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Note: you can find the first part of this discussion of Social Security Survivor Benefits at the link. Part 1 covered the basics of Survivor Benefits, and this article covers other considerations with the Survivor Benefit, including non-spouse survivor’s benefits and coordinating the Survivor Benefit with your own benefit. As mentioned in the prior articles, don’t expect to fully understand these calculations and definitions in the first run-through. Check over the other articles (Part 1 here, Spouse Benefits here and especially the further explanation of Spouse Benefits here) for more information, and post questions in the comment section if they come up.

Coordinating the Survivor Benefit With Your Own Benefit

The Survivor Benefit is exclusive of the surviving spouse’s own retirement benefit. If the surviving spouse is eligible for a retirement benefit that is greater than the Survivor Benefit, only the greater of the two will be payable.

Technically the surviving spouse can choose between the two benefits, if he or she is eligible for both at the same time. This can work to the surviving spouse’s advantage if the Survivor Benefit was taken early. By starting the Survivor Benefit early, the Surviving Spouse could wait to take his or her retirement benefit, allowing this retirement benefit to earn the delayed retirement credits up to as late as age 70. This generally amounts to an increase in the retirement benefit of 8% for each year delayed beyond Full Retirement Age.

Here’s an example – Dick and Jane, both age 62 with retirement benefits available when they reach Full Retirement Age of $2,000 and $1,300, respectively. Neither of them has filed for Social Security retirement or Spousal Benefits. Dick has recently passed away.

If we run the calculation, we find that Dick’s current-age benefit would have been 75% of his Full Retirement Age benefit of $2,000 since he would be 62 at this date. (You can take my word for this reduction, or you could look it up on the table in the earlier article.) Then, if Jane was to apply for Survivor Benefits at this age, her benefit would be further reduced by the early filing, a 19% reduction from the table above.

So here’s the calculation for the Survivor Benefit: Dick’s Full Retirement Age Benefit is $2,000, reduced to 75%, or $1,500. That amount is then reduced by the 19% reduction factor, since Jane is filing early for Survivor Benefits, to total $1,215.

Notice that Jane’s own benefit at Full Retirement Age would be greater than this reduced Survivor Benefit – but at this point, her own benefit would be 75% of $1,300, or $975. So Jane could start taking the reduced Survivor Benefit now, and then later at Full Retirement Age she could switch over to her own retirement benefit, which would be the full $1,300 (plus Cost-of-Living Adjustments), or even later to age 70 when the delayed retirement credits would apply, making her own benefit even greater.

Non-Spouse Dependents

Survivor Benefits aren’t only for spouses. Other dependents can be eligible for Survivor Benefits as well. These dependents include children, grandchildren, and even parents, if they qualify. Just like leaving a sinking boat, children first.

Children

The children of a deceased Social Security participant can be eligible for a Survivor Benefit of 75% of the participant’s Primary Insurance Amount or PIA (effectively the amount of benefit that the participant would receive at Full Retirement Age) if the child is under age 18. As long as the child was the dependent of the deceased participant, whether his or her own son or daughter, step-child, or grandchild, and the deceased participant provided at least half of the support for the child, this Survivor Benefit is available. The child didn’t have to live with the late parent to be eligible.

In addition, the surviving mother or father of the dependent child described above is also eligible for a Survivor Benefit at any age (less than FRA), equal to 75% of the Primary Insurance Amount of the deceased participant. This benefit is available until the child or children are age 16 (no age limit if the child is disabled and entitled to benefits). The only remaining qualification is that the surviving spouse and the deceased participant must have been married for at least 9 months (less if the death is accidental). A divorced spouse can receive this benefit if he or she was married to the decedent for at least 10 years.

Parents

The parents of a deceased participant may be eligible for Survivor Benefits as well, if they were considered dependents of the deceased. If the parents were receiving more than half of their support from the deceased participant and they are over age 62, they can be eligible for this benefit.

If there is only one parent surviving the participant, the Survivor Benefit is equal to 82.5% of the Primary Insurance Amount of the deceased participant. If there are two surviving parents and both are eligible, each would receive a benefit of 75% of the Primary Insurance Amount.

This benefit is exclusive to any retirement benefit that the parents may have available to them. If the parent is eligible for a retirement benefit that is greater than the Survivor Benefit, he or she (or both of them) may receive the Survivor benefit at age 62 (with no reduction) and then later switch over to the retirement benefit at Full Retirement Age or later.

Maximum Family Benefit

Each of these Survivor’s Benefits could be limited by a Maximum Family Benefit that each family unit must adhere to. Essentially there is a limit prescribed by the Social Security Administration on the amount of benefits, based upon the deceased participant’s Primary Insurance Amount (a good explanation of the Primary Insurance Amount and Full Retirement Age can be found by clicking this link). The Maximum Family Benefit ranges between 150% and 180% of the Primary Insurance Amount. Once total benefits exceed the limit, each recipient’s benefit is reduced by the same ratio down to the limit. For a detailed explanation of the Maximum Family Benefit, click the link.

So that completes our discussion of Survivor Benefits. For more information on any of these factors, click the links within the text above – and you can also find all of this information in the book A Social Security Owner’s Manual. If you have comments and questions, I invite you to leave post them below and we’ll try to work out answers for you.

Posted on Dec 2nd, 2024

by author: jblankenship.

Posted in: social security benefits, social security survivor benefits, spousal benefits.
Tagged: social security benefits · social security survivor benefits

The Social Security Survivor Benefit – Part 1

Dec 2nd, 2024

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In a previous article we reviewed the very confusing Social Security Spousal Benefit. That article raised a lot of questions from readers about another confusing provision of the Social Security system: the Survivor Benefit.

As with all of these discussions, don’t expect to immediately understand it – this stuff is complicated, and even the Social Security staff often have difficulty explaining it. Read through this carefully, see the referenced articles for background, and then re-read as needed. And ask questions if you have them.

The Survivor Benefit is not related to the Spousal Benefit, although certain portions of the article with further explanations of the Spousal Benefit will be useful to review as we discuss the Survivor Benefit.

To start with, there are two benefits available to the spouse of a deceased Social Security participant. The first is a small death benefit, amounting to $255 in a one-time payment. The second is the Survivor Benefit, which is a lifetime benefit based upon the deceased participant’s benefit amount at his or her current age.

The Survivor Benefit is generally equal to the deceased worker’s benefit amount (if he or she was collecting benefits at death), and then reduced depending upon the surviving spouse’s age. This is similar to the reduction that is applied to regular retirement benefits. One major difference is that Survivor Benefits can be claimed as early as age 60, rather than age 62 as with regular retirement benefits. At age 60, the Survivor Benefit is reduced to 71.5% for all dates of birth (we’ll get to more on this later).

In addition to the fact that the Survivor Benefit can be received two years earlier than the normal age of 62, the table for Full Retirement Age (FRA) is shifted by two years:

Year of Birth	Survivor’s FRA
1939 or before	65
1940	65 and 2 months
1941	65 and 4 months
1942	65 and 6 months
1943	65 and 8 months
1944	65 and 10 months
1945-1956	66
1957	66 and 2 months
1958	66 and 4 months
1959	66 and 6 months
1960	66 and 8 months
1961	66 and 10 months
1962 or later	67

This means that your Full Retirement Age for Survivor Benefits could be offset by a couple of years from that for your own retirement benefit.

Calculation

Now to add some more complexity to the situation. In order to calculate the Survivor Benefit, we have two factors to consider:

1. The amount of benefit that the deceased spouse would be receiving had he or she survived to this age; and

2. The age of the surviving spouse.

The First Factor: Benefit of the Deceased Spouse

When determining the value of the First Factor, you first need to know whether or not the deceased spouse was currently receiving benefits at the time of his or her death. If so, the First Factor is equal to the present benefit that the deceased spouse was receiving at the time of his or her death plus any Cost of Living Adjustments that would have been applied if time has passed between the death and the survivor applying for benefits.

It’s important to note here that when the deceased spouse was already receiving benefits, any reductions or increases that had been applied are also applied to the Survivor Benefit. For this reason, it’s critical to consider the implications when taking retirement benefits early – doing so can permanently reduce any Survivor Benefit that your spouse might receive should you die first. If the deceased spouse began benefits early and was receiving a reduced benefit, the survivor is guaranteed the higher of the deceased spouse’s benefit or 82.5% of the deceased spouse’s PIA.

On the other hand, if the deceased spouse is not already receiving benefits, if the deceased spouse dies at FRA or later, the First Factor is the amount that the decedent would have received at the current age, if he or she were still living. Otherwise, if the deceased spouse dies before FRA and had not yet begun receiving retirement benefits, the surviving spouse is eligible for a benefit equal to 100% of the deceased spouse’s PIA.

This makes the whole process a lot more complicated to understand, but here’s how it works: If the decedent spouse would have been at Full Retirement Age (FRA) at the time that the survivor applies for benefits, then the First Factor of our equation is based upon his or her Primary Insurance Amount, or PIA. If you’ll recall, the Primary Insurance Amount is the amount of benefit that an individual receives in Social Security benefits at Full Retirement Age.

If the deceased spouse would have been younger than Full Retirement Age when the surviving spouse is filing for benefits and had not filed for benefits as of death, the First Factor is equal to the Primary Insurance Amount. However, if the deceased spouse would have been older than Full Retirement age when the Survivor Benefit is applied for, there is an increase applied to the Primary Insurance Amount. These reductions and increases are explained more completely via the tables in the article that provides further explanations of the provisions of the Social Security system.

The First Factor amount should be relatively easy to come up with, either from prior statements or by giving in and calling the Social Security Administration and getting the proper number.

So now that we have the First Factor figure, let’s move on to the Second Factor.

The Second Factor: Age of the Surviving Spouse

As mentioned previously, the Survivor Benefit can be available as early as age 60. And as with all Social Security benefits, filing at an age earlier than Full Retirement Age (FRA) will result in a reduction of benefits, with a graduated elimination of the reduction as the surviving spouse approaches the Full Retirement Age for Survivor Benefits.

The reductions at various ages are listed in the table below by the surviving spouse’s year of birth:

Year of Birth	60	61	62	63	64	65	66	67
1939 or before	-28.5%	-22.8%	-17.1%	-11.4%	-5.7%	0.0%
1940	-28.5%	-23.0%	-17.5%	-12.0%	-6.4%	-0.9%
1941	-28.5%	-23.2%	-17.8%	-12.5%	-7.1%	-1.8%
1942	-28.5%	-23.3%	-18.1%	-13.0%	-7.8%	-2.6%
1943	-28.5%	-23.5%	-18.4%	-13.4%	-8.4%	-3.4%
1944	-28.5%	-23.6%	-18.7%	-13.8%	-9.0%	-4.1%
1945 to 1956	-28.5%	-23.7%	-19.0%	-14.2%	-9.5%	-4.7%	0.0%
1957	-28.5%	-23.9%	-19.3%	-14.6%	-10.0%	-5.4%	-0.8%
1958	-28.5%	-24.0%	-19.5%	-15.0%	-10.5%	-6.0%	-1.5%
1959	-28.5%	-24.1%	-19.7%	-15.3%	-11.0%	-6.6%	-2.2%
1960	-28.5%	-24.2%	-19.9%	-15.7%	-11.4%	-7.1%	-2.8%
1961	-28.5%	-24.3%	-20.2%	-16.0%	-11.8%	-7.6%	-3.5%
1962 or later	-28.5%	-24.4%	-20.4%	-16.3%	-12.2%	-8.1%	-4.1%	0.0%

As you can see, at age 60, the reduction is 28.5% for all dates of birth. Then the reduction factor is gradually eliminated up through the Survivor Benefit Full Retirement Age.

The Calculation

Now that we have our two factors, the amount of the deceased spouse’s benefit and the age/reduction factor for the surviving spouse, we move on to the actual calculation. The reduction factor is simply applied to the deceased spouse’s benefit.

For example, let’s say that the deceased spouse’s benefit would have been $1,500, and the surviving spouse is 62 years old. If the surviving spouse were to take the Survivor Benefit beginning today, the $1,500 would be reduced by 19.0%, to $1,215 (the 19.0% figure is based upon the table above – the surviving spouse is 62, so he or she was born in 1949 or 1950). Waiting another four years would allow the surviving spouse to receive the full benefit (with no reduction), plus any Cost-of-Living Adjustments (COLAs) that would be applied between now and that date.

Additional Facts About the Survivor Benefit

There are a few more facts that could change the situation completely.

First of all, if the surviving spouse has remarried before age 60, the Survivor Benefit is no longer available to him or her. If the surviving spouse re-marries before age 60 and then subsequently divorces or is subsequently widowed again, the Survivor Benefit is once again available. And if the surviving spouse has more than one late spouse, he or she is eligible to receive Survivor Benefits based upon the highest possible benefit from any of the prior spouses.

In addition to the Survivor Benefit that is available as early as age 60, there is also a Survivor Benefit available for a (potentially) much younger surviving spouse if that survivor is caring for a child aged 16 or younger. This benefit is equal to 100% of the benefit that the decedent-spouse was receiving at his or her death, or the Primary Insurance Amount on his or her record, if he or she was not currently receiving benefits at death.

All of the benefits are dependent upon the fact that the deceased spouse has earned adequate quarters of credit with the Social Security system. For full benefits, the deceased would need to have earned at least 40 quarters, or ten years of work earning (for 2025) $1,810 per quarter or $7,240 for the year. For the surviving spouse caring for a child younger than age 16, reduced benefits are available if the deceased spouse had earned at least 6 quarters of credit in the three years prior to his or her death. Any amount of quarters between the minimum of 6 and the maximum of 40 would allow for a phased increase in the benefit amount.

If a person was married to the deceased spouse for at least 10 years and was divorced, the Survivor Benefit is available just the same as if the couple had not divorced (as long as he or she has not remarried prior to age 60, as mentioned above).

Lastly for now, if the surviving spouse is disabled, the Survivor Benefit could be available as early as age 50, with the same reduction as for a non-disabled surviving spouse at age 60, 28.5%.

Okay, this is enough for Part 1. In Part 2, I’ll cover some of the other types of Survivor Benefits – for children and other beneficiaries – as well as to review coordinating the Survivor Benefit with the surviving spouse’s own benefit. If you’ve got more questions, please leave them as comments, or if you’d like more information I invite you to check out my book, A Social Security Owner’s Manual.

Posted on Dec 2nd, 2024

by author: jblankenship.

Posted in: social security benefits, social security survivor benefits, survivor benefits, survivors.

Using An IRA Rollover to Eliminate Federal Spousal Rights

Nov 25th, 2024

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Qualified Retirement Plans (QRPs), which include 401(k), 403(b) and many other employer-based plans, are governed by federal law under ERISA. One of the tenets of ERISA is that there are certain rights for the spouse of the employee-participant in the plan. One of those rights is that the spouse must consent to any distribution from that plan that is in the form of anything other than a Qualified Joint and Survivor Annuity (QJSA).

Depending upon your circumstances, this might not be the way you would like for things to work out. For example, if you’re planning to get married and you want to ensure that your future spouse doesn’t control distributions from your retirement plan, you could rollover your QRP to an IRA before your marriage – because an IRA isn’t covered by ERISA like the QRP is. A prenuptial agreement could be used to limit a spouse’s rights to an IRA, but it cannot usurp the ERISA rules.

If you’re already married and you have a reason to consider this option, hopefully it’s not because there are storm-clouds on the horizon for your marriage. If this is the case, you will likely have some difficulty in enacting this rollover. The problem, as mentioned before, is that the spousal rights provision requires that your spouse signs off on any distribution other than the QJSA.

If you’re going through a divorce, it’s possible that you’d need to have your ex-spouse sign off on a distribution from your QRP if the QRP isn’t part of the assets to be split. If the QRP isn’t being split for the divorce, you’ll want to make sure that you have a statement in the decree that ensures that the QRP is positively identified as belonging solely to you. Otherwise, your ex could make a claim against a portion of your QRP later, under ERISA.

Bear in mind that the spousal distribution rights from the QRP also apply to death benefits from the plan, in addition to lifetime benefits.

One other thing to keep in mind is that your own state’s law may provide rights to your IRA to your spouse anyhow. If that is the case, the rollover to the IRA may not have the effect you expected.

Posted on Nov 25th, 2024

by author: jblankenship.

Posted in: IRA, qrp, qualified retirement plan, retirement plan.
Tagged: IRA · qrp · qualified retirement plan

The Social Security Spousal Benefit – Further Explanation

Nov 11th, 2024

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

Following up my article which provided several brief examples of the Social Security Spousal Benefit, I thought I’d provide some further explanation and background for the provision. It appears from some of the feedback I have received that there is a great deal of confusion over this provision, so hopefully the further background explanation that I’m providing here will be of help.

I have listed below several additional background details about how the Social Security System works, in order to help you better understand the prior article.

Additional Background Explanation

As stated at the outset of the previous article, this is one of the most confusing provisions of the Social Security system. Don’t expect to fully understand the tenets of the provision in a brief reading – you’ll want to read through the examples carefully, comparing each example to your own situation and considering the outcomes.

1. In the original article, I used two acronyms in my explanations, both of which were explained briefly at the outset of the article. I’ll explain and define each of them further here.

FRA – Full Retirement Age. This is the age at which you would become eligible for your full Social Security benefit (also known as your Primary Insurance Amount, which we’ll get to next). It used to be that FRA (Full Retirement Age) was 65 for all people – but with the 1983 amendment to the system, the age was gradually increased. Full Retirement Age (FRA) depends on your year of birth, according to the table below:

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

PIA – Primary Insurance Amount. This amount is, for most folks*, equal to the amount that you would receive at Full Retirement Age (FRA). This figure is the primary figure against which all calculations are run for figuring your retirement benefit, and for calculating a Spousal Benefit for your wife or husband.

* If an individual is also receiving a pension from a job which was not subject to Social Security withholding taxes, such as a teaching job or a federal, state or local government job, certain reductions will likely apply. You can read more about the impact of these non-Social Security jobs at this article which explains the Windfall Elimination Provision and the Government Pension Offset (WEP and GPO respectively, if you’d like more acronyms).

2. There is a minimum age at which you become eligible for Social Security retirement benefits, and this is the same for all people, 62. If you file at this age (or at any age before Full Retirement Age), you will be subject to a reduction from your Primary Insurance Amount (PIA) based upon the number of months you’re filing before Full Retirement Age. It’s a somewhat complicated formula (but then again, what about this system isn’t?) so rather than explaining how to build a watch I’ll show you what time it is.

The table below shows the reduction factors for various ages and years of birth. You’ll need to find the row for your Year of Birth, and then work your way across to the right for your reduction factor at various ages. Space limitations don’t allow us to display every possible age (limited to exact years), but you can get the idea of how the reduction works for ages in-between.

Year of Birth	62	63	64	65	66	67
1937 or before	-20.00%	-13.33%	-6.67%	0.00%
1938	-20.83%	-14.44%	-7.78%	-1.11%
1939	-21.67%	-15.56%	-8.89%	-2.22%
1940	-22.50%	-16.67%	-10.00%	-3.33%
1941	-23.33%	-17.78%	-11.11%	-4.44%
1942	-24.17%	-18.89%	-12.22%	-5.56%
1943 to 1954	-25.00%	-20.00%	-13.33%	-6.67%	0.00%
1955	-25.83%	-20.83%	-14.44%	-7.78%	-1.11%
1956	-26.67%	-21.67%	-15.56%	-8.89%	-2.22%
1957	-27.50%	-22.50%	-16.67%	-10.00%	-3.33%
1958	-28.33%	-23.33%	-17.78%	-11.11%	-4.44%
1959	-29.17%	-24.17%	-18.89%	-12.22%	-5.56%
1960 or later	-30.00%	-25.00%	-20.00%	-13.33%	-6.67%	0.00%

To use this table, find your Year of Birth in the first column. Move right until you reach the age that you wish to begin early benefits. This figure is the amount of reduction from your Primary Insurance Amount (PIA, see the explanation above) that you will experience by filing at this age.

At the earliest filing age of 62, for a person who was born in 1960 or later the reduction factor will be -30%. In other words, if this person files for benefits at age 62, the benefit would be 70% of the amount that this person would receive if he or she waited until Full Retirement Age (FRA) of 67 to file for benefits.

(FYI – there is also a maximum age for all people, after which your Social Security benefit will no longer earn delayed credits, and that is age 70. Delaying receipt of your benefit after Full Retirement Age causes an increase to your benefit, up to age 70.)

3. A Spousal Benefit can be available to one spouse or the other but not both. The maximum amount that this benefit could be is 50% of the other spouse’s Primary Insurance Amount (PIA, the amount that he or she would receive at Full Retirement Age). The 50% amount is available if the spouse applying for the Spousal Benefit is at least Full Retirement Age. If he or she is younger than Full Retirement Age, a reduced amount could be available. The reductions are listed below:

Year of Birth	62	63	64	65	66	67
1937 or before	-25.00%	-16.67%	-8.33%	0.00%
1938	-25.83%	-18.06%	-9.72%	-1.39%
1939	-26.67%	-19.44%	-11.11%	-2.78%
1940	-27.50%	-20.83%	-12.50%	-4.17%
1941	-28.33%	-22.22%	-13.89%	-5.56%
1942	-29.17%	-23.61%	-15.28%	-6.94%
1943 to 1954	-30.00%	-25.00%	-16.67%	-8.33%	0.00%
1955	-30.83%	-25.83%	-18.06%	-9.72%	-1.39%
1956	-31.67%	-26.67%	-19.44%	-11.11%	-2.78%
1957	-32.50%	-27.50%	-20.83%	-12.50%	-4.17%
1958	-33.33%	-28.33%	-22.22%	-13.89%	-5.56%
1959	-34.17%	-29.17%	-23.61%	-15.28%	-6.94%
1960 or later	-35.00%	-30.00%	-25.00%	-16.67%	-8.33%	0.00%

Following the example listed above where a person born in 1960 or later files for Spousal Benefits at age 62, the 50% factor is reduced by 35%. In other words, the Spousal Benefit factor for this person would be reduced to 65% of the full 50% factor, which calculates to 32.5% of the other spouse’s PIA.

4. Furthermore, the Spousal Benefit is only available if the other spouse has filed for benefits already. Stay with me on this – it’s confusing. This means that until the other spouse files for retirement benefits, the first spouse can’t file for Spousal Benefits. Once the other spouse files for retirement benefits, the first spouse, as long as he or she is at least age 62, can file for Spousal Benefits. It’s important to note that the Spousal Benefit is available only to one spouse in the couple at at time – not both, so you have to choose which option works out better for you and your spouse.

5. At Full Retirement Age, a special provision is available that allows one spouse or the other to file for her own benefit and then suspend receiving the benefit. Originally before the passage of BBA15 this would enable the other spouse to file for Spousal Benefits based upon the first spouse’s record. However, under the new rules, suspending benefits also suspends any auxiliary benefits (including Spousal Benefits) that are based on the record that is suspended. Generally, suspending benefits is no longer a useful strategy with this change to the rules.

6. Deemed Filing requires that, if the individual is eligible for both the Spousal Benefit and his own benefit then that individual must file for both benefits at that time. The only other alternative is not filing for either benefit. This used to only apply when filing before FRA, but now (since 2015) it applies at all ages.

If the individual is not currently eligible for the Spousal Benefit and he is filing for his own benefit, Deemed Filing does not apply. However, if for example a month later his spouse files for her own benefit, making this first spouse eligible for the Spousal Benefit, Deemed Filing will apply and the Spousal Benefit is deemed to have been filed for.

Back to the examples

Now, with this additional background information, you should be able to go back to the first article and it will (hopefully) make more sense.

Keep in mind what I mentioned at the beginning: this is complicated. Don’t expect to pick up on it immediately. If all this does is raise questions, feel free to post your questions in the comments and I’ll try to address your questions as best I can.

In addition, bear in mind that I am an independent financial advisor; I don’t work for the Social Security Administration. As such, in these articles I am reporting the way the system works – not advocating it, not agreeing with it, not defending it. I agree that many of the provisions of the system can be unfair when applied, but I don’t have any sway with the Social Security Administration to fix the problems. I’m a taxpayer just like you, and I have to deal with the system the way it stands as well.

I have spent quite a bit of time studying how the system works in order to help my clients. As a result of my study of the system, I’ve also written a book that you may find useful – A Social Security Owner’s Manual. The Spousal Benefit and many other confusing provisions of the Social Security system are explained in the book.

Posted on Nov 11th, 2024

by author: jblankenship.

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Posted in: Social Security, social security benefits, Social Security spousal benefit, spousal benefits.
Tagged: Social Security · spousal benefit

The Post-55 Exception to the 10% Penalty for Withdrawals from 401(k)

Nov 4th, 2024

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Most of the time, when taking a distribution from a 401(k) or other Qualified Retirement Plan (QRP) prior to age 59½, there generally is a 10% penalty that applies. That is, unless one of the exceptions applies.

If you happen to be over age 55 (technically, if you’re in the calendar year you’ll reach age 55) when you leave employment, there is another exception that applies. Any distribution that you take from the QRP, as long as you were at least 55 years of age when you left employment, will not be subjected to the 10% penalty. Only ordinary income tax will apply to the withdrawal.

This provision only applies to QRPs, such as a 401(k) or 403(b), and not to IRAs. So if you’re leaving employment at or after age 55 but before reaching 59½, it can be in your best interest to not rollover your QRP to an IRA, at least until after you reach 59½. Even if you don’t need the money right away, it could be beneficial to have the source of funds available penalty-free.

For retiring police, firefighters and medics, the age for this exception is 50 – so these folks can take distributions from their QRPs after age 50 if they’ve left employment without penalty.

Posted on Nov 4th, 2024

by author: jblankenship.

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Posted in: 401 k 403 b, Early Distribution, qrp, qualified retirement plan.
Tagged: 401 k 403 b · early retirement · qrp · qualified retirement plan

Converting an Inherited 401(k) to Roth

Oct 21st, 2024

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

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

What’s a bit different about this kind of conversion is that, since it came from an inherited account, the beneficiary must take distribution of the account over the prescribed distribution period, which could be 10 years, or it could be over the lifetime of the beneficiary. This means that, in order for this maneuver to be beneficial, the heir should be in a relatively low tax bracket during the year of the conversion – making the future tax-free withdrawals during the distribution period worthwhile.

A downside to this move is that the heir should be in a position to pay the tax on the account from other funds, otherwise the tax pulled from the account will reduce the funds that can be converted to Roth to grow tax free over time.

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

At any rate, this is yet another reason that an individual might want to leave funds in a 401(k) plan rather than rolling it over to an IRA – since the heir does not have this Roth conversion option available if the money is in a traditional IRA. This option is only available for an inherited 401(k) or QRP, and if your heir is likely to want the option of conversion to Roth, it would need to come from the inherited QRP.

Posted on Oct 21st, 2024

by author: jblankenship.

Posted in: 401k, 403 b, conversion, inherited IRA, IRA, minimum distributions, qrp, qualified retirement plan, retirement plan, Roth Conversion, Roth IRA.
Tagged: qualified retirement plan · roth conversion · roth ira

Which Account to Take your RMDs From

Oct 14th, 2024

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When you’re subject to Required Minimum Distributions (RMDs) and you have more than one IRA account to take the distributions from, you have a choice to make. Even though you have to calculate the RMD amount using all of your IRA accounts combined, the IRS allows you to take the total of all your RMDs from a single account if you wish. The RMDs could also be taken from each account separately, or any combination of all of your traditional IRA accounts.

With this provision in mind, you could take all of your RMDs from the smallest IRA, which would provide you the opportunity to eliminate one of the accounts in your list, thereby simplifying things. By reducing the number of IRA accounts that you have, you could simplify the calculation of RMDs, estate planning, and just general paperwork.

Likewise, if one of your IRAs is held at a custodian that has limited choices or more costly options than your other IRAs, you could take your RMDs from that account, to eventually eliminate the undesired custodian. Or, perhaps one IRA holds an investment that has run up considerably, prompting you to rebalance – this could be an opportunity to take some earnings out of that holding to reduce losses with an anticipated drawback in value.

Another situation is where you have an IRA that owns something very thinly-traded or otherwise difficult to sell. You might bypass taking an RMD from this account, taking the RMD in combination with your other IRA accounts so that you don’t have to suffer a potential loss for this holding.

It might not always work to your best interests to reduce the number of accounts that you have. You may have multiple accounts in order to simplify your estate planning process, so that you can direct each account to a specific beneficiary or class of beneficiaries, for example.

In addition, if you’re hoping to eliminate some of your IRA accounts, you could always combine several IRAs together by rollovers – the end result is essentially the same.

This combination of accounts for RMDs can also be used separately with 403(b) accounts – if you happen to own several 403(b) accounts from previous employers, you can combine the RMDs and take them all from one account. However, this doesn’t work with 401(k) plans, you must take a separate RMD from each 401(k) plan. You also cannot combine unlike accounts (IRAs with 403(b)s or 401(k)s) to take the RMDs for those dissimilar accounts.

Posted on Oct 14th, 2024

by author: jblankenship.

Posted in: IRA, ira money, minimum distributions, qrp, qualified retirement plan, required minimum distribution, retirement accounts.
Tagged: IRA · qualified retirement plan · required minimum distribution

Arguments in Favor of a Rollover

Oct 7th, 2024

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If you have a 401(k), 403(b), a tax-sheltered annuity or other qualified retirement plan from a former employer, you may have considered if it would be beneficial to leave it where it is, or perhaps enact a rollover to an IRA.

While it might be easiest to leave the account where it is, it’s possible that you are sacrificing flexibility and/or paying higher fees in exchange for the easier path.

Quite often, 401(k) plans (and other qualified retirement plans, QRPs) are restricted to managed mutual fund investment options. Managed funds often carry high expense ratios, often greater than 1%. As you know, if you’ve read much about index funds, it is possible to reduce most of your investing expense ratios to far below .5%, in some cases as low as .1%. Over the course of many years, reducing these expenses can have a profound impact on your investment returns.

For example, if you were to save even 1/2 of a percent in expenses, over 20 years this could compound to a 11.05% improvement in your overall investment returns. This also assumes that the new funds you’ve chosen will perform at the same rate that the funds you’re leaving behind would have.

It’s not a pure “no brainer” to decide to do a rollover. There could be compelling reasons to leave the money where it sits, such as if you believe the funds in your plan are superior to options that you could choose outside the plan (such as restricted-access or closed funds), or maybe you have access to investment advice from the custodian at no additional cost. In addition, if you left the employer during or after the year when you reached age 55, you might want to leave the money where it is until you’re at least age 59½ for flexibility in withdrawals without penalty – see this article on post-55 withdrawals for more information. There is also the chance that you could benefit by leaving the funds in the former plan if there is Net Unrealized Appreciation of your former employer’s stock that you intend to have treated by the NUA rules.

In general though, the flexibility to reduce your expenses by choosing any investment available is a pretty compelling argument in favor of the rollover.

Posted on Oct 7th, 2024

by author: jblankenship.

Posted in: employer plan, IRA, qrp, qualified retirement plan, retirement plan.
Tagged: IRA · qrp · qualified retirement plan

Using an IRA Distribution and Withholding to Reduce Estimated Tax Payments

Sep 16th, 2024

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A little-known fact about how withholding works for IRA distributions can work in your favor. While withholding from a paycheck and estimated tax payments are credited as paid during the quarter actually paid, it’s different for withholding from an IRA distribution.

When you have taxes withheld from a distribution from an IRA, no matter when it occurs during the calendar year, it is treated by the IRS as having been withheld evenly throughout the tax year. This means that if you had the bulk of your income in the first quarter of the year, you could take care of the tax burden with a distribution from an IRA and withholding enough tax even in late December of the same year, and there would be no penalty for underwithholding.

So – many folks find themselves in this position, especially in years when income is is not equal in each quarter, or if the tax burden was not known or misunderstood throughout the year.

This method could be used by anyone at any time, as long as you have access to your IRA funds. For example, if you are required to take a distribution, that is, if you’re over age 73 these days or you have an inherited IRA, you could use that distribution to cover your tax burden for the entire year (if it was enough).

Rather than making quarterly estimated tax payments throughout the year, toward the end of the year you could instruct your IRA custodian to distribute enough funds to cover the tax burden for the year (and don’t forget to include the amount of your IRA distribution in your calculation). Then you would also instruct the custodian to withhold the distribution as taxes, using form W-4P.

The one downside to this method is that if the IRA account owner dies before the distribution with withholding for the tax year (and let’s face it, this will probably happen at some point), then the estate will owe penalties for underpayment of estimated tax for that year.

Posted on Sep 16th, 2024

by author: jblankenship.

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Posted in: income tax, IRA, ira funds.
Tagged: income tax · IRA

Using the Prohibited Transaction Rules to Your Advantage

Sep 2nd, 2024

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I’ve written in the past about the types of transactions that are prohibited in your IRA, and how these transactions are generally quite onerous if you happen to use one of them. In fact what happens is that your entire IRA becomes disqualified as of the first of the year in which the transaction occurred.

So – if you’re inquisitive you might wonder: How could I use this to my advantage?

It is possible to work this rule in your favor – but I don’t necessarily recommend it. I present this option here as an exercise of what could be done according to the rules. I learned this one from Natalie Choate, by the way, who you may recall I regard as a rock star in the world of IRA law.

Working in your favor

So, given that the rule against prohibited transactions requires that the IRA is considered to have been entirely distributed on the first day of the tax year when the prohibited transaction occurred, this is a factor that could be used to work to your advantage.

Let’s say for example you owned an investment in your IRA that was worth $10,000 as of the first of the year. Over the course of the year, the investment has now grown in value to something ridiculous, let’s say $500,000. If you were particularly inventive, you might take advantage of the rules and perform some sort of prohibited transaction with your IRA before the end of the tax year. By doing so, your IRA would be disqualified as of the first of the year, and the investment you owned would have been considered distributed at that point in time.

This means that you would owe ordinary income tax on the original $10,000 value, and your investment then has a basis of $10,000 – if you sold it now at its $500,000 value, the additional $490,000 would be taxed at the capital gains rate. If your ordinary income tax rate is 25%, the tax on the full $500,000 would work out to $125,000. But under this plan, only $10,000 is taxed at 25% ($2,500), and $490,000 is taxed at 15% ($73,500), for a total tax on the IRA of $76,000, a savings of $49,000. You’d have to wait until at least the second day of the following year in order to qualify for long-term capital gains. (The above tax calculation is oversimplified. In the real world, the rate of tax would be considerably higher since you’d be bumped up several tax brackets, and Net Investment Income Tax would also apply. Since we’re working in hypotheticals, forgive the simplification.)

If you were caught in just such a situation, this is a way you might use the tax law in your favor for a bit of hindsight tax planning. It doesn’t happen often, but this is one case where you could work the rules to your advantage.

Note: Bear in mind that I have not used this method myself or with clients, and the example I have given is purely hypothetical. If you choose to use this method, although the rules appear to be in your favor, but there are no guarantees that the IRS would agree with this. On face value I believe it will work exactly as I have written, but I have not seen any cases where this set of facts was put into play, successfully or not. Proceed at your own risk.

Posted on Sep 2nd, 2024

by author: jblankenship.

Posted in: capital gains rate, IRA, prohibited transaction.
Tagged: capital gains and losses · IRA · prohibited transaction

Earned Income Credit and Due Diligence

Aug 26th, 2024

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For those familiar with the Earned Income Credit (EIC), you hopefully are familiar with the preparer’s due diligence checklist. This is a checklist that the preparer uses to help determine if the taxpayer’s circumstances are in keeping with the conditions that are required to be met in order to be eligible for the credit. The checklist is formally known as Form 8867, and is available at www.IRS.gov.

When it originally appeared, this checklist was been filled out by the preparer and kept in the preparer’s files. This fact has changed a bit over time – the IRS changed the requirements, such that now the due diligence checklist must be filed along with the return. This filing requirement is the only thing that has changed, the due diligence is the same as before.

Form 8867 is a multi-use checklist, as many of the due diligence requirements cross over between the various tax credits. This form is used for due diligence for the Earned Income Credit (EIC), American Opportunity Tax Credit (AOTC), Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), and Credit for Other Dependents (ODC). It is also used for proof of due diligence in determining the Head of Household (HOH) tax filing status.

The checklist

You can refer to the actual form to see the actual questions that are asked regarding Earned Income Credit. These questions change from time to time. The general emphasis is on proving that the taxpayer is in fact eligible for the EIC based on the number of children claimed, or is claiming the EIC without a qualifying child. Additionally, the checklist requests information about the explanation of half-year residence of a child with the taxpayer, along with tiebreaker rules when the child could possibly be claimed as an eligible child by more than one taxpayer.

Tax Preparer Questions

The tax preparer has to answer a few questions to round out the due diligence. Again, the form itself has this checklist, which will be a much better place to view the questions. The gist of the tax preparer portion makes certain that the taxpayer has taken appropriate steps to ensure that the information collected regarding the EIC is based on facts received from the taxpayer, and not simply on verbal statements. There is requirement for the tax preparer to receive and maintain documentation for the residence of any eligible child, as well as information about income, residency status and the like for the taxpayer and spouse if applicable.

The point of all of this is to ensure that the tax preparer has exerted due diligence in gathering information to ensure that the credit being claimed is allowable and correct. Without this sort of checklist, in the past there have been substantial abuses of this particular credit. Because of this abuse, the due diligence checklist was implemented, along with prescribed penalties to the preparer for not filing the appropriate due diligence, or incomplete due diligence.

This penalty is $560 per credit per return to the preparer – so of course, this can add up pretty quickly if the preparer isn’t doing a good job. Since Form 8867 is used by up to four classes of credits (CTC, ACTC and ODC are considered one class of credits), there can be a penalty of up to $2,240 on a single return if all four credits are being claimed and due diligence is missing or incomplete.

Posted on Aug 26th, 2024

by author: jblankenship.

Posted in: earned income credit, EITC, income tax, income tax credit, irs.
Tagged: earned income credit · EITC · income tax credit

What to Expect If You Owe Money to the IRS

Jul 22nd, 2024

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Often we find ourselves in situations that we never dreamed of – like owing the IRS a considerable amount of money. Maybe you earned a lot more than you expected, perhaps you had a filing status change that dramatically changed your tax rate, or maybe there was a change to your deductions. It doesn’t matter, you’ve found yourself in the situation – what should you expect?

While the majority of Americans get a tax refund from the Internal Revenue Service each year, there are many taxpayers who owe and some who can’t pay the tax all at once. The IRS has a number of ways for people to pay their tax bill.

The IRS has an effort to help struggling taxpayers get a fresh start with their tax liabilities. The goal of this effort is to help individuals and small businesses meet their tax obligations, without adding unnecessary burden. Specifically, the IRS has policies and programs to help taxpayers pay back taxes and avoid tax liens.

Here are ten tips for taxpayers who owe money to the IRS.

Tax bill payments. If you get a bill for late taxes, you are expected to promptly pay the tax owed including any penalties and interest. If you are unable to pay the amount due, it is often in your best interest to get a loan to pay the bill in full rather than to make installment payments to the IRS.
Additional time to pay. Based upon your circumstances, you may be granted a short additional time to pay your tax in full. A brief additional amount of time to pay can be requested through the Online Payment Agreement application or by calling 800-829-1040.
Credit card payments. You can pay your bill with a credit card. The interest rate on a credit card may be lower than the combination of interest and penalties imposed by the Internal Revenue Service. To pay by credit card go to the IRS page Pay your taxes by debit or credit card. There are several options to choose from for this type of payment.
Electronic Funds Transfer. You can pay the balance by electronic funds transfer, check, money order, cashier’s check or cash. To pay using electronic funds transfer, use the Electronic Federal Tax Payment System by either calling 800-555-4477 or using the online access at www.eftps.gov.
Installment Agreement. You may request an installment agreement if you cannot pay the liability in full. This is an agreement between you and the IRS to pay the amount due in monthly installment payments. You must first file all required returns and be current with estimated tax payments.
Online Payment Agreement. If you owe $25,000 or less in combined tax, penalties and interest, you can request an installment agreement using the Online Payment Agreement application.
Form 9465. You can complete and mail an IRS Form 9465, Installment Agreement Request, along with your bill in the envelope you received from the IRS. The IRS will inform you (usually within 30 days) whether your request is approved, denied, or if additional information is needed.
Collection Information Statement. You may still qualify for an installment agreement if you owe more than $25,000, but you are required to complete a Form 433F, Collection Information Statement, before the IRS will consider an installment agreement.
User fees. If an installment agreement lasting more than 180 days is approved, a one-time user fee will be charged. The user fee for a new agreement ranges from $22 to $107 depending on the circumstances of your agreement. For eligible individuals with lower incomes, the fee can be waived or reduced to $43.
Check withholding. Taxpayers who have a balance due may want to consider changing their W4, Employee’s Withholding Allowance Certificate, with their employer. A withholding calculator at www.irs.gov can help taxpayers determine amount that should be withheld.

For more information about the Fresh Start initiative, installment agreements and other payment options visit www.irs.gov. IRS Publications 594, The IRS Collections Process, and 966, Electronic Choices to Pay all Your Federal Taxes, also provide additional information regarding your payment options. The publications and Form 9465 can be obtained from www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Posted on Jul 22nd, 2024

by author: jblankenship.

Posted in: income tax, irs.
Tagged: income tax · irs

The Importance of a Taxable Investment Account

Jul 15th, 2024

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I’ve written about this topic a few times in the past, such as in this article on tax diversification of your investment accounts. It’s an important topic, but probably the most important subtopic is having a significant portion of your investments not only in tax-deferred accounts, like 401(k) or IRA, but also in regularly-taxed accounts. Roth-type accounts are also critically important, but given the limited availability and costly nature of getting assets into a Roth-type account, I’ll focus for now on the importance of the taxable investment account.

With a taxable investment account, you have the opportunity to use the tax code to your advantage, even though it may seem counter to your initial thoughts on the topic.

Granted, in a taxable investment account you don’t get the complete tax-deferral that is available from an IRA or the tax-avoidance in a Roth IRA. Plus, you know that you won’t get to deduct your investments from your taxable income – but at the same time, when you take distributions from the account, any growth that occurred will be taxable.

But the taxability isn’t the same with a taxable account as it is with your IRA. For example, if you invested $10,000 in a taxable account and it grew to $15,000, you would owe tax only on the growth, $5,000. In addition, the tax rate being used is the capital gains rate, which currently tops out at 20%, for total tax on the distribution of $1,000. The net result for your account is a withdrawal worth $14,000.

On the other hand, if you invested $10,000 in an IRA you’d receive a tax deduction for the contributions (over a couple of years, due to limitations), which might amount to $2,500 if you’re in the 25% bracket. After the growth of $5,000 occurred, you are now able to take distribution of the $15,000 – which is fully taxed at your 25% ordinary income tax rate. The total tax is $3,750 – and now your net result for this account works out to $13,750. This is your total IRA account ($15,0000), minus the ordinary income tax ($3,750), plus the tax deduction credit from your original contributions ($2,500).

A Different Outcome

So the taxable account actually is better in the long run, as the example only dealt with a single distribution. And it actually could get even better, depending upon the circumstances of how the $5,000 growth occurred. Let’s say that the investments were in two different asset classes, for example international stock and domestic stock. Over the years, these two asset classes experienced some rather wild swings in returns, for example let’s say that the international stock experienced returns of 15%, -10%, 20%, 20%, 15%, 10%, and 20%. The domestic stock (for the purposes of our example) had returns of -10%, 5%, -15%, -5%, 10%, -5%, and -7.5%.

If each year when there were offsetting losses and gains in each of the asset classes you used the capital gain and loss rules to your advantage, you’d owe tax only on the difference of taxable gain. And when there’s a net loss, you can write off up to $3,000 per year against your ordinary income. Here’s how it works out:

Year	Int’l Stock	Domestic Stock	Net Gain/(Loss)	Tax Impact
1	$5,750	$4,500	$250	$50
2	$5,175	$4,725	($350)	($88)
3	$6,210	$4,016	$326	$65
4	$7,452	$3,815	$1,041	$208
5	$8,570	$4,197	$1,500	$300
6	$9,427	$3,987	$647	$129
7	$11,312	$3,688	$1,586	$317
Totals	Both accounts	$15,000		$981

So, as you can see, you wind up with the same net investment account balance, but by netting your gains and losses annually you wind up paying $29 less in taxes. It should be noted that the Year 2 tax impact includes using the excess loss of $350 against ordinary income, which results in a larger tax reduction in that year since ordinary income is taxed at 25% in our example.

This example is simplified to illustrate the affect. The true benefit occurs as this plays out over many years. The tax benefit of $29 from the example works out to a 4.6% reduction in the tax over just 7 years. Even if you don’t work the gains/losses rules in your favor – perhaps all of your investments increase in value so you have no losses to utilize – the difference between the taxable account’s tax impact and the IRA’s impact is significant enough to make the case. Use a taxable account – the results can be a windfall to you!

Posted on Jul 15th, 2024

by author: jblankenship.

Posted in: capital gains, capital gains tax rates, capital losses, income tax, investing, IRA.
Tagged: capital gains rate · income tax · investment · IRA · ira account · roth ira

Age Adjustments for Social Security

Jul 8th, 2024

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With all the talk about how Social Security is running out of money (or will be, currently projected at 2035), one of the topics that often comes up is the age limits for benefits. As you’re probably aware, the Full Retirement Age (FRA) has been adjusted upward from the original age 65, gradually to age 67 for folks who were born in 1960 or later. This upward adjustment was put into place with the 1983 amendments, ostensibly to reduce the outflows for the system.

With that adjustment in place, and the resulting benefit that the system has received from making that change, you might wonder why some of the other age limits have not been changed. Specifically, why has the early retirement age remained at 62, and the upper limit (maximum benefit age) has also remained set at 70?

I don’t have any definitive information to back this up, but I think there may be a reason behind the lack of change in these upper and lower limits. Look at how the lower limit interplays with the FRA. When the FRA was 65, as it was for folks born prior to 1937, the maximum amount of reduction that could occur by taking benefits at the earliest age of 62 was 20%. As FRA has increased, the amount of time for reduction (the time between age 62 and the increased FRA) has also increased. This resulted in an increase in the amount of reduction for folks starting benefits at the earliest age, to 30% for those with an FRA of 67.

Since a large percentage of folks will inevitably file for benefits at the earliest possible age, leaving the early filing age at 62 results with a high percentage of people receiving benefits at a lower and lower rate. The result is a lower outflow from the system, which extends the period of time before the system starts running out of money.

At the other end of the spectrum, increasing the FRA while leaving the maximum benefit age the same results in a reduced amount of time for Delayed Retirement Credits (DRCs) to accrue. For folks with FRA of 65, the maximum amount of DRC that could accrue was 32.5%. Given changes to the formula, this amount remained fairly constant for the increase up to FRA of age 66. Once that FRA is in effect, the DRC was set at 8% per year, with no change as the FRA increased. So when the FRA increases gradually to age 67, the maximum DRC will correspondingly reduce to 24%.

As the FRA increases, the maximum reduction increases by leaving the early retirement age at 62. While at the same time, the maximum delay credit reduces by leaving the maximum age at 70. The system benefits more by leaving these ages set at 62 and 70 than if they were adjusted, at least in the short term.

I don’t think there’s anything nefarious about this, it’s just another way that the system has benefited from those changes to the FRA.

Posted on Jul 8th, 2024

by author: jblankenship.

Posted in: delayed benefit, early retirement, reduction factors, retirement benefits, social security credit, social security retirement.
Tagged: delayed benefit · retirement benefits · social security credit · social security disability benefits

Enabling a Tax-Free Roth Conversion With a Mixed-Contribution IRA

Jul 1st, 2024

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If you have an IRA that includes contributions that are both pre-tax and post-tax (deductible and non-deductible) as well as growth, you may have an option available to you that will allow for a tax-free Roth conversion.

As you know, a Roth conversion can be done with IRAs that have mixed contributions, but when this is done, you will owe tax on a portion of the rollover – the pro-rata portion that includes the pre-tax money. Even if your pre-tax money is in a totally separate traditional IRA, the conversion of your post-tax money will be partly taxed due to the cream-in-the-coffee rule, which requires that all IRAs be considered as one with regard to distributions (including Roth conversions).

For example, let’s say you have an IRA (or several IRAs combined) that is comprised of $5,000 in deductible contributions, $4,000 in non-deductible contributions, and $1,000 of growth of the contributed funds. If you convert $1,000 to a Roth IRA, you will be taxed on 60% of the $1,000 conversion, and 40% of the conversion will be non-taxable. This is because there is a total of $4,000 (40%) in the account that was non-deductible contributions, which can be converted tax-free. The deductible contributions and the growth in the account are taxable distributions, and so converting them to Roth will result in including that $600 in your income as taxable.

However, if you happen to have a 401(k) plan (or other Qualified Retirement Plan) that you’re participating in, you may have the option available to roll over your pre-tax money from the IRA into the QRP.

Taking our example from before – if you rollover into your 401(k) plan the $6,000 representing the deductible contributions and growth, your IRA will be left with only the $4,000 of non-deductible contributions. This amount can then be converted to a Roth IRA tax-free.

Many QRPs have the option available to allow for roll-in of IRA money. What’s cool about this is that roll-ins are only allowed when the money is pre-tax, as in deductible contributions or growth of the account. This means that you can separate the cream from the coffee – that is, separate the pre-tax money from the post-tax money, by rolling the pre-tax money into your QRP. Then, what’s left is your post-tax money, which you can freely convert to a Roth IRA without incurring tax.

Posted on Jul 1st, 2024

by author: jblankenship.

Posted in: conversion, income tax, IRA, ira account, qrp, Roth Conversion, Roth IRA.
Tagged: conversion · IRA · qrp · roth conversion

Leaving Your IRA to Your Family First, Then to Charity

Jun 24th, 2024

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Suppose you have a situation where you’d like to leave your IRA (or at least some of it) to a family member or a group of beneficiaries, and then leave the remainder of the IRA to a charity of your choice.

One way to do this is to split the beneficiary designation between your family members and the charity. This is a simple way to make this designation, but it might not really achieve the purpose you’re hoping to. Suppose you’d like to make certain that a non-spouse family member has adequate income from your IRA for the remainder of his or her life, but you don’t want to overdo the bequest with a large appropriation (and taxes on the distribution). There’s a way to do this that may fit your needs: the Charitable Remainder Trust, or CRT.

The Charitable Remainder Trust

Using a Charitable Remainder Trust, or CRT, can be a useful way to ultimately pass your IRA or Qualified Retirement Plan (QRP) to a charity, while at the same time providing income to other beneficiaries for life. The way this works is that the CRT would receive a distribution of the IRA’s assets (within 5 years of the death of the original owner), and the beneficiaries can then receive income for the remainder of their lives. Because the remainder of the trust (at least 10% of the original value distributed at the death of the original owner) will ultimately pass to the charity, the estate receives a charitable contribution deduction for a portion of the account, actuarially-defined.

Since the funds are no longer in the IRA or QRP, the beneficiaries are not subjected to Required Minimum Distributions (RMDs) from the account – these can be tailored to the individual beneficiary’s requirements. Amounts between 5% to 50% of the IRA value can be distributed to these beneficiaries. On the downside, the amount of income will have to be pre-set, either a set amount or a set percentage of the account, and this amount cannot be changed. In other words, if the beneficiary wants more than the set amount of distribution, the distribution amount cannot be increased.

If there are multiple beneficiaries of the trust, as members of the beneficiary group die the other remaining beneficiaries will receive the income attributed to those beneficiaries, until all beneficiaries have passed on. Since there are restrictions on the CRT that require that at least 10% of the total trust value remains to be distributed to the charity, it won’t work well if the beneficiary class includes very young members. If there is a very long period of time to pay income, the remaining account value may be reduced below that restricted amount – and the distributions will slowly diminish.

This method may not be useful to everyone, but it could be useful for certain specific situations. An example would be if you had multiple IRAs, and had one in particular that you wanted to eventually pass on to a charity. At the same time you want to ensure that you don’t short-change your family or friends – maybe you have a couple of siblings that you’d like to pass along a life income to, perhaps in addition to leaving other assets these beneficiaries.

The CRT also has the benefit of passing along favorable taxation to the beneficiaries, which can include capital gains and dividends rates as well as ordinary income tax rates. Working with your tax advisor and other professionals is recommended to fully understand this potential.

Posted on Jun 24th, 2024

by author: jblankenship.

Posted in: charitable contribution, Charitable Remainder Trust, CRT, IRA, qrp, qualified retirement plan.
Tagged: charitable contribution · IRA · qrp

Roth IRA for Youngsters

Jun 10th, 2024

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Many times it is among the best of ideas to establish a Roth IRA for your child. This way, your child can benefit from the long-term growth in the account and have a very good head start on retirement savings for later in life. There are other benefits, including the fact that retirement funds are not included when financial aid is being calculated for college expenses, as well as providing funds for the child to use when the time comes to buy a house, for example.

One thing can cause a real problem though: if you undertake to make contributions to a Roth IRA for your child that aren’t based in fact. What’s that? How can this be? So there’s a way you can make contributions to Roth IRA that aren’t based in fact? What fact is that??

The rules for making contributions to Roth IRAs (actually, any IRA) include the fact that the person who owns the account must have earned income. This means that the individual whose account is being contributed to must have earned at least the amount that is being contributed from some sort of job – which could include self-employment or any sort of employment. In addition, scholarships or fellowships that are reported in box 1 of Form W2 are considered earnings for IRA contributions.

If your child doesn’t have income of any realistic form, it is not allowed for you to make contributions to a Roth IRA (or any IRA) on behalf of the child. And it doesn’t work for you to invent income, such as paying the child to clean up his or her room. The income has to be “real” – making contributions without some sort of real income will result in some nasty penalties. The penalty for over-contribution to a Roth IRA is 6% per year, meaning each year that the money is in the account. If several years have gone by, you’ll get hit with this penalty for each and every one of those years – which is even worse than just putting the money in a savings account the first place.

So, if your child has legitimate income, such as from mowing yards or a paper route, it’s perfectly legitimate for the child to make a contribution to a Roth IRA. You can even donate the funds to the child to make that contribution if you like. Just don’t contribute more than the child’s actual earnings.

Posted on Jun 10th, 2024

by author: jblankenship.

Posted in: financial aid, IRA, ira contribution limits, retirement plans, Roth IRA.
Tagged: financial aid · ira contribution limits · retirement plans · roth ira

Is It Really Allowed – Making a Non-Deductible IRA Contribution Followed By a Roth Conversion?

Jun 3rd, 2024

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Photo credit: diedoe

I occasionally receive this question: Can I make a non-deductible IRA contribution, and then shortly after convert the IRA into a Roth IRA? My income is too high for me to make a contribution directly to a Roth IRA. (This is also known as a back-door Roth IRA contribution.)

According to the rules in place today, you can do this. Here are the applicable rules:

There is no income limit for an individual to make a non-deductible IRA contribution.
There is no income limit for an individual to make a Roth Conversion.
There is no time limit on how long a contribution must be in a traditional IRA before converting it to a Roth IRA.

Essentially this situation provides the individual with an income above the limits for a regular Roth Contribution with an avenue to accomplish the funding of a Roth IRA. It seems too good to be true. And even though you may feel like it’s flaunting the law, it’s really okay. Here’s why – even though you don’t realize it, the specific rule of law that could apply is called the Step Transaction Doctrine.

Step Transaction Doctrine

Wikipedia defines the step transaction doctrine as follows:

The step transaction doctrine is a judicial doctrine in the United States that combines a series of formally separate steps, resulting in tax treatment as a single integrated event. The doctrine is often used in combination with other doctrines, such as substance over form. The doctrine is applied to prevent tax abuse, such as tax shelters or bailing assets out of a corporation. The step transaction doctrine originated from a common law principle in Gregory v. Helvering, 293 U.S. 465 (1935) that allowed the court to recharacterize a tax-motivated transaction.

The doctrine states that:

interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction. By thus linking together all interdependent steps with legal or business significance, rather than taking them in isolation, federal tax liability may be based on a realistic view of the entire transaction.

There are three tests for applying the step transaction doctrine: (1) a “binding commitment”; (2) a “mutual interdependence” of steps; or (3) the intent of particular result.

Lots of legalese, I know. Let’s see how those three tests would apply to our situation with the non-deductible IRA to Roth Conversion.

Test 1

The Binding Commitment test determines that a particular action has been taken that binds the taxpayer in a commitment to later take another step in the series. Clearly, making a non-deductible IRA contribution does not bind you to take the next step in the series. Since we only have two steps in our series, we only have to apply the test to the first step.

Test 1: Pass

Test 2

The Mutual Interdependence test looks at each step in the series to determine if any of the steps along the line would have been meaningless without the overall series. Again, making a non-deductible IRA contribution can stand on its own without the series and is therefore not meaningless without the series. The same goes for the Roth Conversion – this step could occur without the non-deductible contribution step and is also not meaningless without the series.

Test 2: Pass

Test 3

The Intent test (also known as the “End Result” test) is the most likely to be applied. This test considers the series as a whole to determine if the individual steps were taken solely to achieve the end result, and not simply a group of non-related steps. So – is it likely that the only reason you’ve made the first step (non-deductible IRA contribution) is to enable the second step (Roth IRA conversion) possible so that you can achieve the end result (money in your Roth IRA account).

Test 3: Unclear

Application

The IRS has not (to date) raised any qualms against this series of transactions, although it’s possible that they could at some point. In looking at the Intent test, you could see how they might have a case. But it’s really not too likely that the IRS will undertake this position.

Since it’s a given that Roth Conversions are allowed with no restrictions by law, and it’s also a given that non-deductible IRA contributions are allowed with no restrictions by law, it’s unlikely that any law will be written to make changes to these rules in the near future. The only way it could be possible is if there were a holding period requirement within an IRA before converting the account’s holdings to a Roth IRA – and that sounds like a messy bit of law (although nowhere near as messy as some current laws are). I’d say if you are in a position to use this strategy, go ahead and do it. The worst that could happen would be a requirement to de-convert the account back into an IRA.

Keep in mind that making a non-deductible IRA contribution doesn’t automatically allow a no-tax impact conversion to Roth. If you happen to have another IRA (or IRAs) that contain deductible contributions, you will have to apply the pro rata tax rules to the conversion. This may result in additional tax on the conversion.

Posted on Jun 3rd, 2024

by author: jblankenship.

Posted in: contribution limit, conversion, income tax, irs, non deductible ira contribution, Roth Conversion, Roth IRA.
Tagged: irs · non deductible ira contribution · roth ira conversion

How PIA Relates to Your Benefit

May 27th, 2024

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Photo credit: jb

If you’ve been looking into your Social Security projected benefits for long, you’ve probably run across the term Primary Insurance Amount, or PIA. Click on the link to see how the PIA is calculated if you need more background information on the PIA.

What’s important to know is that the PIA is essentially the amount of your retirement benefit if you file for it exactly on your Full Retirement Age (FRA) month. But it’s quite common for an individual to file for retirement benefits either before or after FRA. If you file for your retirement benefit before or after FRA, even by a month, there is a difference between your PIA what your benefit will be.

Before FRA

If you file for benefits before the month when you reach FRA, there are two reduction rates that may apply to your benefit, reducing it from the PIA amount. The reason there are two rates is because originally the FRA for everyone was 65. This made it simple to cause a 20% reduction for anyone who started benefits at the earliest age, 62, which was 36 months before FRA. So the reduction factor for any filing up to 36 months before FRA is calculated at a rate of 5/9% (approximately 0.5556%) per month, which works out to 20% for the full 36 months.

Later, when the rules changed such that FRAs could be at ages beyond 65, the original rate of 5/9% per month was deemed too aggressive of a reduction. So a smaller value was determined for reductions beyond the first 36 months of reduction, at 5/12% per month, (approximately 0.4167%). This works out to a 5% reduction for each 12 months beyond the first 36.

Wow, that’s not complicated at all, is it? Geez. Here’s a walkthrough of the formula that you can use to help you calculate the reduction for your benefit before FRA:

1. Enter your Full Retirement Age, years and months:
2. Enter the age you plan to file for benefits, years and months:
3. Subtract line 2 from line 1 in months only
4. Subtract 36 from line 3 (if less than zero, enter zero)
5. If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)
6. If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2
7. Add line 6 to line 5
8. Subtract line 7 from 1.0000
9. Multiply line 8 by your PIA. This is your reduced benefit amount.

Let’s run an example. An individual born in 1955, so his FRA is 66 years and 2 months. His PIA is $2,000, and he intends to file for benefits at age 64 years and 6 months.

1. Enter your Full Retirement Age, years and months:	66y 2m
2. Enter the age you plan to file for benefits, years and months:	64y 6m
3. Subtract line 2 from line 1 in months only	20
4. Subtract 36 from line 3 (if less than zero, enter zero)	0
5. If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)
6. If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2	.11112
7. Add line 6 to line 5	.11112
8. Subtract line 7 from 1.0000	.88888
9. Multiply line 8 by your PIA. This is your reduced benefit amount.	$1,777.76

Now let’s adjust the example so that it uses the additional factor. Same individual as above, but now he plans to retire at age 62 years and 8 months.

1. Enter your Full Retirement Age, years and months:	66y 2m
2. Enter the age you plan to file for benefits, years and months:	62y 8m
3. Subtract line 2 from line 1 in months only	40
4. Subtract 36 from line 3 (if less than zero, enter zero)	4
5. If line 4 is zero, skip to line 7; otherwise, multiply line 4 by 5/12% (or 0.004167)	.016668
6. If line 4 is zero, multiply line 3 by 5/9% (or 0.005556); otherwise, enter .2	.200000
7. Add line 6 to line 5	.216668
8. Subtract line 7 from 1.0000	.783332
9. Multiply line 8 by your PIA. This is your reduced benefit amount.	$1,566.66

Now let’s look at how applying after FRA works.

After FRA

For every month after FRA that you delay applying, your benefit will grow by a factor. For folks born in 1943 and later, the factor is 2/3 of a percent, or roughly 0.6667%. If you were born in 1941 or 1942 (earlier years don’t matter at this point, you’re already 70), the factor is 15/24 of a percent, or approximately 0.625%. These factors equate to 8% per year for those born in 1943 or later, or 7.5% per year for those born earlier.

Here’s a formula to use to help calculate the delay factor and benefit amount for your situation:

1. Enter your Full Retirement Age, years and months:
2. Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):
3. Subtract line 1 from line 2 in months only
4. If your FRA is less than 66, multiply line 3 by 15/24% (or 0.00625); otherwise multiply line 3 by 2/3% (or 0.006667)
5. Add 1.00000 to line 4
6. Multiply line 5 by your PIA. This is your increased benefit amount.

Let’s run through an example. The individual from above, with a FRA of 66 years and 2 months, and a PIA of $2,000, decides to file for benefits at the age of 68 years and 6 months.

1. Enter your Full Retirement Age, years and months:	66y 2m
2. Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):	68y 6m
3. Subtract line 1 from line 2 in months only	28
4. If your FRA is less than 66, multiply line 3 by 15/24% (or 0.00625); otherwise multiply line 3 by 2/3% (or 0.006667)	.186676
5. Add 1.00000 to line 4	1.186676
6. Multiply line 5 by your PIA. This is your increased benefit amount.	$2,373.35

And that’s it. Hope this has helped you to better understand how your PIA and your benefit are related.

Posted on May 27th, 2024

by author: jblankenship.