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Why Inactivity Can Be Your Best Friend

When most of us think about the word inactive, we may think negatively – such as lounging around on the couch, being lazy, or apathetic to a given situation. Most of us feel the need to be active to promote a healthy lifestyle through exercise, perform optimally at our job, or being involved with our family. In many cases, this is valid.

There is one area where inactivity can be beneficial.

When it comes to investing, doing less can help us achieve the expected return we need on our portfolios, while keeping expenses as low as possible.

For many of us, this seems counterintuitive. Many of us can’t help but to do something, anything. Some of us may feel that if we are in control of our investments, we can impact their performance.

But the truth is for most us, we are not in control. We cannot control the markets. We cannot control the fluctuations. Being active in our portfolios to control volatility and returns is a frivolous endeavor.

What do I mean by active? Here are a few examples. Selling out of a stock or fund when it is underperforming, without any other basis for consideration. Just because an asset is underperforming doesn’t mean it should be sold. In fact, we should expect assets in our portfolios to underperform – to lose money from time to time. This means we are diversified.

Another example is buying an asset based on recent performance. Based on its recent good performance, we may feel it’s bound to keep going up. We may also feel the need to buy and sell based off news reports, market prognosticators, or tips from family and friends. This can lead to the temptation of day trading – a recipe for disaster.

To paraphrase the great Warren Buffett, much can be attributed to inactivity, but investors cannot resist the urge to do something.

What do we mean by inactivity? Inactivity means once we have our asset allocation determined, and have the appropriate diversification among the asset classes, we need to sit back and let our investments do their work. This keeps expenses low, transaction costs to a bare minimum, and more importantly, allows us to focus on things we can control – such as other areas in our wealth management planning.

I jokingly call this a “Rip Van Winkle” portfolio. Set it up, fall asleep for many years, then wake up and look at how much money you have. We’ll have save money, time, and energy by not trying to control what we can’t. And over time, we’ll find that we’ve done way better in our investments than those who are busy (and stressing) for the sake of being active.

Converting Directly From a 401(k) to a Roth IRA

converting directlyBack in the olden days prior to 2008, it used to be against the rules to convert funds directly from a 401(k) plan (or other CODA plan, like a 403(b)) to a Roth IRA.  At that time, you were required to do the “conversion two-step” wherein you would first rollover or direct-transfer your funds from the 401(k) plan to a traditional IRA, then do a conversion from the trad IRA into your Roth IRA.  This was an unnecessarily complicated process, and the IRS logically waited until it got ridiculous and then relented listened to taxpayers, allowing taxpayers the option of converting directly from these qualified retirement accounts into a Roth IRA.

This earlier process was needlessly complicated, and it often introduced additional room for taxation, especially if you have after-tax money in your 401(k) plan.

The process is identical to the process for converting directly from a traditional IRA to a Roth IRA.  You can make this conversion from your:

  • Employer’s qualified pension, profit-sharing or stock bonus plan (including a 401(k) or other plan),
  • Annuity plan,
  • Tax-sheltered annuity plan (section 403(b) plan), or
  • Governmental deferred compensation plan (section 457 plan).

You are allowed to convert all or part of the account. Prior to 2010, there was an income limit on converting directly to a Roth IRA from any account, but that limitation was eliminated. Any pre-tax amount converted must be reported as income in the year of the conversion. If your account includes after-tax amounts, there may be some fancy footwork involved but you may be able to convert the after-tax monies without tax or penalty.

The conversion can be done either via a direct trustee-to-trustee transfer or a rollover.  In general, the trustee-to-trustee transfer is the preferred method since a rollover involves making a check payable to you, which requires the payor to withhold 20% of the rollover. If your 401(k) administrator has the option available, you can request a non-direct rollover (check made out to the new IRA account), which will allow you to bypass the withholding requirement.

Any amount that is not successfully converted (via an indirect rollover) within 60 days would be taxable AND subject to the 10% penalty unless other conditions apply. In other words, when you convert these funds over to your Roth account, in order to pay the tax on the withdrawal you’ll need to either hold out a portion and pay the 10% penalty on those funds, or pay the tax from another source.

Auto Insurance Explained

Photo courtesy of Kyle Szegedi via

Most individuals who drive a vehicle have that vehicle insured (or should). In many states (including Illinois) auto insurance is mandatory. However, mandatory does not mean adequate. Even the phrase “full coverage” does not indicate adequate coverage for a person or family. The following is a breakdown of what coverages are generally provided on an auto policy, and some ideas regarding the amount those coverages should be.

A. This coverage is for you or a permitted driver of your vehicle that provides liability coverage in the event you are liable for bodily injury from an auto accident. This coverage provides bodily injury protection on a per person and per accident basis. There’s also coverage for property damage. Coverages are stated in thousands of dollars. For example, 250/500/100 means $250,000 of bodily injury protection per person, $500,000 total per accident, and $100,000 property damage coverage. Coverage amounts can be higher (or lower), but 250/500/100 is the minimum one should have.

B. Medical Payments. This coverage is provided to you and occupants of your vehicle for injuries sustained or for you if you’re struck by a vehicle while as a pedestrian (e.g. walking in a crosswalk and hit by a car). Coverage is usually from $1,000 to $5,000 per person, per occurrence.

C. Uninsured/Under-Insured Motorist. This coverage provides you and occupants of your vehicle coverage in the event another party is liable for your injuries and doesn’t have enough of their own insurance coverage (liability) to cover your injuries or they don’t have any insurance at all. Generally, these amounts are going to be identical to Coverage A amounts on your policy.

D. Coverage for Damage to Your Vehicle (Comprehensive and Collision). This coverage is what most people think of when they hear “full coverage”. Full coverage meaning there’s the required liability protection (Coverage A) along with the optional Coverage D (comp and collision). Let’s break comp and collision down further.

a. Comprehensive (or sometimes called Other Than Collision) is coverage for damage to your vehicle arising from theft, vandalism, colliding with a bird, deer, or other animal, glass damage, fire, hail. Generally, there a deductible involved (your sharing in the loss). After the deductible is met, then insurance pays the remainder for damages. Generally, the higher the deductible, the lower the premium. In many cases, damage from comprehensive losses are not considered at-fault (they won’t increase your premiums).

b. Collision is coverage for damage to your vehicle arising from hitting another car, running off the road, hitting a tree, driving into a lake. Like comprehensive, there will be a deductible involved after which the insurance company will pay for the damages. Unlike comprehensive, in most cases a collision claim will result in an at-fault accident that will likely raise your premiums.

c. For both comp and collision consider the age of the vehicle and the age of the driver. If the vehicle is older (10+ years) consider dropping these coverages and carrying liability only. If you have a young (teen) driver, consider rating he or she on a vehicle with liability only. Naturally, you may not have the choice if you have a lien on the vehicle. In that case, the lender may require comp and collision with specific deductibles.

Here are some other aspects of auto insurance that are good to know. In most cases, your coverage will extend to rental vehicles (check with your carrier to be sure). This means many individuals can skip the extra insurance pitched to them when renting a car while on business or vacation.

Insurance follows the vehicle. This means that if you borrow someone’s car or they borrow yours and there’s an accident, the insurance used first is the insurance that on the vehicle involved in the accident, regardless of driver.

Additionally, most policies will not provide coverage outside of the US. Some exceptions are Canada and within a certain distance inside the border of Mexico. Again, check with your specific carrier.

Finally, many carriers will specifically exclude coverage for auto racing, driving a vehicle without permission, business use, being an Uber or taxi driver, or regular use of a vehicle by a driver not underwritten on the policy.

As always, if you have any questions about auto insurance (or other insurance) feel free to contact us. Even though we don’t “sell” insurance, our office is licensed in insurance to give you the advice you need.

The Importance of IRA Custodial Documents

custodial documentsRemember when you opened your IRA account? And the broker or advisor handed you the 37-page custodial documents? Read that cover-to-cover, dintcha?

Unfortunately, too many of us don’t read these documents closely, and may end up getting a big surprise later on.  What sorts of surprises, you might ask…? Well, here are two major surprises that could await you:

Per Capita or Per Stirpes? If you have multiple beneficiaries of your IRA, how your IRA custodian determines between these two will be important to know. This difference will determine how your account will be distributed.  Here’s how – Per Capita means that, for example, if you have three equal beneficiaries designated on your account and one of the beneficiaries pre-deceases you, the account will then be split in two, between the two remaining beneficiaries.  If the account were to be split Per Stirpes, the two remaining beneficiaries would each receive a 1/3 share, and the beneficiaries (or the estate) of the deceased beneficiary would receive the remaining 1/3 share. Typically there is a check-box on the beneficiary form to help you designate your beneficiaries as you wish, and if not specified by you, ultimately the control comes down to the custodial documents.  This becomes even more important with the second consideration…

Divorced, but forgot to change beneficiary form? Depending upon the custodial agreement, the custodian could follow the court’s ruling, wherein the divorce decree may declare that all marital property is split as indicated and named in the document, with no other splitting to be done. Or, the custodian could go strictly “by the book”, where the beneficiary form indicates a specific individual as the primary beneficiary, regardless of any other outside document. And here is how the Per Stirpes/Per Capita issue becomes important in this case:  what happens if the former spouse is the only named beneficiary on the account (no secondary beneficiary(ies)), and the former spouse pre-deceases the account owner? If the custodian holds to the Per Stirpes definition, the former spouse’s heirs could reap the benefits of the account… scary huh?

So, in the end, it pays to know a little about the custodial documents on your IRA account, just so you don’t have any surprises.  If you don’t understand it or can’t follow what the document is telling you, make your advisor explain it to you – especially these two factors mentioned above.  That’s part of an advisor’s job – to advise you – and you’re paying them to do that sort of thing.

Who should do a mid-year tax checkup?

As a followup to my two posts last week on mid-year withholding checkup and estimated tax checkup, I found another notice from the IRS last week that pointed out there are certain groups of people really need to do amid-year checkup. This alert was part of the IRS’ communication IR-2018-80.

Special alert for key groups to check withholding

The IRS always recommends employees check their withholding at the beginning of each year or when their personal circumstances change to make sure they’re having the right amount of tax withheld from their paychecks.

Following the recent tax law changes, it’s especially important for certain people to use the Withholding Calculator on to check if they are having the right amount of withholding.

Among the groups, in particular, who should check their withholding are people who:

  • Belong to a two-income family.
  • Work two or more jobs or only work for part of the year.
  • Have children and claim credits such as the Child Tax Credit.
  • Have older dependents, including children age 17 or older.
  • Itemized deductions on their 2017 tax returns.
  • Earn high incomes and have more complex tax returns.
  • Received large tax refunds or had large tax bills for 2017.

“The IRS urges people in these groups to take a few minutes and review their withholding and tax situation,” Kautter said. “Taking this step will help avoid surprises next year at tax time. ”

The new law increased the standard deduction, removed personal exemptions, increased the child tax credit, limited or discontinued certain deductions, and changed the tax rates and brackets.

If you fit into one of those groups and need more information on how to do a mid-year withholding checkup, see the article at the link.

3 Ways to Do a Roth Conversion – Tax Free

tax free roth conversionIf you have money in an IRA and you’d like to do a tax free Roth conversion, you may be wondering just how to do it. There are actually several ways to do a tax free Roth conversion, and three very common options are listed below.

After-Tax IRA Contributions

If your traditional IRA is composed only of after-tax (non-deducted) contributions, you can convert those funds over to a Roth IRA without tax consequence.  This is because the funds were taxed before you contributed them to the IRA, and so no tax is due when you convert the funds to a Roth IRA. This often is the case if you have no other traditional IRAs and you’ve made non-deductible contributions to the account (often from income limitations). You can convert these non-deductible contributions from the traditional IRA to a Roth IRA with no tax consequences. The only tax (if this is your only traditional IRA and it only contains non-deductible contributions) is if there is any growth on the contributed funds, such as interest earned or capital gains that have occurred.

The “gotcha” in this is that the IRA must be ONLY non-deducted, after-tax contributions.  Plus this must be the only IRA that you have – see the article: Turns Out You CAN Be A Little Bit Pregnant for more details, including a way around the “Pregnant” Rule.

If you happen to have other IRAs or other, deducted contributions in the traditional IRA, it’s not the end of the world. You’ll just have more tax to pay on the Roth Conversion.

After-Tax Qualified Retirement Plan Contributions

If you happen to have after-tax contributions to a Qualified Retirement Plan (QRP) such as a 401k plan, these can be used for a tax free Roth Conversion if you’ve terminated employment or the retirement plan has terminated. You can do this without having to worry about the “Pregnant” rule I mentioned above.  This is because QRP funds are treated differently, and as such you are allowed to move specific contribution money separate from other contribution money (e.g., pre-tax contributions separate from after-tax contributions).

Also, if you have money in a Roth 401k, it’s not actually considered a conversion but you can rollover your Roth 401k money into a Roth IRA with no tax consequences, as long as your plan allows. Generally this means you have either reached age 59½ (for some plans; many do not allow in-service distributions), or you must have left employment with that employer.

Zero Tax Bracket

If you have no or very low taxable income, that is, if you’re below the 10% tax bracket, any funds that you distribute from your traditional IRA up to the limit – which would be your AGI minus your exemptions and itemized or standard deductions and any tax credits – would be tax free.  Granted, this is likely to be a somewhat small amount for most people in this situation, but for others, such as business owners or farmers with carried-over Net Operating Losses, it could be sizeable.  See the linked article for more information on NOL carryovers and Roth IRA conversions.

Photo by Phillip

Mid-year estimated payments checkup

estimated payments checkup calculatorAs a retiree, you may have a bit more difficulty determining if your withheld tax throughout the year is going to be enough. This is especially true in 2018, with the new tax tables and rules associated with the Tax Cuts and Jobs Act of 2017. For this reason, you may want to do a mid-year estimated payments checkup, to help ensure you’re having enough (but not too much) tax withheld.

If you’re not retired or are retired and still working part-time, you may want to check out the Mid-year withholding checkup article to help make sure you have enough tax withheld.

There are commercial programs available to help you figure this out (check with your tax preparer or tax software), or you can use the IRS Form 1040ES to help you work through an estimated payments checkup. I’ll briefly describe the process below using Form 1040ES.

Estimated payments checkup

Go to the IRS website ( and search for Form 1040ES. The form itself includes the instructions for filling out the form, as well as vouchers that you can use to make estimated payments (if needed). This will help you with your mid-year estimated payments checkup.

You’ll need to gather quite a bit of information together for this form. I’ll step you through the process (high level) below, so that you’ll have an idea of everything you’ll need when you start working through the form.

You need to estimate your income for the year. This may include pensions, annuities, required minimum distributions (RMDs) from IRAs, 401k’s and other plans, plus interest, dividends, any rental, partnership or corporate income, and your Social Security benefits. Go ahead and project the total amount that you’ll receive from each source through the end of the tax year. For most of these payments, if they occur monthly you can just multiply the monthly amount by 12. If it’s a quarterly payment, multiply by 4. If it only comes once a year, just project the total amount to the best of your knowledge (use last year’s tax return and documents to help you with this process). Make sure that you count the gross amount, not the net check that you receive after taxes and other deductions!

Next, if you’re having money withheld from any of these payments, go ahead and project that amount for the year as well – just the same as you did with the payments you receive.

You’ll also need to understand a few things about your tax return filing in order to fill out Form 1040ES properly:

  • Filing status
  • Can anyone else claim you as a dependent? Same for your spouse if filing jointly.
  • How many jobs have you worked (or will you work) in 2018? Same for your spouse.
  • Will you or your spouse receive a taxable scholarship or grant in 2018?
  • Are you or your spouse age 65 or older in 2018? Blind?
  • Number of dependents (not including spouse) to claim on your 2018 return.
  • Number of children that will be claimed for child-care expenses, child tax credit, and earned income credit

You’ll need to estimate your deductions next. If you’ve always used the standard deduction in the past, chances are you’ll continue to use the standard deduction in 2018. If you have had circumstances change, such as buying a house, moving to a higher-tax state, you’ve made significant contributions to charity, or you have significant medical expenses (beyond insurance coverage), then you’ll want to go through the exercise of calculating your itemized deductions. The calculator steps you through the process of estimating your taxes, medical expenses, interest paid on mortgages, charitable contributions and other itemized deductions.

When you have all of the above information together, you can work your way through Form 1040ES and calculate any shortfall that you will have in withheld tax. The form is designed to limit your withheld tax to the minimum before a penalty is applied. This means that you only have to withhold 90% of the current year’s tax, or 100% of the previous year’s tax, and your shortfall can be up to $1,000 before a penalty applies to your situation.

Understand that you may owe as much as $1,000 or more in tax when you file your tax return if you follow Form 1040ES to the letter!

Your result will help you to determine what the amount of estimated payments are that you may need to make for the year (if required). You can also make adjustments to withholding on any of your income sources to make up a withholding shortfall, by submitting a new W-4P form to your pension administrator, for example.

Mid-year withholding checkup

This little guy just had a withholding checkup - important to make sure he is having enough tax withheld from his pay.Now that we have a few months’ worth of the new tax tables (from the Tax Cuts and Jobs Act of 2017) under our belts, it’s a good idea to do a withholding checkup against your paycheck. A withholding checkup is a common exercise that many people perform to make sure that they are having enough, but not too much, tax withheld throughout the year. You can do a withholding checkup at any point in the year (after at least one paycheck), so feel free to use this process later in the year as you see fit.

Note to retirees: this withholding checkup will not work correctly for you. You will need to review the Mid-year Estimated Payments Checkup to make sure you have the proper amount of tax being withheld from your various sources, and whether or not it is necessary for you to make estimated payments throughout the year.

The good news is that the IRS has a calculator available that can help you do the withholding checkup. If you go to the IRS’ website ( and search for “tax withholding”, you will be able to access the Withholding Calculator – or just click the link to go to the Withholding Calculator page directly. Have your most recent pay-stub available when you go to the calculator.

Mid-year withholding checkup

As you work through the calculator, you’ll need to know a few things about your tax return, so it will be handy to have a copy of your 2017 return available (or at least know the answer to the questions below):

  • Filing status
  • Can anyone else claim you as a dependent? Same for your spouse if filing jointly.
  • How many jobs have you worked (or will you work) in 2018? Same for your spouse.
  • Do you have a 401k, cafeteria plan (such as healthcare or child-care) through your employer? Same for spouse.
  • Will you or your spouse receive a taxable scholarship or grant in 2018?
  • Are you or your spouse age 65 or older in 2018? Blind?
  • Number of dependents (not including spouse) to claim on your 2018 return.
  • Number of children that will be claimed for child-care expenses, child tax credit, and earned income credit

You’ll also need the specific information from your pay-stub: gross income, bonuses, deferred income (to a retirement plan), how much is being withheld for income tax (be careful and only count the income tax, not Social Security or Medicare tax, or FICA), and how many pay periods are remaining. For all of this information, you will need the current pay period amount and the total year-to-date amount, as well as how often you are paid, with how many pay periods are remaining. You’ll need to gather this information for each job that you hold or intend to hold through the year.

Next, you’ll add in any non-wage income – such as rental income, interest and dividends, or partnerships and corporation income. You’ll also estimate any reductions to income that you may have, such as deductible contributions to an IRA. If you’re not sure about these numbers (and who could be, this early in the year?) then just use the figures from your 2017 tax return.

After that, you’ll need to estimate your deductions. If you’ve always used the standard deduction in the past, chances are you’ll continue to use the standard deduction in 2018. If you have had circumstances change, such as buying a house, moving to a higher-tax state, you’ve made significant contributions to charity, or you have significant medical expenses (beyond insurance coverage), then you’ll want to go through the exercise of calculating your itemized deductions. The calculator steps you through the process of estimating your taxes, medical expenses, interest paid on mortgages, charitable contributions and other itemized deductions.

The result will show you how you should make changes (if needed) to your W-4 with each employer. If you make these changes, your withholding should be adjusted to fit your income tax needs for the current year.

It is critical that, if you make changes to your W-4 as a result of this withholding checkup, you should come back and re-check again early in the following year to make sure everything is set up correctly for the coming year.

Early Withdrawal from Retirement Plans

Six-twenty is an early withdrawal time.If you are retiring before the “normal” retirement age of 59½ or older, or if you find yourself in need of money, you may need to make an early withdrawal from your retirement plan. An early withdrawal from your retirement plan is not without consequences – there will be taxes for sure, and quite possibly (likely?) penalties (referred to as “additional tax on early withdrawals” below). For exceptions to the early withdrawal penalty for IRAs, see this article. Otherwise, for exceptions to the early withdrawal penalty for a 401k, see this article.

Recently the IRS published Tax Tip 2018-40, which details some items that you need to remember as you consider an early withdrawal from a retirement plan. The actual text of their Tip is below.

Things to Remember when Considering Early Withdrawal from Retirement Plans

Many taxpayers may need to take out money early from their Individual Retirement Account or retirement plan. Doing so, however, can trigger an additional tax on early withdrawals. They would owe this tax on top of other income tax they may have to pay. Here are a few key points to know:

  • Early withdrawals. An early withdrawal is taking a distribution from an IRA or retirement plan before reaching age 59½.
  • Additional tax. Taxpayers who took early withdrawals from an IRA or retirement plan must report them when they file their tax return. They may owe income tax on the amount plus an additional 10 percent tax if it was an early withdrawal.
  • Nontaxable withdrawals. The additional 10 percent tax doesn’t apply to nontaxable withdrawals, such as contributions that taxpayers paid tax on before they put them into the plan.
  • early withdrawal can come with a penaltyRollover. A rollover happens when someone takes cash or other assets from one plan and puts it in another plan. They normally have 60 days to complete a rollover to make it tax-free.
  • Exceptions. There are many exceptions to the additional 10-percent tax. Some of the rules for retirement plans are different from the rules for IRAs.
  • Disaster Relief. Participants in certain disaster areas may have relief from the 10-percent early withdrawal tax on early withdrawals from their retirement accounts.
  • File Form 5329. Taxpayers who took early withdrawals last year may have to file Form 5329,  Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, with their federal tax returns.

Use IRS e-file. Early withdrawal rules can be complex. IRS e-file can help. It’s the easiest and most accurate way to file a tax return. The tax preparation software that taxpayers use to e-file will pick the right tax forms, do the math and help get the tax benefits they’re due. Seven out of 10 taxpayers qualify to use IRS Free File tax software. Free File is only available through the IRS website.

What Makes Up the Family Maximum Benefit?

This fella is having trouble figuring out what is in his FMB.As reviewed in the article The Family Maximum Benefit (Retirement), there is a maximum amount that can be paid on a particular Social Security record.  As you’re planning for your family’s benefits, it is important to know what is involved in establishing the maximum benefit, as well as what can be impacted by the maximum limit.

What’s Not Included

Maybe it would be easiest to point out a few things that don’t go into the calculation for the Family Maximum limit:

  • Ex-spouse spousal benefits are not included
  • Ex-spouse survivor benefits are not included
  • Any delayed retirement credits on the primary beneficiary’s record are not included
  • Any PIA amount of a dually-entitled spouse (spousal benefits in excess of the recipient’s PIA are included)

So – with those items excluded, that leaves us with the question of what IS included:

What Is Included

Included in calculating the Family Maximum benefit limit would be everything else that wasn’t specifically excluded, based upon the primary recipient’s record:

  • Primary beneficiary’s benefit, up to the Primary Insurance Amount
  • Spousal Benefits for a current spouse (not an ex), but only the amount above the PIA of the recipient
  • Survivor Benefits for the spouse who was married to the primary beneficiary at the date of death
  • Child’s benefits
  • Spouse benefits for a spouse caring for young children under age 16
  • Other beneficiary benefits, including aged parents, other dependents, etc.

What Can Be Impacted by FMB

Once the Family Maximum Benefit amount is calculated, certain benefits can be reduced as a result (if the maximum is breached).  First of all, it’s important to note that those benefits mentioned in the “What’s Not Included” section above are not subject to reduction by the FMB.  In addition, the primary beneficiary’s retirement or disability benefit would also not be reduced by a limit imposed by FMB.

All of the other, secondary benefits, such as survivor benefits by the last-current spouse, spousal benefits, child’s benefits, and other beneficiary benefits can be reduced.  Each benefit is reduced pro-rata depending on the FMB figure that has been developed.

Example of FMB calculation

So let’s work through an example: John, age 70, just filed for his retirement benefit, in the amount of $3,000.  His Primary Insurance Amount (PIA) is $2,273.

John was married twice previously, to Jane first (age 62) and then to Sally (age 63), and each of those marriages lasted more than ten years.  He married his current wife, Celeste (age 30), three years ago and they have newborn triplets.

The family maximum benefit is calculated as follows (2012 figures, the year John reached age 62):

1) 150% of the first $980 = $1,470

2) 272% of the next $435 = $1,183

3) 134% of the next $430 = $576

4) 175% of the remaining PIA ($428) = $749

5) adding these up ($1,470 + $1,183 + $576 + $749) = $3,978 <= this is the FMB limit for John’s record

Now, we know that Jane’s spousal benefit and Sally’s spousal benefit are not included in the FMB.  Additionally, John’s Delayed Retirement Credit ($727) is also not included.  The following benefits are included in determining if the FMB has been reached:

  • John’s PIA of $2,273
  • Celeste’s benefit for caring for the children of $1,136 (half of John’s)
  • Each child’s benefit of $1,136 (x3 = $3,408) (also half)

For a total of $6,817, which is $2,839 more than the FMB.  Since John’s PIA amount cannot be reduced, Celeste’s and the childrens’ benefits will be reduced at a rate of 58% less than their original amounts – to $477 for each of the benefits.  (That calculation was done by taking the full FMB, subtracting John’s PIA, and then splitting up the remaining amount pro rata among the other beneficiaries.)

Now, if Celeste was at or older than her FRA, the computation would be adjusted based on Celeste’s benefit based on her own record. With the example above, let’s say Celeste is 66 (her FRA) and she has a PIA of $1,000 based on her own lifetime earnings. This is because Celeste is dually-entitled – first to her own benefit of $1,000, and second to a spousal excess benefit of $136. The first $1,000 of benefits that Celeste can receive are not counted toward the family maximum benefit. In fact, her “excess” spousal benefit amount of $136 is subtracted from the total of family maximum benefits (right after John’s PIA), and the remainder is split among the 3 children.

  • Original FMB – $3,978
  • Minus John’s PIA – $3,978 – $2,273 = $1,705
  • Minus Celeste’s excess Spousal Benefit – $1,705 – $136 = $1,579
  • Divided among the 3 children – $1,579 ÷ 3 = $523

So each child receives $523, Celeste receives $1,136, and John gets his DRC-enhanced benefit of $3,000.

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.

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