Getting Your Financial Ducks In A Row Rotating Header Image

The Family Maximum Benefit (Retirement)

family dinner by eyeliamWhen a worker is receiving retirement benefits and/or members of his family are also receiving benefits based upon the retirement benefits, such as via spousal benefits, benefits for children, or other family members benefits, there is a maximum amount of benefit that can be distributed in total.  (There is a separate maximum benefit computation for disability benefits, which we’ll cover in another article.)

How the Family Maximum Benefit is Computed

When computing the Family Maximum Benefit (FMB), the Social Security Administration falls back to its old habits of using a very convoluted formula, similar to the formula for computing the Primary Insurance Amount (PIA).  The formula starts with the PIA of the worker whose record is being used to provide these benefits. The PIA is then broken into four separate portions based upon Bend Points (these are not the same Bend Points as those used in determining the retirement benefit or PIA itself).

The Bend Points for FMB are based upon when they were first calculated in 1979.  At that time, the Average Wage Index (AWI) was $9,779.44 for 1977 (remember, the AWI is always two years behind) – and for 2016 the AWI is $48,642.15.  Dividing the 2016 AWI by the 1977 AWI gives us a factor of 4.9739 to compute the Bend Points for 2018.

The original Bend Points were: $230, $332, and $433.  Multiplying these Bend Points by our factor of 4.9739 gives us Bend Points of $1,144, $1,651, and $2,154.  These are rounded to the nearest dollar.

Computation for the Current Year

So here’s how we use those bend points to determine the FMB, for a worker who becomes age 62 or dies in 2018 before attaining age 62:

1) 150% of the first $1,144 of the PIA, plus
2) 272% of the amount between $1,144 and $1,651 of the PIA, plus
3) 134% of the amount between $1,651 and $2,154 of the PIA, plus
4) 175% of the amount above $2,154 of the PIA.

The total of the four amounts is then rounded to the next lower multiple of $.10 if it’s not already a multiple of $.10.

Here’s an example:

A worker age 62 with a PIA of $2,200 has a FMB calculated as follows:

1) 150% times $1,144 = $1,716
2) 272% times $507 ($1,651 minus $1,144) = $1,379.04
3) 134% times $503 ($2,154 minus $1,651) = $674.02
4) 175% times $46 ($2,200 minus $2,154) = $80.50

Adding these together ($1,716 + $1,379.04 + $674.02 + $80.50) equals $3,849.56, rounded down to a FMB of $3,849.50 for this particular worker in 2018.

Photo by eyeliam

Wash Sale Rules

If you’ve been investing for any period of time, you may have run across the term Wash Sale – do you know what it means?  And what are the IRS rules regarding Wash Sales?

wash-day-by-ooojasonoooIn a nutshell, a wash sale occurs when you sell a security (stock, bond, or mutual fund, for example) at a loss, either followed by or preceded by a purchase of substantially the same security within 30 days of the sale.  The IRS disallows the recognition of the loss for tax purposes in such cases. Without the purchase portion of the set of transactions, you would be allowed to utilize the capital loss to offset other capital losses and possibly offset ordinary income, depending upon the circumstances.

The Details

When you sell, at a loss, a security of any sort that would be treated as a capital item, the loss will be disallowed for tax purposes if you purchased substantially the same security within 30 days before or after the sale:

  • In a taxable account or a deferred account (all accounts under your household are counted together, that is, yours, your spouse’s, and any corporation you control) or
  • As options or futures contracts

Of course, the initial sale of the security must be within a taxable account – that is, not within an IRA or other deferred-tax account. This is because we’re referring to capital gains treatment of gains and losses, which do not apply to IRAs and deferred-tax accounts. Prior to Revenue Ruling 2008-5, one could effectively purchase a new, substantially same position in your IRA or Roth IRA within the 30 day period after the loss sale in your taxable account, and it would not engage the wash rule. This has been disallowed now.

So what makes up a substantially identical security?

In the IRS’ own words:

In determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case. Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation. However, they may be substantially identical in some cases. For example, in a reorganization, the stocks and securities of the predecessor and successor corporations may be substantially identical.

Similarly, bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation. However, where the bonds or preferred stock are convertible into common stock of the same corporation, the relative values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical. For example, preferred stock is substantially identical to the common stock if the preferred stock:

  • Is convertible into common stock,
  • Has the same voting rights as the common stock,
  • Is subject to the same dividend restrictions,
  • Trades at prices that do not vary significantly from the conversion ratio, and
  • Is unrestricted as to convertibility.
The above is quoted directly from IRS Publication 550

The question comes up all the time – I always say as a rule of thumb that if you have to question whether your choice of a replacement is substantially identical or not, then it’s not worth it to have to argue the point with the IRS when you’re audited.  It’s only 30 days, after all.

Examples of Wash Sale Avoidance

Below are a few examples to help understand the idea of substantially identical, and how to avoid it in practice.

Example 1:  You sell, at a loss, shares of a mutual fund that is invested in the S&P 500 index. On the same day you purchase a mutual fund that is invested in a total stock market index. The two investments are not substantially identical, so you avoid wash sale treatment. If you instead purchased another mutual fund (perhaps with another fund family) that invests in the S&P 500 index, you will be subject to the wash sale rules because the new fund is substantially identical to the original fund.

Example 2: You sell, at a loss, shares of a mutual fund that owns a portfolio of Treasury Inflation-Protected Securities (TIPS). Within 30 days you use the proceeds from the sale to purchase another mutual fund that invests in GNMA bonds (Government National Mortgage Association, or Ginny Mae). This set of transactions avoids the wash sale, because GNMA bonds are not identical to TIPS.

Example 3: You sell your S&P 500 index investment mentioned in example 1. You wait 30 days, and on the 31st day you purchase the exact same (or another fund family’s) S&P 500 index investment. This set of transactions avoids wash sale treatment because enough time has passed (30 days) since the sale for a loss.

Examples for Handling Wash Sale Disallowed Losses

So, instead of allowing the loss, the IRS gives you the ability to increase the basis of the security that you purchased, by the amount of loss that you were disallowed.

Example 1: You own 100 shares of stock that you purchased last year for $1,000.  You sell those shares for $750, and within 30 days, you purchase another 100 shares for $800.  You have a disallowed loss of $250, which will be added to the basis of your current holding, making the basis now $1,050 ($800 plus $250).

Example 2: You purchase 100 shares of stock for $1,000, and then sell them for $750 within 30 days.  Your loss is disallowed.  In this case, since you don’t own the stock any more, the loss is just gone, unless you repurchase the position within 30 days.

Example 3: You own 100 shares of stock that you purchased last year for $1,000. You sell all 100 of those shares for $500, and within 30 days you purchase 50 shares again for $200.  These 50 shares will have a basis of $450 due to the disallowed loss of $250.  You would still have an allowed loss of $250 for the activity unless you repurchased additional shares within 30 days.

It can get really complicated if you have multiple purchases and sales and overlapping 30 day periods, so if you have a particular situation that you’d like to review, please let me know.  Other complicating factors include the use of short sales, options, and futures contracts.

Photo by ooOJasonOoo

Volatility is a Two-Way Street

In many cases, whenever we think of volatility we think negatively. Try it yourself. Think of the word volatility and say it out loud. What thoughts, words, or images pop into your head? Bad news? Market losses? Losing money? The color red?

The point is that we tend to give volatility a bad rap – and rightfully so. Generally, the word is thrown at us during periods of when the market, and our investments, lose value. Volatility, however, works both ways. It’s also present when the market and our investments are doing well. We just don’t call it volatility. We call it returns, gains, appreciation, a bull market, etc.

The point is to expect volatility – good or bad. It’s part of investing in capital markets. We need to understand that just because our portfolios are doing well – doesn’t mean volatility is absent. Volatility is what helps produce long-term expected returns. It’s how we’re compensated for investing outside of riskless assets.

However, if volatility – good or bad – has an individual running for the antacids, then it’s generally a good sign that individual shouldn’t be invested in capital markets at all. Or, if an investor has a short-term time frame for a goal, such as an emergency fund or saving for a car or down payment for a house, volatility, while giving the potential for a higher return, also means the potential for losses – something to avoid for short-term goals.

Investors can manage volatility through proper asset allocation and diversification. In other words, investors should expect to lose and gain throughout their investing time-frame. Proper asset allocation and diversification can ensure that an investor experiences the volatility most appropriate for their risk tolerance and time horizon.

Social Security Full Retirement Age – Explained

full retirement age has nothing to do with a lone tree in a field.The Full Retirement Age, or FRA (gotta love Social Security for their acronyms!), is a key figure for the individual who is planning to receive Social Security retirement benefits.  Back in the olden days, when Social Security was first dreamed up, Full Retirement Age was always age 65.

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

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

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

Note: persons born on January 1 of any year should refer to the FRA for the previous year, because when you’re born on the first of any month, SSA determines your birth month to be the month prior to your actual birth date.

Photo by Jule_Berlin

Reasons #12 & #35 That You Might Need A Financial Advisor

Bob Dylan might need a financial advisorTrying not to be self-serving with this – I am, after all, a financial advisor.  The point of this post is to explain that, in spite of all of the negative press that folks in the financial advice-giving business often receive, there are still very good reasons you might need a financial advisor on your side.  You definitely need to make sure you’re been careful about choosing the advisor. There are plenty of articles to help you find one when you need a financial advisor.

The Basics

As I’ve mentioned here before on several occasions, there are three primary things that you need to do to be successful at financial stuff.  Those three things are:

  • Organization – understand what you have, where you have it, and how it is presently invested.  This is followed by developing a good plan for saving and investing toward goals that you’ve set for your financial dealings.
  • Discipline – once you’ve developed the plan, stick to it.  At the same time, continuously review your decisions to ensure that they are correct for the long term, adjusting only when positively necessary.
  • Efficiency – don’t waste time, money, and your sanity chasing the trends.  Maintain cost efficiency, tax efficiency, and time efficiency by automating your processes and avoiding superfluous moves.

A fourth tenet of success in financial dealings that I’ve mentioned recently is Purpose.  This has to do with your goal-setting, ensuring that you’ve determined your own higher purpose in life, and from that you can align your activities to be certain that you are achieving those ultimate goals for your life.

Reasons That You Might Need A Financial Advisor

One of the poor habits that we (the collective “we”, meaning most all investors) have is often referred to as “confirmation bias”.  What this means is that we 1) require much less information to form an initial opinion about something than it takes for us to change that opinion; and 2) we have a tendency to pay more attention to, and give greater weight to, information that supports our opinion than to information that contradicts our belief.

A second poor habit is referred to as “herding” – meaning that we’ll often follow what the popular press is reporting as the complete picture, rather than something with short-term meaning and little relevance to the longer term.  When herding is playing out in the upswing times, our confirmation bias causes us to hold back and not get involved early on in the herding activity.  But once we have joined the herd (too late), even if a downswing is imminent or under way, the confirmation bias that we hold so dear keeps us from “pulling the trigger” to get out (once again, too late).

The upswing/downswing behaviors are further accented by a natural human tendency to avoid recognizing losses, because they hurt more than gains feel good (2.7 times more, some researchers have estimated!). We’d be better off in the long run to pay no attention to the short term upswings and downswings and keep our eyes on the long term.

The third poor habit is our tendency to believe that activity is required to “fix” things – as well as having a short-sighted point of view.  So, even though we are investing toward a goal that is ten, twenty, or thirty years in the future, we still agonize over each quarter’s results, believing that we need to take some sort of action based upon an up or down result in the previous 90 days.

When you have a trusted financial advisor, she can help you to address these habits.  This process follows the three tenets mentioned above (four if your advisor is being totally comprehensive in helping you with your financial life).  With a properly organized financial plan, followed with strict discipline in an efficient manner, you should be able to avoid those three habits that cause so much grief.

Maintaining the long term view often means having to “sit on our hands” – because the three habits I mentioned above combine to nearly force us to do something, when the right move is to do nothing.  As has been quoted many times of late: Don’t just do something, sit there!

Photo by Stoned59

The “Default” Default Distribution Period

default distribution of antlers is uniform, not quite like the default distribution of an inherited IRAWhat happens when there is no designated beneficiary for the IRA account?  More specifically, what is the longest distribution period that heirs are allowed to stretch an IRA when there is no designated beneficiary? What is the default distribution period when there is no lifetime or age to determine the distribution period of an inherited IRA?

As with most questions put forth to the IRS, there’s more than one answer.  So, here are the answers:  5 or 15.3.  If you’re the bottom-line type, you can quit reading now.

A few more details beyond the numbers?  The answer is 5 years if the IRA owner died prior to his Required Beginning Date (RBD), which is April 1 of the year following the year in which he becomes age 70½, regardless of whether or not a distribution has already been taken.  The answer is 15.3 years if the IRA owner died on or after his RBD.  Okay, now you bottom-liners can go do something else.

The Messy Details of Default Distribution Periods

If you’ve stuck around you must be really short on things to do or terribly interested in the nuances of tax law.  In either case, I’m sure we can get together sometime and swap stories about that one time at band camp… :-)  Following are the details of these two answers, in reverse order (yeah, thought I’d rock your world!).

Original Owner Died After Required Beginning Date

First lets review RBD:  an IRA owner’s Required Beginning Date (RBD) is defined as April 1 of the year following the year in which the IRA owner reaches age 70½.  So, if you reach age 70 on or before June 30 of any particular year, your RBD will be April 1 of the following year.  If you are first able to refer to yourself as a septuagenarian on or after July 1 of any particular year, your RBD will not occur until April 1 of the second calendar year in the future.  For example, if your 70th birthday arrived on July 3, 2017, then you would have an RBD of April 1, 2019.

Therefore, if the owner of an IRA dies after his or her RBD and there is no designated beneficiary for the account, the rules state that the IRA can be paid out to the heirs or estate over the remaining life expectancy of the original owner.  At age 71 (which is the youngest age an IRA owner can be during the year of RBD) the life expectancy table indicates an expected lifespan of 16.3 more years.  Since the distributions must begin (at the latest) during the year after the IRA owner’s passing, the life expectancy would be reduced by 1, resulting in a default distribution period of 15.3 years.  The beneficiary(s) would be determined by an external will, trust, or the courts, since there is no valid named beneficiary on the custodial documents of the IRA.

Original Owner Died Before Required Beginning Date

If the IRA owner passed away prior to RBD and there is no designated beneficiary for the account, then the default distribution period is always 5 years. This is the Internal Revenue Code-prescribed length of time that an IRA must be distributed when no primary beneficiary is designated.

But, 5 years from when? Since the first distribution must occur in the year following the year of the original owner’s passing, the account must be distributed by the end of the fifth year after the owner’s death.

Will TCJA Encourage QCD?

charitable distribution of bread could not be considered a QCDWhen Congress was debating the merits of the Tax Cuts and Jobs Act of 2017 (TCJA) late last year, one of the items that took a lot of focus was the change to the Standard Deduction. The Standard Deduction was increased to nearly double what it was in years’ past. The deduction went from $12,700 in 2017 for joint filers to $24,000; for singles, the increase went from $6,350 to $12,000. Single filers over age 65 get an extra $1,600 deduction; married filers get to increase their Standard Deduction by $1,300 each if over age 65*. A byproduct of this change is that QCD (Qualified Charitable Distributions) from IRAs may become more popular than ever.

QCD basics

Here’s a brief rundown of the basics of QCDs: When you are at least age 70½ years old and subject to Required Minimum Distributions (RMDs) from your IRAs, you can opt to make distributions from your IRA directly to a qualified charity. The QCD distribution can be used to satisfy your annual RMD if you wish.

This doesn’t seem like such a big deal, does it? But the tax law has a nice surprise available to you if you use this option: the amount distributed as a QCD is never counted as taxable income on your tax return. So what?! you might say… who cares, I could make a charitable contribution and deduct it in my itemized deductions! No difference.

But that’s where you’re wrong. Since a QCD bypasses being counted as taxable income (above the line, on the front page of your 1040 form), it doesn’t increase your Adjusted Gross Income (AGI, the bottom line on the front page of your 1040). And keeping your AGI low is important for many other calculations on your tax return – such as medical expense deductions, miscellaneous deductions, and many credits. Using the QCD keeps that money out of the equation altogether!

Plus – this is the reason QCDs may become more popular than ever – since it’s not included as income, you don’t have to meet the limit of (now) $24,000 (plus $1,300 for each member of the couple over age 65) of itemized deductions for this charitable contribution to have an impact on your tax bottom line.

QCD Example

For example, let’s say your overall income (including your RMD of $5,000) is $55,000. If you take the distribution directly in cash and then hand $2,500 over to your favorite charity, your taxable income will work out to $28,400 (subtracting the $24,000 standard deduction and the extra deduction of $1,300 each for being over age 65 from your overall income).  The key here is that your itemized deductions are not enough to be greater than the standard deduction – and it’s harder to reach now that there is a limit of $10,000 on state and local tax, in addition to the fact that it’s doubled.

However, if you made a QCD of $2,500 to your favorite charity and then took the remaining $2,500 as cash, your overall income for the year would only be $52,500, since the QCD money isn’t counted. End result is that your taxable income will now be $25,900 ($52,500 minus the standard deduction of $24,000 and $1,300 apiece for being over age 65). You’ve satisfied your RMD, made the same amount of contribution to your favorite charity, and are paying less tax, because the standard deduction doesn’t change. Big win!

Of course, the larger the QCD the better – if you qualify, you might want to consider making all of your charitable contributions in this manner. The limit for QCD treatment is $100,000 per person per year, so you have a lot of headroom to work with.

I believe this is a rare opportunity to take advantage of the tax law, make significant donations to your chosen charity(ies), and pay less tax in the long run.

* Hat tip to the alert Bogleheads who pointed out I had neglected to include the additional standard deduction amounts for filers over age 65, which is everyone who this article pertains to! Thanks!

Transitioning to a Financial Planning Career

Every once I a while I will be asked to give my opinion on some logical steps to take when pursuing a financial planning career. This post may be beneficial for individuals who are entering the financial planning profession right out of college or are looking to change careers. Some are steps to take and others are questions to ask yourself and others along the way.

  1. What is it about financial planning do/would you enjoy? It could be client-facing meetings, technology, back-office work, or a combination. And you may not know until you try your hand at several things. Ask some current planners or even your own. The point is to find an area that you enjoy and work to get better at it.
  2. Find the right firm. Will you work for an RIA or broker-dealer? What type of firm do you want to align with? This could mean starting your own firm, or joining an already successful firm. Both have advantages and disadvantages. Starting your own firm means being your own boss, autonomy, and building a company. However, you’re stuck with a big learning curve and expenses. Joining a firm has the advantages of not reinventing the wheel, built-in support and compliance, and a solid client base. A good firm should also want you to succeed and advance in the company – if that’s your goal. But, you are subject to management’s edicts, philosophy, quotas, and hours.
  3. Choose your compensation method. Generally, there are three ways financial planners get paid. Fee-only is where clients pay you or the firms directly for any advice given. Fee and commission is where clients may pay fees to you or the firm, but you or the firm also receive commission on any sales of products such as funds, insurance, etc. Commission only is where you or the firm are only compensated if the client buys a product (more aptly, you sell a product). Being paid only commissions can make it difficult to have a long-term focus (as it’s likely you’ll be more focused on survival, not clients). Finally, if you will get paid a salary, ask how that salary is derived (from the above three methods).
  4. Ask yourself how you would want to be treated as a client. This is like the “Golden Rule” of doing to others what you’d want for yourself. How would you want to pay for advice and services? What type of firm would you employ? What qualities would you look for in a competent, professional planner? Knowing how you’d want to be treated as a client will go a long way in your happiness and satisfaction as a planner.
  5. Always be learning. To be a successful planner, you must keep learning. One of the first steps to take is to earn the CFP® designation. The CFP® designation is considered the gold standard in financial planning. It signals to clients that they will be working with a professional, fiduciary planner who has met the rigorous education, ethics, experience, and exam requirements. But don’t stop there. There are other quality, specialty designations as well. Obtaining additional designations may depend on what area of financial planning you want to specialize. Many designations require continuing education. Take the hard, beneficial CE. Don’t be that planner who takes CE at the 11th hour just to get it done.
  6. It takes time. Back in the 90s, when I was living in Boston, there was quite a bit of road construction going on. Hanging from an overpass was a sign that read, “Rome wasn’t built in a day; if it was, we would have hired their contractors.” Becoming better, and even an expert at anything takes time. Expect road blocks, hurdles, and to make some mistakes. Grit will help overcome many of these; as will finding the right company, compensation method, and philosophy.

Good luck!

Restricted Application in 2018

You could use a machine like this to strategize your Social Security benefits filing, or you could use a restricted application.In 2018, folks who are reaching that magical age of 66, which is Full Retirement Age (or FRA, in SSA parlance), may have some decisions to make. This is especially true for married couples, or folks who were married before and are now divorced. The restricted application still applies if you were born before 1954.

Because reaching age 66 in 2018 means you were born in 1952, you are still in line for some special benefits. When the rules changed in 2015, Congress grandfathered some special options to you and your contemporaries born before 1954.

Being born before 1954 gives you the unique privilege to use the “restricted application” option when filing for benefits. (For more details on restricted application, see this article.)

This means that, if you are married to someone who also has a Social Security retirement benefit coming to them, you can (as of age 66) start taking a Spousal Benefit while delaying your own benefit to a later date. (The same applies to an unmarried divorcee who was married for at least 10 years to someone who has a Social Security benefit available.)

Restricted Application in practice

For example, Kelly and James are looking at their options for Social Security benefits. Kelly, who will reach FRA in 2018, has a potential Social Security retirement benefit of $2,000 per month available to her if she files for benefits this year. James, who worked in jobs with lower salary through his career, could have a benefit of $1,500 if he waits until he reaches his FRA in two years (he was born in 1954).

The specific set of circumstances places Kelly and James at a decision-point. Since Kelly was born before 1954, she has the option of using the restricted application – but she can’t file that application until James has filed for his own retirement benefit. Originally, they had intended for both of them to delay filing to age 70, to achieve the greatest benefit for each.

However, with the restricted application available to her, Kelly and James can put a different spin on the process. If James was to file for his own benefits in 2018 (since he’s only going to be 64 this year), he would receive a total benefit of $1,300 per month. But also, now that he’s filed, Kelly can put in a restricted application for Spousal Benefits only – which would net her $750 per month. She is still allowed to delay her own benefit up to age 70, even though she’s receiving the Spousal Benefit.

This will provide the couple with a total benefit of $2,050 per month for the coming 4 years. Then, when Kelly files for her benefit at age 70, she’ll get the full delay credits, 32%, added to her Primary Insurance Amount of $2,000. This will up her benefit to $2,640 in total, which, when added to James’ $1,300, gives the couple a total benefit of $3,940. (Given the amount of James’ PIA at $1,500, he is not eligible for a Spousal Benefit when Kelly files for her own benefit. If his PIA was something less than half of Kelly’s PIA at $2,000, he could receive an additional benefit upon her filing.)

This is less than the total benefit amount that they would have started receiving at age 70 if they had both delayed. That would have come to $4,620, because James’ benefit could have been enhanced by the delay credits to a total of $1,980.

But by using the restricted application strategy, they will receive benefits of more than $98,000 in the intervening 4 years. This works out to 12 years’ worth of the delay credits on James’ benefit – so their break-even point would be at Kelly’s age 82, James’ age 80.

Plus, regardless of the fact that he filed for his own benefit early, if Kelly dies first, James will be eligible to receive Kelly’s enhanced benefit in place of his own as a Survivor Benefit.

As with all Social Security strategies, it pays to know how it all works, in the context of your own situation. The above is just one example of how knowing the rules can make a big difference in the outcome for some folks.

Disclaiming an Inherited IRA

Disclaimed an inherited IRA and inherited this awesome hawk instead.I know, I know – who would want to disclaim an inherited IRA, right?

Well, it happens a lot more often than you think – for many reasons. An individual may disclaim an inherited IRA to keep from loading one beneficiary’s estate with too many assets. Or maybe to even things out, make it more equal, for all common beneficiaries.  Whatever the reason, the IRS has rules associated with disclaiming an inherited IRA, and as usual, there is no sense of humor if you foul it up.

Generally, a beneficiary disclaiming an inherited IRA is pretty straightforward – spelled out in Internal Revenue Code §2518, as long as the primary beneficiary executes a written instrument to disclaim all or a portion of the inherited IRA within 9 months of the death of the original account owner, the contingent beneficiary(s) will inherit the remaining account.

One additional little wrinkle – the primary beneficiary cannot have received a benefit from the account prior to disclaiming.  And one other thing that complicates matters… according to the rules, if the decedent was already subject to Required Minimum Distributions (RMD), the beneficiary must continue those distributions in a timely manner.

So if you’ve been following this, maybe you see the issue: let’s say that the IRA owner dies in November, and has not taken his RMD for the year.  The primary beneficiary has not had an opportunity to consider whether or not it makes sense to disclaim the inherited IRA or not, and the year-end is closing fast.  So, the RMD is distributed to the primary beneficiary.  According to the rules, this beneficiary has now received a benefit from the account, so she shouldn’t be able to disclaim, right?

The good news is that Revenue Ruling 2005-36 clarified, simplified, and made everything square on this issue.  Within this ruling, the IRS recognizes that sometimes these situations come about, so they’ve allowed for RMD for the year of death to be distributed to the primary beneficary but not counted as a “benefit” for the purpose of disclaiming rule. So in other words, the RMD doesn’t disqualify the primary beneficiary from having the option of disclaiming.

In addition, RR 2005-36 clarified a couple  of other situations, wherein a primary beneficiary could disclaim a portion of an inherited IRA, allowing that portion to flow to the contingent beneficiary(s).  This can be done as a specific (pecuniary, to use the IRS’ parlance) dollar amount, or a percentage of the account as of the date of death.

That part is important to note, because when a portion of the account is disclaimed, any income attributable to that disclaimed amount has to be disclaimed as well.  So if the account was worth $100,000 on the date of death, and the primary beneficiary disclaimed 25%, then the primary beneficiary would receive $75,000 plus the gains or minus the losses associated with that amount.  The remainder would go to the contingent beneficiary(s).  If an RMD is paid to the primary beneficiary and the primary beneficiary later disclaims a portion of the account, the RMD is counted as part of the primary beneficiary’s non-disclaimed portion.

It’s complicated, so if you have additional questions, just hit me up in the comments – I’ll do my best to help clarify things.

IRA RMD Reporting

So we’ve talked about how to calculate your Required Minimum Distributions (RMD) from your IRA and when you must take it. But how does the IRS know that you’ve done what you’re supposed to? How does RMD reporting work? As you might expect, the IRS doesn’t leave it to chance. They know exactly what you’ve done or not done.

1099r for rmd reportingWhen you receive a distribution from an IRA, a Form 1099-R is generated at the end of the tax year.  If the distribution is for your RMD for the year (treated as a normal distribution) there will be a Code of 7 in Box 7 of the form.  This will be true of any amount that you receive from your IRA in a “normal” distribution.  The amount of the distribution will be found in Box 1 of the form, and the taxable amount will be in Box 2.

5498 for rmd reportingIn addition, Form 5498 will be generated for your IRA and sent to you by January 31 of the following year – meaning, if you receive a 5498 before January 31 of the current year, it is relating to an IRA balance as of December 31 of the prior year.  This statement will detail the amount of your RMD if you’re over age 70½ (based on your age, the standard table, and the balance in the IRA as of 12/31).

Both of these forms are filed with the IRS at the same time that they’re sent to you. So the IRS simply cross-references the distribution (Form 1099-R) with the balance information from Form 5498, thereby making sure that you have taken the appropriate distribution. It’s not always as simple as that, since the IRS must aggregate all of your IRA balances together, as well as all of your distributions, before making the calculations.

If you haven’t taken the distribution as you should have, you’ll receive a communication (often a year or two later) from the IRS asking what’s up (in so many words). The unfortunate problem is that you’ll be subjected to a 50% penalty for not taking the RMD in a timely manner – quite an exorbitant amount, you’ll agree.

Do I have an RMD reporting requirement?

So when you take the distribution, is there a check-box or something for RMD reporting? Maybe something that says the distribution is an RMD? The answer is no. When you’re subject to RMDs, the first money that you take out of your IRAs is counted toward satisfying your RMD for the year. As long as you take that required amount out, whether from one IRA or all of your IRAs together, the RMD is satisfied.

For employer plans, including 401(k), 403(b), 457, and SEP/SIMPLE plans, you must take the RMD from each account separately, they’re not aggregated like IRAs are, nor are they lumped together with IRAs. Just keep this in mind as you plan your distributions for the year.

Exemptions and Dependents for 2017 Tax Returns

Understanding dependent and exemption rules for 2017 income taxes is important.It is important to know and understand who can be claimed as a dependent, as well as who can generate a personal exemption for your taxes. It’s not as simple as you might think, especially in complex family situations, such as when a child lives separate from one of his parents, or when there are more than two generations living in the same home.

And best of all, you only really need to know this for the 2017 tax year (at least the exemption part), since exemptions are eliminated for your 2018 tax return.

Recently the IRS published IRS Tax Tip 2018-20, which outlines several reminders about exemptions and dependents for 2017 returns. The text of the Tip is reproduced below:

Five Things to Remember About Exemptions and Dependents for Tax Year 2017

Most taxpayers can claim one personal exemption for themselves and, if married, one for their spouse. This helps reduce their taxable income on their 2017 tax return. They may also be able to claim an exemption for each of their dependents. Each exemption normally allows them to deduct $4,050 on their 2017 tax return. While each is worth the same amount, different rules apply to each type.

Here are five key points for taxpayers to keep in mind on exemptions and dependents when filing their 2017 tax return:

  1. Claiming Personal Exemptions. On a joint return, taxpayers can claim one exemption for themselves and one for their spouse. If a married taxpayer files a separate return, they can only claim an exemption for their spouse if their spouse meets all of these requirements. The spouse:
    • Had no gross income.
    • Is not filing a tax return.
    • Was not the dependent of another taxpayer.
  2. Claiming Exemptions for Dependents. A dependent is either a child or a relative who meets a set of tests. Taxpayers can normally claim an exemption for their dependents. Taxpayers should remember to list a Social Security number for each dependent on their tax return.
  3. Dependents Cannot Claim Exemption. If a taxpayer claims an exemption for their dependent, the dependent cannot claim a personal exemption on their own tax return. This is true even if the taxpayer does not claim the dependent’s exemption on their tax return.
  4. Dependents May Have to File a Tax Return. This depends on certain factors like total income, whether they are married, and if they owe certain taxes.
  5. Exemption Phase-Out. Taxpayers earning above certain amounts will lose part or all the $4,050 exemption. These amounts differ based on the taxpayer’s filing status.

The IRS urges taxpayers to file electronically. The software will walk taxpayers through the steps of completing their return, making sure all the necessary information is included about dependents.  E-file options include free Volunteer Assistance, IRS Free File, commercial software and professional assistance.

Taxpayers can get questions about claiming dependents answered by using the Interactive Tax Assistant tool on The ITA called Whom May I Claim as a Dependent will help taxpayers determine if they can claim someone on their return.

More Information:

New Deadline for Rollover of 401k Loan Distributions

TCJA allows an easing of the deadline for rollover of 401k loan distributions.Under the newly-passed Tax Cuts and Jobs Act of 2017 (TCJA), there has been a slight change for folks who have taken loans from their workplace retirement plan and subsequently left the job before paying the loan back. These 401k loan distributions (as they are known) are immediately due upon leaving the job, considered a distribution from the plan if unable or unwilling to pay it back. This results in a taxable distribution, plus a 10% penalty unless you’re over age 59½. (You could avoid the 10% penalty as early as age 55 if you’re leaving the employer.)

The distribution could be mitigated by rolling over the same amount of the distribution into an IRA within the regular 60-day limit. The new provision in TCJA allows an extension of this time, up to the due date of the tax return for the year of the distribution. This applies to 401k, 403b, and 457 plans equally, but we’ll just call them 401k loan distributions for brevity.

For example, Willard has a loan with a balance of $10,000 against his 401k plan. He’s been paying it back regularly, per the plan rules. In 2018 he leaves the job, but he doesn’t have enough money to pay back the loan right away. So his old job’s 401k administrator considers this a distribution from the plan, and since Willard is 50 years old, there are no exceptions to apply. This will result in a 1099R at the end of the tax year from the 401k administrator, indicating a fully-taxable distribution with no exceptions applied.

In the olden days, Willard could still avoid the tax and 10% penalty on the distribution if he could somehow come up with $10,000 within 60 days and roll that money into an IRA. In the new world of TCJA, Willard doesn’t have to come up with the money within 60 days: he has until April 15, 2019 to come up with $10,000 and roll that money into an IRA. This will avoid all tax and penalty on the rolled-over distribution.

Keep in mind that this only applies to 401k loan distributions that occur as a result of the employee terminating his employment or the company terminating the retirement plan. If the plan loan distribution occurs because the employee has not kept up with his payments against the loan, this is still considered a distribution subject to ordinary income tax and the 10% penalty if applicable. This type of distribution has no way to avoid the tax and penalty by a rollover.

Best and Worst States for Retirement Finances

statesRetirement can be one of the most anticipated and exciting times in a person’s life.  When the time comes to start this new chapter, it is important to consider all of the factors to make the transition as easy as possible.  Diligent financial planning is one of the most important things that can make a senior’s retirement successful, and it is especially helpful to know that there are some states that have better financial environments than others.  Whether retirees already live in one of these states, or are looking for a new place to reside, knowing expense expectations can help seniors make the right decision about their future.

In order to help retiring seniors discover this information in a simplified manner, developed a list of the best and worst states in America for retirement finances.  Using SeniorScore™, the first comprehensive data-driven scoring system specifically designed to identify and measure the livability for seniors, the most and least accommodating states for retiring seniors have been identified. By analyzing over 100 variables, and heavily weighing financial factors such as tax rates, cost of living expenses, average income, and senior living costs, we have ranked the states based on retirement financial planning.

The best state for retirement finances also happens to have some of the most beautiful terrain in the country.  Wyoming came in at the top of the list due to it’s low nursing home costs as well as low property taxes.  When analyzing retirement finance data, a few Southern United States fared well as well.  Assisted living costs in Alabama are very low and Louisiana boasts a low cost of living in general.  For these and other reasons, Alabama and Louisiana made the top 5 best states for retirement finances list.

Surprisingly, two of the worst states for retirement finances are at opposite ends of the country.  California is the number one worst state on the list for seniors who want to retire, based on its financial landscape, according to  Property, sales and income taxes are all very high in California, and the cost of living is much higher than the national average.  Moving on to the opposite coast, Maine also made the list of the worst states in America for retirement finances.  The average household income in Maine is lower, yet the cost of living is very high, making it difficult for savers to reach their retirement goals.

Read more about “The Best and Worst States for Retirement Finances.”

The article above was provided by which connects older people and their support systems to more than 50,000 housing options. The free senior living search engine contains comprehensive information on providers nationwide, including assisted livingnursing homesmemory carehome healthcare, independent living, adult day services, retirement homes, respite care, and hospice care.

No K-12 Tax Break for Using Illinois’ Brightstart

brightstartOne of the provisions in the Tax Cuts and Jobs Act of 2017 (TCJA) included the ability for an owner of a 529 education savings plan (such as Illinois’ Brightstart) to use the funds for K-12 private schooling just the same as for post high school expenses. This means that, at least at the federal level, owners of these plans will not pay tax on the growth of these funds if used for any private K-12 schooling. Previously this option was only available with a Coverdell savings plan, but TCJA extends this treatment to 529 plans.

In Illinois however, the state Treasurer and Department of Revenue have come forth to state that this usage will not be allowed by the state. This means that, if an owner of an Illinois Brightstart or Bright Directions 529 plan uses the funds from that account for K-12 tuition, the state of Illinois will tax the growth of the funds. The income will be included as ordinary income in Illinois, taxed at the standard 4.95% rate.

Not only that, but the state income deduction for contributions to either plan is effectively nullified if the money is not used for post-secondary expenses. So if a family contributed money over the years to a Brightstart plan and deducted those contributions from income for Illinois tax, and then they ultimately use those funds for K-12 expenses, the state requires a claw-back of the original deduction. This would effectively penalize the family for saving – for taking the tax reduction incentive and then using the funds in a manner not allowed by the state.

Behind this move is the assertion that the 529 plans were put in place to save toward college education expenses, not private K-12 schooling.

The Brighstart and Bright Directions plans’ disbursals for K-12 expenses would still have the federal tax break – which is non-inclusion of growth on the funds at the federal level. But the clawback inclusion of prior contributions and inclusion of growth as income at the state level will likely eliminate that federal tax benefit for most savers.

This does not eliminate the long-standing option of contributing funds to one of the Illinois plans (and thereby generating an income deduction) and then as quickly as the following day generating a distribution to pay for college expenses. Illinois’ Treasurer Michael Frerichs acknowledged this is still available, although likening the strategy to money laundering. I wouldn’t be surprised if this option receives more scrutiny in the near future.

Other states?

There are 30+ states that provide similar tax breaks as Illinois’ for their residents saving in the state-sponsored 529 plans. Some states, including Missouri, Utah and Delaware, have come out to indicate that they will follow the federal tax-treatment of 529 distributions. Many other states are considering their options and proposing legislation for how to handle this new provision. Thus far, only Illinois has published their choice to not follow the feds.

Coverdell plans, originally slated to be eliminated with TCJA, are still available and still have the ability to be used without tax consequences for K-12 expenses as well. But Coverdell plans do not provide the tax reduction option for contributions that Illinois’ 529 plans do. Plus, Coverdell plans have a very limited contribution level: $2,000 per beneficiary (student) per year, and this contribution amount is only available for couples earning less than $220,000 in 2018.

Back-door Roth Blessed by Congress

back-door RothFor years now, the back-door Roth IRA contribution method has been discussed ad nauseam in the financial industry press. It’s been touted as a possibility, but always with a caveat: taking this course of action may ultimately be disallowed by the IRS. As of the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, all skepticism about this method should be removed.

Let’s back up a bit and talk about the back-door Roth. This is the action where you make a non-deductible contribution to your traditional IRA, followed later by a tax-free Roth conversion of that contribution. Folks often took these steps because they were above the income limits for a normal Roth IRA contribution. The problem was that the IRS had never weighed in on the concept. As such, there were many folks in the industry who took a conservative point of view with regard to this action. The IRS has ways to disallow such an action if they deemed that it was to work around the law. But that’s all over for now.

Tax Cuts and Jobs Act

The back-door Roth contribution is not specifically addressed in TCJA, but it was discussed on the record by the Conference Committee in their Explanatory Statement of the TCJA. In that document, the Conference Committee states in four places that “Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA…” (for full context, see the Joint Explanatory Statement of the Committee of Conference, footnotes 268, 269, 276, 277, beginning on page 114.)

This verbiage not only blesses the back-door Roth contribution technique currently and going forward, the matter-of-fact manner of the footnotes seems to declare that this has always been acceptable.

So – have at it with your back-door Roth contributions!

Life Moves Pretty Fast…

In the classic 80’s movie, Ferris Bueller’s Day Off, Ferris Bueller says, “Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it.”

In other words, life happens. That’s why it’s important to meet with your financial planner to see if anything has changed, and if there’s anything that needs to be done to assist with those changes.

The reason it’s important to meet with your planner is that he or she can ask questions and propose situations that you might not even be aware of or think about. A recent example would be how the new tax law affects your situation. Another example would be a child that is going to college, a job change, death, divorce, or 2018 being the year you plan to retire.

A financial planner will be able to provide another set of eyes to your situation to perhaps think of things you may not have, or to potentially look at your situation objectively, without any personal bias you may have. An example being hanging onto an investment you fell in love with and don’t want to sell, but the prudent thing to do is to sell. Or, it may mean preventing you from a bad financial decision (bitcoin, or unnecessary debt).

However, life does move pretty fast. We get caught up with our careers, family, friends, among other things. Sometimes we tend to be reactive, rather than proactive. That is, we usually think about things only when they need to be taken care of, or after something has happened.

That’s why it’s good to periodically meet with your financial planner. And if you don’t have one, consider meeting with a few and finding one that works well with you and your situation. Even if you think you don’t need any help or your situation hasn’t changed, a financial planner may be able to see something you don’t. And if you’re concerned about a planner creating an artificial need or overselling you, find a fiduciary. They’re legally required to educate you and tell you whether or not you have an issue that needs to be addressed.

Roth Recharacterization is No Longer Allowed

recharacterizationWith the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, recharacterization of a Roth Conversion is no longer allowed. This begins with tax year 2018.

Briefly, recharacterization of a Roth conversion is (used to be) useful if you wanted to undo a Roth conversion sometime before your tax return is filed for the year in question. If you’d like more information on recharacterization and why you might want (or have wanted) to do this, you can check out the article on Recharacterizing.

So now, if you convert funds from an IRA or 401k into a Roth IRA account, you no longer have this back-out option available to you.

The legislation did not make it clear whether the restriction takes place for any recharacterization after 2017 or if it’s based on any conversion done after 2017. This makes it unclear whether a 2017 conversion could still be recharacterized by October 15, 2018, or if the recharacterization had to be complete by year-end 2017. The verbiage used indicates that the recharacterization disallowance “shall apply to taxable years beginning after December 31, 2017.”

Some think this means the ban applies to conversions after 2017 – while others think this means the ban applies to recharacterizations after 2017. Jury is still out on this, and IRS is likely to clarify later this year.

jb note: Astute super-reader clydewolf mentions: 

Kaye Thomas at says he has confirmed with the IRS
that 2017 Conversions can be recharacterized.,84769

Other types of recharacterization are still allowed – the primary one being recharacterizing of an unintended IRA rollover or contribution that is later disallowed due to income limitations. This type of recharacterization is still allowed after TCJA 2017.

For example, if you contribute the maximum amount ($5,500) to your IRA this year and later you discover that your income is above the limits for a deductible IRA contribution (but still under the Roth IRA contribution limits). You have the option of recharacterizing the contribution in your traditional IRA to a Roth IRA contribution. With this action, your recharacterized contribution will be treated as if made to the Roth IRA at the same time as you originally made it to the traditional IRA – as long as you recharacterize before the filing date of your tax return (generally October 15 of the following year after the contribution).

Income ≠ Wealth

There’s a big difference between income and wealth. Income can be considered the amount of money an individual earns on a consistent basis. For most individuals, this is a paycheck. Wealth can be considered an individual’s net worth, or, more specifically, how much income their wealth generates and how long they can sustain a given lifestyle without having to receive a conventional paycheck.

Some individuals may confuse the two. Some may feel that a high income equates to wealth. They may also think that to be wealthy or to generate wealth, their income must be high. This isn’t the case. While a high income may help to build wealth faster, it is no guarantee that an individual is or will be wealthy.

Let’s look at an example of two couples, about the same age, nearing retirement and wondering if they have enough wealth to do so. These are based on actual client interactions, although some info will be generalized to maintain anonymity.

The first couple, Hank and Bess, has saved roughly $3 million in retirement accounts. They are both in their mid-50sand neither earned more than $50,000 annually throughout their careers. This couple is debt-free, while owning two vehicles, two homes, a business (purchased with cash just before retirement) and needs about $38,000 annually to meet their retirement expenses – half of which will be covered by their Social Security when they take it.

Conservatively, this couple needs to earn just over half of a percent (.00633) annually to cover the $19,000 needed for their expenses, from their $3 million portfolio, while leaving the principal untouched. This couple is very wealthy.

The second couple, Stan and Kat, currently still work and earn about $750,000 annually. They have a big house with a mortgage, no kids, and make payments on two luxury sedans. They make quite a bit of money annually and their lifestyle shows it. However, when considering retirement, this couple’s wealth – what they have currently saved to support their wanted retirement lifestyle, would last them between 10 to 13 years.

On the outside, it may look like Stan and Kat are very wealthy. However, compared to Hank and Bess, their wealth is quite low. Unless they change their lifestyle, or saving habits, Stan and Kat’s retirement outlook remains grim.

Income doesn’t not equate to wealth. As you can see from the examples above, it doesn’t take a huge income to build wealth. It takes discipline to save, avoiding unnecessary debt, and delaying gratification to have a comfortable retirement in the future.

How to Build Wealth

owe taxesHow you choose to spend or invest your money can have an impact on your net worth. Many of you are familiar with the net worth equation which is Assets – Liabilities = Net Worth. In other words, what you own, minus what you owe, equals what’s yours.

However, what is conventional wisdom isn’t always what’s best. What I mean is, just because something is generally known as an “asset” doesn’t mean it’s going to help your wealth. Here are a few examples.

  1. Your house. While generally considered an asset, and to some, an investment, your home can also drain you of net worth and cash flow. Homes need upkeep, repairs, insurance, utilities, taxes, and many have mortgage payments. Additionally, your home does not produce any free cash flow. There’s also no guarantee your home will appreciate (it may even depreciate). However, paying down your mortgage will generally help your net worth.
  2. Your car. Let me be blunt. Your car is a wasting asset. It depreciates over time and in many cases, ends up costing you more that you paid for it. Vehicle loans aside, cars need insurance, gas, maintenance, and upkeep. A loan on a vehicle is making payments on a depreciating asset. Like your home, your vehicle produces zero cash flow.
  3. Your things. Your things include furniture, knick-knacks, toys, appliances, etc. Like vehicles, they generally do not appreciate. Like your home and vehicles, they produce zero cash flow.

The reason I mention the above examples is to encourage you to think of buying true assets, if your goal is to increase your wealth. True assets appreciate and may provide cash flow. Here are some examples.

  1. Stocks and bonds. Stocks represent ownership of a company and provide cash flow via dividends. Bonds represent owning a company’s debt and provide cash flow in the form of interest payments. Additionally, you can own multiple stocks and bonds with mutual funds or ETFs – which pass the cash flows and appreciation to their investors.
  2. Real estate. By real estate, I do not mean your home. I mean real estate that produces cash flow such as commercial properties or residential rental real estate. Real estate also provides tax advantages through depreciation, like-kind exchanges, and other business expenses.
  3. A business. Owning a business may provide opportunities to create cash flow and potential tax advantages through business deductions. Additionally, businesses that provide value (in addition to cash flow) can also be sold for profit.
  4. Education via college, internships, or self-education can increase your knowledge, human capital, and can increase your cash flow through promotions, pay increases, and intellectual capital.

By focusing on true assets – those that can provide cash flow and potential for appreciation can have a beneficial impact on your net worth and wealth. While it’s not a bad thing to have a home, furniture, vehicles, etc. (I own these), if your goal is to increase your wealth and net worth, consider focusing on true assets.

%d bloggers like this: