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The Equity-Indexed Annuity

If you’re anywhere near retirement age, or if you’re in retirement, chances are you’ve had an Equity-Indexed Annuity (EIA) pitched to you.

Now, if for some reason you’ve missed out on these pitches (Maybe you’ve been out the country? Don’t have a phone? Don’t read your mail?) here’s the gist:  Insurance salesman tells you about this wonderful product that allows you to participate in the stock market’s upside, while not experiencing any of the market downside.  In today’s stock market climate, sounds pretty good, huh?

A couple of things come into play that the salesguy doesn’t highlight for you:

First, your “participation” in market upside is limited. Typically there is a cap on the amount of market upside that the account will pay out, and in this market climate, the upside potential is tremendous, which will primarily benefit the insurance company, not you.  In other words, given that the market has experienced a significant drop, there is high potential for significant increases in the coming months and years.  If there is a cap on your upside “participation” of say, 6% or 8%, the rest of the account’s upswing goes to the insurance company’s bottom line.

Now, you might say – that’s a small price to pay for not having to endure a downswing in the market like we have experienced recently.  And I would agree with you on that score. However: this is a hindsight statement, because again, the chance is quite small that the market will continue trending continually lower after its performance of late. There often are minimum guaranteed rates of return that can help on the downside as well, but the end result can be that you get back less from the contract than you originally deposited.

And so – the downside protection that you receive comes at the cost of limited upside. The limited upside throttles back your performance in the bull market periods, leaving you with dismal returns overall.  But that’s not the biggest issue you face with these accounts…

The second issue is the overall cost of these accounts. Annually, there is a fee charged against the value of the account of between 2% and 3% annually.  Doesn’t seem like much, until you think back to the caps that are placed on your account’s participation in the market.  Suddenly, that 8% cap becomes 5% when you remove the annual fees.  And what about if the market just goes sideways?  You still lose 3% to fees every year.

The third issue is the annuity term. As with all annuities, there is a term during which you are not free to withdraw the balance without penalty. The penalty varies but can be steep, as much as 20% depending on the contract. This can cause a liquidity problem – if you need money right away, you might not have ready access to it without paying the penalty.

I just thought I’d give you a brief rundown on these accounts since they’re getting a lot of “push” these days – since the market decline has highlighted their selling points, plus there is a lot of upside potential benefit to the companies pushing them.

There’s a reason equity-indexed annuities are popular: market drops are scary. And sometimes we’ll overlook the downsides to get some protection against scary things.

There’s also a reason equity-indexed annuities are popular with insurance companies: historically, the market returns negative overall results one out of every four years. Plus, the average annualized return of the S&P 500 over the past 50 years has been approximately 11%. So the insurance company has to pay the guarantee only 25% of the time, and the rest of the time (on average) they are able to glean 3% off the top of the contract.

Finally, equity-indexed annuity is one of the only types of investment that FINRA has seen fit to produce an investor alert about. It’s important to have your eyes wide open if you’re considering one of these contracts.

Are Resolutions Worth It?

After the first of the years it’s common of individuals to aspire to change their lives for the better. Many individuals come up with New Year’s resolutions – with aspirations of accomplishing certain goals or tasks that have eluded them in the past.

eating healthy

But do resolutions really work? In other words, what good is a resolution without action?

Granted, I am being nitpicky. But think of it this way. If I were to write down a handful of resolutions that I wanted to achieve in 2019 and beyond – they would simply be words on paper.

Don’t get me wrong, having the resolutions or goals listed is an excellent start, but again, until they’re acted upon, nothing will happen. All the words and intentions in the world are nothing without action.

So how can we convert resolutions into measurable acts?

First, do one thing today that is an action toward accomplishing your resolution. For example, this could be filling out the form to start saving into your retirement plan. It may mean a few keystrokes to increase your savings by 1%.

Perhaps it’s a weight loss goal. The simply act today could mean stepping outside of your door and walking. Or it could mean grocery shopping and only buying healthy, nutritious food.

If your resolution includes decluttering, it could mean simply cleaning your workspace, home office, etc.

The resolution could be to write more. Start today with just a sentence, then move to a paragraph, then a page.

The point is to simply start. And start small. It’s easier (and motivating) to accomplish small tasks. Accomplishing these small tasks will give you energy and motivate you to act on other things.

Finally, be consistent. Commit to carrying out one or a few of the acts needed to accomplish your resolutions. In no timer (generally 30 days) you’ll have made them a part of your routine, your habits, and they’ll no longer feel like tasks. They’ll be second nature.

The 457(b) Special Catch-Up

If you’re a governmental employee, you may be aware that your employer offers a 457(b) retirement plan. Additionally, you likely know that like a 401(k), the 457(b) allows you to contribute $19,000 annually to the plan with an additional $6,000 catch-up for those aged 50 or older.

What you may not be aware of is the special catch-up provision the 457(b) offers. This special catch-up provision allows a governmental employee that is within 3 years of the normal retirement age (as dictated in the plan) to contribute up to twice the annual amount ($38,000 for 2019).

To take advantage of this special contribution the plan sponsor (employer) must allow it in the verbiage of the plan. Additionally, the employee must have unused contribution amounts from prior years. In other words, an employee can contribute twice the amount normally allowed if that employee has unused contributions from prior years; they didn’t contribute the maximum in previous years.

In addition, for an employee to take advantage of the special catch-up the employee must not also be making age-based (age 50 and over) catch-ups in the year the special catch-up contributions are being made.

Finally, the IRS states that the special contribution must be the lesser of twice the annual limit ($38,000 in 2019) or the normal annual limit ($19,000 in 2019) plus any unused basic limit from previous years. However, employees taking advantage of unused basic limit contributions from previous cannot make age-based catch-up contributions and unused basic deferrals from previous years.

What Is It That You Want To DO?

Note: Taking a little break from tax law and retirement planning for the day…

One of the questions that I often ask folks as we’re working on financial matters is – “what is it that you want to DO?”  And in this case, DO is capitalized to be emphatic, because the context of the question is with regard to life.  “What is it that you want to DO in your life?”

purpose-by-sidewalk-flyingDeep down, we all have the desire to matter.  We want to, in some way, create a legacy of our life, so that this time we’ve spent here doesn’t seem like we’ve wasted our chances.  Not that what we do every day – caring for our families, performing our job, etc., is a waste of time.  But if we’re not cognizant of a greater purpose for our life, oftentimes life seems unfulfilled.  It doesn’t have to be grandiose, we all have our little corners of the world that we can impact in a positive way that will leave a legacy long after we’re gone.

Believe me, I’m not in any way saying that I have all the answers.  In fact, I have quite a few questions that you might want to ask yourself as you consider just “what is it that you want to DO?”.  These questions are have a financial angle (duh, financial planner, remember?) but have a greater reach, as in how money interplays with your aims for your life.

  • How would you describe your relationship with money?  Is it a means to an end, or is a particular number the goal you’re aiming toward?  If you answered the latter, what are you going to do with that sum of money when you get it?
  • What in your life brings meaning to your existence?  It may be volunteer work, your job, or just being with your family.  How would a drastic reduction in your financial situation, such as loss of a job, impact your meaningful activities?  Would a dramatic improvement in your financial situation, such as winning the lottery, lead you to doing more meaningful activities?
  • If you’ve got an idea of what you’d like to accomplish in your life to leave a legacy, how does money affect your ability to do “your thing”?  Are you doing those things now – that is, making those contributions – that will help to leave the impact you’re hoping to leave on the world?
  • Quite often, it is said, that we don’t really get to know our personal strengths until we’ve faced adversity.  If you’ve suffered a financial setback, what personal attributes do you have that you can use to help you deal with the situation and get yourself (and your family) through the crisis?
  • As you consider your personal values, is there anything that you feel you’re lacking?  Is it possible that we have too much “stuff” in our lives that keeps us from truly appreciating and evoking our values? Can you think of ways to eliminate some of the excess “stuff” so that the more important things take priority?
  • Consider the above questions again, only substitute time for money in the question… and then do it again, substituting talents. Going through this process can produce real clarity.

Pretty sure we haven’t resolved anything here today – but hopefully some of the questions I’ve asked have sparked you to action (or at the very least, deep thought).  Because the actions we take in our lives are our only way to create that legacy. In the end we want to look back on our life and feel satisfied that we’ve done our best. 

That’s what it’s all about, right?

Take care, jb


Should I Itemize or Use The Standard Deduction?

Taxes (Photo credit: Tax Credits)

As you prepare your tax return, you have a decision to make about your tax deductions – you can choose between itemizing and using the standard deduction.  But how do you choose?

The Standard Deduction is just what it sounds like – a standardized deduction that you can choose to utilize by default, and you don’t have to do a lot of recordkeeping through the year in order to use the the standard deduction.  In order to itemize deductions, you need to save receipts from various deductible expenses through the year, and use those to prepare your itemized return.

Oftentimes it is a foregone conclusion, once you understand the differences between itemizing and the standard deduction.

Standard Deduction vs. Itemizing: Facts to Help You Choose

Each year, millions of taxpayers choose whether to take the standard deduction or to itemize their deductions.  The following seven facts from the IRS can help you choose the method that gives you the lowest tax.

  1. Qualifying expenses – Whether to itemize deductions on your tax return depends on how much your spent on certain expenses last year.  If the total amount you spent on qualifying medical care, mortgage interest, taxes, and charitable contributions is more than your standard deduction, you can usually benefit by itemizing.
  2. Standard Deduction amounts– Your standard deduction is based on your filing status and is subject to inflation adjustments each year.  For the 2018 tax year, the amounts are:
    • Single, $12,000
    • Married Filing Jointly, $24,000
    • Head of Household, $18,000
    • Married Filing Separately, $12,000
    • Qualifying Widow(er), $24,000
  3. Some taxpayers have different standard deductions – The standard deduction amount depends upon your filing status, whether you are 65 or older or blind and whether another taxpayer can claim an exemption for you.  If any of these apply, use the Standard Deduction Worksheet in the 1040 instructions.
  4. Married Filing Separately – When a married couple files separate returns and one spouse itemizes deductions, the other spouse cannot claim the standard deduction and therefore must itemize to claim their allowable deductions.
  5. Some taxpayers are not eligible for the standard deduction – These taxpayers include nonresident aliens, dual-status aliens and individuals who file returns for periods of less than 12 months due to a change in accounting periods.
  6. Forms to use – The standard deduction can be taken on your Form 1040. To itemize your deductions, use Schedule A, Itemized Deductions.

RMDs From IRAs

rmds from irasI’ve made the observation before – IRAs are like belly-buttons: just about everyone has one these days, and quite often they have more than one.

Wait a second, maybe they’re not quite like belly-buttons after all.

Oh well, you get the point – just about everyone has at least one IRA in their various retirement savings plans, and these accounts will eventually be subjected to Required Minimum Distributions (RMDs) when the owner of the account reaches age 70½.

So what are RMDs from IRAs, you might ask? When the IRA was first developed, it was determined that there must be a requirement for the account owner to withdraw the funds that have been hidden from taxes over the lifetime of the account. Otherwise the IRS would never benefit without the taxes that are levied against the account withdrawals. To facilitate the forced withdrawals, a schedule was prepared approximating the life span of the account owner year after year. This schedule prescribes a minimum amount to be withdrawn each year that the account owner is alive, until the account is exhausted.

A participant in a traditional IRA (Roth IRAs are not subject to RMD rules by the original owner) must begin receiving distributions from the IRA by April 1 of the year following the year that the participant reaches age 70½. In other words, assuming that the participant reaches age 70 during the months of January through June of 2019,  the participant reaches age 70½ during the 2019 calendar year.  Therefore, the first RMD must be withdrawn before April 1, 2020.

On the other hand, an individual who reaches age 70 during the latter half (July through December) of 2019 does not reach age 70½ until the 2020 calendar year.  As such, this individual’s first RMD must be withdrawn by April 1, 2021.

After that first year’s RMD is withdrawn, the second year’s RMD must be taken by December 31 of the same year. In our examples above, the first participant must make a RMD withdrawal by April 1, 2020, and another by December 31, 2020. The second example participant must make a RMD withdrawal by April 1, 2021 and another by December 31, 2021. For all subsequent years, the RMD must simply be withdrawn by December 31 in order to be credited for that year.

If you don’t want to double up the distributions for your first and second RMDs, you can take the first RMD by December 31 of the year you reach age 70½. By taking your first and second RMDs as originally described, you will be taxed on both distributions in a single year. This might result in adverse taxes to you.

Calculation of RMDs from IRAs

Calculation of the RMDs from IRAs is fairly straightforward, although there is some math involved. For the first year of RMD, the participant could be age 70 or 71, depending on when the birthday falls. IRS determines your applicable age based on your age at the end of the year. According to the Uniform Lifetime Table (See IRS Publication 590 for more detail on other tables), the distribution period for a 70-year-old is 27.4, and 26.5 for a 71-year-old.

Jerry has IRAs worth $100,000 at the end of the previous year and will be 70 at the end of the current year. Jerry will divide the balance of $100,000 by 27.4 to produce the result of $3,649.64 – the RMD for his first year.

Each subsequent year, Jerry reviews the balance of his accounts on December 31 of the previous year. Jerry looks up the distribution period from the Uniform Lifetime Table for his attained age for the current year. He then takes the balance and divides by the factor for his current year, producing the RMD amount. Then Jerry just has to take a distribution of at least that amount (the RMD) during the calendar year.

Note, I made a point of indicating that you calculate your RMD based on the balance of all of your IRAs. This is because the IRS considers all of your traditional IRAs as one single account for the purpose of RMDs. You are required to take RMD withdrawals based on the overall total of all accounts. This withdrawal can be from one account, evenly from all accounts, or in whatever combination you wish as long as you meet the minimum distribution for all accounts that you own.

It’s different for RMDs from non-IRA retirement accounts. With the exception of 403(b) plans, employer plans cannot be aggregated to determine RMDs. But that’s a subject for another time.

Another point that is extremely important to note: taking these distributions is a requirement. Failing to take the appropriate distribution will result in a penalty of 50% (yes, half!) of the RMD that was not taken. As you can see, it really pays to know how to take the proper RMDs from IRAs. The IRS has very little sense of humor about it.

Understand that the examples I’ve given are for simple situations, involving the original owner of the account and no other complications. In the case of an inherited IRA or other complicating factors, or if the account is an employer’s qualified plan rather than an IRA, many other factors come into play that will change the circumstances considerably. If you need help on one of these more complicated situations, it probably would pay off in the long run to have a professional help you with the calculations.

Estate Planning Essentials


How many of you reading this have an estate? If you think you have an estate, then please keep reading – this should be you and everyone else reading this. That is, everyone has an estate.

Many individuals believe that to have an estate they must have a certain amount of “stuff”, net worth, income, social status, etc. Furthermore, these same individuals may feel estate planning involves complex documents, high legal fees, considerable time. While this may be true for some estate plans, it’s not always the case.

Additionally, many individuals feel that estate planning involves planning for incapacity or death. Although not pleasant to discuss, planning for one’s incapacity or death is an important part of their overall financial plan.

Having these discussions before incapacity arises (a possibility) or death occurs (a certainty) can help ease the stress for loved ones dealing with these situations of and when they happen. It may also help prevent arguing and discord among relatives who may act based on what they think you wanted versus what you actually want.

Besides planning for incapacity or death, estate planning can also involve the distribution of assets when people are alive and well. Many individuals need estate planning regarding gifting, philanthropy, taxation, etc.

Almost everyone needs some type of estate plan. The simplicity or complexity will depend on the vicissitudes pertaining to each individual or family.

The following is a list of some estate planning essentials that you may consider for your overall financial plan. Of course, it’s highly recommended you seek the advice and assistance of competent financial professional and or an attorney to help draft documents and align your estate plan to your overall financial plan.

  • A will. A will is a legal document that allows you to choose which individuals get your possessions when you die. For parents, wills are imperative as they will determine who will become guardian of children if the parents pass away while the children are minors.

Dying without a will (called dying intestate) can be problematic. Without a will, the state of the deceased individual will determine distribution of assets, guardianship for minor children, etc. It can be a mess. A will can ensure that your wishes are carried out.

For parents: consider having discussions with those individuals you feel you’d want as guardians for your children. Make sure they are in agreement and want to undertake this huge responsibility.

  • A trust. A trust is another legal document that ensures that some type of property (called corpus) is administered in a certain way (generally your intentions) according to the verbiage in the trust.

Some of the more common types of trusts involve trusts for minor children. If parents pass away, they pay leave money to children to ensure financial stability for their upbringing. However, minor children are likely not going to be able to handle financial matters. A trust will have the money set aside for the children (the beneficiaries) but managed by an individual (the trustee) whom the parents deemed financially fit to distribute and use trust assets for the children.

Other types of trusts may be necessary depending on the situation. These involve special needs trusts for parents of special needs children, spendthrift trusts (to limit or prevent wasteful spending by beneficiaries), and charitable trusts (to carry out charitable intentions).

Lastly, trusts avoid the publicity of probate – which means that when your will is going through court, it becomes public knowledge.

  • Powers of Attorney. Powers of attorney are documents designed to allow an individual to act on your behalf – generally in the event you cannot act on our own behalf.  The two most common powers of attorney are powers of attorney for property and powers of attorney for health care.

A power of attorney for property allows an individual to make financial decisions for you. This may include paying bills, financial transactions, etc. This power may be granted right away (when you’re fully capable of making said decisions) or may be “springing” which means the power is granted when you become incapacitated.

A power of attorney for health care allows an individual to act on your behalf regarding medical decisions. In the event of your incapacitation, this document allows an individual you’ve chosen to make decisions for you regarding treatment, procedures, and, should the situation be that dire, whether to remain on life support.

If you’re feeling uncomfortable reading this, imagine the discomfort a family faces with these decisions without this document in place.

  • Other advanced medical directives. Additional documents to consider include living wills, do not resuscitate orders (DNRs), and organ donation. Living wills provide a guide to the doctors or your power of attorney for health care regarding how you’d want to be treated medically and whether you would want to remain on life support.

Do not resuscitate orders tell medical professionals to not take life-saving measures – depending on the medical condition and per your wishes.

  • Beneficiary designations. One of the easiest ways to estate plan is via your beneficiary designations on your life insurance policies, retirement plans (401k, IRAs, etc.), annuities, and investment accounts.

Naming beneficiaries allows you to determine who receives those assets in the event of your death. Like trusts, beneficiary designations avoid the publicity of probate.

A beneficiary designation can also work congruently with trusts. In other words, an individual can name a trust as their beneficiary on their life insurance (say, if they have minor children) and the trust then receives the life insurance proceeds and the trustee distributes the proceeds to the beneficiaries per the language in the trust.

If you’re considering an estate plan or believe that your current plan needs updating (e.g. after a life event such as marriage, divorce, a birth, a death, etc.), talk to a financial professional and or your attorney. There are several do-it-yourself websites available, but to quote Abraham Lincoln, “He who represents himself has a fool for a client.”

Roth IRA Conversion Strategy – Fill Out the Bracket

One strategy to consider as you think about making Roth IRA conversions is the idea of “fill out the bracket”.  With this strategy, you consider your income level and what bracket you’re in, and if it makes sense, convert enough of your IRA or QRP (such as a 401k) to effectively use up the remainder of the tax rate bracket that you’re in.

180px-Arnie_Roth can fill out the bracketOf course, this mostly makes sense in the lowest brackets, but for some folks with potentially high incomes it may be appropriate at higher brackets.  Your feeling on this also depends on what you think will happen with tax rates as you get to the point where you’re ready to retire – and if you’re like me, you’ve got to believe that tax rates are on the rise.

The following table illustrates the highest income you could have within each tax bracket, using the rates for a Single taxpayer and a Married Taxpayer, using only the Standard Deduction for 2018. If you itemize, add the difference of your itemized deductions above the standard deduction of $12,000 for single and $24,000 for married.

If you’re at or over age 65, add $1,600 if you’re single, or $1,300 for each member of a married couple who is 65 or older. Add the same amount if you’re blind.

2018 Top Income Levels Per Bracket

Tax Bracket
























To use the above table, calculate your income – from wages, salaries, tips, dividends, interest, short-term capital gains, rental income, etc..  Figure out which bracket you fit into, based on the table.  Subtract your income amount from the amount for your applicable bracket:  the remainder is how much you could convert to a Roth IRA while remaining in that tax bracket.

As an example, let’s say you’re single, with no dependents.  Your total income for the year will be $30,000.  When we go to the table we see that you’re in the 12% bracket. The top gross income in that bracket is $50,700, so you could convert up to $20,700 to a Roth IRA to fill out the bracket, without bumping yourself up above the 12% rate.  The tax on that conversion would be $2,484.

For another example, let’s say you’re married, and your household income is also $30,000.  According to the table, you’re in the 10% bracket, and the upper limit on the bracket is $43,050. To fill out the bracket, you could convert as much as $13,050 without going above the 10% bracket. Tax on that conversion would be 10%, or $1,305.

Now, you might be saying to yourself, that’s all well and good, but how many families of four have the wherewithall to undertake a Roth conversion in those circumstances? After all, who wants to pay an additional tax of $1,305?! You’re right, maybe this concept is not terribly practical for folks in those particular circumstances. But consider someone who is semi-retired, who has very little earned income beyond some interest and dividends.  How about a married individual, with part-time work earnings of $10,000?  This individual could convert as much as $14,000 to a Roth IRA – and owe no income tax at all!

For future planning, below are the top levels of income for the brackets for 2019. If over 65 and/or blind, add $1,300 if married, or $1,650 if single. The standard deduction for 2019 is $24,400 if married and $12,200 if single, so if you itemize, add any amount above those limits:

2019 Top Income Levels Per Bracket

Tax Bracket
























As I’ve mentioned before, unless you’re very, very competent with income taxes, please, do yourself a favor and run any plans of this nature past a tax professional.  It’s well worth the cost – you don’t want to make mistakes on this sort of thing!  And if you rely on a web page as your tax advisor, don’t expect the page to represent your interests before the IRS if something gets screwed up. Regardless of the fact that the tax prep website is supposed to be correct, you’re still liable for the tax and penalties if there’s a mistake!

Changes to IRMAA for 2019

For 2019, there is a change to the Income-Related Monthly Adjustment Amounts (IRMAA) for Medicare. The change is to add another level of adjustment to IRMAA for 2019.

In the past, there were five levels of IRMAA. For 2019, there is a new level added to the top end of the IRMAA adjustments.

IRMAA for 2019

The previous levels remain the same – the first level being the standard premium for Medicare Part B. For 2019, this is $135.50, up $1.50 from 2018. This represents 25% of the actual cost of Medicare Part B. Single people with Modified Adjusted Gross Income (MAGI) up to $85,000 are eligible for this premium amount. Married folks with MAGI up to $170,000 also pay this amount.

The second level, for singles with MAGI between $85,001 and $107,000 (married between $170,001 to $214,000), have their Medicare Part B premium adjusted upward to pay a total of 35% of the true cost. This amounts to a premium of $189.60 for 2019.

When MAGI for singles is between $107,001 and $133,500 ($214,001 to $267,000 for married), the third level premium for Medicare Part B is adjusted to $267.90, which is 50% of the cost of Part B. Between the MAGI amounts of $133,501 and $160,000 for singles ($267,001 to $320,000 if married), the premium for the fourth level jumps to $352.20, which is 65% of Part B’s cost.

The fifth level pays 80% of the cost of Medicare Part B. This applies to singles with MAGI between $160,001 and $500,000 (between $320,001 and $750,000 for marrieds). The premium at this level is $433.40.

The sixth level of IRMAA for 2019 applies to singles with MAGI above $500,000, and married folks with MAGI above $750,000. This level of IRMAA’s premium is $460.50, which is 85% of the true cost of Medicare Part B.

There is also a new level of Medicare Part D premium adjustment for 2019 (we’ll cover in another article).

Also New for 2019: Marriage Penalty

It should be noted that the IRMAA-adjusted premium for Medicare Part B applies to both members of a married couple, and is based on the jointly-filed tax return’s MAGI. 

Also with the new level of IRMAA for 2019, for the first time a marriage penalty is introduced. Previously the IRMAA adjustment MAGI levels for married folks were simply double the single MAGI levels. As detailed above, starting in 2019, the fifth level for married folks is capped at $750,000, which is only 1½ times the upper level for single people. This level then becomes the lower end of the top level of IRMAA for 2019.

2018 Form 1040: Say hello to my little friend

The long-awaited 2018 Form 1040 has been finalized by the IRS. It comes very close to the promised “postcard” size, at 8½ x 5½, two-sided.

Here’s the front page:

2018 Form 1040 p1

And here’s the back page:

2018 Form 1040 p2

You can go to the website to see Form 1040 “live”.

Turns out that, apparently, all that was necessary to make the Form 1040 “easier” was to just create new schedules and move lots of pieces from the old Form 1040 to new schedules.

Gone from Form 1040 are many components that we’ve grown to expect: IRA deduction, for one, was always on the front page of Form 1040, one of the traditional “above the line” deductions in calculating the Adjusted Gross Income.

The IRA deduction is still available, but you have to file a separate Schedule 1 (brand new for 2018) to take it and many other above the line deductions. I suppose now we’ll start referring to these deductions as Line 7 deductions – because that’s where they landed on the new form.

There are several of these new Schedules to get used to. As mentioned, Schedule 1 is where you’d include additions to or subtractions from your gross income to arrive at the adjusted gross income. Some examples of additions include: business income (from Schedule C), capital gains and losses (Schedule D), farm income (Schedule F), unemployment compensation, prize or award money, and gambling winnings. Subtraction examples include: student loan interest deduction, self-employment tax, educator expenses, and IRA contributions. Effectively all of Schedule 1 comes from the old Form 1040 front page. The figures from Schedule 1 are applied to Form 1040 in Line 6 (additions) and Line 7 (subtractions).

Schedule 2 encompasses Alternative Minimum Tax (AMT) and excess advance premium credit repayments. The total of these amounts flows to Line 11b on the new Form 1040. This Schedule replaces the old Lines 45 & 46.

Schedule 3 is for non-refundable credits (other than the child tax credit and the credit for other dependents). Located here are the foreign tax credit, child and dependent care credit, education credit, Saver’s credit, and others. The Schedule 3 total flows to Line 12 on Form 1040, and is added to the child tax credit and credit for other dependents (Line 12a). Schedule 3 has replaced Lines 50-54, and new Line 12a replaces old Line 49.

Schedule 4 is for additional taxes, such as self-employment tax, extra tax on retirement plans (Form 5329 tax), and other additions to tax. The result from Schedule 4 flows to Line 14 on Form 1040. This Schedule has replaced Lines 57-62.

Schedule 5 is where the refundable credits come in. These were previously located on lines 66-73. Earned Income Credit has its own place on Form 1040, on Line 17a, as do the additional child tax credit (Line 17b) and the American Opportunity credit (Line 17c). The rest of the refundable credits are found on Schedule 5: estimated tax payments, net premium tax credit, and the like. These amounts from Schedule 5 are included with the above three items produce a sum on Line 17 of Form 1040.

Schedule 6 has limited applicability – it is for taxpayers with a foreign address or who wish to designate a third party to discuss their tax return.

All in all, I’d say we didn’t improve much with this change. The instructions are actually a bit longer than before, at 117 pages (versus 107 for 2017 Form 1040). But that’s likely due to the introduction of the new schedules and the like.

Can You Beat the Market?

In investing and finance, the words “beat the market” appear from time to time either as part of an investment strategy, conversation, or a combination of both. Investors can often be lured by the phrase in the hopes of achieving returns superior than the market or “above average”.

When we refer to the market, we’re generally referring to a benchmark such as the Dow Jones Industrial Average (The Dow) or the S&P 500.

First off, I’d like to offer a bit of clarity before attempting to answer the titular question. If fact, I’d like to ask two questions and answer both – because they will have different answers, even though they look similar.

First, I think it’s appropriate to ask this question:

Can the market be beaten?

To which I answer, yes. The market can be beat, and there are times where certain investments have done better than the market.

The second question I’d like to ask is found in the title:

Can you beat the market?

To which I answer, likely no, and good luck if you try.

Do you see the similarities in the questions? Both have inferences of outperforming the market, but the second question asks the reader specifically. In other words, the market can be beat, and gets beaten every year. The odds are, you won’t do it.

The reason it’s hard to beat the market is information, or lack of it. Do you have access to the information that billion-dollar firms have access to – and the speed in which they can access it?

Do you have the money and time to invest in company analysis, research, and due diligence?

Finally (and maybe most important), do you have the temperament to try to beat the market? By temperament I mean the patience, tolerance, grit,and self-control. These are needed to stay in an investment when it’s getting beat up as well as the wisdom to sell or buy when necessary.

And then there are the costs of trying to beat the market – fees, commissions, etc., all eat into returns. The market doesn’t have to contend with them.

While not impossible, beating the market is a gargantuan battle. And to do so consistently is extremely difficult. Let me also leave you with some proof. Every year S&P releases information on how US equity funds did relative to their benchmark (the market). You can find the report by clicking here.

Principles of Pollex: The Rule of 72/Rule of 78’s

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

ruleIn this installment of our ongoing Principles of Pollex series, we’re going to talk about two Rules from the financial world that are actually real, true, undisputed Rules, rather than the guidelines with dubious proof that we’ve talked about before.  These two Rules are not open to interpretation.  The first is about investments, and the second is about loans.  Both are useful in their own ways…

Rule of 72

The Rule of 72 is a quick and easy way to determine when an invested amount will double in value, given a particular fixed rate of return.  Please take note that this only works with a fixed rate of return.  The actual formula is as follows:

72/R = Y (where the divisor R = the fixed rate of return and result Y = the number of years to double the value of an invested amount)

So, if you were to invest $1,000 at a rate of 4%, 72 divided by 4 equals 18. Therefore it would take 18 years to double in value to $2,000 at the fixed rate of 4%.

Another way to use this formula is to determine the fixed rate of return that you would need to achieve in order to double the value of an investment within a particular known timeframe.  This is possible because the formula can be rewritten as 72/Y = R as an equivalent.  Here’s an example:

If you had $1,000 and you wanted to double the value to $2,000 within 10 years, you divide 72 by 10 years, and the result is 7.2. So, you would have to achieve at least a 7.2% return to accomplish a doubling of your investment in 10 years.

Rule of 78’s

This rule is useful for calculating loan interest being paid with each payment of a loan, or the accumulated amount of interest paid to date. This applies primarily to mortgage loans or other loans that are not based on simple interest calculations, like credit card debt. The name of this rule comes from the fact that when the numbers 1 through 12 are added together, the result is 78.   But why is that important?  Don’t fret – we’re getting to that part!

You’ve heard that most of the interest is paid first in a loan, right?  It’s true: interest in common Rule of 78’s loans (also called “sum of the digits” loans) is loaded toward the front of the pay-back cycle.  The way that interest is paid off in a 1-year (12-month) loan is as follows:  in the first month, 12/78ths of the interest is paid; in the second month, 11/78ths; third month, 10/78ths; and so on until 1/78th is paid in the final month.  The remainder of each fixed amount of payment each month goes toward the principle.

So using the Rule of 78’s we can figure out how much interest has been paid at any one time (assuming the payments are paid exactly as prescribed, no additional payments or late payments have been made) by adding up the Rule of 78’s factors up to the present month.  If we know that the total finance charge for our one-year loan is $200, and we’ve made four payments, we can see that we’ve paid $107.69 in interest so far.  This is calculated as:

(12+11+10+9) / 78 * $200 = $107.69

But what if our loan is for 36 months instead of just one year?  This is where the alternative name, “sum of the digits” comes into play… Of course adding up the months of payment won’t equal 78 – when we add 1 through 36 together we get 666 (ominous, I know!).  Following what we discovered about a 12-month loan, we know that in the first month, 36/666ths of the total interest will be paid; during the second month, 35/666ths; and so on.  Knowing what our denominator is now, we can cipher the amount of interest that will be paid with the 20th payment – 17/666ths – for example.

Keep in mind that the Rule of 78’s calculations are only useful in “pre-computed” loans – such as auto loans or mortgages.  For revolving loans (like a credit card), you pay interest currently each month (or the interest is added currently if you’re not paying the interest amount).

Have fun and “rule” your financial universe!

You can’t deduct IRA losses any more

deduct ira lossesAs of 2018, it is no longer possible to deduct IRA losses from your income. The Tax Cuts and Jobs Act of 2018 eliminated this and many other miscellaneous itemized deductions.

Prior to 2018, if you had losses in your IRA with non-deductible contributions, you could cash out the entire IRA and deduct the loss on your Schedule A of your tax return. The deduction was limited to the amount greater than 2% of your Adjusted Gross Income. The loss had to be in excess of your basis, the non-deducted contributions to the account. Plus, the loss must be aggregated over all of your IRA accounts – because of the pro rata rule for distributions.

I realize that this is a pretty rare circumstance. But if you have losses in your IRA it used to be a consolation prize after you’ve had significant losses in your IRA.

Sorry to be the bearer of bad news.

IRAs and Blended Families

mountain dew bust a cap by Steve SnodgrassIn today’s society, the historically “traditional” family is becoming less and less commonplace – apparently as many as 50% of all children under age 13 are currently living with one biological parent and that parent’s current partner who is not a biological parent of the child.  Often as well, there is a significant age differential between the biological parent and the parent’s partner.  Even if there is little difference in ages, quite often situations arise where estate planning including IRAs can become complicated.

An example would be when the biological parent dies at a relatively early age, leaving an IRA to the surviving (non-biological parent) spouse. There could be a significant amount of time where the surviving spouse needs financial support – all the while the children could be denied access to their (potential) inheritance.  It’s not hard to imagine a scenario where there is an adversarial relationship between the children and the surviving spouse, with concerns arising over the surviving spouse’s management of and use or distribution of the funds in the inherited IRA.

Structuring IRAs for Blended Families

Of course, estate planning requires much more than simply reviewing the IRA components of your collective assets.  It is necessary to review all retirement accounts, life insurance policies, trusts, transfer-on-death accounts (TOD) and property titled as joint tenancy with rights of survivorship – all of the assets that are not normally impacted by testamentary trusts or wills.  These assets will pass directly to the named beneficiaries and/or surviving owners.  In addition, reviewing the tenets of your will and/or testamentary trusts will round out the picture.  By doing such a review, you can tally up all of the assets that are being directed to each heir under current conditions.

Given this starting point, you’ll want to consider how you want to distribute your assets compared with how they are presently set up to be distributed.  Often in such cases, it may be discovered that there is an inequity to the assets initially inherited by the spouse, with the children as secondary, or remainder, beneficiaries.  In a blended family this can cause animosity between the children and the surviving non-biological parent. (Imagine a “death watch” by children with regard to the step-parent.)  Steps can be taken to ensure that the children receive an inheritance separate and apart from the remainder sums that (for example) would be available from an IRA or a retirement plan.

The reason this is necessary is that, if an IRA or other qualified retirement plan is the primary asset in the estate, upon inheritance by the surviving spouse there is no guarantee that the IRA will have any assets remaining at all upon the death of the second spouse – or even if the original secondary beneficiaries will continue to have that status.  Since the surviving spouse has the ability to treat the inherited IRA as his or her own account, he or she can designate other beneficiaries (perhaps his or her own children?), thereby cutting out the original owner’s children.  But it doesn’t have to be that diabolical… it could be that the surviving spouse remarries and decides to use the entirety of the IRA in purchasing a yacht to sail around the world with her new husband.  In either case, your original intent may not be carried out by a simple designation of beneficiaries and contingent beneficiaries.

To achieve an appropriate division of assets among the surviving non-biological parent and the children, several options are available.  For example, life insurance policies could be used to provide an equitable inheritance to the children immediately upon your death.  Another option would be to split the IRA into separate IRA accounts, naming each of your intended heirs individually on the separate accounts to ensure that each child (and the surviving spouse) receives whatever you deem to be that individual’s appropriate portion of your estate.

Another item of importance is that if some of your assets are in a qualified retirement plan such as a 401(k), you need to take extra steps – especially if you intend to leave those assets to someone other than your spouse.  Accounts like a 401(k) (e.g., 403(b) or 457 plan) are under the jurisdiction of ERISA and IRAs are not. The ERISA regulations require that if you name someone other than your spouse as the beneficiary of the account, your spouse must waive his or her rights to the plan assets upon your death.  By rolling over those assets to an IRA, you will have much more flexibility in designating beneficiaries of the assets.

It should be noted though, that when rolling over funds from an ERISA-controlled plan to an IRA with a non-spouse beneficiary, your spouse will still have to sign off, waiving rights to the account.

The Point

The point of all this is that, too often the decision of naming beneficiaries of your IRA or other qualified plan is perceived as an “automatic” choice – spouse as the primary, children as the secondary beneficiaries.  In a blended family there are complications to the relationships that you need to address and account for in your plan.  If you don’t pay careful attention to what this really means in terms of actual distribution of assets among your beneficiaries, the result can be something much different from what you hoped for.  This can be especially troublesome in a blended family of the sort described previously.  By making some changes with your IRAs or accounting for asset distribution with life insurance policies (for example), you can ensure that your assets are distributed in the fashion that you’d hoped for.

Note: I have purposely not included discussion of estate taxes in this article in order to maintain simplicity.

How a 401k Contribution Affects Your Paycheck


As you begin a new job, or if you are a longer-term employee who is just starting to make contributions to a 401(k) plan, you are confronted with a question:  Do you know how a 401k contribution affects your paycheck? Believe it or not, you could actually increase your bottom line assets by reducing your income through a 401(k) contribution.

Let’s work through an example so that we can more completely understand what happens.

Your New Job

So, you’ve started a new job, with an annual pay of $30,000. We won’t go into all of the details behind a W4 at this point, but for the sake of the example, we’ll say you filed your W4 to exactly match your tax expected of $1,970 for the year (and you started in January). Your state tax is a flat 5%. In addition to this, you have opted to take advantage of your employer’s health insurance plan, which costs $50 per month. You are paid on an every-other-week schedule, for 26 pay periods per year.

This means that your take-home pay amounts to approximately $884.82, which is calculated as follows:

Salary ($30,000/26)


Federal withholding


State withholding




Health Insurance


Net Pay


How a 401k contribution affects your paycheck

So, you now are ready to begin making contributions to your available 401k plan. The company will match your contributions as follows:

100% of the first 2% of contributions

50% of the next 2% of contributions

25% of the next 2% of contributions

If you make a total of 6% in contributions to your 401k, the company will match that with 3.5% contributed to your account. Your 6% of $30,000 will amount to $1,800 per year, and the company match will be an additional $1,050, for a total contribution of $2,850.

For each paycheck, you are making a contribution of 6%, which is $69.23, and the company’s match is an additional $40.38 added to your account. The result in change to your paycheck will work out as follows:


Salary ($30,000/26)


401k contribution


Federal withholding


State withholding




Health Insurance


Net Pay


The difference in your final take-home pay is only $57.45, which is $11.78 less than the amount that you contributed to the 401(k) account. This is due to the fact that when you make a contribution to the 401k account, this amount is no longer subject to income tax for this tax year. Your taxable income went down by $1,800 and your tax went down correspondingly.

When you consider what your overall economic result from this new paycheck is, you’ll see that making the 401(k) contribution is, indeed, a no-brainer:

Net pay


401k contribution


Company match


Total economic increase


As you can see, the end result is that you actually have increased your overall money on your balance sheet assets by $52.16, which is a 5.73% increase. Plus, you’re paying less income tax to boot! Granted, your 401k account and the company match are restricted in access, but your overall situation is a significant increase.

Saver’s Credit

There’s one more item that causes an economic benefit when you make a 401k contribution. The Saver’s Credit is a tax credit that you may be eligible for if your income is below certain levels. (See the article Don’t forget the Saver’s Credit for more details.)

Since in our example the employee’s income is $30,000, she is eligible for a Saver’s Credit equal to 10% of the 401k contributions for the tax year. Since she set aside a total of $1,800, this is an additional $180 to add to the bottom line. So, for the deferral of $1,800 of income, altogether our example taxpayer has had an economic benefit of $1,436 added on top of the $1,800 deferral – a fantastic return of nearly 80%!

Keep in mind that, while we used 401k as the example type of account, the same could apply to a 403b, or other sort of tax-deferral account. In addition, keep in mind that your later distributions from the 401k will be subject to ordinary income tax.

How to Resolve an Over-Contribution to Your IRA

over-contributionEven with our best laid plans, sometimes we make mistakes. Perhaps you underestimated your income for the year and contributed more to your IRA than could be deductible; maybe you rolled over an amount that was not eligible for rollover; or maybe you made a contribution to an IRA that you were not eligible to contribute to, such as an inherited IRA. Whatever the case, you have an over-contribution into an IRA and need to take action, otherwise you can be setting yourself up for some penalties and other un-wanted taxation.

Actions for Dealing With an Over-Contribution

You have three options for dealing with the over-contribution situation:  you can pull the over-contribution out; you could also re-characterize the contribution; or you could do nothing.

Pull the over-contribution out. This is known as a corrective distribution. Essentially this is exactly as it sounds: you pull out the money that represents the over-contribution, plus (here’s the wrinkle) any growth or income attributed to the over-contribution. You need to do this by the due date (including extensions) of the tax return for the year of the contribution. In this case “due date” has a special meaning: if you filed your return on time (including extensions) this means October 15 of the year following the year of the contribution, even if you did not use an extension; however, if you did not file your return on time, the deadline is (was) April 15 of the year following the contribution year.

So if you contributed a total of $1,000 more than you were eligible for to your IRA, and there was growth and income of $200 attributable to the over-contribution, you need to withdraw $1,200 before October 15 of the year after your contribution year. And, you’ll need to pay ordinary income tax on the $200 of earnings. Of course if you didn’t file your tax return on time, (actually if you plan to not file your tax return on time) you need to pull out your over-contribution by April 15.

Recharacterize. This method resolves an over-contribution to a Roth IRA, by changing the character of the contribution to a traditional IRA instead of a Roth IRA. This can only be done if you’re eligible to make a contribution (either deductible or non-deductible) to a traditional IRA (you meet the income, other plan coverage, and age limits). To do this you submit Form 8606 to the IRS indicating a change to the over-contribution amount, plus or minus any earnings or losses that have occurred attributed to the over-contribution, from Roth to traditional. This has the same deadlines mentioned above for the corrective distribution. (It should be noted that this type of recharacterization is the only type allowed as of 2018 with the changes to tax law. Previously there were other allowed recharacterizations, from Roth IRA due to conversion, but these are no longer allowed.)

Do nothing. In essence you’re not exactly doing nothing – you’re accepting the fact that the over-contribution occurred, and you’ve chosen to accept the consequences. The consequences are that for any amount you’ve over-contributed, you are subject to a 6% penalty for excess contribution. This may be the best course of action if the over-contribution can be absorbed as a contribution in the following year.

As an example, maybe you made a contribution to your Roth IRA of $5,000 for the year, and it turns out that your income level only allows a contribution of $4,800 – something you didn’t discover until it was too late. The consequence is that you’ll owe a penalty of 6% – $12 total – on the over-contribution of $200. As long as you are eligible to contribute at least $200 to your Roth IRA in the following year (and you don’t over-contribute again), you can pay the penalty and leave the money where it is, considering it a contribution for the following tax year.

Unfortunately, if the over-contribution amount in question is large, this method doesn’t always help. This can be the case if you’ve mistakenly rolled over an inherited IRA into your own IRA instead of an inherited IRA – and you’re a nonspouse beneficiary. If you don’t catch it in time, you will be subject to the 6% penalty for the year of the rollover and every subsequent year thereafter until you distribute the IRA. When you finally catch the mistake (or rather, the IRS catches your mistake, more likely), you’ll be subject to ordinary income tax (and retroactive penalties and interest) on the entire distribution as well, since you effectively treated the IRA as your own money from the very start.

Why are Social Security benefits taxed?

Hey, I paid in all of this money over my career. Now that I’m taking money back out of it, they’re taxing me again. Seems like I’m paying taxes on tax money I paid in. Why are Social Security benefits taxed?

social security benefits taxedThis question comes up pretty regularly – and recently it came up again via Twitter from a reader. I’ll give this my best explanation – but you have to grant me a favor: Please understand that in my explanation I am not defending the practice, I am simply explaining why Social Security benefits are included as taxable income.

Let’s start with a history lesson. Originally, Social Security benefits were not taxed at all. This is because of the nature of the benefits – your benefits are NOT a return of the taxes you have paid into the system. Congress originally looked at this as a gratuity, rather than income, to the beneficiary. This is because the benefit is completely unrelated to the amount of taxes you have paid in.

In fact, several classes of beneficiaries receive a significant amount more in benefits than they ever paid in Social Security taxes, if any taxes were paid at all. Spousal and dependents’ benefits, disability benefits, and survivor benefits are the main ones that come to mind. For example, a minor child’s benefit being received as a result of a parent’s receiving Social Security benefits does not result from the amount of taxes that the child or the parent paid into the system. Otherwise, a childless Social Security beneficiary would be eligible for a larger benefit payment when compared to a beneficiary with a child under age 16.

Benefits are instead related to the amount of income that you have received on your record, not the amount of taxes you paid in. This has been the case since the beginning of the Social Security system. In fact, the revenue-generating portion of the Social Security Act is a completely separate Title in the law from the benefit payment Title.

1983 – up to 50% of Social Security benefits taxed

The non-taxable nature of Social Security benefits continued until the amendments to the Social Security Act of 1983. Among many sweeping changes to the Social Security system, this enacted law included a provision to tax Social Security benefits, returning the corresponding tax revenues to the Social Security trust fund.

The reasoning behind this is that Social Security benefits are not a gratuity as originally proposed, but rather a retirement income, much like a pension. Taxation of pension as income is broken up in to two pieces: the part that the employee contributes, if it was subject to income tax, is not included as taxable income; while the employer’s portion and any portion that was contributed pre-tax to the pension is subject to income taxation.

Since Social Security benefits are not exactly the same as a pension, the calculation of the tax on benefits is only a rough estimate of the portion that might be considered as the “after tax” contribution of the employee, and then only at the time of the legislation. This calculation has only slightly changed over the years and as a result has no relation to any consideration of comparing Social Security benefits to pensions at this day and age.

From the beginning, Social Security benefits have been paid for by three sources: your own Social Security tax paid into the system, your employer’s Social Security tax paid into the system, and interest on the balance in the Social Security trust fund, invested in Treasury securities. As of 1983, these three sources weren’t enough to keep the trust fund liquid and regularly paying benefits as promised. In addition to increasing the payroll tax rate, increasing future benefit eligibility ages and other changes, the Social Security amendments of 1983 included the provision to tax Social Security benefits.

The nature of the original taxation was that a threshold was first allowed ($25,000 for singles and $32,000 for married couples), and above these amounts of provisional income* up to 50% of Social Security benefits would be included in taxable income. The revenue from this taxation is added to the appropriate Social Security trust fund as an additional revenue source.

*Provisional income is all other sources of taxable income, plus tax-free interest, plus 50% of the amount of Social Security benefits. Any amount of provisional income above the threshold, up to 50% of the total Social Security benefit, was included in taxable income.

The thresholds mentioned above were put into place to provide relief for low income individuals. These amounts are not in any way related to Social Security benefits, they are a pure function of tax law. The thresholds were intentionally not subject to future cost-of-living indexing, such that as time passes and inflation of incomes occurs, fewer and fewer beneficiaries will benefit from this relief. It was a hidden future benefit reducer mixed in with the legislation at the time. This has often come up as a question as well – “How come those thresholds are never increased? They’re woefully out of date!” It was intentional that they would eventually become less and less beneficial over time.

This arrangement continued for 10 years, when another adjustment was made.

1993 – up to 85% of Social Security benefits taxed

In 1993, as a part of the Omnibus Budget Reconciliation Act, a provision was added to bump up the included level of Social Security benefits taxed. Under this provision, a second threshold level was added: $34,000 for singles and $44,000 for married couples. When provisional income (see above) is greater than this second threshold level, up to 85% of Social Security benefits are included as taxable income. This 85% level is the maximum amount (under present law) that Social Security benefits are included as taxable income.

The reasoning behind this update was to bring the taxation of Social Security benefits into closer alignment with the way other retirement income is included as taxable income.

Once again, the thresholds are not indexed to inflation, so in the future these “relief” thresholds will become less and less beneficial to recipients and more Social Security benefits are included as taxable income, bolstering the trust fund further.

Let’s get back to the original question now. For further details see this article on how Social Security taxation works.

Why are Social Security benefits taxed?

Now that the history lesson is complete, let’s answer the question.

social security benefits taxed

Social Security benefits are not like a savings account, they’re more like an insurance product. The Social Security benefits that you receive are not based on the amount of tax that you paid into the system. Much the same as with your auto insurance, you shouldn’t think of it as putting X dollars in, so you should get X dollars back out. With auto insurance you’re paying money in so that if the adverse event occurs (you wreck your car), the insurance company will give you money to repair or replace the car. Social Security benefits insure against the adverse event of living too long. Regardless of how much you paid in taxes into the system, your Social Security retirement benefit will continue to be paid out to you no matter how long you live. And after you die, if you have a surviving spouse and/or qualified surviving dependents, they will continue to be paid as well.

Since these benefits are not directly tied to the amount you paid into the system, the amount you receive in benefits is effectively a retirement income. With the thresholds on provisional income and the levels of inclusion (0%, 50% and 85%) you are getting relief for a portion of the money that you did pay in as Social Security tax. Depending on your income level, it’s quite likely that the “relief” is a paltry amount and nowhere near what you paid in for taxes over the years – but that’s the nature of an insurance plan. Some folks come out way ahead with a very long life of benefits, possibly based on very little income by comparison. Others pay into the system for their entire careers and never receive a penny in Social Security benefits because they died before starting to receive the benefit.

Otherwise, if Social Security worked like a savings account, we’d see headlines all the time about folks in their 80’s and 90’s, dependent on Social Security benefits for a significant portion of their livelihood, discovering that they’ve “used up” the money they contributed over the years. And we don’t want that, right?

Don’t Forget the Saver’s Credit on Your Tax Return

saver's credit

Image courtesy of Salvatore Vuono at

Did you realize that there is a saver’s credit available to you for your contributions to retirement plans?  There are income limits, but if you fit the limits, this type of credit can be exactly what you need to get you started on your retirement savings activities.

Plan Now to Get Full Benefit of Saver’s Credit; Tax Credit Helps Low- and Moderate-Income Workers Save for Retirement

Low- and moderate-income workers can take steps now to save for retirement and earn a special tax credit in 2018 and the years ahead, according to the Internal Revenue Service.

The saver’s credit helps offset part of the first $4,000 workers voluntarily contribute to IRAs and to 401(k) plans and similar workplace retirement programs. Also known as the retirement savings contributions credit, the saver’s credit is available in addition to any other tax savings that apply.

Eligible workers still have time to make qualifying retirement contributions and get the saver’s credit on their 2018 tax return.  People have until April 15, 2019, to set up a new individual retirement arrangement or add money to an existing IRA for 2018. However, elective deferrals (contributions) must be made by the end of the year to a 401(k) plan or similar workplace program, such as a 403(b) plan for employees of public schools and certain tax-exempt organizations, a governmental 457 plan for state or local government employees, and the Thrift Savings Plan for federal employees.  Employees who are unable to set aside money for this year may want to schedule their 2019 contributions soon so their employer can begin withholding them in January.

The saver’s credit can be claimed by:

  • Married couples filing jointly with incomes up to $63,000 in 2018 or $64,000 in 2019;
  • Heads of Household with incomes up to $47,250 in 2018 or $48,000 in 2019; and
  • Married individuals filing separately and singles with incomes up to $31,500 in 2018 or $32,000 in 2019.

Like other tax credits, the saver’s credit can increase a taxpayer’s refund or reduce the tax owed.  Though the maximum saver’s credit is $2,000, $4,000 for married couples, the IRS cautioned that it is often much less and, due in part to the impact of other deductions and credits, may, in fact, be zero for some taxpayers.

A taxpayer’s credit amount is based on his or her filing status, adjusted gross income, tax liability and amount contributed to qualifying retirement programs.  Form 8880 is used to claim the saver’s credit, and its instructions have details on figuring the credit correctly.

The saver’s credit supplements other tax benefits available to people who set money aside for retirement.  For example, most workers may deduct their contributions to a traditional IRA.  Though Roth IRA contributions are not deductible, qualifying withdrawals, usually after retirement, are tax-free.  Normally, contributions to 401(k) and similar workplace plans are not taxed until withdrawn.

Other special rules that apply to the savers credit include the following:

  • Eligible taxpayers must be at least 18 years of age.
  • Anyone claimed as a dependent on someone else’s return cannot take the credit.
  • A student cannot take the credit.  A person enrolled as a full-time student during any part of 5 calendar months during the year is considered a student.

Certain retirement plan distributions reduce the contribution amount used to figure the credit.  For 2018, this rule applies to distributions received after 2017 and before the due date, including extensions, of the 2018 return.  Form 8880 and its instructions have details on making this computation.

Begun in 2002 as a temporary provision, the saver’s credit was made a permanent part of the tax code in legislation enacted in 2006.  To help preserve the value of the credit, income limits are now adjusted annually to keep pace with inflation.  More information about the credit is on

Thoughts on FIRE

As a financial planner it’s common to come across articles, blogs, and other material advocating individuals, especially those that are young to embrace FIRE. The acronym FIRE stands for Financial Independence Retire Early.

Essentially what this movement advocates is for individuals to save as much as they can, in order to retire early, preferably while young, and no longer be dependent on wages.

At first glance, this appears to be a great concept to embrace. After all, there are many individuals who would like to retire early and not have to worry about where the next paycheck is coming from.

However, the FIRE lifestyle is not a strategy to be taken lightly. Additionally, be wary of those selling the idea of FIRE, without having skin in the game.

Let me explain.

First, to retire early, and be financially independent requires an enormous amount of discipline and an extreme amount of frugality. The general recommendation for folks saving for retirement is 15-25% of gross income to an IRA or 401k. Those looking to FIRE, should aim for 50-75% of gross income.

Why so much?

Think of it this way. If someone retires early at age 30, and expects to live another 50 years, that’s 50 years of living off portfolio income! Keep in mind this portfolio income is still subject to volatility – so even in down years, withdrawals must be made.

So, an individual looking for FIRE, must be frugal while saving, but also while in retirement. There’s a lot of sacrificing to be done. This isn’t necessarily bad but should be considered.

Some articles report that FIRE individuals retired on $1 million, expecting to live off 4% annually, or $40,000. Personally, I think this is way too low. What if their investments decline? Is the 4% guaranteed? What about unforeseen expenses such as health care, education, etc.?

Additionally, people who FIRE, can expect their Social Security income to be small.

Second, play devil’s advocate with those selling the FIRE philosophy. I’ve read several articles and blogs from self-proclaimed FIRE folks that say they “retired early and so can you.” But after further inspection, they aren’t truly retired. They either have a spouse that still works, or they continue to earn income through their blog, side jobs, etc.

Again, none of this is bad, but is it really retirement or simply working from home? Could they maintain their FIRE lifestyle if they quit blogging, or working from home? This I question.

Finally, there’s nothing wrong with working. Many individuals receive great satisfaction from their job – giving a sense of purpose, pride, and contribution. Many individuals would could retire, choose to continue working for other reasons – money aside. They have a sense of purpose, and many love what they do. Why would they retire?

Personally, I have nothing wrong with FIRE. I think it’s a lifestyle choice that can work for many individuals. For individuals considering embracing the FIRE philosophy, it will be important to do their due diligence, prepare for extreme frugality, and save more than they expected. It’s not something to play around with; after all, we all know what happens when we play with fire…

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