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

The Affect of Earnings on Your Social Security Benefit

Nov 27th, 2023

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Your wage earnings and other income can impact your Social Security benefit in several ways. These earnings can increase the amount of your Social Security benefit that is taxable. In some cases, continued earnings can increase your future benefit rate as well. Wage earnings while collecting benefits can also reduce your current benefit if you’re over the annual earnings limits and you’re under Full Retirement Age. Continued wage earnings at or above the substantial earnings limits can also result in a smaller WEP reduction, or perhaps eliminate WEP altogether.

Taxation

Depending on your level of income, Social Security benefits may be included at as high as an 85% rate with your other taxable income on your tax return. But this level can range to as little as 0% if your provisional income (all of your other income besides Social Security benefits plus 1/2 of your Social Security benefit) is low enough.

For more details on how this works, check out this article on taxation of Social Security benefits.

Increasing future benefits

When you continue to work, depending on your wage income (or net self employment income), you may be increasing your future benefits. This happens when you have relatively low income reported in some earlier years (or perhaps zero income) and those low or zero years are included in your top-35 years of indexed earnings on record with Social Security.

To see how your benefit might increase, here’s an article about the calculation of the Average Indexed Monthly Earnings (AIME), which is used then to produce your Primary Insurance Amount (PIA) – a critical figure in determining your Social Security benefit amount.

Reducing current benefits

What happens if you are earning a significant amount of money (more than the limits) and you decide to go ahead and begin receiving your benefit before Full Retirement Age (FRA)?

When you’re under FRA, wage earnings greater than the limits will result in a $1 for $2 over the limit reduction to your annual benefits. Eventually at FRA you’ll get credit for those withheld benefits, but in the meantime your benefit is reduced by the over-earnings.

If you’re already at or older than FRA, you have no limit on your earnings, either as an employee or as a self-employed individual. Your earnings have no negative impact on your Social Security retirement benefit, although if your earnings are significant and more than some of your earlier earnings years, your future benefits could possibly increase as mentioned above. In addition, any benefits that your dependents or spouse may be receiving that are based upon your record are also not impacted by your earnings at this stage.

Smaller or eliminated WEP reduction

If your earnings from SS-covered wages are at or above the substantial earnings limits, you can gradually eliminate the impact of WEP reduction on your benefits. Once you have 20 or more years of these substantial earnings, WEP’s impact begins to shrink with each added year of substantial earnings. When you reach 30 years of substantial earnings covered by Social Security, WEP is effectively eliminated for you.

For more on how this works, see this article on substantial earnings with regard to WEP.

Posted on Nov 27th, 2023

by author: jblankenship.

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Posted in: earnings test, income tax, social security benefits, wep, windfall elimination provision.
Tagged: earnings test · income tax · social security benefits

Which Retirement Account Should You Tap First?

Nov 13th, 2023

by jblankenship.

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If you have multiple options of various different kinds of accounts to choose from, such as an IRA, a Roth IRA, a qualified retirement plan (such as a 401(k) plan) also known as a QRP, and perhaps an inherited IRA; you may be asking yourself: which one should I withdraw from first?

If you’re under age 59½, some of the options include considerable penalties – withdrawals from either the traditional IRA or the QRP will incur a 10% penalty for early withdrawal unless you meet one of the exceptions. So this leaves the Roth IRA or the inherited IRA. Each of these can be taxable to some degree, or partly non-taxable, depending upon the circumstances.

If the inherited IRA was subject to estate tax upon the passing of the original owner, you may be able to take a portion of your withdrawal in credit against the estate tax, due to the IRD tax deduction. In today’s world, this is less and less likely due to the increased estate tax exemption of $12+ million, but it’s still something to consider in your quest.

If you’re age 59½ or older and still working, the 10% penalty will not apply to any of your accounts, but that doesn’t mean that your choice is completely unlimited with no consequences. There are still tax issues to consider, as well as other affects that the law places on you as the owner of these accounts.

At any age, your contributions and conversions more than five years old can be withdrawn from your Roth IRA without tax or penalty. Any growth in the account will be subject to tax and penalty, and any conversions that were completed less than five years ago will also be subject to the 10% penalty.

Since you’re required to take a distribution from the inherited IRA (if you’re not the surviving spouse in some cases), this is where you’ll be taking a withdrawal no matter what other circumstances are occurring. If your need for money is greater than the Required Minimum Distribution (RMD) from the inherited IRA, then the most tax efficient option is to take a withdrawal of your contributions to the Roth IRA.

After those choices, you also could take a loan from your 401(k) plan (as long as this is available). This would be another option that is tax efficient (in general) but you would need to pay back the loan, and in turn this is a good way to derail your retirement savings. This could also result in taxation of your loan amount if you leave employment.

Lastly, you can always take money from your IRA and pay the taxes and penalties. This is probably the least desirable of all the options, as it is the most costly.

Something else to consider, if you have an inherited IRA and you’re not the surviving spouse: you’re required to take the RMD from the account each year, and this can often be a nuisance to keep track of. If you’re in need of money you can take extra from the inherited account and this will reduce future RMDs or perhaps eliminate them if you drain the account. Of course each dollar withdrawn is likely subject to ordinary income tax.

The other thing that makes the inherited IRA the better choice (over your other retirement accounts) is that you can defer use of these accounts until you reach age 73 (for your entire lifetime for the Roth) – and the rate of withdrawal will be less than with the inherited IRA.

In addition, for your owned accounts (non-inherited) your beneficiaries of those accounts can stretch payments over 10 years, or their lifetimes if they are specially eligible designated beneficiaries.

Once you reach age 73 (if born between 1951 and 1959), you must begin taking distributions from your IRAs and QRPs. These are a required minimum amount each year, so you can take the minimum and augment that amount by withdrawing from your Roth IRA options if you have them available.

As in earlier ages, you still need to withdraw the RMDs from your inherited IRAs, this continues throughout your life or as long as there is money in the account.

The goal should be to keep current taxes to a minimum, so using the Roth account may be a good option if you need more money than the RMDs provide for you. However, your Roth IRA is the one account that never requires you to take withdrawals during your lifetime. This can result in a legacy to provide for your heirs – one that will have no tax consequences to your beneficiaries.

Posted on Nov 13th, 2023

by author: jblankenship.

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Posted in: conversions, inherited IRA, IRA, qrp, retirement accounts, Roth IRA.
Tagged: inherited IRA · IRA · qrp · retirement accounts · roth ira

How to Get Your Prior Year Tax Return Information From the IRS

Nov 6th, 2023

by jblankenship.

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2018 Form 1040 If you’re trying to find information from your prior years’ tax returns and you don’t have the old forms (who has the space to keep all that!?), you have a few options available to you.

Generally speaking, your tax preparer should have old records for you – as long as it wasn’t too long ago. Sometimes this is a challenge for the preparer, as changes to software and office systems can result in difficult to retrieve records, although within reason your preparer should be able to get the forms for you.

If your preparer either doesn’t have the information or you’re reluctant to approach the preparer for the information, or you’ve moved, or the preparer is no longer in business, you have another option available to you: the IRS.

According to this IRS Tax Tip, there are things you need to know if you need federal tax return information from a previously-filed tax return.

Taxpayers who didn’t save a copy of their prior year’s tax return, but now need it, have a few options to get the information. Individuals should generally keep copies of their tax returns and any documents for at least three years after they file.

If a taxpayer doesn’t have this information here’s how they can get it:

Ask the software provider or tax preparer

Individuals should first check with their software provider or tax preparer for a copy of their tax return.

Get a tax transcript

If a taxpayer can’t get a copy of a prior year return, then they may order a tax transcript from the IRS. These are free and available for the most current tax year after the IRS has processed the return. To protect taxpayers’ identities, this document partially hides personally identifiable information such as names, addresses and Social Security numbers. All financial entries, including the filer’s adjusted gross income, are fully visible. People can get them for the past three years, and they need to allow time for delivery.

Here are the three ways to get transcripts:

Online. People can use Get Transcript Online to view, print or download a copy of all transcript types. They must verify their identity using the Secure Access process. Taxpayers who are unable to register or prefer not to use Get Transcript Online may use Get Transcript by Mail to order a tax return or account transcript type. Taxpayers should allow five to 10 calendar days for delivery.
By phone. Taxpayers can call 800-908-9946 to request a transcript by phone. Transcripts requested by phone will be mailed to the taxpayer.
By mail. Taxpayers can complete and send either Form 4506-T or Form 4506-T-EZ to the IRS to get one by mail. They use Form 4506-T to request other tax records: tax account transcript, record of account, wage and income and verification of non-filing. These forms are available on the Forms, Instructions and Publications page on IRS.gov.

Request a copy of a tax return from the IRS

Prior year tax returns are available from the IRS for a fee. Taxpayers can request a copy of a tax return by completing and mailing Form 4506 to the IRS address listed on the form. There’s a $43 fee for each copy and these are available for the current tax year and up to seven years prior.

Posted on Nov 6th, 2023

by author: jblankenship.

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

10% Penalty Applied to Roth Conversion? Maybe

Oct 16th, 2023

by jblankenship.

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In general, when you withdraw funds from an IRA prior to age 59½, your withdrawal is subject to both income tax and the 10% early withdrawal penalty. The 10% penalty is waived if your withdrawal is for one of the exception categories, including first-time home purchase, certain medical expenses, and the like. For a complete list of the exceptions, see the article I had previously written which provides links to the various exceptions to the 10% penalty.

One of the exceptions to the penalty is a withdrawal for a Roth Conversion. You still must pay ordinary income tax on the conversion, but generally the 10% penalty will not apply to amounts converted from a traditional IRA to a Roth IRA.

However (and there’s always a however in life), there are a couple of situations where the 10% penalty could impact you as you enact your Roth Conversion.

Funds used to pay the tax

If you used some of the funds from your Roth Conversion to pay the tax on the conversion, then effectively those funds were not converted. Therefore, if you’re under age 59½, the 10% penalty will apply to those funds that you used to pay the tax on the conversion.

For example, if you withdrew $50,000 from your traditional IRA to convert to a Roth IRA, but pulled out $5,000 to pay the tax on the conversion, then you really only converted $45,000 into the Roth IRA – and the $5,000 was withdrawn for other purposes than the conversion – so therefore subject to the 10% penalty. The entire $50,000 withdrawn from the traditional IRA would also be subject to ordinary income tax, as you might expect.

Funds withdrawn within the first five years

When you convert funds from a traditional IRA to a Roth IRA and you’re under age 59½, the converted funds are restricted from withdrawal for the lesser of five years or until you reach age 59½. If you withdraw the converted funds from the Roth IRA prior to the date the restriction is lifted, your withdrawal will be subject to the 10% penalty.

This restriction is in place to keep a taxpayer from converting funds to a Roth IRA prior to age 59½ (avoiding the 10% penalty) and then immediately withdrawing the funds from the Roth IRA account, thereby effectively taking a withdrawal from the traditional IRA without penalty. By requiring a delay for such withdrawals of up to five years, this strategy will lose its luster for someone who is hoping to use it to his advantage.

It does provide a way for an individual to do some advance planning if he or she chose to do so, though…

Advance Planning Strategy

Imagine if you were age 50 and hoped to retire in five years. You have a traditional IRA, amounting to $250,000, plus a pension and a 401(k) plan at your employer. You know that you’ll need $50,000 per year to live on during the years of age 55 to 60 – so you could convert $50,000 per year for the next five years, paying the tax from other sources.

Then you would have $50,000 per year available to you, beginning at age 55, that would be totally free from tax and penalty, since the conversion occurred more than five years in the past. When you reach age 60 you’ll have unencumbered access to your other sources of income (since you’re over age 59½), and in a few years you’ll have Social Security available as well.

It’s not a strategy that will work for everyone, but in certain circumstances it might work well for you.

NOTE: You’d want to plan this out very carefully so that you don’t trip up on any of the conversion dates and your future withdrawal dates.

Posted on Oct 16th, 2023

by author: jblankenship.

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Posted in: Early Distribution, IRA, retirement accounts, Roth Conversion, Roth IRA.
Tagged: IRA · roth conversion · roth ira

More Clarification on Rollovers and Transfers

Oct 9th, 2023

by jblankenship.

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I’m compelled to provide an additional update to the posts I’ve provided in the past in the article Running Afoul of One Rollover Per Year Rule and its follow-up More on the One-Rollover-Per-Year Rule. This is primarily to provide clarity to a portion of this rule that I personally was unclear on when the articles were originally written.

The rule is that you are restricted to one IRA rollover in a 12-month period. So let’s define a few things for the purpose of this discussion:

Rollover – this is when you move money from one IRA to another, first taking possession of the funds prior to depositing the funds into the new (or the same old) IRA account. You have 60 days to complete this process. At the end of the tax year you’ll receive a 1099R from the original custodian, with a distribution code of 1 or 7 (this form is important to the rule).

Transfer – Also known as a trustee-to-trustee transfer or a direct rollover, in this case you do not take possession of the funds, they are transferred directly from one IRA to another. Another possible way this could occur if you receive a check from the old custodian made out to the new custodian. Typically this sort of movement of funds does not generate a 1099R at the end of the year, as you’ve not actually made a distribution – no taxable event has occurred.

12 months – this really means a full year, 365 days in a normal year, 366 days in a leap year.

The Rule

Now that we have our definitions, here is the rule:

You are restricted to only one Rollover for ALL IRA accounts that you own, either receiving or distributing during a full 12 months from the date of the first distribution.

Transfers are not influenced by this rule. You are allowed to make as many transfers between IRAs as you like, uninhibited by the rule.

An example is in order: You have an IRA at Mutual Fund Company A, and you take a rollover distribution, after which you deposit the money into your IRA account at Brokerage B. You are restricted in that you cannot make any other rollovers into or out of any IRAs that you personally own, except for inherited IRAs, which you are not allowed to make a rollover distribution from anyway (only transfers are allowed). IRAs owned by your spouse are also not limited by actions you’ve made with IRAs that you own.

Roth IRA Conversions and Recharacterizations do not apply to this rule either – these are different sorts of distributions, and can be taxable events, but are not subject to this rule’s restriction.

Lastly, the rule does not apply to rollovers into or out of Qualified Retirement Plans (QRPs) such as a 401(k). You are free to do as many rollovers into or out of an IRA to/from QRPs with no time restrictions. This can often give you an extra advantage if you really need to move money again and a transfer is not in order.

Hopefully this has helped to fully clarify the rule.

Posted on Oct 9th, 2023

by author: jblankenship.

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

Avoid Errors In Your Tax Filing

Sep 25th, 2023

by jblankenship.

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As we approach the extended income tax filing deadline, folks all over the country are in a mad rush to fill out returns and complete the filing process. Software for return preparation has helped to resolve a lot of the issues and errors that occur in filing your returns, but still errors occur – there’s no way to completely fool-proof the process.

Below is a list that was published by the IRS, entitled Tax-Time Errors Filers Should Avoid:

Tax-Time Errors Filers Should Avoid

Mistakes on tax returns mean they take longer to process, which in turn may cause your refund to arrive later. The IRS cautions against these nine common errors so your refund is timely.

Incorrect or missing Social Security Numbers When entering SSNs for anyone listed on your tax return, be sure to enter them exactly as they appear on the Social Security cards.
Incorrect or Misspelling of Dependent’s Last Name When entering a dependent’s last name on your tax return, ensure they are entered exactly as they appear on their Social Security card.
Filing Status Errors Make sure you choose the correct filing status for your situation. There are five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er) with Dependent Child. See Publication 501, Exemptions, Standard Deduction, and Filing Information to determine the filing status that best fits your needs.
Math Errors When preparing paper returns, review all math for accuracy. Or file electronically; the software does the math for you!
Computation Errors Take your time. Many taxpayers make mistakes when figuring their taxable income, withholding and estimated tax payments, Earned Income Tax Credit, Standard Deduction for age 65 or over or blind, the taxable amount of Social Security benefits, and the Child and Dependent Care Credit.
Incorrect Bank Account Numbers for Direct Deposit or Debit If you are using direct deposit for a refund or direct debit for a payment, make sure that you review the routing and account numbers for your financial institution.
Forgetting to Sign and Date the Return An unsigned tax return is like an unsigned check – it is invalid. And, remember on joint returns both taxpayers must sign the return (another item that is not necessary when filing electronically, although electronic signatures, authorization, are required).
Incorrect Adjusted Gross Income Information Taxpayers filing electronically must sign the return electronically using a Personal Identification Number. To verify their identity, taxpayers will be prompted to enter their AGI from the originally filed federal income tax return for the prior year, or the PIN number used previously if they used a PIN for the prior year. Taxpayers should not use an AGI amount from an amended return, Form 1040X, or a math error correction made by the IRS.
Figuring Credits or Deductions Taxpayers can make mistakes figuring things like their earned income tax credit, child and dependent care credit and child tax credit. Tax software will calculate these credits and deductions and include any required forms and schedules.

Posted on Sep 25th, 2023

by author: jblankenship.

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

Advice on Social Security Benefits

Sep 18th, 2023

by jblankenship.

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I get a lot of questions about when to take Social Security benefits most efficiently, and when to begin Spousal Benefits. And unfortunately, I am often at a loss for giving a specific answer to the individual, because I just don’t have enough information.

Social Security planning has very many factors that must be considered – for example:

It’s important to consider earnings from your job if you’re filing early and continuing to work (see Social Security Earnings Tests for more information), as this can impact the amount of benefits you actually receive.
Your health status and longevity are critical to the equation as well – since delaying strategies often rely on your longevity to achieve payback (more information in the article Your Payback from Social Security).
Of course, your marital status is important to the equation as well. If you’re married, you should think about Spousal Benefits and Survivor Benefits in addition to your own benefit. And if you’re divorced or widowed, additional considerations must be brought into the equation as well.
Probably the most important of all – do you need the money right now? Too often this factor is overlooked in our zeal to “get our money back”. As you’ll see in this article on delaying benefits, it can be very worth your while to delay receiving benefits – but again, this shouldn’t be done blindly.

Each individual’s circumstances has other factors to consider as well. Your overall retirement plan has to be the context against which these factors should be considered.

As you take these factors and others into account, it’s important to perform break-even analysis on your benefits at various ages, along with that of your spouse (if you have one). Then it’s up to you to decide what makes the most sense in your situation. If you have a trusted advisor that you can work with to help you with your analysis, all the better.

And lastly, if I can help you with this analysis, this is what I do for a living. As always, I am happy to help you understand the nuances of the various programs and all – the only thing I ask of you is that you pass the word along to your friends and acquaintances. It’s my hope that when questions about Social Security and other financial issues come up, I can help.

Posted on Sep 18th, 2023

by author: jblankenship.

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Posted in: fiduciary, file and suspend, retirement, security retirement benefits, Social Security.
Tagged: fiduciary · file and suspend · retirement · Social Security · social security benefits

Required Minimum Distributions for IRAs and 401(k)s

Sep 5th, 2023

by jblankenship.

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This is one of those subjects that can be a bit confusing – and it’s based on the rules that apply to the different kinds of plans, as well as different kinds of beneficiaries. You are aware that you’re required* to begin taking Required Minimum Distributions (RMDs) once you reach age ~~70½~~ – ~~no wait, 72~~ – whoops now it’s 73*** – but did you know that specifically which account you take the RMD from has some flexibility? Well – not only flexibility, also some rigidity…

There is a Difference Between IRA and 401(k)

Starting off, we need to understand that, in the IRS’s eyes, there is a big difference between an IRA and a 401(k). For brevity, we’re referring to all sorts of Qualified Retirement Plans, such as 403(b)** or 457 plans, as 401(k) plans. You may consider the two things to be more or less equal, but if you think about it, there are considerable differences between an IRA and a 401(k) – amounts you can fund the account with each year, catch-up arrangements, who can defer funds into each kind of plan, and the list goes on.

A 401(k) plan, being an employer-provided retirement plan, has a completely different set of rules governing it – including provisions that go all the way back to the original ERISA legislation. Among those rules are the rules about RMDs.

On the other hand, the IRA is not covered by ERISA, and as such there are other rules that apply to these arrangements – including the RMDs.

We don’t have nearly enough space here to go over everything that is different between these two types of plans, but we’ll cover the RMD treatment.

Required Minimum Distributions (RMD)

Each and every 401(k) plan* that you own is treated as a separate account in the eyes of the IRS. As such, if you have four old 401(k) plans when you reach age 73, you will have to calculate and take a separate RMD from each 401(k) plan that you have. In other words, you couldn’t aggregate all the plans together and take one RMD from one of the accounts that is large enough to cover all the RMDs. In addition, you have to consider each account separately and figure out how much of each RMD is taxable, if you happen to have post-tax dollars in the account(s).

However, no matter how many IRAs that you have, the IRS looks at all of these plans as one single plan, so you are allowed to pool all of the account balances together, calculate the RMD amount, and then withdraw that amount any single IRA account or any combination of accounts. Your tax basis is aggregated as well (if you have non-deducted contributions in the accounts), so the tax treatment is a consideration for the entire pool of your IRAs in total (rather than account by account as is the case with 401(k) plans).

Example

You have two old 401(k) plans and three IRAs. This is your year, you’ve reached age 73, so you have to start taking RMDs. How do you do it for these five accounts?

Each 401(k) plan’s RMD has to be calculated separately – and a RMD taken directly from each account. But you can pool the IRA account balances together, calculate and take one RMD from one of the accounts that is large enough to cover all three accounts’ minimum distribution. Or from multiple accounts if you wish, as long as the total of your distributions is at least as much as the RMD amount calculated for all of your IRAs.

This is another reason why it can be helpful (from a paperwork standpoint, if nothing else) to rollover your old 401(k) plans into IRAs. By doing this, you don’t have to take a distribution from, in the case of the example above, three different accounts at a minimum.

* Note: if you are still working after age 73 and you’re not a 5% or more owner of the company and your 401(k) plan allows it, you may not be required to take RMDs from the account. This is yet another difference between IRAs and 401(k)s with regard to distributions.
**Also – specifically for 403(b) accounts – you may aggregate all of your 403(b) accounts together for RMD calculation and distribution.
***Lastly, the switcheroo about the age to begin RMDs is the result of the SECURE Act(s) – as of 2023 the RMD age is 73, and will remain so until 2033.

Posted on Sep 5th, 2023

by author: jblankenship.

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Posted in: 401k, 403 b, employer plan, IRA, iras, minimum distributions, qrp, qualified retirement plan, required minimum distribution, retirement plan, rmd, tax.
Tagged: 401 k · 403 b · IRA · qrp · rmd

NUA and the Roth Conversion

Aug 28th, 2023

by jblankenship.

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comte by kthread You may or may not be familiar with the concept of Net Unrealized Appreciation (NUA) as it relates to company stock owned in your 401(k) plan. Click the link to get a rundown on it if you’re not familiar with NUA.

Briefly, when you take distribution from your 401(k) you can rollover everything but the company stock (your company) to an IRA, and then put the company stock in a taxable account. By doing this, you pay tax only on the basis of the company stock, and in the future you will only have to pay capital gains tax on the sale of the company stock, rather than ordinary income tax as you would if the company stock (or the proceeds) were in a traditional IRA.

Now, let’s toss in the Roth Conversion concept – you pay tax on the amount that would be otherwise taxable if the distribution were in cash, but you place the funds in a Roth IRA account, and you don’t have to pay tax on it in the future at all (as long as you meet the qualifications).

How do these two concepts work together? Well, at one time, it was thought that you could work both sides of the coin and utilize the loophole: if you converted the company stock directly to the Roth, it seems that you would only have to pay tax on the basis of the stock (per NUA rules), and then never have to pay tax on the capital gains. This is because the stock is held in a Roth IRA.

Not so fast, though. The IRS figured this out pretty quickly after the rules for conversion from a qualified plan to a Roth IRA were put into effect in 2009. For this specific circumstance, you must treat the Roth conversion from a qualified plan as if it were first rolled over to a traditional IRA, and then converted to a Roth IRA. The one exception to the way this is handled is that you only have to consider the qualified plan’s funds that you’re converting – rather than all of your IRAs as you would normally (cream in the coffee rule) – for tax purposes.

At any rate, since you must treat the Roth conversion as if it were originally rolled into a traditional IRA, the NUA treatment option is foregone at that point. So if you tried to do this, you’d end up with a failure, and no NUA treatment would be available to you.

This results in your having to pay ordinary income tax on the entire value of your company stock holdings if you do such a conversion (rather than just the basis). So it may still be to your benefit to enact the NUA rule and put the company stock into a taxable account rather than an IRA – but you’ll have to run the numbers to figure out if this will work best for you.

Photo by kthread

Posted on Aug 28th, 2023

by author: jblankenship.

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Posted in: forbes.com, IRA, net unrealized appreciation, NUA, retirement plan, Roth Conversion, Roth IRA, roth ira conversion.
Tagged: IRA · NUA

Property Flipping Gains Deemed Ordinary Income, Not Capital Gains

Aug 21st, 2023

by jblankenship.

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fixer upper by mike t ormsby Since the housing market downturn, the national pastime of “property flipping” has fallen in popularity – heck, I haven’t seen a TV show on property flipping in ages. But the activity of buying a fixer-upper, applying a little sweat equity, and then reselling for a profit has been going on ever since Gog first rehabbed and sold that condo-cave with a view.

If you (or someone you know) are involved in flipping, there have been tax cases that you may want to pay particular attention to. Most of the time, the question of how the sales receipts are classified was addressed, and how the Tax Court responded should be of interest to anyone involved in flipping.

Here’s how one case played out: the taxpayer asserted (among other things), that the activity of buying, rehabbing, and then reselling the properties was an investment activity, and so any gains should be treated as capital gains. The IRS disagreed that this was investment activity, but rather a purchase and re-sell of inventory, and that the income from the activity should be treated as ordinary income.

The Tax Court agreed with the IRS. The nature of the taxpayer’s buying and reselling activity, given that they bought and sold between four and eight properties per year, holding them for two to three months in most cases. According to the Tax Court Memo, the following factors are used to determine whether an asset is a capital investment or if it is an item purchased with the sole intent to resell:

The taxpayer’s purpose in acquiring the property
The purpose for which the property was subsequently held
The taxpayer’s everyday business and the relationship of the income from the property to the total income
The frequency, continuity, and substantiality of sales of property
The extent of developing and improving the property to increase the sales revenue
The extent to which the taxpayer used advertising, promotion or other activities to increase sales
The use of a business office for the sale of property
The character and degree of supervision or control the taxpayer exercised over any representative selling the property
The time and effort the taxpayer habitually devoted to the sales

For the full text of TC Memo 2010-261, click the link. There are bound to be many other cases but this one caught my eye when this article was first written, nearly 13 years ago. As far as I can determine, this treatment still applies today.

Apparently the factor in the above list that caused the greatest damage to the taxpayer’s assertion of investment activity is #4, frequency of sales. In addition, the absence of any intent to lease the properties to generate returns underscores the case that the property was purchased solely to re-sell.

Since the taxpayer in this case purchased and sold fifteen properties within three years and did not attempt to lease or hold the properties for a significant period of time, the Tax Court deemed that the taxpayer’s business activity would be most appropriately classified as “dealers of real estate”. With that classification, the profits derived from sales (above the purchase price and rehab expenses) would be deemed to be ordinary income, subject to self-employment tax and ordinary income tax.

Other factors weighed on this decision, not the least of which was the fact that the profits from sales of properties constituted the primary source of income for the taxpayer during the period.

Understandably, given the much lower tax rate on capital gains versus ordinary income tax rates (not to mention the self-employment tax incurred), it would have been far better for the taxpayer if the profits had been considered capital gains.

As I understand it, in order to be truly successful at property flipping, volume is important. Turning over properties quickly at a profit while putting as little money at risk for as short a period of time possible is the name of the game. This can hardly be described as capital gains oriented activity – at least that’s what the Tax Court says.

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Posted on Aug 21st, 2023

by author: jblankenship.

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Posted in: capital gains, irs, tax, tax case.
Tagged: tax

Timeless Thoughts on Investing

Aug 14th, 2023

by jblankenship.

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800px-Timeless_Books I was recently re-reading an older book, The Money Game, by “Adam Smith”, and I came across a very poignant passage that I thought I should share. This book was written in 1967, and it is a very interesting take on money and how we view it.

The passage relates to how we perceive investments in general, as well as the importance of having a goal for your investments and saving activities. Keep in mind that this passage was written more than 55 years ago, so some references will be woefully out of date, but the message is still clear and valid. Let me know if it gives you inspiration – I thought it was particularly good:

A stock is, for all practical purposes, a piece of paper that sits in a bank vault. Most likely you will never see it. It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day. The most important thing to realize is simplistic: The stock doesn’t know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of those things are unreciprocated by the stock or the group of stocks. You can be in love if you want to, but that piece of paper doesn’t love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate.

It may sound a little silly to have a reminder saying The Stock Doesn’t Know You Own It were it not for all the identity fuel provided by the market these days. You could almost sell these identities as buttons: I Am the Owner of IBM, My Stocks Are Up 80 Percent; Flying Tiger Has Been So Good to Me I love It; You All Laughed When I Bought Solitron and Look at Me Now.

Then there is a great big master button called I Am a Millionaire, or I Am So Shrewd My Portfolio Has Gone into Seven Figures. The magic of this million-dollar number, and of its accessibility to Everyman, is so great that books sell with titles like How I Made A Million or You Can Make Millions, with very little content at all. They are the most dangerous of all the things written on the market because (and I collect them as a hobby) inevitably there is some mechanical formula somewhere within. Never mind who you are or what your capacities and abilities are, just charge in with the book open to chapter three.

If you know that the stock doesn’t know you own it, you are ahead of the game. You are ahead because you can change your mind and your actions without regard to what you did or thought yesterday; you can, as Mister Johnson said, start out with no preconceived notions. Every day is a new day, providing, in the Game, a new set of continuously measurable options. You can live up to all those old market saws, you can cut your losses and let your profits run, and it doesn’t even make your scar tissue itch because, being selfless, you are unscarred.

It has been my fate to know people who have made considerable amounts of money, sometimes millions, in the market. One is Harry, who made it and blew it and made it again. Harry really wanted to make a million dollars, and he did. I think Mr. Linheart Stearns had a very good point when he said the end object of investment ought to be serenity. Now if you think making a million dollars will give you serenity, there are two things you can do. One is to find a good head doctor and see if you can discover why you think a million dollars will give you this serenity. This will involve lying on a couch, remembering dreams, talking about your mother, and paying forty dollars an hour. If your course is successful, you will realize that you do not want a million dollars but something else which the million dollars represents to you, such as love, potency, mother, or what have you. Released, you can go off about your business and not worry any more, and you will be poorer only by the number of hours you spent in accomplishing this times forty dollars.

The other thing you can do is to go ahead and make the million dollars and be serene. Then you will have both a million dollars and serenity, and you do not have to deduct the number of hours times forty dollars unless you feel guilty about making it.

It seems simple, and there is indeed a catch. What do you do if the million dollars arrives and serenity does not? Aha, you say, you will worry about that when you get to it, you are shure you can handle it. Perhaps you can. Money, contrary to popular myth, does help people more than it spoils them, simply because it opens up more options. The danger is that when you have your million, you then want two, because you have a button saying I Am A Millionaire and that is who you are, and there are, all of a sudden – as you will notice – so many people with buttons saying I Am a Double Millionaire.

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The trouble with Harry is not just the trouble with one man who made and lost a lot of money, nor even that there are hatching, at this very instant, other Harrys who will play out this role next month and next year. The trouble goes beyond Harry, beyond Wall Street; it’s a kind of virus in the whole country, when the cards of identity say not how well the shoe is cobbled or the song is sung, but are a set of numbers from an adding machine. Usually we hear only the triumphs by adding machine, but those who live by numbers can also perish by them, and it is a terrible thing to have an adding machine write an epitaph, either way. Perhaps measuring men by the marketplace is one of the penalties of our age, but if some scholar would tell us why this must be, we would all know more about ourselves.

Boilt down, the gist of this passage is two lessons:

1) Don’t get emotionally involved in your stock, fund, or whatever investment you make. All decisions should be made without regard to your past ownership or any other factors besides the fundamental and technical analysis you do on your investment choices.

2) Have a goal in mind for your investment activity. What “Smith” recommends is simply serenity – and if you can define “serenity” for yourself, you’ve set the goal. And if serenity isn’t what you’re looking for, choose and define “chaos” or whatever is important to you.

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Excerpt from The Money Game, by ‘Adam Smith’, pages 81-84

Posted on Aug 14th, 2023

by author: jblankenship.

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Posted in: Book review, financial planning, investing.
Tagged: financial planning

Principles of Pollex: Investment Allocation

Aug 9th, 2023

by jblankenship.

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Photo credit: jb

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

In this installment of the Principles of Pollex, we address a compelling Investment Allocation Rule of Thumb: Invest X% of your money in bonds, and the remainder in stocks – where “X” is equal to your age. According to this rule, if you’re 35 years old, you’ll have 35% invested in bonds and 65% invested in stocks.

What’s Good About It

Absent any other allocation strategy, at least this strategy provides you with a structure for scaling back your exposure to stocks over time. It’s important to understand that your risk exposure should in general reduce as you reach closer and closer to your goal. This is because you have less time between now and the use of the funds to make up for any downturns.

But you need to keep in mind that once you reach retirement age, you’re not “done”. You have many more years ahead of you (hopefully!) for that investment to support your lifetime spending needs.

In addition to the structure, using such an allocation strategy will require you to be more conservative earlier on in your investing life, and less conservative later in your life, than is likely for most folks. Left to our own devices, we’d be a little more likely to be overly aggressive in the early years (100% stocks, for example) when we ought to have an exposure to bonds to help balance out the portfolio to help us make it through market downturns without losing faith.

In addition, as we start into retirement years, too often we think that we should become totally conservative (100% bonds) when in actuality we have a long time (30+ years left in our projected life) to make the portfolio continue to work for us. With that long-term horizon we need to continue with an exposure to stocks in order to keep up with inflation and have continued growth in the portfolio.

What’s Not So Good

As with all Rules of Thumb, the problem with this one is that it’s too general to be appropriate for everyone – really for anyone. For most people with long-term investing horizons, such as 25 years or more, this allocation scheme is very conservative, and may result in needlessly squelching possible returns early in your investing career.

On the other hand, if you had chosen this sort of allocation scheme, you’d be (likely) much better insulated against significant stock market downturns like the one in 2022 than if you’d gone with a 100% stock exposure.

Additionally, while this rule of thumb does account for your timeline to a degree, assuming that at retirement (let’s say age 65) your risk tolerance and requirement for returns is in the range where a 65% bond/35% stock portfolio will meet your needs. The problem is that this is likely too conservative to meet most folks’ needs over the potential 30 or more years that you need the portfolio to continue meeting inflation and growing.

Lastly, this allocation plan only takes into account the two very broad allocation options of stocks and bonds. A well-diversified portfolio may also include sub-categories of global bonds and stocks, commodities, real estate, and other components that are not so easily “thumbed”.

A Better Way, Maybe?

If you need a rule of thumb, maybe you could take this same one and put in an additional factor to make it not quite so conservative – like adding 25% to the stock factor, and possibly limiting both factors to no less than 10%. So, for a person age 35, you would have a stock component of 90% (100% minus your age, 35, plus 25% equals 90%) and a bond component of 10%. Each subsequent year you’d increase the bond portion by 1% and decrease the stock portion by 1%. At any age less than 35, you’d still be at a 90/10 stock-to-bond ratio. Upon retirement you might reduce the additional 25% factor somewhat – maybe to add only 10%, for example – so that at age 65 your ratio would be 45% stock, 55% bond.

Another way could be to work with a professional financial advisor to lay out a proper allocation plan that is tuned to your own timeline, risk tolerance, and preferences. But if you’re fixed on doing it yourself, this adapted principle of pollex may be useful to you. You will probably want to put a little more effort into your plan than this – and likely you will over time.

Posted on Aug 9th, 2023

by author: jblankenship.

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Posted in: financial planning, investing, principles of pollex, rules of thumb.
Tagged: financial planning

Let It All Go – IRS gives you 11 years… (now 12½ years!)

Aug 7th, 2023

by jblankenship.

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Photo credit: diedoe

When you were a kid, did you ever dream of being able to just let it all go – not having to follow any rules, no penalties, no restrictions? What if I told you that the IRS provides you with just such an environment – where you are free to literally do (or not do) almost anything you want with your IRA? Including buying yourself that pet camel you always wanted?

So just where is this nirvana? Where you can just go willy-nilly and do whatever suits you with your IRA? It’s not a where, but rather, when.

Between the ages of 59½ and 72 there are no rules or restrictions regarding withdrawals from your IRA – including no required withdrawals. How ’bout them apples?? That’s a full 150 months where you can take money out of your IRA at any time, for any reason, and there are no consequences! Well, the one consequence is that you have to pay ordinary income tax on the tax-deferred withdrawals. You’re also free to not take money out of your account, if you wish – a privilege that you might yearn for after you reach the end of this free-for-all time.

One other thing that comes up during this span of 12½ years: at age 70½, you have the ability to begin making Qualified Charitable Distributions (QCDs) from your IRA. These can be very useful if you are making charitable contributions anyhow, and you otherwise take the Standard Deduction. It used to be (back in the olden days before the SECURE Act) that you had to be subject to RMDs in order to take advantage of QCDs, but no longer. You just need to be 70½ years of age and you’re all set to take QCDs.

And it gets better if you have a 401(k) – you have from age 55 to age 72 with no restrictions, the only additional requirement being that you have separated from service (left your employer) on or after age 55. And many employers are stepping up and helping folks out with that lately – hardly a day goes by without hearing of someone “separating from service”.

On the other hand, if you’re still employed by that employer, the required minimum distributions don’t apply to you at age 72. Often the employer restricts your distributions while employed (but not always).

So – when everything seems to be going against you, you can sit back and think about how the IRS has given you this wonderful span of time… eleven full years… with no restrictions.

Posted on Aug 7th, 2023

by author: jblankenship.

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

Organization, Efficiency & Discipline

Jun 12th, 2023

by jblankenship.

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Photo credit: jb

Simplification is usually beneficial to any pursuit. If you can break down the basic principles of whatever “big thing” it is that you’re hoping to accomplish into simple concepts, you’ll do well in your pursuit.

This is true for whatever you’re hoping to accomplish – climbing Mount Everest (train, prepare, keep going up); write a book (gather information, organize, keep writing); or get a college degree (show up, pay attention, study). In preparing for retirement (or saving for any goal), I’ve always broken the concepts down to organization, efficiency, and discipline.

Organization

In order to get things started, it’s important to know where you are in your financial life. When you’re getting driving directions from Google Maps, the first thing they ask you is where you’re starting from. The same goes for “mapping” your financial path. Gather together your information and organize it so that you know what assets and what liabilities you have. This can be as simple as listing everything out on a piece of paper, or a computer spreadsheet, or using some of the tools available on the internet, such as Mint.com.

Also gather your information about your monthly and annual expense requirements – preferably with an eye toward understanding what is a “must” expense and what is a “nice” expense. If you’re having trouble balancing your budget (your income is less than your expenses) you’ll need to look at the “nice” expenses and determine what you can do without.

The last piece of Organizing is to set forth a goal – or several goals, depending on your situation. Maybe it’s a goal to retire in five years… or to send your kids to college in 8 years. Whatever is the goal, you need to quantify it (put it in terms of dollars and time), and so that you can map out the way to get there from where you are now.

Having everything organized will tell where you are financially, and knowing what your expenses are compared to your income will help you to understand what you can do to make changes in your financial life in order to reach those goals.

Efficiency

Now that you know where you are and where you’re going, it’s time to figure out how to get there. As you know, there are many types of investment accounts, investment products, and the like, that you could use to increase your bottom line. My preference is to use the most Efficient methods, in terms of placement of funds, taxes, expenses, and risks, in order to take you toward those goals.

When saving for a goal, especially a goal with a long-term time horizon such as retirement, it makes good sense to be tax-efficient as possible with your choices of investing accounts. IRAs and 401ks provide near-term tax benefits but might prove to be more tax-costly in the long run; Roth-type accounts provide longer-term tax benefits due to the tax-free qualified withdrawals from those accounts.

Efficiency of investment occurs when you utilize vehicles such as mutual funds to provide diversification across multiple investments within one transaction. It is far more efficient to purchase no-load, zero-expense (or near zero) mutual funds and ETFs than it is to track and purchase a large number of individual stocks (and bonds).

Efficiency in expenses can be addressed by utilizing no-load index mutual funds and/or Exchange-Traded Fund (ETF) indexes. These two types of investment products generally provide the most cost-efficient methods of investing. In addition to the cost-efficiency, ETFs are also very tax-efficient, due to the structure of the funds.

Not only are indexes very cost-efficient and tax-efficient, but indexes are also risk-efficient as well. If you invest in indexes you are getting (generally) the market’s movement in returns – something that less than 40% of managed funds can do regularly.

Discipline

Now that you’ve figured out the methods to use in getting to your goals, you have generated a plan to accomplish those goals. This is where discipline comes into the picture. In order to achieve these goals, you have to create your plan and stick to it, through thick and thin.

When the market is having difficulties and your accounts are experiencing a downturn, you need to maintain the intestinal fortitude to continue with your investing activities. This is where a good financial advisor or just an accountability partner can help you out a great deal.

It’s maintaining the long-term view in the face of short-term “noise” like a market downturn that helps you to meet those goals. Chickening out and selling at the wrong time can derail things.

Discipline also extends to creating your budget and sticking to it as well. By reviewing your expenses and determining where you can reduce, you’ll be able to free up more money each month to eliminated debt and increase your savings balances. But this only works if you really stick to the budget. Fudging it will gradually erode the result you’ve planned.

Bottom line

By putting these basic tenets of Organization, Efficiency & Discipline to work for you, you will soon begin to see progress toward your goals. Keeping things as simple as possible helps to ensure that you’ll stay with your plan. As with everything else, let me know if you have questions!

Posted on Jun 12th, 2023

by author: jblankenship.

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Posted in: financial planning, investing, rules of thumb.
Tagged: financial planning

How to Apply for Social Security Benefits

Jun 5th, 2023

by jblankenship.

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Photo credit: jb

There are three methods you can use to apply for Social Security retirement benefits. And since you’re reading this article you’re likely overwhelmed by the prospect and don’t know where to start, so here’s how to apply:

By Phone – call the Social Security Administration at 1-800-772-1213 between the hours of 8am and 7pm (they don’t say, but I’m assuming this is Eastern time) to apply. You can also call 1-800-325-0778 for TTY service, if you require it. Advice from the Social Security site indicates that there are often long wait times, and that early in the day is typically better (8am to 10am) with somewhat shorter waits. Later in the week and later in the month are generally shorter wait times as well. In other words, calling at 3pm on Monday the 1st of the month is likely going to result in very long wait times on the phone.

In Person – just show up at your local Social Security Administration office, or call to set up an appointment at your local office (this is probably the better option, for less wait time). You can find the closest office by clicking this link and entering your ZIP code. From what I hear, visiting the local office can be a hit or miss experience, similar to visiting the DMV to get your driver’s license renewed. You could get right in with little wait, but more likely you’ll spend quite a bit of time “in queue”. Here’s a tip though: if you can work it out, I understand that the day after Thanksgiving is the best day of all to visit the local SSA office. They’re open and operating, but nobody expects them to be. It’s worth a try.

Also, you’re not required to go to only the nearest office. If there’s another office nearby that is perhaps not as busy as your closest office, try getting an appointment there.

Much like the phone queue, Mondays and the first week of the month, or the day after a federal holiday are the busiest times for these offices. Also, like every other people-intensive business, Social Security has staffing shortages that tends to cause longer wait times in the office.

Online – you can go to the Social Security website and there, right in the middle of the page, is a link to “Apply for benefits”. You can use this online application if you’re at least 61 years and 9 months of age, and you plan to begin your benefits within the next four months (you also live in the US or one of its commonwealths or territories). If you’ve already set up your mySocialSecurity account, you should be able to just log in to the system and get started. Otherwise, you’ll need to set up your account, which might take a while to complete the process.

If you’re already age 62 or better, you could begin receiving benefits as early as the month you apply. In addition, if you’re at least 64 years, 8 months of age, your online Social Security benefit application will automatically include applying for Medicare.

Things you’ll need before you start the process, no matter which method you use:

Your date and place of birth and Social Security number;
Your bank or other financial institution’s Routing Transit Number and the account number, if you want the benefits electronically deposited. You can get this information from a check or deposit slip;
The amount of money earned last year and this year. If you are filing for benefits in the months of September through December, you will also need to estimate next year’s earnings;
The name and address of your employer(s) for this year and last year;
The beginning and ending dates of any active U.S. military service you had before 1968;
The name, Social Security number and date of birth or age of your current spouse and any former spouse. You should also know the dates and places of marriage and dates of divorce or death (if appropriate); and
A copy of your Social Security Statement, or access to the online version. Even if the earnings on your Statement are not correct or you are not sure if they are correct, please fill out the application. The Social Security Administration will assist you in reviewing and correcting your record after they receive the application.

Posted on Jun 5th, 2023

by author: jblankenship.

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Posted in: Medicare, Social Security.
Tagged: Social Security

078-05-1120 – is this Your Number?

May 29th, 2023

by jblankenship.

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Hopefully it’s not what you think is your Social Security number, although it’s quite possible that at some point you (or someone you know) did think it was your (or their) correct number. Why is that? It’s a very interesting story (with thanks to the Social Security Administration for the story):

The story of the most misused number of all time. . .

Mrs. Whitcher compares the Social Security card “issued by Woolworth” with her own real card of the same number.

The most misused SSN of all time was (078-05-1120). In 1938, wallet manufacturer the E. H. Ferree company in Lockport, New York decided to promote its product by showing how a Social Security card would fit into its wallets. A sample card, used for display purposes, was inserted in each wallet. Company Vice President and Treasurer Douglas Patterson thought it would be a clever idea to use the actual SSN of his secretary, Mrs. Hilda Schrader Whitcher (it was a much simpler time, tbh).

The wallet was sold by Woolworth stores and other department stores all over the country. Even though the card was only half the size of a real Social Security card, was printed all in red, and had the word “specimen” written across the face, many purchasers of the wallet adopted the SSN as their own. In the peak year of 1943, 5,755 people were using Hilda’s number. SSA acted to eliminate the problem by voiding the number and publicizing that it was incorrect to use it. (Mrs. Whitcher was issued a new number.) However, the number continued to be used for many years. In all, over 40,000 people reported this as their SSN. As late as 1977, 12 people were found to still be using the SSN “issued by Woolworth.”

The card that started all the fuss!

Mrs. Whitcher recalled coming back from lunch one day to find her fellow workers teasing her about her new-found fame. They were singing the refrain from a popular song of the day: “Here comes the million-dollar baby from the five and ten cent store.”

Although the snafu gave her a measure of fame, it was mostly a nuisance. The FBI even showed up at her door to ask her about the widespread use of her number. In later years she observed: “They started using the number. They thought it was their own. I can’t understand how people can be so stupid. I can’t understand that.”

Not The Only One

The New York wallet manufacturer was not the only one to cause confusion about Social Security numbers. More than a dozen similar cases have occurred over the years–usually when someone publishes a facsimile of an SSN using a made-up number. (The Whitcher case is far and away the worst involving a real SSN and an actual person.)

One embarrassing episode was the fault of the Social Security Board itself. In 1940 the Board published a pamphlet explaining the new program and showing a facsimile of a card on the cover. The card in the illustration used a made-up number of 219-09-9999. Sure enough, in 1962 a woman presented herself to the Provo, Utah Social Security office complaining that her new employer was refusing to accept her old Social Security number–219-09-9999. When it was explained that this could not possibly be her number, she whipped out her copy of the 1940 pamphlet to prove that yes indeed it was her number!

Lifelock

Then there’s the story of Lifelock, the identity-fraud protection company. The CEO of the company proudly proclaimed that his company’s protection was so good that he could publish his own Social Security number, 457-55-5462, and have no fear of identity theft.

You guessed it, this number has been used countless times by potential fraud perpetrators, apparently 13 of which have been successful in their endeavors, according to some reports.

Posted on May 29th, 2023

by author: jblankenship.

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Posted in: reader questions, Social Security.
Tagged: Social Security

19? No, 22 Ways to Withdraw IRA Funds Without Penalty

May 22nd, 2023

by jblankenship.

4 comments

Photo credit: dido

We’ve covered a lot of ground on how you can access your IRA funds in this blog. Over time I have developed the following list of the ways to withdraw IRA funds without penalty. The penalty for early withdrawal of IRA funds is 10% of the withdrawal, unless one of the exceptions is met. This list is for Traditional IRAs only. For a similar list regarding early withdrawal from a 401k plan, follow this link. This list has been updated with the Secure 2.0 exceptions that came into law in 2022, so that there are now 22 ways to withdraw funds from an IRA without penalty.

It is key to note that, although these exceptions allow the distribution of funds without triggering the 10% penalty, in most cases the account owner is still liable for the ordinary income tax on distributions. Consult your tax advisor for additional information.

19 22 Ways to Withdraw IRA Funds Without Penalty

We’ll start with the obvious:

1. Normal distribution – take your withdrawal after age 59½
2. Before Tax Due – Withdraw annual contributions before the due date of your tax return – an example would be to withdraw your 2023 contributions (and any associated growth) before April 15, 2024.
3. Excess Contributions – Withdraw excess contributions before the due date of your tax return – if you discovered that you had contributed more than allowed (due to income limits or error) you are allowed to remove the excess and any associated growth before the tax return is due for the year.
4. Required Minimum Distributions – technically this one is covered by #1 above for most circumstances, but it also covers the case where RMD is required of a person who has inherited an IRA, regardless of age.

Now we’ll move into some of the not-so-obvious methods, starting with SOSEPP.

Series Of Substantially Equal Periodic Payments

This is the classic Section 72(t) method for withdrawing funds without penalty. Essentially you agree to continue taking the same amount from your IRA for the greater of five years or until you reach age 59½. There are three methods of SOSEPP:

5. Required Minimum Distribution method – uses the IRS RMD table (usually Table III) to determine your Equal Payments.
6. Fixed Amortization method – in this method, you calculate your Equal Payment based on one of three life expectancy tables published by the IRS.
7. Fixed Annuitization method – this method uses an annuitization factor published by the IRS to determine your Equal Payments.

Additional Section 72(t) methods for taking distribution from your IRA include:

8. Qualified Higher Education Expenses – you can withdraw your IRA funds to help pay for college, within limits.
9. Death – If you die, your beneficiaries are able to take distributions from your IRA without penalty, including RMDs (see #4 above).
10. Disability – If you are “totally and permanently disabled” by IRS definition, you can take distributions from your IRA without penalty.
11. High Unreimbursed Medical Expenses – for yourself, your spouse, or your qualified dependent. If you face these expenses, you are allowed to withdraw a limited amount (the actual expenses minus 7.5% of your AGI) without penalty.
12. Medical Insurance Premiums – if you’ve lost your job and receive unemployment compensation, you are eligible to withdraw an amount to pay for your medical insurance premiums (with some additional limits).
13. First-Time Home Purchase – up to $10,000 ($20,000 for a couple) of the costs of buying, building, or re-building a “first home”. First home is determined by whether you had no present interest in a main home for two years prior to the purchase.

And lastly, here are a few additional ways that you can withdraw your IRA funds without penalty:

14. Qualified Reservist – If you were called to duty after September 11, 2001 and served for at least 6 months, you are allowed to make a withdrawal from your IRA during your active duty period without penalty.
15. Divorce – although not a particular IRS regulation, multiple Private Letter Rulings have allowed divorced parties to “split” an IRA into two separate IRAs, both with the original restrictions on distribution. For an IRA this is known as a transfer incident to divorce, while in a 401k plan it’s known as a QDRO.
16. Roth IRA Conversion – when you convert your funds from a Traditional IRA to a Roth IRA, although you pay tax on the distribution, there is no 10% penalty applied.
17. Rollover – using the 60-day period, you are eligible to have access to your funds without penalty as long as the rollover is completed and the distributed funds are deposited into an IRA (the same or a new account) within 60 days.
18. Payment to Advisor/Investment Manager – you are allowed to authorize your custodian to pay your Advisor or Investment Manager from your IRA funds any fees for managing your IRA. This includes transaction fees and annual custodian fees.
19. Periodic Temporary “Disaster Relief” provisions – from time to time, as the situation merits, Congress will enact special legislation allowing individuals impacted (primarily) by natural disasters to access IRA funds without paying the 10% penalty. Notable examples of such a recent provision was for victims of Hurricanes Harvey and Irma. With the passage of Secure 2.0 in 2022, this exception has been made permanent. Under this exception, an individual can take a penalty-free withdrawal of up to $22,000 total from an IRA or other retirement plan if the individual’s primary residence is located within a federally-declared disaster area, an economic loss was sustained, and the withdrawal is taken within 180 days of the first day of the disaster or later if the disaster was declared later. The withdrawal can be repaid at any time during the ensuing three years, and if not repaid the income can be spread (recognized) equally over three years.
20. Terminal Illness – beginning in 2023, if an individual is certified by a physician as having a terminal illness, which an illness that is reasonably expected to result in death in 84 months or less, an exception to the 10% penalty is granted. There is no maximum, and like the disaster relief exception, can be paid pack within three years. The difference is that the income, if not paid back, must be completely recognized in the year of the distribution.
21. Domestic Abuse – beginning in 2024, victims of domestic abuse by a spouse or domestic partner that occurred within the previous 12 months are allowed an exception to the 10% penalty. This exception is allowed on the lesser of $10,000 or 50% of the vested balance of the account. These distributions can likewise be repaid over the following three years, but if not repaid must be recognized as taxable income in the year of the distribution.
22. Financial Emergency – Effective in 2024, in the event of an “unforeseeable or immediate financial need relating to personal or family emergencies”, up to $1,000 can be withdrawn without penalty. This exception, if taken, negates the option for the following three years unless the original distribution is repaid, or future contributions exceed the amount of the previous emergency distribution.
23. Birth or adoption – After the birth of a child, or after an adoption is finalized, each parent is allowed to withdraw up to $5,000 from his or her IRA or retirement plan without penalty. The withdrawal must be after the birth or adoption, and is allowed penalty-free up to 12 months afterwards.

Now, did your list have 25 different ways? Perhaps I’ve overlooked some… let me know if you have other ways in your list that folks can withdraw IRA funds without penalty. Let me know what you think!

Posted on May 22nd, 2023

by author: jblankenship.

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Posted in: 72t, Early Distribution, Early Withdrawal, IRA, ira account, qrp, retirement accounts, Roth Conversion.
Tagged: IRA

Maximize your Social Security benefits by changing your thinking

May 15th, 2023

by jblankenship.

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Photo credit: jb

When it comes to Social Security retirement benefits, many folks look at the payments as something they’ve earned… and that’s not totally off base if you happen to receive benefits, because the amount of the benefit that you receive is a direct result of your earnings over your career. But really, Social Security is something else altogether.

Technically, Social Security retirement benefits are referred to as “Old Age, Survivors and Disability Insurance”, or OASDI for short. I emphasized Insurance there, because that’s what it is. It’s not an investment, because there’s not an account with your name on a pile of money, just waiting for you to retire. Rather, this is an insurance program, specifically insurance against living longer than the average.

Like any other insurance plan, you pay in premiums (in the form of payroll taxation), and if you live to the appropriate age, you may receive a benefit from the plan. If you live longer than average, you might receive more in benefits than you ever paid in; on the other hand, if you don’t live long enough you might not receive any benefits from the plan, or very little benefits. In this case, your premiums go to paying for other insureds who do live longer. In addition, your spouse or child beneficiary(ies) may be eligible for benefits based on your record.

That’s how insurance works. Let’s draw a comparison to auto insurance. With auto insurance you pay monthly premiums to the insurance company, and if you have damage to your vehicle, or some other type of claim like damage to someone else’s property or medical expenses associated with an auto accident, then the insurance company pays for your damage, to a limited degree (after deductibles, and within plan limits).

Much the same as the description of Social Security, if you don’t experience an event and therefore don’t submit a claim, you won’t get any payments from the insurance company. Likewise, if all you ever had was a cracked windshield, you’d get much less payback than someone who totaled their car. Your premiums then are used to pay for folks who have experienced events and submitted claims for reimbursement.

No one goes into the agreement to purchase auto insurance with the express intent to get their money back out of the policy (well, at least no non-sociopaths).

So what are the similarities?

You pay in premiums to both an auto policy and Social Security
You pay these premiums to protect you against an event. In the case of auto insurance, it’s to help pay for damage to the car (among other things). Social Security protects you against living longer than you otherwise have money to cover.
In both cases, the premiums of folks who don’t have claims (or fewer claims) are used to cover the claims of folks who experience the event being insured against.

With Social Security, assuming that you’ll live to the “average” (as determined by actuaries) age of around 82, you’ll receive a similar amount of retirement benefits no matter what age you start receiving those benefits. (There may be slight differences depending on the relative ages of a married couple but we won’t focus on that for now.) We might consider the amount received by about 82 to be the “base” amount of benefits.

But unless you have a reason to believe your lifespan will be something less than average, I’d guess that most folks are at least hoping to live some amount of time beyond the average. It’s that time beyond the average that makes the decision about the age to begin receiving Social Security retirement benefits so important. (Keep in mind that the lifespan of your spouse might be the important factor here as well, if your spouse is eligible for survivor benefits and outlives you.)

The relationship between the amount of Social Security retirement benefits and the age you file for those benefits is that, the longer you delay (between the earliest filing age of 62 and the latest age of 70) the larger the monthly benefit you will receive. And subsequently, if you live past the average age mentioned above, each month of delay results in a larger lifetime benefit, maximized if you delay to the latest filing age of 70.

Usually, delaying filing for Social Security benefits to age 70 requires a trade off somewhere – maybe you’ll have to take more money out of your IRAs or other retirement savings earlier than you’d expected, or you might need to work longer than planned. Either of these options can bridge the gap between the earliest filing age and the latest filing age in order to help you maximize your Social Security benefit.

Since Social Security retirement benefits are tax efficient, cost-of-living-adjusted, guaranteed (don’t sacrifice me on the guaranteed part, we’re not talking about policy here), and infinite (once you start receiving the benefit you’ll receive it for life), it makes a great deal of sense to maximize that monthly benefit amount. Especially so if you plan to live past “average”.

Think about it – above we mentioned a “base” amount of money you’ll receive from Social Security benefits by the average age of death, around 82 years of age. So if you’re average, you’ll get the base amount of money, and that’s all. If, unfortunately, you don’t live as long as the average, you won’t get as much in benefits – that’s the way it works, some folks don’t win the lottery of life.

But if you live longer than the average age, every single month’s benefit is a bonus above the base. So again I ask, if you are expecting to live longer than the average, why wouldn’t you try to maximize the amounts that will be, essentially, your bonus?

For a minimized example, let’s say other than your Social Security benefits you have IRA funds and other sources that just make up the difference between your living expense needs and the amount you’ll receive in Social Security benefits. When you get to age 83, you’ve expended all of your other sources completely, and now all you have is Social Security to live on – doesn’t it make sense that you should have maximized this benefit, so that as your life expectancy goes onward you’ll have the largest possible monthly benefit?

I should point out that in a case like the above minimized example, you should probably take some other action earlier, like working longer, or finding ways to reduce your living expenses. Otherwise when you outlive your savings you may be faced with some difficult decisions and be forced to take on a spartan lifestyle by comparison.

Arguments against delaying:

I don’t have enough money saved otherwise to get me through to the later filing age.
- Not much to counterpoint this with. If you don’t have the resources to delay, you may have no choice but to either file for Social Security earlier, or continue working (or pick up a part-time job) in order to cover your living expenses. Another viable alternative is to reduce expenses somehow – downsizing your home, lifestyle, etc., or selling some of your “things”.
I don’t want to use my savings so early in my life! I’ve saved all these years, using it to delay filing only draws down how much money I’ll have for later on. (Also – I want to leave something from my retirement account for my heirs!)
- (building off the prior answer) If you have at least enough funds to get you through to the later filing age, you should use those less attractive funds (fully taxable, not guaranteed, not cost-of-living-adjusted, and finite – there’s only so much in the pot) to allow yourself to maximize your Social Security benefits. Face it, if you’re that close to the edge with your savings, you need Social Security benefits to be as large as possible.
- Besides, you saved that money for a reason – to help pay for your retirement. That’s exactly what you’ll be doing as you use these funds to live on while delaying Social Security filing.
- Regarding leaving something to your heirs, if it comes down to paying for food versus leaving that inheritance behind, you know what the choice is going to be. If you live longer than your money can last, the heirs will be the last thing on your mind.
I can do so much better with my own investing than Social Security can. I’ll take the benefits early and invest them to maximize my possible income stream for later in life.
- First of all, delaying results in an increase to your monthly benefit amount by anywhere from 6%-8% for each year of delay, guaranteed. (That guarantee should have no arguments). If you can guarantee a return of 6%-8% every year, you’re a genius and you have no business reading such mundane articles as this. Go solve world hunger, why don’t you?
- Secondly, unless you’re extremely well disciplined, this concept of “I’ll invest it all” is sham and you’re likely fooling yourself. Very few people could put this into action, and then you’ve still got the guaranteed 6%-8% factor mentioned above to overcome.
- Actually, in the long run, that 6%-8% increase works out to much more, due to the fact that as long as you live you’ll continue receiving your Social Security benefit. Think about how that can play out if you live to 90, 95, 100, or 110!
What if I don’t live to age 82 (or age 70)? Then all of that money is just wasted. My uncle (or cousin, brother, neighbor, etc.) worked his whole life paying into Social Security and died at age 61½ (or 69, etc.) and got nothing.
- Just the same as with auto insurance, in some cases you pay into it for a long time and never make a claim. In other cases you have (heaven forbid) a terrible auto accident and have huge medical, property, and auto replacement claims, which are paid by your auto insurance. With Social Security retirement benefits, there’s always the possibility that you might not get any benefit, or very little in the way of benefits over your lifetime if your life is shortened by an untimely death. It’s the gamble that you take, to ensure that you’re covered in the event of living longer than expected.
I’m filing as early as possible to get my money back.
- Keeping with our comparison to auto insurance, often there are small possible claims that you could submit, like a door ding from a parking lot. Auto insurance has disincentives to discourage these small claims – submitting and being paid for these small claims will result in an increase to your premiums. Social Security’s disincentives apply when filing earlier in your life – you’ll receive a smaller monthly benefit amount when filing sometime before the maximum age.
Social Security is going broke. I’m filing now (or as soon as possible) while it’s still available.
- Suffice it to say – if you feel this way, then by all means, go ahead and file whenever you want to. I disagree with your viewpoint, but I will not argue it, experience tells me that this point of view is not likely to be changed so I won’t try.

We didn’t cover the nuances involved with spousal benefits, dependent benefits, or survivor benefits. These auxiliary benefits could impact your filing decision in either direction, and coordination of all available benefits is necessary to achieve an optimal outcome.

Posted on May 15th, 2023

by author: jblankenship.

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Posted in: financial planning, Social Security.

ABC’s of Medigap Policies

May 8th, 2023

by jblankenship.

6 comments

Photo credit: jb

Medigap policies come in many flavors. If you’ve done any reading in this area at all, you’ve probably come to realize that the whole thing is a messy alphabet soup… and it’s really, really hard to figure it all out. If you want more details on the choice between Medigap and Medicare Advantage plans, see the article Medicare Supplements versus Medicare Advantage Plans.

What I’ve done here is to pull together a resource that may be helpful as you consider your options for a Medigap plan.

The ABC’s

Unless otherwise noted, the coverages are 100% of the item listed.

Plan A covers:

Medicare Part A coinsurance hospital costs up to an additional 365 days after Medicare benefits are used up
Medicare Part B coinsurance or copayments
Blood (well, the first 3 pints anyhow)
Part A Hospice Care coinsurance or copayment

Plan B covers:

Everything covered by Plan A, plus:
Medicare Part A deductible

Plan C covers:

Everything covered by Plan B, plus:
Skilled nursing facility care coinsurance
Medicare Part B deductible
Foreign travel emergency (80%, up to plan limits)

Plan D covers:

Everything covered by Plan B, plus:
Skilled nursing facility care coinsurance
Foreign travel emergency (80%, up to plan limits)

(in other words, everything in Plan C except the Medicare Part B deductible)

Plan E is no longer available as of May 31, 2010

Plan F covers:

Everything covered by Plan C, plus:
Medicare Part B excess charges
Plan F also offers a high-deductible plan as well, in some states

Plan G covers:

Everything covered by Plan D plus:
Medicare Part B excess charges
Plan G also offers a high-deductible plan as well, in some states

(in other words, everything in Plan F except the Medicare Part B deductible)

Plans H, I, and J are no longer available as of May 31, 2010

Now we’re getting to some of the more flexible plan options. These have been developed to provide similar benefits as other plans but with additional participation by the insured in order to reduce the premium costs.

Plan K covers:

Everything covered by Plan D with the following exceptions:
Foreign travel emergency is not covered
There is a 50% coverage on the following:
- Medicare Part B coinsurance or copayments
- Blood (again, just the first 3 pints)
- Part A Hospice Care coinsurance or copayment
- Skilled nursing care facility coinsurance
- Medicare Part A deductible
There is a yearly out-of-pocket maximum for all coinsurance and copayments of $6,940 (for 2023). After this has been met (along with your annual Medicare Part B deductible), the plan pays 100% of each covered service.

Plan L covers:

The same coverage as Plan K except a 75% coverage on the items at 50% coverage in Plan K
The yearly out-of-pocket maximum for Plan L is $3,470 (for 2023), with the same detail as Plan K otherwise

Plan M covers:

Everything covered by Plan D with the following exception:
Medicare Part A deductible is only covered at a 50% rate

Plan N covers:

Everything covered by Plan D with the following exception:
The Medicare Part B coinsurance or copayment is covered 100% except for copayment for some office visits and some emergency room visits

Posted on May 8th, 2023

by author: jblankenship.

6 comments already - add to the conversation!

Posted in: Insurance, Medicare.

Book Review: Nutshells – Planning Strategies for a Tax-Free, High-Income Retirement

Apr 24th, 2023

by jblankenship.

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Photo credit: jb

Had an opportunity to read a new book over the tax season (in my spare time!). I found this book, by Jasen Dahm, CFA, CPA, to be a very good review of strategies to maximize your income and avoid taxes where possible, while planning your retirement income stream.

In today’s world, we’re for the most part on our own when it comes to planning our retirement income. Gone (mostly) are the days of company pensions taking care of the lion’s share of our retirement income needs. In the place of pensions are many different options, including 401(k), IRA, Roth-type accounts, Social Security, and insurance products, plus some outliers such as Health Savings Accounts and 529 plans. With proper planning, it is possible to maximize your retirement income stream, minimizing taxes along the way. This book is a very good guide to understanding the principles that can help you along that path.

Too often the tax-reduction concept is relatively short-sighted in most retirement planning models. When taken in the context of a lifetime process, real value can be provided with strategic planning.

Dahm uses excellent examples throughout the book to illustrate the concepts, with three different case studies that continue throughout the book. As each new concept is unveiled, the concept is applied to each of the case studies, with very good explanatory effect. These case studies are especially valuable to drive home the benefits of the strategies the author is explaining.

The goal is to produce a tax-free, high-income retirement. For most, the “tax-free” part is highly unlikely, but certainly possible, as illustrated by the author. (Personally, I’ll settle for a tax-reduced income, aiming toward tax-free if the circumstances work out properly!)

As is the bane of all financial writers, myself included, there’s nothing especially new in this book – very little changes about the mechanics of retirement investing and the like. However, the author uses his examples to provide what are perhaps some new insights into ways to strategize your initial and ongoing investment activities, as well as how to efficiently and effectively draw the funds from the various sources when the time comes.

I found this book to be an excellent primer for an all-around review of the options available to retirement investors, with extra emphasis on a few options that many gloss over.

For example, Dahm spends a good bit of time explaining the benefits of LIRP (life insurance retirement products), a topic that usually doesn’t get much emphasis if the writer isn’t vested in insurance sales. And if the writer is selling insurance, you wouldn’t typically get such excellent information about all of the other types of accounts that Dahm has painstakingly reviewed and explained here. (I have no idea if Mr. Dahm is in the business of insurance sales or not. Regardless, he does a good job of explaining the benefits without selling products. Kudos!)

In addition, the author also explains how to fit Health Savings Accounts (HSAs) and 529 plans into the overall scheme, something that often gets short shrift from many other authors. HSAs are often seen as an “extra” for many folks, and they’re often unsure of the benefits of such accounts. In this book, you can learn how these accounts and 529 (college savings) accounts can be integrated into your lifetime tax-saving activities, right alongside your 401(k) and other retirement saving activities.

All in all, I would highly recommend this book for investors (novice to experienced) and advisors. There are gems to be found within, and even if all of the concepts are well-known to the reader, I bet you’ll gain something by the review and fresh insight from this talented author. Novice investors can use this as a jumping-off point for understanding all of the options available to them; experienced investors can gain new insights into strategic asset positioning. Advisors will probably learn a thing or two as well.

Posted on Apr 24th, 2023

by author: jblankenship.

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Posted in: Uncategorized.

Taxation

Increasing future benefits

Reducing current benefits

Smaller or eliminated WEP reduction

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Ask the software provider or tax preparer

Get a tax transcript

Here are the three ways to get transcripts:

Request a copy of a tax return from the IRS

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Funds used to pay the tax

Funds withdrawn within the first five years

Advance Planning Strategy

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The Rule

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Tax-Time Errors Filers Should Avoid

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There is a Difference Between IRA and 401(k)

Required Minimum Distributions (RMD)

Example

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What’s Good About It

What’s Not So Good

A Better Way, Maybe?

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Organization

Efficiency

Discipline

Bottom line

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Not The Only One

Lifelock

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19 22 Ways to Withdraw IRA Funds Without Penalty

Series Of Substantially Equal Periodic Payments

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So what are the similarities?

Arguments against delaying:

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The ABC’s

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