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Sometimes the Obvious Choice Isn’t Optimal

Situations arise where it seems like the law was written in our favor. Tax laws change, retirement accounts have their tax advantages, and the best intentions get us excited to take action.

However, it may not always make the most sense to do what seems to be the best or most obvious thing. There are times we can stop, think, and see if the most obvious choice is the best decision for our situation.

For example, the tax law allows an individual with company stock in their 401(k) to take advantage of Net Unrealized Appreciation in their retirement account. To understand what NUA is, please see our previous articles and posts.

In a nutshell, by keeping employer stock in the account until retirement and taking advantage of NUA, the tax law allows significant tax savings on the appreciation of the stock in a 401(k). However, just because it makes the most sense from a tax percentage, it may not be the ideal decision.

Although there may be a big tax savings, there could be a huge tax bill when trying to take advantage of this option. A five or six-figure tax bill or higher, may not be the most ideal choice for a retiring individual. The tax rate as a percentage may be lower because of capital gains, but the overall tax paid as a dollar amount may be higher then simply taking distributions and paying ordinary income tax.

Another example is a Roth 401(k). This allows after-tax money to be saved to the account, and qualified distributions to be withdrawn tax-free in retirement. However, in most cases the tax-free benefit doesn’t come into play until a person reaches age 59.5.

It looks like a great option, but for someone wanting to retire earlier than age 59.5, having most of their retirement income in a Roth 401(k) may not make sense. It may be wiser to save in a non-qualified account, where money can be accessed before age 59.5, without penalty.

Finally, it may be tempting to save a lot for college. People may want to save so much that they ignore their own retirement savings. They’re getting the benefit of saving for college which is great but may fall short of their retirement income needs since much of their money was going to pay for college. Again, it seems like a good idea at first, but the long-term consequences of lost retirement savings may be catastrophic.

The point is not that the above strategies are poor choices. They can be very good financial decisions; but they need to be weighed with the other potential options available, potential consequences, and impact on other financial and wealth management goals.

Adjusting Your Withholding and Estimated Tax Payments

Now is a good time to look at the amount of tax that you have withheld from your pay, pension or Social Security, as well as any estimated payments that you make throughout the year. The amount of any payment that you had to make on April 15 should be fresh in your mind. If it was a sizable amount you should review the situation and quite possibly adjust your withholding or estimated payments.

It’s also possible that you’ve been having more tax withheld than necessary. If you received a rather large refund, you’re essentially giving the government a tax-free loan of your money for a good part of a year. Many folks like to receive a big refund, it’s sort of a “bonus” each year, but you could help yourself out paycheck-by-paycheck if you adjusted withholding. If you still want the “bonus” effect, set up an automatic deposit into a savings account and make it “hands off”. Then in April you can withdraw the money and do whatever you would have done with the refund.

Withholding Water
Image by GStevens via Flickr

For example, if you commonly receive a $2,500 refund, you could adjust your withholding so that you get an extra $100 per month in your take-home pay, and still have a $1,300 refund after filing your taxes. Better yet, adjust your withholding to have an extra $200 in take-home pay and then you’ll still get a $100 refund.

So How Do You Do It?

First of all, you need to estimate how much your total pay is going to be for the year. You can start with your pay stub for the current month – then project out for the remainder of the year how much your total pay will be at the end of the year.  The same would be true for pensions and Social Security payments. Be sure to use the “taxable gross” or perhaps “gross pay” figures for your calculations, not the take-home amount. If you only have a “gross pay” figure, understand that some deductions will come out of your check pre-tax, like a 401(k) contribution, so you’ll want to reduce the “gross pay” figure by those deductions to come up with your taxable income.

Having calculated the total taxable income you’ll receive for the year, make the same sort of calculation to project the amount of income tax you’ll have withheld for the year. Do the same thing for your state income tax withholding (if you’re lucky enough to live in one of the states that imposes an income tax).

Don’t forget to include any planned IRA distributions (including Roth Conversions) as income, along with any tax you plan to withhold from these distributions. Also calculate any capital gains or losses you may be planning during the year, as well as your dividends you’ll receive.

If you have self-employment income, the calculation becomes a bit more difficult. To be conservative, just subtract your expected expenses from your expected income to produce a net income figure to work with.

Next, go to the IRS website and locate Form 1040-ES for the current year. This form will help you to complete the calculations. Follow the instructions on the form, using your prior year’s tax return to help you with things like any credits you will receive. In the instructions for form 1040-ES, you’ll also find the tax rates to apply to your projected taxable income for the year.

You’ll need to make sure that your total withholding and estimated payments tally up to at least 90% of the projected tax you’ll owe, or 100% (110% if your AGI is $150,000 or more) of your prior year’s tax amount (whichever is less). If your withholding is less than the prior year’s tax and more than $1,000 less than the 90% figure for this year’s tax, you could be subject to a penalty for underpayment. Generally this is only applied if you have had a significant underpayment in the previous year (the first year is a “gimme”).

You’ll also want to locate the estimated tax payment calculations for your state tax withholding and run through the numbers there as well.

Okay, I did that. Now what?

If you’re underpaying your tax significantly, now it’s time to figure out how to reconcile the situation. (If you’re overpaying tax and you want to increase your take-home pay or net payments from pensions or Social Security, you can use similar measures.) The tactics you use depend upon the type of pay that you receive:

W2 Pay (regular employee pay): If you are receiving a paycheck from an employer, you can make adjustments to the amount of pay that is being withheld by using Form W4 – available from your Human Resources department. Follow the instructions for the form, making adjustments for your pay as it continues through the remainder of the year so that you have a total withholding that is appropriate for your projected taxable income. A simple way to do this is to request a specific amount to be withheld in addition to your regular withholding. Many employers provide access to a substitute Form W4 online.

Pensions: Much the same as with W2 pay, you make adjustments to your withholding for pension payments using Form W4P, which will be available from your pension administrator. Use the same methods of calculation mentioned above with W2 pay. Many pension providers have an online facility to allow changes to Form W4P withholding.

Social Security: Same as pensions and W2 pay. You will be using Form W4V, available from the Social Security Administration. This is also available online at

IRA or 401(k) Distributions: When you take a distribution from an IRA or 401(k) account, one part of your distribution includes the ability to withhold taxes from the distribution. You can increase the total tax you’ve had withheld for the year by having some of your distribution withheld in taxes. Distributions from 401(k) plans automatically have 20% withheld, although you can increase that amount. You may not decrease it, however. IRAs do not have this mandatory withholding.

When doing a Roth Conversion, you need to keep in mind that any amount that you don’t convert by either having it withheld for taxes or just taking as a regular distribution will not only be taxed but also can be subjected to the early withdrawal 10% penalty if you’re under age 59½.

1099 Pay (such as an independent contractor) or self employment income: In this case you can make estimated payments using the vouchers included with Form 1040-ES. You’ll want to make these payments in a timely fashion – April 15, June 15, September 15 and January 15 – for the amount of net income you’ve received up to the end of the prior month. Don’t forget to run the calculations for your self-employment income and include that in your estimated payments.

You can make estimated payments no matter what sort of income you receive throughout the year, in addition to the Form W4 adjustments mentioned above. Failure to make these payments in a timely manner can also result in interest and penalties for underpayment.


Bear in mind, the quarterly estimated payments are necessary to be made within specific timeframes. Form W4 withholding is also sent to the IRS (by your employer) regularly, in a timely fashion. Withholding from an IRA or 401(k) distribution is the only one that doesn’t have to be spread out over the year. For example, if you found that your tax withholding was going to be too little for the year, you could wait until December and make up the difference using an IRA distribution withholding mentioned above (this is not recommended). See the article IRA Trick – Eliminate Estimated Tax Payments for more details.

Filing after restricted application


You are one of the lucky folks who was born before 1954 and you filed a restricted application for Social Security spousal benefits. This allowed for your own Social Security benefit to be delayed, accruing the delayed retirement credits (DRCs). So now you’re about to turn 70 – what should you do now? Will your own Social Security benefit be automatically applied once you hit 70?

Unfortunately, no. You will need to go through the regular Social Security application process. This is the only way to get your own Social Security benefit to start up for you now that it has maximized.

You should not delay past age 70 in filing this application. There is no further increase to your Social Security benefits after you’ve reached 70, so waiting will only leave money behind that you are due at this point. Generally you should file this application within the 2-3 month period prior to your 70th birthday.

If for some reason you missed filing for your own Social Security retirement benefit at age 70, you should file as soon as possible. If it’s been less than 6 months since your 70th birthday, you can get a retroactive lump sum for the missed months. Unfortunately, if it’s been more than 6 months, you’ll have lost any additional months (beyond 6) that you should have received.

Use POMS to help your case with SSA

Recently a client asked me about a situation with her Social Security benefits. She had spoken with Social Security (SSA) several times and has received erroneous information each time. Below is how we used POMS to help her prove that she had benefits coming to her.

The individual in question is a divorcee (a year ago, after a 40 year marriage) who was born in 1953 (reaching 66 this month). The ex-husband has been collecting Social Security benefits for several years. 

She’s heard about the restricted application for folks born before 1954, and it seems as if this should fit her situation. However, in speaking with SSA about it, she’s been told that she is not eligible for spousal benefits via a restricted application because it has not been 2 years since her divorce (it’s now been about 14 months).

While what SSA told her would be true in some cases, the fact that her ex-husband is already receiving benefits overrides the 2-year waiting period for independent entitlement. This is all well and good to know, but how does she prove this to SSA?

This is where we go to POMS. In case you’re not familiar with POMS, it’s a database of the Social Security Program Operations Manual System. Within POMS are all of the rules and procedures that are used to implement all of the different programs and facets that Social Security administers. You can find it by clicking on this POMS table of contents link.

Specifically for this case, we’re looking at the POMS page indexed as RS 00202.005 Divorced Spouse, Section B. Within section B we find the following information:

B. Policy – Entitlement Requirements

   1. Divorced Spouse

       To be entitled as a divorced spouse, a claimant must:

    1. be the divorced spouse of a NH entitled to a RIB or DIB

(I removed the parenthetical references to clarify)

Following is some more clarifying information about the POMS reference above:

NH – stands for NumberHolder – this is someone who has a Social Security Number assigned to them. In this case, it is referring to the ex-husband as the NH.

RIB or DIB – means Retirement Insurance Benefit or Disability Insurance Benefit. Since the ex-husband has been receiving retirement benefits for several years, he’s “entitled to a RIB”.

Because of this, as long as the individual fits in with the rest of the requirements listed in the Section B, she is eligible for the ex-spouse benefit via a restricted application.

Don’t let Section B.1.e trip you up – the words “entitled to” mean that the individual has filed an application for the RIB or DIB. Since she has not filed for RIB at this point, she is still eligible for the ex-spouse benefit, via restricted application, since she was born before 1954. This is regardless of the amount of her own RIB when compared to the ex-spouse benefit.

To SSA, there is a distinctly different meaning between the words “eligible for” and “entitled to”. “Eligible for” means you meet the requirements for a benefit except for filing an application. “Entitled to” means you’ve filed an application for the benefit.

In Section C you’ll find the definition which includes the 2-year waiting period. However, Section C does not apply in this case since Section B applies to the client.

Use POMS to help your understanding

You can use POMS to help you better understand how SSA’s rules work. But don’t expect to just simply open it up and find your answer. POMS is a large system, encompassing more than 15,400+ pages. I know this, because I am reading through all of the pages, and I’m indexing the pages as I read them (I’ve read through almost 7,000 pages so far). And I learn something new every time I sit down to work on this read-through. On top of this, POMS is an ever-evolving system, with changes being applied nearly every day. (Most of the day-to-day changes are for clarification or to simplify wording or update annual figures, but sometimes actual policy changes are implemented via a POMS update.)

The point is that POMS is the official manual which SSA uses to implement their policies and rules. So if you spend time learning about your unique situation and the rules that apply to it, you can be in a much better position to ensure that the rules will be applied properly to your situation. If SSA disagrees with your expected outcome, you can ask the SSA staff to direct you to the POMS section that applies. That way you can view for yourself how they’re applying the rule. If you’ve found some other reference that seems to contradict, ask the SSA folks about this. These are your benefits after all, you deserve to understand the rules they’re applying to you.

Friends With (Social Security) Benefits

Social Security is arguably one of the most important cash flows for individuals in retirement. Many individuals have paid into the system for years, and in turn will be eligible for reduced benefits as early as age 62, or at their full retirement age (between ages 66 and 67).

The decision on when to start collecting benefits is important and can impact your retirement cash flows for your remaining retirement. This decision should not be taken lightly, and it should not be left to informal conversations with friends, coworkers, etc. In other words, don’t base your decision to take benefits based on what your friends have done. Your situation is different. And in most cases, your decision is final.

There are several strategies that may be employed when collecting benefits. Such strategies include taking benefits early at a reduced amount, delaying benefits for a higher amount, spousal retiree benefits, and even restricted application (rare, but still allowed).

While it’s not bad to discuss Social Security with friends and relatives, the decision on when to collect should not be based solely on when they took theirs, or plan to take theirs. Some reasons include different working periods, salaries, family dynamics, longevity, and other sources of retirement income.

To get a clear understanding of the benefits you may be eligible for, one of the first steps to take is talking with the Social Security Administration. Calling your local office, making an appointment, and discussing your options is wise, and the people at the SSA are equipped to help give you the best information about your options for benefits.

Additionally, it may be wise to discuss your situations and goals with a financial professional with expertise in Social Security (expertise meaning they have in-depth knowledge of Social Security – not just a software package that tells them what to do). He or she will be able to provide insight, advice, and recommendations for your situation. They may ask questions you haven’t thought of in order to give you the best options for your filing strategy.

Social Security benefits are an important part of many retiree’s plans. Don’t base the decision of such an important retirement cash flow on what friends have done. Make the decision based on the best information and advice relative to you.

The Do It Yourself Do Over For Social Security

Do it yourself
Image by iNNoVaNDiS via Flickr

About 10 years ago, the Social Security Administration made a change to their rules that took a powerful option off the books – the payback and Do-Over.

Back in the olden days (prior to December, 2010), there was an option available that allowed a person to file for Social Security retirement benefits at any age, and then later pay back all of the benefits received and re-file at a later age. This action effectively cleaned the slate and allowed starting over at your later age at a higher rate.

When the rule was changed, the payback and re-file now must be completed within 12 months of your filing date. But all is not lost – there is still a way to reset things if you find yourself having filed earlier than you really needed to and you wound up working longer than you thought.

The Do It Yourself Do Over

If you’re still under Full Retirement Age (FRA) and working, you’ve probably heard about how earning more than a certain amount will result in forfeiture of part of your benefits. (More on the specifics on the earnings test here.) The thing about forfeiting some of your Social Security benefit is that – once you reach FRA, you’ll get credit back for the benefits that you forfeited. (This only applies to your own retirement benefit, not spousal or survivor benefits.)

In a way, by earning more than the limits, you’re effectively paying back the amounts that are being forfeited, and at FRA your benefit will be recalculated, which is the Do Over in disguise.

Granted, this isn’t exactly as  powerful as the original Do Over, but it’s a way that you could re-set when you’ve started receiving benefits earlier than you needed and would like to get that credit back and file at a later age, without as much (or with no) reductions in your benefit.

Large IRA Planning Opportunities


According to a report from the GAO, in 2011 (most recent data) there were over 600,000 Americans with IRAs with a balance of $1 million or more. Suffice it to say, that number is bound to be much larger today, nearly 10 years later. In fact, Fidelity recently reported that the number of folks with $1 million or more in a 401(k) plan is nearly 200,000.

With that in mind, if you’re in this group or plan to be in this group, what are the planning opportunities that you have available to you? Naturally this fits into the “good problem to have” environment, because having a significant amount in retirement accounts can help ensure a comfortable retirement.

On the other hand, $1 million isn’t necessarily that much money when you consider that you’ll need to make it stretch out over (possibly) 30+ years in your retirement. For a 70-year-old with a $1 million IRA, the Required Minimum Distribution (RMD) is only approximately $36,500. For many folks, that’s hardly a drop in the bucket for living expenses, if that’s the only money available.

Thankfully there are other sources many folks have available to them – such as Social Security, pensions, and other investments outside of retirement accounts. 

For some folks, such a withdrawal is more than they’ll need. If the IRA money is likely to be more than you need for living expenses (specifically when you reach age 70½), there can be some opportunities early on in the process to help you ease the tax hit. This is especially important right now, during a time of historically-low income tax rates.

For example, if your taxable income needs are met with an income of $80,000 (for a married taxpayer), this puts you in the 12% tax bracket with approximately $23,000 of headroom (income that would continue to be taxed at the 12% rate). Further, you have an additional roughly $89,000 that could be claimed as income before you breached the 22% bracket. So that makes a total of around $112,000 of income that you could claim before hitting the 24% bracket.

For one possible strategy, you could convert a portion of your $1 million-plus IRA over to Roth, taking advantage of these low rates while we have them. This wouldn’t be without a significant tax burden – it would cost approximately $22,305 extra in taxes to convert this amount (about 20%). If you have other sources of funds to pay the tax, you’ll preserve more of the Roth money for later use (tax-free!). But even if you have to use the IRA withdrawal and only convert approximately $90,000 to the Roth, this still makes a lot of sense.

As you convert this money from traditional IRA to Roth IRA, you’re removing that money from the Required Minimum Distribution calculations, thereby reducing the amount that you’ll be required to withdraw when you reach 70½. Gradually you can reduce the size of the traditional IRA and bolster your Roth IRA, forestalling the over-distribution mentioned earlier.

In addition to the benefit of reducing future RMDs, converting to Roth will set your heirs up with a tax-free fund at your passing. Of course, tax-free is far better than fully-taxable, which is how a traditional IRA is treated when inherited. Plus, when you add in the looming legislation of the SECURE Act, your heirs might be forced to take the full amount of your IRA as taxable income over as little as 5 years (or possibly 10 years).

Rather than convert the money from traditional to Roth, you might also consider using the traditional IRA money in place of income that you could produce from non-IRA assets. For example, if you have a taxable investment account that is subject to capital gains taxes, preserving this money can also be very beneficial from an estate planning standpoint. So instead of taking money from your capital gains-taxed fund, take it from the IRA and preserve the capital gains account.

This is because your taxable account, when you die, receives a step up in basis for your heirs. So, for example, if your taxable account is worth $500,000 and $100,000 of it represents capital gains, when your beneficiaries inherit the account the capital gains are wiped out. Your heirs will only have capital gains to the extent of any growth that occurs after your death. This is almost as beneficial as a Roth account, but not quite.

Another strategy you might consider is using the IRA money instead of filing for Social Security early. As detailed in the post Should I Use IRA Funds or Social Security at Age 62?, it can be tax-advantageous to use IRA funds (or another source) and delay taking Social Security until it’s maximized.

In either of the above strategies, since you’ll be withdrawing more fully-taxable money from your IRA you’ll be artificially increasing your income, at least for a few years. Keep in mind the impacts that this might have on any income-based medical insurance expenses – such as if you are eligible for ACA exchange premium reductions.

In general, for a married couple to take advantage of these significantly-lower medical premiums from the ACA exchanges, your taxable income must be less than approximately $67,000. Over that amount, and your medical premiums could increase dramatically. This would be applicable at any age under 65, Medicare eligibility age.

Plus, even if you’re able to get by with an employer-based medical plan and don’t have to worry about the ACA exchange income limitations, once you reach 65 you might be subjected to additional premiums for Medicare if your income is above certain levels. If your MAGI is over $170,000, this would bump up your Medicare premium to $189.60 from the usual $135.50. There’s also an increase of $12.40 a month to your Medicare Part D premium (if you have it) for this income level. This increase is based on your gross income two years previous, so keep this in mind as you plan.

Lastly, if you still have an IRA which is going to cause you a significant amount of extra taxable income when you reach 70½, consider using a Qualified Charitable Distribution (QCD) at that time. The QCD provision allows you to directly distribute funds from your traditional IRA to a qualified charity, and you don’t have to claim this distribution as income on your tax return. This is especially helpful if you are already inclined to make significant contributions to a charity or charities – and whatever money you distribute by QCD is counted toward your RMD for the year.

Stressful Events

adjusting withholdingAt times in our lives, we may be faced with sudden events, occurrences, or outcomes that we never expected to happen. Such events may cause us to react, even overreact out of emotion rather than taking time to think things through. Granted, this is easier said than done.

The death of a loved one can take a huge emotional toll on us. Aside from coping with our loss, there’s the additional stress of taking care of things after the death. Wills, trusts, property transfers, and retirement accounts all need to be handled.

Divorce is also a stressful event. Deciding on property division, living arrangements, parenting time, and legal aspects all take their toll. Feelings of fear, anger, sadness, and resignation can linger for a long time.

Losing a job also adds stress to our lives. Our minds may reel with the sudden loss of income, what we’re going to do next, along with the fear of being unemployed. Retirement plans may suddenly be shattered. Feelings of guilt may arise when a provider feels they’ve let their family down.

Throughout all these events, it is ok to slow things down, and even do nothing – for a period of time. It may also help to talk with someone to get their input and advice.

For example, when someone loses their job, he or she may feel they need to get money – and fast. This could lead to dipping into retirement accounts, gambling, or other unwise actions.

Instead, an individual can apply for unemployment, update their resume, and take some time to let the dust settle, before doing anything rash. Their emergency fund will help with expenses through this time as well.

In a divorce, reacting emotionally under stress can cause an individual to make decisions they’ll later regret. This could be from disposing or spending of assets unnecessarily, giving up assets they are otherwise entitled to, or relinquishing time with kids.

It’s ok to slow down and try to think clearly and reflect. Here’s where hiring an attorney may be a wise decision. As fiduciaries, they can take an unemotional approach to the divorce, with the knowledge of the law to help with the situation.

Regardless of the event, individuals may also benefit from talking with someone – a counselor, spouse, friend, loved one, or trusted professional. Taking with someone can help relieve some of the stress of the situation and the individual may have some objective, unbiased advice to help process and think clearer.

Taking the time to slow down, think, and not react emotionally can improve the outcome of an unpleasant situation and potentially save thousands of dollars from unwise decisions.


Spousal Benefits are for One Spouse at a Time

Note: with the passage of the Bipartisan Budget Act of 2015 into law, File & Suspend and Restricted Application have been effectively eliminated for anyone born in 1954 or later. If born before 1954 there are some options still available, but these are limited as well. Please see the article The Death of File & Suspend and Restricted Application for more details.

This post intends to clarify something that comes up repeatedly: both spouses cannot collect Spousal Benefits at the same time.

If you stop and think about the mechanics of Spousal Benefits, it should become clear to you that this isn’t possible. Below is a recap of the rules that are necessary for Spousal Benefits to work.

Modern differential, cut away to show structure
Image via Wikipedia

Rules for Spousal Benefits

1. In order for a spouse to file for Spousal Benefits, the other spouse in the couple must have filed for his or her own retirement benefit as well.

2. When the spouse begins receiving Spousal Benefits, he or she must also be currently receiving his or her own retirement benefit at the same time due to deemed filing. If the benefits are filed for before FRA (Full Retirement Age), both benefits (retirement and spousal) are permanently reduced. If the spouse receiving spousal benefits was born before 1954, it is possible to file solely for spousal benefits after FRA. If born in 1954 or later, deemed filing requires filing for both benefits when either is filed for if eligible for both.

3. The Spousal Benefit is always a differential between the individual’s own PIA and the factor-applied PIA of the other spouse. If Spousal Benefits are being applied for at or after FRA, the factor is 50%; it’s between 32.5% and 35% at age 62 (depending on FRA), and phased for ages in-between. This differential is then added to the retirement benefit. If the spouse in question is at FRA or older, then the Spousal Benefit differential is 50%.

Now, if all of that is confusing, don’t feel alone. It’s a very confusing set of rules. Let’s run through some examples to sort things out.

Spousal Benefit Examples

John and Priscilla are both age 62. John has a PIA of $800, while Priscilla has a PIA of $2,000.  If John wants to file for Spousal Benefits now, he must file for his own benefit first, and it will be reduced to $600 since he’s filing early. The second thing that must happen is that Priscilla must also be collecting her benefit. Now John can also file for Spousal Benefits (in fact he must due to deemed filing rules, if he is eligible when he files for his retirement benefit). John’s Spousal Benefit will be reduced to 35% of Priscilla’s PIA minus his PIA. But wait a minute: 35% of Priscilla’s PIA is only $700, and John’s PIA is $800. So the reduction means that John gets no Spousal Benefit at all.

How about if they decide to delay Priscilla’s filing until her FRA. So now, John still started his own retirement benefit at 62, so that portion of his benefit is permanently reduced. Priscilla files for her own benefit at FRA. Once she has done so, John is now eligible for the Spousal Benefit. The differential is now 50% of Priscilla’s PIA minus John’s PIA ($1,000 – $800), which equates to $200. This is added to John’s reduced benefit of $600, for a total benefit of $800. Note that, even though they waited until FRA for John to file for Spousal Benefits, he will never receive 50% of Priscilla’s PIA, since his own benefit has been reduced by filing for it at age 62. Had he waited until FRA to file for his own retirement benefit, he could have a total benefit equal to half of Priscilla’s PIA.

There’s another way this could work out:  What if Priscilla files for her retirement benefit at FRA and John delays filing? Could John still receive a Spousal Benefit based on Priscilla’s record? No – because if John has delayed filing for his own retirement benefit, deemed filing will require him to file for his own benefit when he files for spousal benefits. Regardless, his Spousal Benefit will be 50% of Priscilla’s PIA if he first files for any benefit at or after his FRA.

So now we come to the crux of the matter, the question that started this post off from the beginning:  Can both John and Priscilla file for Spousal Benefits? If you think about what’s required for Spousal Benefits to be available, you’ll have your answer.

Clearly, John could file solely for Spousal Benefits when he reaches FRA, but in order to be eligible, Priscilla must have filed for her retirement benefit. On the other hand, Priscilla could file for spousal benefits, but since her own benefit is greater than 50% of John’s, no spousal benefit is available to her.

The act of filing for retirement benefits establishes the currently-filed PIA for that individual. So, while John could still receive a small increase over his PIA in terms of a Spousal Benefit (half of Priscilla’s PIA is $1,000, minus his PIA of $800 equals $200), Priscilla doesn’t have that luxury. Half of John’s PIA is only $400, and Priscilla’s PIA is $2,000, so there is no differential available for her Spousal Benefit. If Priscilla was born before 1954, it is possible for her to file solely for the Spousal Benefit at or after her FRA. If born in 1954 or later, this option is not available.

So the answer is: You can’t have receive Spousal Benefits for both spouses at the same time. Both must have filed for their own retirement benefits, and as such only one can have a Spousal Benefit (and only if his or her own PIA is less than 50% of the other spouse’s PIA). I hope this helps to clear things up.

Should I Use IRA Funds or Social Security at Age 62?

orange flowers
Image via Wikipedia

Folks who have retired or are preparing to retire before the Social Security Full Retirement Age (FRA) face a dilemma if they have IRA assets available. Specifically, is it better to take an income from the IRA account during the years prior to FRA (or age 70) in order to receive a larger Social Security benefit; or should you preserve IRA assets by taking the reduced Social Security benefits at age 62?

At face value, given the nature of IRA assets, it seems like the best thing to do is to preserve the IRA’s tax-deferral on those assets, even though it means that your Social Security benefit will be reduced.

If you look at the taxation of Social Security benefits though, you might discover that delaying receipt of your Social Security will provide a much more tax effective income later in life. In the tables below I’ll work through the numbers to illustrate what I’m talking about.


For our example, we have an individual who has a pre-tax income requirement of $75,000 per year. The individual has significant IRA assets available. If he takes Social Security at age 62, he will receive $22,500 per year. Delaying Social Security benefits to FRA would get him $30,000; waiting until age 70 would provide a benefit of $39,600 per year. In tables below we show what the tax impact would be for using Social Security at age 62, FRA, and age 70. In each case the required income is always $75,000.

Tax table in use is from 2019, and we’re assuming the individual is single. COLAs are not included in the example.

Table 1 – taking Social Security benefit at age 62:

62 $ 52,500 $ 22,500 $ 8,932
63 $ 52,500 $ 22,500 $ 8,932
64 $ 52,500 $ 22,500 $ 8,932
65 $ 52,500 $ 22,500 $ 8,932
66 $ 52,500 $ 22,500 $ 8,932
90 $ 52,500 $ 22,500 $ 8,932
Totals $ 1,522,500 $ 652,500 $ 259,028

Table 2 – taking Social Security benefit at age 66:

62 $ 75,000 $ 0 $ 9,674
63 $ 75,000 $ 0 $ 9,674
64 $ 75,000 $ 0 $ 9,674
65 $ 75,000 $ 0 $ 9,674
66 $ 45,000 $ 30,000 $ 8,684
90 $ 45,000 $ 30,000 $ 8,684
Totals $ 1,425,000 $ 750,000 $ 255,808

Table 3 – taking Social Security benefit at age 70:

62 $ 75,000 $ 0 $ 9,674
63 $ 75,000 $ 0 $ 9,674
64 $ 75,000 $ 0 $ 9,674
65 $ 75,000 $ 0 $ 9,674
66 $ 75,000 $ 0 $ 9,674
67 $ 75,000 $ 0 $ 9,674
68 $ 75,000 $ 0 $ 9,674
69 $ 75,000 $ 0 $ 9,674
70 $ 35,400 $ 39,600 $ 5,917
90 $ 35,400 $ 39,600 $ 5,917
Totals $ 1,343,400 $ 831,600 $ 201,647

The difference that you see in the tables is due to the fact that Social Security benefits are at most taxed at an 85% rate. With that in mind, the larger the portion of your required income that you can have covered by Social Security, the better. At this income level, the rate of taxable Social Security is even less, as only 85% of the amount above the $44,000 base (provisional income plus half of the Social Security benefit). This results in almost $5,000 less in taxes paid over the 29-year period illustrated by delaying to age FRA. The big benefit comes by a reduction of nearly $58,000 in taxes when you delay to age 70.

Note: at higher income levels, this differential will be less significant, but still results in a tax savings by delaying. It should also be noted that COLAs were not factored in, nor was inflation – these factors were eliminated to reduce complexity of the calculations. In addition, in calculating the tax, only the standard deduction was included.

This is to assume that the individual has the available IRA assets to allow for the early use of the funds, although in the end result, delaying to age 70 required less of a total outlay from the IRA, by nearly $180,000, in addition to the tax savings.

Hands down, this is a very significant reason to delay receiving Social Security benefits at least to FRA, and even more reason to delay to age 70. The only factor working against this strategy would be an early, untimely death, especially if the individual in question is not married. In that case the IRA assets would have been used up much more quickly than necessary, and no surviving spouse is available to carry on with the Social Security survivor benefit.

Trust Me, You’re Gonna Like This – The See-Through Trust as a Beneficiary

sniff alert by obensonOne area that often gets short shrift in discussions of IRAs and beneficiary designation is the use of a trust as the beneficiary. Part of the reason behind this may be the perceived complexity of trusts in general; at any rate, it’s not as complicated as it sounds, and it can be beneficial, depending upon your circumstances. We’re specifically discussing the “see-through” trust here, as this type of trust is most appropriate for IRA and Qualified Retirement Plan beneficiary designations.

The See-Through Trust as a Beneficiary

If you designate a trust as the beneficiary of your IRA or Qualified Retirement Plan (QRP), the trust should be set up with certain properties associated with it:

  • the trust must be valid under the plan owner’s state’s law;
  • the trust must be irrevocable upon the plan owner’s death;
  • the trust beneficiaries must be identifiable;
  • ALL of the trust beneficiaries must be individuals (cannot be another trust); and
  • the trust documentation must be delivered to the plan administrator or custodian by October 31 of the year following the year of death of the plan owner.

Taken together, these properties describe a “see-through” or “look-through” trust. Other types of trusts could be eligible as beneficiaries, but the see-through trust provides the ability to enact a rollover (a trustee-to-trustee transfer) to an inherited IRA for the benefit of the individual beneficiaries, if there are multiple beneficiaries. With this ability, your beneficiaries can split out the IRA into separate inherited IRAs and stretch out the payments over each beneficiary’s individual lifetime, rather than all beneficiaries having to use the oldest beneficiary’s lifetime for Required Minimum Distribution (RMD) calculations.


You might want to use a trust as your beneficiary because it is much simpler to make changes to the trust documents than to file additional beneficiary designation forms with your plan administrator. The trust also provides for additional flexibility. For example, if you wanted your IRA to be distributed to your three children, and in the event of one or more of your children’s pre-deceasing you then you’d like that child’s share to be apportioned equally among the heirs of that child – and so on, and so on. This sort of language doesn’t always fit in very well with the standard IRA beneficiary designation form, but a trust could quite easily describe this situation ad infinitum.

In addition, you might want to include certain provisions in a trust to carry out your wishes. For example, you might want to include a spend-thrift provision, which could control the amount of distributions over a specified schedule, rather than a lump-sum distribution.

Other provisions could ensure that, for example, children from a previous marriage will receive benefit from the account, in addition to a current spouse. This is often handled by way of a QTIP trust.

The Spousal Benefit

Fun With Dick and Jane
Image via Wikipedia

Note: with the passage of the Bipartisan Budget Act of 2015, File & Suspend and Restricted Application have been effectively eliminated for anyone born in 1954 or later. If born before 1954 there are some options still available, but these are limited as well. Please see the article The Death of File & Suspend and Restricted Application for more details. Specifically, Example 4 and Example 5 below are not available if the person filing for spousal benefits was born in 1954 or later.

One of the most confusing concepts in the Social Security retirement system is the Spousal Benefit. This option allows one spouse to file for benefits and the other spouse to receive a benefit based upon the first spouse’s retirement benefit. The greatest amount that the Spousal Benefit could be is 50% of the PIA (Primary Insurance Amount, generally equal to the retirement benefit at Full Retirement Age, or FRA) of the spouse who has filed.

Let’s work through a few examples to explain this. Let’s say we have a couple named Dick and Jane. Dick is 66 years old (his FRA), and Jane is 62. Dick is eligible for a benefit at his current age of $2,400 per month, and Jane would be eligible for a benefit of $1,000 when she reaches FRA (66 years, 6 months).

Example 1

If Jane files for her own benefit today, it will be reduced by 27.5% due to early filing, leaving her a total benefit of $725. If she also files for the Spousal Benefit today (Dick will have to file for his retirement benefit to enable this), then her Spousal benefit would be equal to 50% of Dick’s PIA minus a factor for filing early ($2,400 times 50% times 67.5% equals $810) minus her own reduced benefit of $725. In other words, filing for the Spousal Benefit now would increase Jane’s overall benefit by $85 per month.

Example 2

Jane could delay until she reaches FRA before filing for Spousal Benefits, which would then give her a Spousal Benefit of 50% of Dick’s PIA ($2,400 times 50% equals $1,200) minus her PIA of $1,000, for a Spousal Benefit differential of $200 ($1,200 minus $1,000). Her total benefit would be the reduced amount of $725 plus the $200 differential, totaling $925.

Due to deemed filing, this delay is only possible for Jane if Dick delays filing for his retirement benefit until Jane is at FRA. Dick would then be 70 years, 6 months. If Dick files for his retirement benefit at any earlier age, Jane will be deemed to have filed for the spousal benefit as soon as she becomes eligible for the benefit (when Dick has filed).

If, for example, Dick files for his benefit at his age 70, Jane will be 66 at that point, 6 months before her FRA. The deemed spousal benefit for Jane would be 47.92% of Dick’s PIA, or $1,150. Subtracting Jane’s PIA from this amount yields $150, which is then added to her earlier-reduced benefit of $725 for a total monthly benefit amount of $875.

Example 3

If Jane delays receiving her own retirement benefit until FRA, she would receive the full $1,000. At this point she would also file for Spousal Benefits, giving her an additional $200 (as calculated above) for a total benefit of $1,200, exactly half of Dick’s PIA.

Keep this factor in mind: Jane can file for her own benefit early and delay the Spousal Benefit until later (as long as she’s not currently eligible for the Spousal Benefit in the month that she files for her own benefit, due to deemed filing); she cannot file for Spousal Benefits early (before FRA) and delay her own benefit.

Example 4 (only if Jane was born before 1954)

On the other hand, Jane could wait until she reaches FRA and then file solely for the Spousal Benefit, delaying her own benefit until age 70 if she wishes (if she were born before 1954).

This is because once Jane reaches FRA she is no longer subject to the deemed filing rule. This means that her Spousal Benefit would be calculated based upon 50% of Dick’s PIA – but Jane’s PIA is not subtracted from it since she has not filed yet.

If Jane was born on or after January 2, 1954, this option is not available.

Example 5 (only if Dick was born before 1954)

Mixing this up a bit, Jane could file for her own benefit at any age, and then Dick could file for a Spousal Benefit based upon 50% of Jane’s PIA since he’s 66, his FRA. Just like in Example 4, his Spousal Benefit would not be reduced by his benefit since he has not filed yet. Later Dick would file for his own benefit (as late as his age 70), which then would deem Jane to have filed for the spousal benefit based on Dick’s record.

As before, if Dick was born on or after January 2, 1954, this option is not available.


The following rules apply:

  • In order to be eligible for Spousal Benefits, your spouse must have filed for his or her own benefit.
  • If applying for your own benefit prior to FRA when you’re also eligible for Spousal Benefits (that is, your spouse has applied for his or her own benefit already), deemed filing requires you to apply for both the Spousal Benefit and your own benefit at the same time.
  • The Spousal Benefit is always a differential between your own PIA and your spouse’s PIA with a factor applied (50% at the greatest, 35% at the least, depending on your age).
  • If you have already applied for your own benefits, the Spousal Benefit differential is added to your own benefit to give you your total benefit. If your own benefit is reduced due to filing early, your total benefit will always be something less than 50% of your spouse’s PIA, even if you wait until your own FRA to file for Spousal Benefits.
  • Spousal Benefits are only available to one spouse at a time.

Hopefully this review will help you as you work through the options of the Spousal Benefits for you and your spouse.  If not, you can always leave a question in the comments – and I’ll do my best to help you understand the way it works.

Substantial Earnings With Regard to WEP


Image by London Permaculture via Flickr

If you’re subject to the Windfall Elimination Provision (WEP), your Social Security retirement benefit can be reduced in the first bend point to as little as 40% from the normal 90% rate. The WEP applies if you worked in a job that did not require Social Security withholding in addition to a job that was subject to Social Security withholding. Here’s how substantial earnings can help.

If you’ve worked in the Social Security-covered job for a significant amount of time and the amount of earnings you received there was substantial, it is possible that the reduction due to WEP could be lessened and eventually eliminated if you amass enough years of substantial earnings.

Each year’s substantial earnings is only applicable to that particular year. So if you earned more than the substantial earnings in one year, this doesn’t carry over to the next year. At the same time, if you miss the substantial earnings limit for the year, even by one dollar, you cannot count that year as a substantial earnings year.

According to the Social Security Administration, substantial earnings is defined as an amount equal or above the amounts shown in the table below:

Year Substantial Earnings
1937-1954 $900
1955-1958 $1,050
1959-1965 $1,200
1966-1967 $1,650
1968-1971 $1,950
1972 $2,250
1973 $2,700
1974 $3,300
1975 $3,525
1976 $3,825
1977 $4,125
1978 $4,425
1979 $4,725
1980 $5,100
1981 $5,550
1982 $6,075
1983 $6,675
1984 $7,050
1985 $7,425
1986 $7,825
1987 $8,175
1988 $8,400
1989 $8,925
1990 $9,525
1991 $9,900
1992 $10,350
1993 $10,725
1994 $11,250
1995 $11,325
1996 $11,625
1997 $12,150
1998 $12,675
1999 $13,425
2000 $14,175
2001 $14,925
2002 $15,750
2003 $16,125
2004 $16,275
2005 $16,725
2006 $17,475
2007 $18,150
2008 $18,975
2009-2011 $19,800
2012 $20,475
2013 $21,075
2014 $21,750
2015 $22,050
2016 $22,050
2017 $23,625
2018 $23,850
2019 $24,720

So, if your earnings from your Social Security-covered job are substantial according to the table above, it is possible to change the reduction factor, increasing it from the standard 40% – and even possibly eliminating it, depending upon how many years you’ve earned those substantial earnings.

As long as you’ve had those substantial earnings for more than 20 years, follow the table below to determine what your first bend point factor would be.

Years First Bend Point
Percentage Factor
30 or more 90%
29 85%
28 80%
27 75%
26 70%
25 65%
24 60%
23 55%
22 50%
21 45%
20 or less 40%

What this means is that if you had 20 or fewer years in a Social Security-covered job with substantial earnings, your WEP-reduced factor on the first bend point is 40%. For each year more than 20 of substantial earnings, your WEP-reduced factor increases by 5%, and if you have 30 or more years of substantial earnings, the WEP doesn’t impact your first bend point factor at all.

Effectively, with 20 or fewer years of substantial Social Security-covered earnings, your projected benefit is reduced by 50% of the first bend point (from 90% to 40%). See the article on calculation of your PIA for more on how the bend points work.

Sam, You Made The Pants Too Short!

high water pants by TimWilson With apologies to the writer and performers of the original “Sam, You Made The Pants Too Long!”… This article is about what happens when your IRA declines substantially in value and you’ve put a 72t Series Of Substantially Equal Periodic Payments plan (SOSEPP) into play – and the decline in value has brought your IRA to a point where the balance will no longer support your Equal Payments.

What Happens When Your IRA Will No Longer Support Your SOSEPP?

Here’s an example: You’ve set up a SOSEPP in your IRA, beginning at age 50. As we all know (see this post for details) you have to keep the payments going until you reach age 59½. During that time, many things can happen, both positive and negative. In this case, the IRA began with a balance of $100,000, and your annual payments are $3,000. Things go fine for the first few years, although your account doesn’t seem to be growing. So, you decide to take a leap and invest it all in a wild-eyed fund – some Madoff fellow’s running it. Then, lo and behold, one morning you wake up and find that your IRA balance has become – $12 total. You’re 56 years old, so you have three and a half more years that you are supposed to be taking this regular payment of $3,000 from your account! What do you do? You’ve read about the crazy penalties for busting a 72t payout plan – yikes!


Calm down. Take a breath, it’s really not so bad. There are several options: You could rollover funds from another account into the IRA, either from another IRA account or a 401(k). You could also choose to make your one-time change to your SOSEPP plan. Or, you could choose to let it die, and go on with your life. The best option is probably the last one – it allows you to be as flexible as you can be.

If you chose the first option, it certainly would work – and your SOSEPP would just continue on as originally planned. But what if you have decided at this stage that you really don’t need that series of payments anyway? And it’s just a pain in the rear keeping up with the paperwork and remembering to take the payment each year…?

The same holds true for the one-time change to the RMD method. If you did that, now you’d have to re-calculate your payment each year on a very small balance. Once again, a pain in the rear – so why not just take the third option?

Let it die

If you go ahead and take the last payment out of your account (the remaining $12) and close the account – your SOSEPP is no longer in effect. You now have the option of starting a new SOSEPP from another IRA account, or just discontinuing the idea of the 72t payout. If you chose to start a new plan, you’d have to start over with a new five-year or (since in the example, you’re age 56) for three and a half more years until you reach age 59½.

What’s key to understand in this is that, for SOSEPP’s, the IRS considers each IRA account separately – yeah, I know, for everything else, all IRAs are considered as one. What can I say? They don’t want you to get too comfortable and start predicting how they’ll move – just when you think they’re gonna zig? They zag. So with that in mind, if one account (the one with the SOSEPP attached) runs dry, there’s no penalty if you just drop it and move on with your life.

That’s literally all there is to it. No penalty, no muss, no fuss.

Guaranteed Income (Annuitization)

Annuities sometimes get a bad rap. The distaste people have for annuities may be based on a bad experience with a salesperson, the fear of “the insurance company getting all your money when you die”, or just plain misinformation.

Annuities can be a great choice for your retirement. That is, after annuitization an annuity provides a guaranteed income stream to you and or your spouse for the rest of your lives. Think of this as your own defined benefit pension. In fact, if you don’t have a defined benefit pension, you may consider the guaranteed income a private annuity provides. The guarantee comes from the insurance company providing the annuity. To date, no insurance company as ever defaulted on its annuity obligations.

So why can annuitization be a good thing for you? Let’s look at an example.

Let’s say you’ve determined when you retire that your annual expenses are $115,000. This sum includes your living expenses, taxes, and doing fun things in retirement (such as travel, dining out, and hobbies). You’ve determined that Social Security will provide $30,000 per year which leaves $85,000 to be covered with other retirement savings.

It’s safe to say that Social Security is providing $30,000 (inflation adjusted) per year in guaranteed income. In other words, you know that at the very least you’ll always have $30,000 per year for income, or $30,000 of expenses will always be covered. But maybe you’re uncomfortable with knowing only $30,000 is guaranteed. This is where the annuity can help.

Depending on the amount of money you have saved for retirement, you could purchase an annuity to provide a guaranteed income stream that meets 50, 75, or even 100 percent of your needed income – for the rest of your life! The amount you choose to annuitize will be dependent on several factors such as retirement savings, other income, RMDs, and estate goals (gifts and inheritances).

The flip side, however, is what can happen if you die before your life expectancy. It is true that in some circumstances the insurance company keeps your money (if you had a single life annuity) and this money goes back into the risk pool of other annuitants. But there are options to make sure that this doesn’t happen such as joint and survivor annuities, period certain annuities, and refund annuities. 

Annuitizing a portion of your retirement income shouldn’t be readily dismissed. Guaranteeing some of your income can reduce stress, meet certain retirement expenses, and ensure you never run out of money. Should you need help navigating your options, consider working with a fiduciary – preferably one who doesn’t sell annuities.

Your Account(?) at Social Security

forget-me-not social security by swanksalotOne of the biggest misconceptions about Social Security is that each individual has a specific “account” which holds all the money you’ve had withheld from your paycheck over the years. Nothing could be further from the truth… as we’ve mentioned before on this blog, the Social Security system is a pay-as-you-go system (largely) where withholding today is used to pay benefits for current recipients.

It is for this reason that much consternation has been brought about in recent years with regard to the question of the Social Security system’s running out of money. You see, for quite a while the Social Security system has had a surplus over current expenses, with the surplus amounts being placed in the trust fund. In 2020 it is expected that current benefits being paid out will become greater than the payroll taxes are bringing in, so the difference will come from the trust fund.

No Pile of Money

The point is – there’s not a pile of money sitting somewhere with your name on it, although your “contributions” are tracked through the years, as a matter of adminis-trivia. There is no guarantee at any point in time that the money you’ve put into the system will ever be returned to you, but then again you may receive far more in benefits than you paid in.

For example, if you were single with no dependents and worked all your life paying in to the Social Security system but died just prior to starting to receive your Social Security retirement benefit, it would all be for naught (for your benefit). There’s no residual that goes to your estate.

On the other hand, to consider an extreme example at the other end of the spectrum:  Ida May Fuller, the individual who received the first ever Social Security benefit check in January of 1940, had worked for only 3 years under the Social Security system, paying in a total of $22.54 in Social Security taxes during that time. Mrs. Fuller lived to age 100, and she received benefits in the amount of $22,888.92 over the course of the 35 years.

Inherited 401k plan

An inherited 401k plan isn’t necessarily a different kind of retirement plan from a regular 401k plan in the hands of the original participant. However, the rules around an inherited 401k plan are unusual enough to warrant their own review.

When an individual inherits a 401k plan, generally this individual must begin taking minimum distributions from the plan, on a preset schedule. There are a few things to consider, the first of which is whether the beneficiary is the spouse of the original owner, or another person (non-spouse).

If the beneficiary is a spouse, special options are available for handling the inherited 401k plan. As a spouse-beneficiary, you have 3 primary options to choose from:

  1. You can leave the money in the 401k plan.
  2. You can rollover the money from the 401k plan to an inherited IRA.
  3. You can rollover the money from the 401k plan into an IRA in your own name (not the same as #2).

If you inherit a 401k plan from someone other than your spouse, you are limited to either #1 or #2 above. We’ll go over the three options in detail next.

Leave the money in the 401k plan

If you choose to leave your inherited 401k in the original account, you now have to figure out the Required Minimum Distribution for the account.

If the original owner was over age 70½ and already taking RMDs from the account, you must continue with those same distributions based on the lifetime of the original owner. You can choose to take out more each year, but you have to at least take out the minimum that applies as if the original owner were still living.

These same rules apply if the original owner was still employed past 70½ and not subject to RMDs. The RMDs must begin in the year following the original owner’s death, in this case, and will use the original owner’s age to determine the amount of each RMD.

If the original owner was younger than age 70½ at his or her death and therefore not subject to RMDs, the rule is different if you are the spouse or a non-spouse beneficiary.

If you are the spouse of the original owner you have the option of delaying until the original owner would have been 70½ years old before taking the RMDs. In this case, the RMDs would be based on the decedent’s assumed age (had he or she still been living) in each year of distribution.

If you are a non-spouse beneficiary, the default rule is that you must withdraw the entire amount of the 401k account by December 31 of the fifth year following the year that the original owner died. You can take some money out each year, or take it all at once, it just has to be withdrawn before the end of the fifth year.

Some plans (although these are relatively few) have another option for the non-spouse beneficiary: to stretch RMDs out based on the beneficiary’s lifetime. This is similar to the option described below in the case where you rollover the account to an inherited IRA. It’s more often the case that the rollover is undertaken to enable stretching payments, as few 401k plans include a stretch feature.

In all cases, you have the option of taking more than the minimum out of the account each year. In none of these cases will you have a 10% penalty applied for early distribution, but you will owe income tax on all pre-tax money withdrawn.

Rollover the inherited 401k to an inherited IRA

If you choose instead to rollover the inherited 401k to an inherited IRA, you have a bit more flexibility, but only a bit. Not all plans allow this rollover option – some plans are more restrictive and force only the 5-year complete payout option detailed previously.

As before when leaving the money in the 401k account, if the decedent original owner was already taking RMDs (or would have except for being still employed and over age 70½), you must at a minimum continue those RMDs based on the lifetime of the original owner.

However, if the original owner was under age 70½ and therefore not taking RMDs, by rolling over the account to an inherited IRA you have the option of “stretching” the IRA distributions. If you’re younger than the original owner was, you can start taking RMDs based on your age, which will result in a longer timeline for distribution of the funds as compared to using the original owner’s age.

Rollover the inherited 401k to your own IRA

This option is only available for a spouse beneficiary.

As a spouse, you have the option of rolling over the 401k plan to an IRA in your own name (not an inherited IRA). This action can cause restrictions that you may not want, but it could open up flexibility as well.

If you are under age 59½ and are the spouse beneficiary, rolling over the inherited 401k plan to your own IRA will eliminate your ability to withdraw funds from the account without penalty, unless you meet one of the exceptions. Once you reach age 59½ or an exception applies, you will be able to access the money without penalties. It’s important to note that this rollover action does completely eliminate your ability to withdraw funds without penalty before age 59½.

If you’re between 59½ and 70½ years old, rolling over the inherited 401k to your own IRA can give you more flexibility. By doing this action, if your late spouse was already subject to RMDs, you can delay RMDs now until you reach age 70½. This is because the account is no longer associated with your late spouse – it’s your IRA. You also can freely withdraw any amount for any purpose and only pay ordinary income tax on the distribution, no early withdrawal penalty will apply.

If you’re over age 70½ and you rollover the inherited 401k plan to your own IRA, you must take RMDs based on your lifetime and the account balance in your IRA.

As before, except for the case where you’re under age 59½ (when penalty-free withdrawals are not allowed), you are allowed to take more than the minimum distribution each year, but you must at least take the minimum.

Roth Conversion of Inherited 401k

One of the provisions that is available to the individual who inherits a 401k or other Qualified Retirement Plan (QRP) is the ability to convert the fund to a Roth IRA.

This gives the beneficiary of the original QRP the option of having all of the tax paid up front on the account, and then all growth in the account in the future is tax free, as with all Roth IRA accounts.

What’s a bit different about this kind of conversion is that, since it came from an inherited account, the beneficiary must immediately begin taking distribution of the account over his or her lifetime, according to the single life table. This means that, in order for this maneuver to be beneficial, the heir should be relatively young, such that there will be time for a lengthy growth period for the account – making the tax-free nature of the Roth account worthwhile.

A downside to this move is that the heir should also be in a position to pay the tax on the conversion from other funds, otherwise the tax pulled from the account (and therefore not converted to Roth) will reduce the funds that can grow tax-free over time.

If the heir has an IRA of his or her own that could be converted, and there are only enough other funds for paying tax to enable the conversion of one account or the other, the IRA should be converted rather than the 401(k). This is because the IRA has a much better chance for long-term growth than the inherited QRP due to the requirement for distribution of the account (as discussed above).

This is yet another reason that an individual might want to leave funds in a 401k plan rather than rolling it over to an IRA – since the heir does not have this Roth conversion option available if the money is in a traditional IRA. This option is only available for an inherited 401k.

Inherited Roth 401k

If the account that you’ve inherited is a Roth 401k, if you leave it in the original Roth 401k account, you’ll need to take RMDs from the account each year, based on your age and the account balance.

You could also rollover the Roth 401k to an inherited Roth IRA (similar to the conversion described previously). This is a tax-free event since the money is coming from an account that has already been treated as Roth with contributions.

As a spouse, you further have the option of rollover of the account to a Roth IRA in your own name (not an inherited Roth IRA). This would eliminate the RMD requirement during your lifetime.

Deemed Filing

Many times the question comes up – Since my spouse has filed for Social Security retirement benefits, can I file for only the Spousal Benefit?


This is a complicated question with two answers, depending on your date of birth. This is because there are two different rules: one that applies if you were born before 1954 and one if you were born in 1954 or after. These rules came into effect in 2016, after passage of the Bipartisan Budget Act of 2015.

It is certainly possible for the individual born before 1954 who is at or over Full Retirement Age (FRA). This is a common circumstance that many folks employ, although the number of people who can employ this is diminishing. One spouse files for benefits and the other, hoping to achieve the full Delayed Retirement Credits (DRCs) while still receiving a benefit, files for the Spousal Benefit only. This is a perfectly allowable method, but only for folks born on or before January 1, 1954.

If you’re under FRA (no matter when you were born), the option for filing solely for a spousal benefit is not available. This is because, prior to FRA, if you file for the Spousal Benefit, you are deemed to have filed for your own benefit as well. This is known as “deemed filing”, and it applies in all circumstances when you’re under FRA. The result of this action is that your own benefit will be permanently reduced, as will the Spousal Benefit that you’re filing for early as well. The reverse is true as well: if you file for your own benefit before FRA and you’re also eligible for a spousal benefit, you are deemed to have filed for both benefits at the same time. If you are not eligible for the spousal benefit at the time of your filing for your own benefit, as soon as you become eligible for the spousal benefit, deemed filing requires that you have automatically filed for the spousal benefit.

The group of people born before 1954 will all be at or older than FRA by January 1, 2020, so this group’s decision process is coming to an end. Let’s look at how deemed filing works for folks born in 1954 or later.

For anyone born on or after January 2, 1954, deemed filing has a very absolute application. In any case where you’re eligible for both a spousal benefit and your own retirement benefit, deemed filing will require that any application for benefits is an application for both benefits. No matter whether you’re over, under, or exactly at FRA, you can no longer separate these benefits.

If you are not eligible for a spousal benefit when you first file for your own retirement benefit, of course you’ll only be filing for the benefit that you’re currently eligible for. But as soon as you become eligible for a spousal benefit (because your spouse filed for his or her own benefit), you are deemed to have filed for the spousal benefit in the first month of your eligibility.

Deemed filing only applies to your own benefit and the spousal benefit. If you are eligible, for example, for both your own benefit and a survivor benefit, you can separate these two benefits in your filing, regardless of your age and date of birth. You could file for your own benefit at one age (perhaps before FRA) and delay the survivor benefit until you reach FRA (when it is maximized). The reverse is also true: If you’re eligible for a survivor benefit, you could file for the survivor benefit only and delay filing for your own benefit until as late as age 70, when your retirement benefit is maximized. The earlier filing for either benefit has no impact on the later filing for the other.

Turns Out You CAN Be A Little Bit Pregnant

surprise by PinkMoose Remember back in junior high (or whenever it was) during health class (or sex ed, or whatever they called it for you) – how it was explained that pregnancy is a black or white thing: “nobody gets just a little bit pregnant” was the story my health teacher gave us to remember. As it turns out, there are many other absolutes in life that are similar. However, in a totally characteristic move, the IRS gives us a way that takes something that you think would be absolute, and twists it so that you can, in fact, be a little bit pregnant (or rather, a little bit taxable, a little bit tax free, in this case).

Confused yet? Sorry, that wasn’t my intent… some people refer to this as the “cream in the coffee” rule. With this analogy, it is explained that once you put cream in your coffee, you can’t take out just some of the coffee or just cream, you have to take out both cream and coffee. Oh bother, with the analogies! Let’s get into this.

IRA Funds – Part Taxable, Part Tax-Free

If you’ve made after-tax contributions to your traditional (non-Roth) IRA, you’re likely expecting that at some point you can take those contributions out again, tax free. And you’re right to expect that, because that’s exactly what you can do. However (and there’s always a however in life, right?), if the after-tax money you have in your IRA isn’t the only money in ALL of your IRAs, any money that you take out will be partly taxable and partly tax-free. (this was where the “little bit pregnant” thing comes in)

Here’s how it works: Let’s say you have two IRAs, each worth $5,000. One is a traditional deducted (pre-tax) IRA, and the other is a traditional non-deducted (after-tax) IRA. If you wanted to take $100 out of either account, the IRS considers all of your IRAs as one account. Any money taken out of either account is considered pro rata, partly taxable and partly non-taxable. So in the $100 that you take out, $50 will be tax-free, and $50 will be taxed.

Let’s do another example, a little more real world:  You have two IRAs, one worth $5,000, which is made up exclusively of a $3,000 deducted contribution and $2,000 worth of growth and interest; the second is made up of a $4,000 deducted contribution, a $5,000 non-deducted contribution, and $1,000 worth of growth and interest, for a total of $10,000. You would like to take a distribution of $1,500 from one of the accounts. In the IRS’ eyes, you are taking out $500 which is non-taxed, and $1,000 which will be taxed. This is because, out of the total of $15,000 in the two accounts, only $5,000 was “after tax” funds. Everything else, the growth, interest and the deductible contributions, is considered taxable.

How To Get Around It (or How You Can NOT Be A Little Bit Pregnant)

Don’t lose faith, though, there is one way around this dilemma. The IRS allows you to roll over funds from your IRA into a Qualified Retirement Plan (QRP) such as a 401(k) – but ONLY the taxable portion may be rolled over to the QRP. If there are commingled funds in your account(s). So, in this case, the IRS goes along with the absolute (go figger – they treat the same money two different ways!) and requires that no after-tax contributions be rolled over into the QRP.

So, if you have a 401(k) plan at work, or an existing 401(k) that you haven’t rolled over into an IRA, you can use this account to split out your taxable IRA money from the non-taxable IRA money. Then you could do a tax-free conversion of the non-taxed IRA money into a Roth IRA if you wished, for example, as long as you fit all the other criteria.

Going back to our example above, you would rollover to your 401(k) plan the $10,000 from the two IRAs that represent the deductible contributions plus the growth and interest. This leaves you with $5,000 in non-deductible contributions from the one IRA. You could take a withdrawal as you had planned at this point, with no tax or penalty.

In addition, since your only IRA now only holds non-deductible contributions (no growth or deductible contributions), you could convert the IRA to a Roth IRA – also with no tax or penalty. This is a strategy that many have used to separate the cream from the coffee to make the Roth conversion painlessly.

The Earnings Test is Specific to the Individual

all thats left by adonis hunter ahptical

This topic comes from a reader, J., who asks the following question:

My wife is 62 and she works a part-time job earning around $23k per year. She is planning to retire in June, and so her total earnings for the year will be approximately $11,500. She would like to begin taking Social Security benefits right after her retirement.

The question is this:  will her earnings test be based upon her “individual” earnings, or on the higher combined earnings of the two of us (I am still working, earning in excess of the earnings test amount)? Since her earnings of approximately $11,500 are under the $17,640 earnings limit, her earnings would not be reduced – but if the earnings test is based upon both of our earnings combined, her earnings would definitely be reduced. How does this work?

My Response

Each person’s earnings record is specific to that individual – the only time the spouse enters into the equation is in calculating spousal or survivor’s benefits. Therefore, the only earnings considered for the “earnings test” for your wife – are those of your wife, and not the household (not including your income, in other words). Actually one other time that the household earnings are considered is when you file your tax return: at your household income level, her benefit might be included as taxable at as high as the 85% rate.

In addition, there is a special rule that applies to the first year of retirement, when a person retires mid-year: the retiree who retires in mid-year is eligible for a full benefit (however reduced by age, in your wife’s case) for any whole month that the person is considered retired, regardless of total yearly earnings.

“Considered retired” when at less than Full Retirement Age is defined as having earned $1,455 (monthly) or less and not performing substantial services in self-employment. “Substantial services in self-employment” is defined as more than 45 hours per month in a business or more than 15 hours to a business in a highly skilled occupation (e.g., brain surgery or writing a blog about Social Security and financial planning).

So, with this in mind, your wife would be eligible for her age-reduced benefit for the remainder of the year after her retirement, with no reductions due to earnings tests (as long as she doesn’t pick up another job).

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