturally, the specific credit(s) you may qualify for depends on your situation. For example, parents can take advantage of the child tax credit, American opportunity tax credit, child and dependent care credit, and the earned income tax credit. Other credits you may be eligible for are the lifetime learning credit, saver’s credit, adoption credit, and residential energy credit.

To see what credits and deductions make the most sense for your situation, talk to a tax professional such as a CPA that specializes in taxes, an EA, or tax attorney. You don’t want to leave money on the table or pay more tax than required.

IRD from an IRA



The topic of Income in Respect of a Decedent (IRD) can be a particularly confusing aspect of the tax code – but it doesn’t need to be. Put simply, IRD is any income that a decedent (the person who died) would have received had death not occurred – that has NOT been included as income on the individual’s final tax return. In essence, this rule provides that certain items in the estate, specifically income items, do not receive a step-up in basis. This income has to be accounted for on one of three tax returns:

  • estate
  • beneficiary’s income tax return (whoever received the income)
  • other assignee of right to the income besides a beneficiary

If you are the beneficiary of an IRA and are required to include some IRD on your tax return, you may be eligible for a special IRD deduction. This deduction is limited to any estate tax that was paid on the income received in respect of the decedent. This would have to be a significantly-sized estate, since the applicable exclusion amount for 2019 is $11.4MM.

It is important to note that the IRD deduction is only available for federal estate tax – your state estate tax may or may not be deductible, you’ll need to check that with your state authorities.

IRD from an IRA

From an IRA, IRD includes any income that you receive that was included in the gross estate. Any growth that occurs after the date of death of the original owner becomes income to the beneficiary, and therefore is not IRD. Any estate tax that can be attributed to that IRD is deductible as a miscellaneous deduction on Schedule A of Form 1040 – this deduction is NOT one of the miscellaneous deductions that was eliminated with TCJA 2017. If the IRA had basis – that is, if the IRA included non-deductible contributions – then those contributions are not taxed to the beneficiary as IRD. Income tax has already been assessed on these amounts prior to contribution.

Roth IRA Nuances

For a Roth IRA, the IRD only includes income received via non-qualified distributions, and then only the portion that represents growth in the account. The main way that you could get caught by this one is if the IRA has not been established for the required five-year period prior to the death of the original owner. Any income (growth) in the account up to the date of death is IRD, the contributions are tax-free, and any growth after the date of death is income to the beneficiary (and not IRD).

IRD Deduction

To calculate the IRD deduction, you need to know the amount of the taxable estate, the amount of tax paid on the estate, and the value of the IRD item(s) in the estate. As an example, we’ll say we have an estate valued at $15MM, and an IRA worth $1MM. On the entire estate, we paid tax of $1,440,000 (40%).

Next, we calculate the estate tax on the value of the taxable estate without the value of the IRA – and we come up with $1,040,000. So the estate tax attributable to IRD is $400,000, or 40% of the IRA value. So, as distributions are made from the IRA, you can claim a deduction of 40% of each distribution until the entire $400,000 attributed estate tax is used up. This deduction offsets (in theory) the fact that you must include the distribution as ordinary taxable income.

Once again, this is not an activity for the faint of heart. I suggest working closely with your tax pro to make sure that you’re calculating things correctly – it can amount to some sizeable tax issues if you’ve fouled it up somehow.

How to Check the Status of Your Tax Refund

tax refundSo – you’ve gone through the effort of filing your tax return, or maybe you went to a tax preparer and your return has been filed.  You see that you’re going to be getting a sizeable refund this year – in spite of your careful planning – and you’re anxious to get your hands on it! How can you check on it to see what’s going on with it??

Go Online (where else?)

First of all, you can go to the IRS’ website at and access the interactive tool called Where’s My Refund (also available in Spanish as ¿Dónde Está Mi Reembolso?), which will give you quick, accurate information about your refund. From the front page click on “Refund Status” to get to the tool.

After you’ve eFiled (or had the return eFiled for you) you can get information about the refund 72 hours after the IRS acknowledges receipt of your return. If you file a paper return, the refund information will not be available online for three to four weeks after you’ve mailed the return.

In order to check on the status of your refund, you’ll need to have a few items with you (so don’t try this on the train):

  • Your Social Security number or ITIN
  • Your filing status (Single, Married Filing Jointly, Married Filing Separately, Head of Household, or Qualifying Widow(er))
  • The EXACT whole dollar refund amount shown on your return

Once you’ve plugged all that into the system, you might get several responses. For example, the system may simply tell you that your return has been received and is being processed. Or, you could receive the mailing date or direct deposit date of your refund. Or, if you’re really unlucky (or maybe you have enemies in the Post Office), you may find that the IRS could not deliver your refund due to an incorrect address. In that case, you may be able to correct or change your address online.

If there happens to be an issue with your particular situation, the online system may give you some options to work with to resolve those situations. An example would be if you have not received your refund within 28 days from the original mailing date (per IRS records), you can initiate a refund trace using the system.

If you don’t happen to have internet access, you can always call the IRS refund hotline at 800-829-1954. You’ll have to have the same information listed above (Social Security number, filing status, and exact whole dollar refund amount) to use the phone system as well.

A little insiders’ tip:  refund checks are normally mailed on Fridays. If you check the status of your refund and don’t find a mailing date, it won’t do any good to check again until after the following Friday.

Missing a W2? Here’s What to Do…

missing a w2So – you’re all set to do your taxes.  And then… you realize you’re missing something.  One of your W2’s hasn’t shown up in the mail.  Maybe it was a short-term or a part-time gig, or maybe the business changed hands – or maybe it just got lost in the mail.

Whatever the reason, you’re missing one of the documents that you need in order to prepare your tax return.  So what do you do?

What Do You Do?

Your employer is required to send your W2 earnings statement to you by February 1 for the prior year’s earnings. But sometimes things go awry, and you don’t receive the form. There are four steps to follow to retrieve the required information…

  1. Contact your employer – inquire if and when the W2 forms were mailed out.  It’s possible that the postal service returned it to your employer due to an incorrect or incomplete address.  Even if it hasn’t been returned, your employer should be able to produce a new copy of the form and send it out to you.
  2. Contact the IRS – the IRS receives a copy of all W2 forms filed.  Wait until after February 16, and then you can call the taxpayer assistance line at 800-829-1040.  Make sure you have as much information about the earnings as possible – including your employer’s name and address, your dates of employment, and an estimate of your earnings (you can get this from your end-of-year pay stub).  The IRS should be able to produce the appropriate information for you or direct you to the steps you need to take.
  3. File your return – on time if you can, or with a timely filed extension request, even if you have not received the W2.  If you have taken the first two steps and still have not received the form by April 15, use Form 4852, “Substitute for Form W2, Wage and Tax Statement”.  Attach Form 4852 to your return, using your last pay stub to estimate your earnings and withholding taxes.  Keep in mind that using Form 4852 may delay any refund due to additional processing required.
  4. File an amended return – if you happen to receive your W2 after you’ve filed using Form 4852 and the W2 includes different information than you used to prepare your return.  Use Form 1040X to file this amended return, within 3 years of the original return deadline.

You can find the forms mentioned above on the IRS website.

Why track expenses?

One of the primary things that we suggest to clients is to track expenses. In some cases, this means noting down each expense as you make it, daily, so that even the incidental cash outlays are tracked.

Another way to do this is to use an automated method, one of the many apps available, to monitor your expenses through your credit card and bank accounts.

Either way, when you track expenses there are a couple of outcomes that can have a positive influence on your financial life.

The first is that you become more aware of each outlay of money, whether in cash or from a credit card. Since you track expenses they don’t just pass by, they have a record that you can see and refer to. That coffee you bought on a whim has a life now, and you can see the impact that the purchase had on your life.

The second positive outcome is that once you track expenses and summarize them, you begin to see a picture of your priorities. Whatever you’re spending money on is a priority, and the more you spend, the higher the priority.

These are also reasons why the concept of bullet-journaling is so popular and effective. If you track your every activity on a day-to-day basis, you have a record of all the things you spend your time on. And, as when you track expenses, you can review the history of your time spent – showing your priorities in terms of time. Whatever you spend your time on is a priority, and the more time you spend, the higher the priority.

Knowing where your priorities are historically gives you a chance to address these priorities for the future.

And since you’re taking note of your spending (in time or money) regularly, you can make decisions about how that spending is done. In some cases the decision can be made in the moment – deciding not to spend your precious time or money on that particular item – or making long-term decisions about spending time or money.

For example, you might make the conscious choice to no longer spend time with repetitive tasks by automating or outsourcing. And when you track expenses, you might make decisions about trimming back or eliminating frivolous incidentals, like lottery tickets.

The point is, whether you track expenses or track your time, summarizing this historical record gives you the opportunity to make decisions about how you spend those precious resources in the future. You can control your priorities only if you pay attention to what they actually are.

Taxation of Income, Capital Gains, and Interest

When you receive income, it’s likely going to be subject to taxation. However, the type of income will determine the specific tax treatment, and ultimately determine how much you get to keep.

We can break income down into three basic types: ordinary income, capital gains income, and interest income. Here’s a breakdown of each.

  • Ordinary Income – Ordinary income (OI) is income received that is subject to ordinary income tax rates. These tax rates are the rates individuals pay on incremental amounts of income. Rates can be as low as 10% and as high as 37%. Income typically subject to OI rates is income from your wages (W2, self-employment), taxable bond interest, taxable retirement income, and annuity income.
  • Capital Gains Income – Capital gains income occurs from the sale of assets such as stocks, bonds, mutual funds, ETFs, real estate*, and other assets. Depending on how long the assets were held determines if capital gains are taxed at OI rates or more favorable long-term rates. Assets held for one year or less and then sold, have any gain subject to OI rates. Asset held longer than one year and then sold have gains taxed at long term capital gains (LTCG) rates – which are either 0%, 15%, or 20% – depending on your total income. The higher your total income, the higher the LTCG rate you’ll pay. Qualified dividends from stocks are generally taxed at the favorable LTCG rates.
  • Interest Income – Interest income is income from assets that generate interest such as bonds, savings accounts, CDs, treasuries (savings bonds, T-bills, etc.), and money market accounts. In most cases this income is taxed at OI rates. One exception is interest from municipal bonds issued by city or state governments. Interest on these bonds is not taxable at the federal level and may avoid state and local taxation as well.

Knowing how specific income is taxed can help with the process of where to hold specific assets and in which accounts – called asset location (discussed later). This can improve your tax efficiency. Additionally, capital losses (selling an asset for less than you paid for it) may be used to offset other income, also improving tax efficiency.

These are the basics of income. Naturally, there are going to be exceptions and complexities that may apply to you. To avoid costly mistakes, you may benefit from the advice of a tax professional -usually a CPA who specializes in tax, an Enrolled Agent (EA – enrolled to represent taxpayers before the IRS), or a tax attorney. *Gains on the sale of your primary residence may not be taxed up to $250,000 for single and up to $500,000 for married tax filers. Specific rules app

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