Financial Ducks In A Row • Independent financial advice: IRA, Social Security, income tax, and all things financial

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 (www.IRS.gov) 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

Mar 28th, 2018

by jblankenship.

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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.
Rollover. 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?

Mar 26th, 2018

by jblankenship.

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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 63% less than their original amounts – to $426 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)

Mar 21st, 2018

by jblankenship.

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When 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.

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

Mar 12th, 2018

by jblankenship.

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Photo credit: jb

Trying 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!

Will TCJA Encourage QCD?

Mar 5th, 2018

by jblankenship.

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charitable distribution of bread could not be considered a QCD When 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!

Restricted Application in 2018

Feb 28th, 2018

by jblankenship.

47 comments

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

Feb 26th, 2018

by jblankenship.

58 comments

Photo credit: diedoe

I know, I know – who would want to disclaim an inherited IRA, right?

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

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

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

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

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

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

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

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

IRA RMD Reporting

Feb 19th, 2018

by jblankenship.

6 comments

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

Photo credit: jb

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

Photo credit: jb

In addition, Form 5498 will be generated for your IRA and sent to you by January 31 of the following year – meaning, if you receive a 5498 before January 31 of the current year, it is relating to an IRA balance as of December 31 of the prior year. This statement will detail the amount of your RMD if you’re over age 70½ (or over 72 beginning in 2021).

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

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

Do I have an RMD reporting requirement?

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

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

Exemptions and Dependents for 2017 Tax Returns

Feb 12th, 2018

by jblankenship.

1 comment

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

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

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

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

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

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

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

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

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

More Information:

Publication 17, Your Federal Income Tax
Publication 501, Exemptions, Standard Deduction and Filing Information.

New Deadline for Rollover of 401k Loan Distributions

Feb 5th, 2018

by jblankenship.

9 comments

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

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

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

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

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

Best and Worst States for Retirement Finances

Jan 29th, 2018

by jblankenship.

2 comments

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

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

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

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

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

No K-12 Tax Break for Using Illinois’ Brightstart

Jan 22nd, 2018

by jblankenship.

1 comment

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

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

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

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

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

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

Other states?

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

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

Back-door Roth Blessed by Congress

Jan 16th, 2018

by jblankenship.

8 comments

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

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

Tax Cuts and Jobs Act

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

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

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

Roth Recharacterization is No Longer Allowed

Jan 8th, 2018

by jblankenship.

3 comments

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

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

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

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

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

jb note: Astute super-reader clydewolf mentions:

Kaye Thomas at Fairmark.com says he has confirmed with the IRS
that 2017 Conversions can be recharacterized.
http://fairmark.com/forum/read.php?2,84769

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

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

Non-Spouse Rollover of Inherited IRA or Plan

Dec 18th, 2017

by jblankenship.

1 comment

Photo credit: diedoe

When you inherit an IRA from someone other than your spouse, you are able to take advantage of certain protections or deferrals of tax inherent in the IRA, but you are somewhat restricted in your actions with the account. These non-spouse rollover rules also apply to a spouse who has elected NOT to treat the inherited IRA as his own IRA.

Other than the trustee-to-trustee transfer, an inherited IRA is not permitted to be rolled over – in other words, a non-spouse rollover (the 60-day variety) is not allowed.

On top of the distinction between a spouse and a non-spouse, there is a new distinction as well: between an Eligible Designated Beneficiary and a designated beneficiary.

There are five types of individuals who make up the group of eligible designated beneficiaries. The five are:

Spouse beneficiaries
Minor child (of the original owner) beneficiaries
Disabled beneficiaries
Chronically Ill beneficiary
Beneficiary who is not more than 10 years younger than the original owner

Each of these beneficiary classes has the option of using the old-style of required distribution, utilizing the individual beneficiary’s own lifetime as the period over which to distribute the account.

If you are a beneficiary who doesn’t fit into the groups above, you are considered a designated beneficiary.

Restrictions for all non-spouse Eligible Designated Beneficiaries (EDB)

First of all, you are not allowed to treat the IRA as your own – in other words, the account can only be re-titled as an inherited IRA. This means that you can move the account to another custodian (via trustee-to-trustee transfer only) or leave it at the same custodian, and change the title to read as “John Doe IRA (Deceased January 1, 2009) FBO Janie Brown” or something very similar.

In addition to the restriction on titling, the Eligible Designated Beneficiary must begin taking Required Minimum Distributions (RMD) as described below:

If the owner of the account died on or after his Required Beginning Date, which is generally April 1 of the year following the year in which he reached age 72 (70½ under 2019 and earlier rules), the RMD is based on the longer of: 1) the owner’s life expectancy¹; 2) the beneficiary’s life expectancy¹; 3) the oldest of multiple beneficiaries’ life expectancy¹ (if there are more than one beneficiary).
If the owner of the account died before his Required Beginning Date, the RMD is based upon the Eligible Designated Beneficiary’s life expectancy¹ or the life expectancy¹ of the oldest Eligible Designated Beneficiary if there are more than one.

The Designated Beneficiary

Other designated beneficiaries (not the EDB kind) also have the titling restriction, the same as all other non-spouse beneficiaries. In addition to the restriction on titling, the IRA beneficiary must take complete distribution of the IRA proceeds within 10 years, beginning with the year following the year of the death of the original owner.

The designated beneficiary is generally determined on September 30 of the year following the year of the death of the plan owner. In order to be named the designated beneficiary, an individual must be named on the plan documents as of the date of death (no changes can be made after death). If any person who is named the beneficiary in the plan documents is no longer a beneficiary as of September 30 of the year following the year of death, such person will not be considered as a possible designated beneficiary. This could come about if one of the original beneficiaries chose to disclaim entitlement to the account.

If an individual who is the primary beneficiary as of the owner’s date of death dies prior to September 30 of the year following the year of death, this individual is still considered to be the primary beneficiary, rather than any contingent beneficiaries. The deceased beneficiary’s estate would receive the account and his or her age would be used for determining distribution.

If the account is split (as described in the article about splitting inherited IRAs), each beneficiary of the inherited account(s) will be considered the designated beneficiary of that split account. This applies if the account has been split before December 31 of the year following the year of death of the original owner.

Distribution Rules for the non-EDB

It is important to note, the following rules apply as you take full distribution within the required 10 years:

you’re allowed to spread the distribution out in monthly, quarterly, annually, or any schedule of payments as long as the account is fully distributed by the end of the tenth year following the year of the death of the original owner;
if you are the beneficiary of more than one IRA, you must determine distribution timeline for each inherited IRA individually;
there is no annual RMD for inherited IRAs (unless inherited by an EDB), only the 10-year complete distribution rule.

Footnotes:

¹ Life expectancy is generally determined in these cases by the IRS Single Life Table, also known as Table I, which you can find by clicking this link.

Divorcee Social Security Benefits

Dec 11th, 2017

by jblankenship.

2 comments

The below article is an excerpt from my new book Social Security for the Suddenly Single. This focused book is all about divorcee Social Security retirement and survivor benefits, and it’s available on Amazon. The book was written to address the lack of information about divorcee Social Security. You’ll find everything you need to know about divorcee Social Security retirement and survivor benefits within.

Divorcee Benefits Matrix

Below you will find a matrix that describes the various divorcee Social Security benefits you may have available to you.

To use this matrix, start at 1, choosing your birth year. Then move to 2 and choose the age you wish to learn about available benefits. Now choose your length of marriage (3), and your ex-spouse’s status (living or deceased) – 4. Lastly, choose the appropriate column for 5, whether or not you have a Child in Care under age 16.

Case: Bernadette

As an example, Bernadette was married to Robby for 17 years. Robby is still living, age 62, 2 years older than Bernadette. Robby has not begun collecting benefits at this point. The couple has no children, and they have been divorced for one year.

Bernadette is wondering about the earliest benefits she can receive from Social Security. She starts in column 1 with “Any Birth Year”, and then reviews the second column. At her present age of 60, she sees that while Robby is still living she is not eligible for any benefits.

So she looks to the next row in the Age column (2) – indicating age 62 to FRA. Since her Step 3 value is that the Marriage lasted 10 years or longer, Bernadette next checks step 4 – Robby is still living, and not presently collecting benefits. However, by the time Bernadette reaches age 62, it will have been two years since the divorce. Because of this, Bernadette sees that she is (between the ages of 62 and her FRA) eligible for the larger of the reduced Spousal Benefit or her own reduced benefit.

Bernadette would also like to estimate what her benefit would be if she waits until her FRA or later to apply for benefits. Knowing what she knows from the previous exercise, she would just move down the table to the appropriate Step 1 value. Her birth year is 1957 so she chooses the row “1954 or later”. This indicates that Bernadette will be eligible for the larger of her own benefit or the Spousal benefit – neither benefit is reduced since this estimate is assuming she’s either at or older than FRA.

Lastly, Bernadette would like to check on what benefits she might be eligible for upon Robby’s death. Moving to the right on the matrix to the set of columns indicating the ex-spouse is deceased, and since there is no Child in Care, Bernadette can review the various Survivor Benefit options that are available at various ages for her. At her present age (60) she would be eligible for a reduced Survivor Benefit if Robby were to die. At any age from 62 to FRA, she would be eligible for her choice of the reduced Survivor Benefit or her own reduced benefit. At or older than FRA, she has the same choice available, but neither benefit is reduced once she’s reached FRA or older.

Creditor Protection for Retirement Plan Assets

Dec 4th, 2017

by jblankenship.

1 comment

In this day and age with bankruptcies on the rise, quite often this question comes up: are my retirement plan assets protected from a creditor? And of course, there are two ways you can take this – are the assets protected from a creditor of my employer; and are the assets protected from my personal creditors?

Photo credit: diedoe

Employer Creditors

Your vested qualified retirement plans (401(k), 403(b), etc.) are always protected from creditors, in the event that your company should declare bankruptcy. Vested retirement plans are your property (*upon distribution), not the property of the employer. The same is true for vested traditional qualified pension plans. However, with certain nonqualified retirement plans and non-vested plans or funds, there is a strong possibility that these assets could be accessed by your employer’s creditor in the event of a bankruptcy of the company.

The nonqualified plans are often called executive compensation, rabbi trust, deferred compensation, or supplemental retirement savings (among many other terms). The key here is that these accounts are “non-qualified”, and as such are not protected by the ERISA law. These accounts are very often open to access by creditors, so be aware of this if you’re a participant in such an account. Check with your HR department if you’re unsure if your retirement account(s) are qualified (and thus protected by ERISA) or not.

IRAs, being individual accounts totally separate from your employer (unless you’re self-employed) are not considered in any way to be assets of your employer. If you are self-employed and are not incorporated in some fashion, depending upon your state law, some of your IRA assets could be at risk, depending upon the state that you live in, and the balance of the account (see below).

Personal Creditors

In general, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) provides that both traditional and Roth IRAs derived from contributions are protected from creditors up to $1 million. This protection only applies to bankruptcy, not to other judgments, and as such state law applies for all other situations. For example, your IRA is not protected against a judgment in the case of divorce, an IRS lien, or a criminal judgment against you. The level of creditor protection varies widely by state. For more up-to-date information on the protection within your state, click this link. Rollover (including trustee-to-trustee transfer) amounts from employer plans, SEP or SIMPLE IRAs maintain the original account’s ERISA protection from creditors.

There are cases, as illustrated recently in a case that was decided in 2007, where an inherited IRA with a revocable trust as the beneficiary became available to the decedent’s creditors. This case was in the state of Kansas, so other states may have differing laws, this was just an example. The way to resolve or avoid this is to use an irrevocable see-through trust as the beneficiary and use discretionary and spendthrift clauses within the trust as protection. Otherwise, naming an individual (or individuals) as the IRA beneficiary(s) would avoid this problem as well.

Further problems develop in the inherited IRA spectrum due to the fact that most state courts do not consider an inherited IRA to be a “retirement account”, since the owner (the beneficiary of the decedent) is currently receiving an income from the account. This is important because retirement accounts are specifically protected from creditors (due to BAPCPA).

Closing

Even though the IRA has somewhat fewer protections against creditors versus the employer plans, if you’ve left the employer this shouldn’t be the reason to leave funds in the old account. An IRA account can be considerably more flexible, easier to access, and (likely) lower in cost overall. Rolled-over funds maintain ERISA protection, as well.

A SIMPLE Kind of Plan

Nov 20th, 2017

by jblankenship.

1 comment

The SIMPLE Plan is a type of retirement account for small businesses that is simpler (ah hah!) to administer and more portable than the 401(k) plans that are more appropriate for larger businesses. SIMPLE is an acronym (probably a backronym, more likely) which stands for Savings Incentive Match PLan for Employees.

Photo credit: coop

A SIMPLE typically is based on an IRA-type account, but could be based on a 401(k) plan. What we’ll cover here is the IRA-type of SIMPLE plan. The difference (with the 401(k)-type) is that there are more restrictions on employer activities, and less room for error (as can be the case with 401(k) plans).

A SIMPLE Kind of Plan

Much like a regular 401(k) plan, a SIMPLE Plan is an agreement between the employer and employee where the employee agrees to a salary deferral. This deferral effectively reduces the employee’s taxable take home pay, and the employer then contributes the deferred amount into the SIMPLE IRA account on behalf of the employee. These contributions must be made to a SIMPLE IRA account, not a Traditional IRA.

To be eligible for a SIMPLE Plan, the employee must have received at least $5,000 in compensation during any two years (need not be consecutive) prior to the current tax year, and can reasonably expect to receive at least $5,000 in compensation in the current tax year (calendar year). For the purposes of the SIMPLE Plan, a self-employed individual would be considered an employee if she received earned income as described (at least $5,000).

Also, certain classes of employees can be excluded from participation, such as union members subject to collective bargaining, or nonresident aliens who have received no compensation from US sources. The employer can have no more than 100 employees who are in the class that are allowed to participate in the SIMPLE plan.

No eligible employee may “opt out” of participation – however, eligible employees are not required to defer salary into the plan. This just means that they would have no deferral contributions or company matching contributions to the plan while they choose not to defer. Nonelective contributions by the employer would still be added to the account, regardless of whether the eligible employee defers salary for that year.

Types of Contributions

There are three different types of contributions that can be made to a SIMPLE Plan – salary deferrals, employer matches, and nonelective contributions.

Salary Deferrals are much the same as 401(k) salary deferrals. The employee decides to defer a percentage of his salary, which reduces his taxable take-home pay, and the deferral is contributed to a SIMPLE IRA on his behalf.

Employer Matches are also similar to the same activity in a 401(k) plan. The employer elects to match the employee contributions, dollar-for-dollar, up to 3% of the employee’s salary, although this amount can be less. (see Limits below for additional information)

Nonelective Contributions – in some cases, the employer may decide to make contributions on behalf of ALL eligible employees, rather than only for those that are participating in the SIMPLE Plan. In this case, the employer has opted for making the Nonelective Contributions instead of Employer Matching Contributions. These Nonelective Contributions are for 2% of employee salary.

Limits

For Employer Matching contributions, the employer has some leeway in making the contributions for a particular tax year, but there are quite a few restrictions on how this leeway can be applied:

as described above, in general the matching contribution must be dollar-for-dollar up to 3% of the employee’s deferral for the year; however –
the matching contribution can be reduced to as little as 1% (or any amount between 1% and 3%) for a tax year as long as the amount is not reduced below 3% for more than two out of five tax years (including the current tax year) and the employees are informed in a timely fashion of the reduction in match.
the Nonelective Contribution of 2% can be substituted for the Employer Matching Contribution for any given year as long as employees are notified.

Contributions (for 2016-2018) are limited to $12,500 in employee deferrals, plus a catch up provision of $3,000 if the employee is age 50 or older during the tax year. (These figures are subject to annual adjustment due to inflation.)

Employer matches are limited to the amount the employee defers, up to 3%.

Note that SIMPLE deferral is counted toward the overall 401(k) limit ($18,000 for 2017; $18,500 for 2018; $24,000 and $24,500 respectively if over age 50) in deferrals for the tax year. If an employee is subject to more than one retirement plan, this limit applies to all deferrals to 401(k)’s and SIMPLE plans for the tax year.

Gallimaufry*

There are a few additional things of interest regarding rollovers and the SIMPLE plan that must be pointed out:

After you’ve had the SIMPLE IRA open for 2 or more years, you are allowed to rollover other IRA funds into a SIMPLE IRA. Before that, you are not allowed to rollover IRA or other accounts (besides another SIMPLE IRA) into your SIMPLE IRA.
In order to rollover amounts from your SIMPLE IRA into a Traditional IRA, the account must have been in existence for at least two years; otherwise your only option for a rollover is into another SIMPLE IRA (which then inherits the earlier SIMPLE IRAs starting date for rollover purposes).
The same two-year rule applies to Converting a SIMPLE IRA to a Roth IRA. There is no SIMPLE Roth IRA.
Early distributions (not subject to any of the exceptions) that occur during the first two years of the account’s existence are subject to a 25% additional penalty (instead of the usual 10% penalty for other IRA accounts).

Other than those restrictions, all of the other distribution rules apply to SIMPLE IRAs that apply to Traditional IRAs: distributions are taxable as ordinary income; with some exceptions, qualified distributions can not begin until age 59½; rollovers and trustee-to-trustee transfers are allowed as non-taxable events (subject to the two year rule above); conversions to Roth IRAs are allowed without penalty (subject to the two-year rule); and early distributions not subject to exception are subject to an additional 10% penalty (25% in the first two years as described above).

(* a hodgepodge of additional stuff)

Contest for today: The first person to leave a comment that explains why I used the particular picture above for this article will receive a pound of our delicious virtual back-bacon. Extra points if you can mention something unique about that particular picture, as well. Best of luck to all participants! (Canadians are welcome to guess this time as well!) :-)

Photo by Thomas Hill

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

Mid-year withholding checkup

Things to Remember when Considering Early Withdrawal from Retirement Plans

What’s Not Included

What Is Included

What Can Be Impacted by FMB

Example of FMB calculation

How the Family Maximum Benefit is Computed

Computation for the Current Year

The Basics

Reasons That You Might Need A Financial Advisor

QCD basics

QCD Example

Restricted Application in practice

Do I have an RMD reporting requirement?

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

Other states?

Tax Cuts and Jobs Act

Restrictions for all non-spouse Eligible Designated Beneficiaries (EDB)

The Designated Beneficiary

Distribution Rules for the non-EDB

Divorcee Benefits Matrix

Case: Bernadette

Employer Creditors

Personal Creditors

Closing

A SIMPLE Kind of Plan

Types of Contributions

Limits

Gallimaufry*

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