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

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Photo credit: jb

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.

10 comments already - add to the conversation!

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

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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.

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

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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.

Photo by mike t ormsby

Posted on Aug 21st, 2023

by author: jblankenship.

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

Timeless Thoughts on Investing

Aug 14th, 2023

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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.

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

Principles of Pollex: Investment Allocation

Aug 9th, 2023

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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.

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

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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.

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

Organization, Efficiency & Discipline

Jun 12th, 2023

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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.

3 comments already - add to the conversation!

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

How to Apply for Social Security Benefits

Jun 5th, 2023

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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.

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

078-05-1120 – is this Your Number?

May 29th, 2023

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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.

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

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

May 22nd, 2023

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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.

4 comments already - add to the conversation!

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

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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.

Posted in: financial planning, Social Security.

ABC’s of Medigap Policies

May 8th, 2023

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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

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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.

Posted in: Uncategorized.

Your Retirement Plan and Where You Live

Apr 3rd, 2023

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2006_zones We’ve covered a lot of ground with regard to how various tax laws impact your retirement plans: pensions, IRAs, 403(b) and 401(k) plans. But we’ve primarily focused on the US income tax laws (the IRS) affect your plans – and there are many nuances that you need to take into account with regard to state tax laws.

State Tax

The big deal with state tax laws and retirement plans is that some states have special tax deals for money inside of retirement plans. If you happen to live in (or are planning to move to) such a state, it makes good sense to understand any special nuances in the tax laws before doing anything.

This is due to the fact that, for example, it could make a huge difference in the tax impact if you cashed out a plan in one state versus another. Here in Illinois, there is no state tax on retirement income – whether from a pension plan, from an IRA or from a 401(k), as well as Social Security benefits. The same is true for Iowa, Mississippi and Pennsylvania. So if you are planning to move to Illinois (for example) for retirement – it would pay off if you wait until you move to your new home before withdrawing IRA assets, especially if you’re moving from somewhere with a high state income tax.

In addition to those states, there are 9 states that have no income tax at all – therefore those states also do not tax retirement income. These nine states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.

Some states with an income tax will provide certain exemptions for retirement income. For example, twenty-six states exempt military retirement pay from income tax (Alabama, Arizona, Arkansas, Connecticut, Hawaii, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, Utah, and Wisconsin). Nine more states only partially tax military retirement pay (Colorado, Delaware, Idaho, Kentucky, Maryland, New Mexico, Oregon, South Carolina, and West Virginia, plus the District of Columbia).

Social Security benefits are untaxed by most states. Only Colorado, Connecticut, Kansas and Minnesota tax this income, and most of these have some formula for at least a partial exemption.

So pay attention to, and get acquainted with, the tax laws in your state and any states you’re considering for a new home (either in retirement or at another time in your life) so that you don’t miss out on any tax treatment – or worse, make a move that precludes some tax treatment from being available. You might want to plan your distributions until you get to the new state, for example, if retirement income is untaxed there.

Posted on Apr 3rd, 2023

by author: jblankenship.

Posted in: financial planning, IRA, retirement plan, tax.
Tagged: financial planning · IRA · retirement plan · tax

Roth Conversion While Receiving 72t Payments

Mar 27th, 2023

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Photo credit: jb

With all of the conversation going on with regard to Roth IRA Conversions, I thought it would be useful to address a special set of circumstances with regard to Conversions. As the title implies – we’re talking about the eligibility of an IRA for conversion if it is also subject to a Series of Substantially Equal Periodic Payments (SOSEPP), commonly referred to as 72t payments. For background on SOSEPP, you can see the article Early Withdrawal of an IRA – Series of Substantially Equal Periodic Payments.

As you know (if you’re read the article about Penalties for Changing SOSEPP) it can be costly to you if you make a change to your SOSEPP once you’ve set it up. The good news is that a Roth Conversion is NOT considered a “distribution for purposes of determining whether a modification within the meaning of section 72(t)(4)(A) has occurred”, and therefore in itself will not trigger a loss of the penalty-exempt status of the SOSEPP.

What does happen then, in such a circumstance? Well, that’s when things go into the “it depends” category, followed closely by a whole lotta “no guidance from the IRS”.

If you have converted the entire balance of your IRA that is subject to the SOSEPP to a Roth IRA, you will be required to continue taking your series of payments from the new Roth IRA just the same as if they were still coming from the traditional IRA. If you don’t, you will most likely be subjected to recapture penalties on the earlier SOSEPP distributions, unless you’ve reached the end of the distribution requirement period – after five years or age 59½, whichever is later.

On the other hand, if you’ve only converted a portion of the traditional IRA to a Roth IRA, this is where it gets murky. The IRS has not provided definitive guidelines on exactly how you handle the SOSEPP from here… it is abundantly clear that you must continue your series of periodic payments until the end of the distribution period. What’s not clear is if you must continue taking the payments from the remainder of the traditional IRA, or from the Roth IRA, or proportionately from both accounts, or in any amounts you choose from either account, as long as the amount is proper to fit the bounds of your SOSEPP.

The best way to deal with this situation would be to convert the entire account if that’s feasible. If it’s just not feasible, then you should ask for a Private Letter Ruling from the IRS – especially if we’re talking about sizeable amounts (you be the judge). If the possible tax and penalty is relatively minor, I’d suggest taking proportionate amounts from the trad and Roth IRAs until the SOSEPP distribution requirement period ends. Make sure that you keep documentation on all of these transactions – you’ll need it if the IRS comes a-callin’.

Understand that the SOSEPP payment amount is not eligible to be converted to Roth. This is because 72t (SOSEPP) payments are not eligible for rollover. So in any given tax year while the SOSEPP is in effect, you must take the scheduled payment in cash, but then you may convert (or rollover) any additional amount that you like. Just make sure that you continue to take the SOSEPP scheduled payments each year while the SOSEPP is in effect and you should be golden.

Posted on Mar 27th, 2023

by author: jblankenship.

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Posted in: 72t, IRA, retirement plan, Roth conversion, tax.
Tagged: IRA · retirement plan · tax

Principles of Pollex: Auto Purchases

Mar 20th, 2023

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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. Therefore, this on-going series is all about financial Rules of Thumb.)

Buying a car is such a common activity that many folks don’t give much effort to following any “rules” around this purchase. I’ve often suggested a couple of rules that you may find useful or interesting…

The Decision to purchase a car in the first place

You need to be certain that your decision to purchase is based on a real need. Too often we get caught up in our desires and “keeping up with the Jones’s” when it comes to auto purchases. If your current car is providing you with service and isn’t beginning to fall apart, you should consider delaying a purchase until it actually makes sense for you.

The reason I say this is because a car is a depreciating asset – except in certain cases where you use your car to make money, such as in a delivery business, a car only costs you money – it doesn’t make money for you. And the cost of the car itself isn’t the only cost you’ll incur, you also need to consider additional insurance costs. If you buy a new car, you’ll need to carry full coverage for the replacement of a much more expensive item than your current, depreciated value, vehicle.

But here’s a rule of thumb that you might use to determine the overall cost of owning a vehicle: to get an idea of the total cost of ownership, including insurance, maintenance, and all, double the price and divide by 60. This is a rough guess of the cost, but you can probably do much better by going to a website like Edmunds.com and using their “Cost to Own” calculator.

Suggestions if you’re buying a new car

If you’ve chosen to purchase a new car, here are a few suggestions that will make your choice a better option for you in the long run:

Buy with cash. You should save up and purchase your auto with cash if you can do it. This way you are doing two things for yourself: 1) you’re able to negotiate specifically on the price of the new car and your trade-in’s value; and 2) you aren’t paying someone else for the use of the money.

There are exceptions to this rule, of course. The first is if you don’t have the cash available, which means one of two things, either you will need to delay the purchase or borrow the money to buy. Delaying is a good choice if your present auto still meets your needs (see my comment above regarding the decision to purchase a car in the first place).

Don’t finance for more than four years, preferably three years. In today’s world it’s possible to finance a car for 72 months, or six years, or longer. But if that’s the only way you can afford to make payments, you’re taking on more than you can really afford. This is because of the fact that a vehicle reduces in value dramatically over the first two or three years, and if you finance for much longer than three years, by the time you’ve reached the point where the car is starting to cost a lot of maintenance money (and therefore you’re thinking of trading for a newer model), it is worth much less than you still owe. This is known as being “upside-down” with regard to the financial value of the vehicle.

Put at least 20% down. This rule of thumb is helpful to ensure that you aren’t financing more than necessary. This will also help you to follow the four-year (or three-year) rule above, all the while keeping your payments lower. Just the same as in the “buy with cash” recommendation, if you can’t put at least 20% down in payment at the purchase, you should delay your purchase until you can do so.

Buy a used car

Another, possibly the best, rule of thumb with regard to auto purchases is to buy a used car, and drive it until it literally drops from exhaustion. It may not be glamorous (what sound financial advice is?) but this is one of those recommendations that has passed the test of time, and has been a part of some of the world’s greatest financial success stories.

According to Stanley and Danko’s seminal book “The Millionaire Next Door”, in the chapter called “You Aren’t What You Drive” – the average millionaire doesn’t put much value on having a brand-spanking new car. In fact, more than 37% of the millionaires that were surveyed purchased a used car most recently, and even if they bought it new, they held onto their car for a good while before trading:

Latest Model-Year of Vehicle Owned	Percent of Millionaires
Current Year	23.5%
Last Year/One Year Old	22.8%
Two Years Old	16.1%
Three Years Old	12.4%
Four Years Old	6.3%
Five Years Old	6.6%
Six Years Old or Older	12.3%

Those purchasing motor vehicles accounted for 81% of the sample of millionaires; those leasing accounted for 19%.

Posted on Mar 20th, 2023

by author: jblankenship.

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

Should You Separate Your Rollovers From Your Contributory IRAs?

Mar 13th, 2023

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Photo credit: jb

For the most part, it is recommended to merge all of your IRA money together into a single account, to simplify record-keeping, allocation, and paperwork in general. However, there may be circumstances where it could make very good sense to separate your contributory IRAs from 401(k) plan rollovers – and it pertains to creditor’s rights.

If you look at the article Creditor Protection for Retirement Plan Assets, you’ll see that IRAs in general have protection from creditors in the case of bankruptcy, up to $1 million. On the other hand, separated rollover assets from a 401(k) or other ERISA-protected account enjoy indefinite protection from creditors.

Rolling over the ERISA-protected funds into an account that contains contributory IRA funds (that is, an IRA that you have made deductible or non-deductible contributions to) automatically removes the ERISA protection and therefore the indefinite protection from creditors.

So it may make sense for folks who could be impacted by this protection (or rather the removal of the protection) to maintain separate accounts for rolled-over ERISA funds. This would be anyone whose total IRA account is (or may become) over $1 million – and regardless of whether or not you think bankruptcy is a possibility. In today’s sue-happy world, unusual circumstances could creep up on you at any moment and put you in the position where you might need this protection.

It’s very important to note that this protection only applies to actual bankruptcy – if you’re merely being sued by a creditor and you haven’t declared bankruptcy, your protection depends on federal non-bankruptcy law and state law. The article mentioned at the outset includes links to state law information with regard to these kinds of situations.

Posted on Mar 13th, 2023

by author: jblankenship.

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

More reasons to keep on rolling (to an IRA, that is)

Mar 6th, 2023

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Photo credit: jb

We have discussed in the past that it is usually better to rollover an old 401(k) plan from a former employer to an IRA – more flexibility in investments, (usually) lower costs, more control, etc., are among the chief reasons to do so.

However, in some cases your old 401(k) plan may have access to desirable investments that you couldn’t otherwise access, or possibly you have access to other benefits from participation, such as availability of a financial advisor. As long as the overall costs remain low in the plan, you might want to leave the funds there. Plus there are also some additional benefits inherent within 401(k) accounts that are not available to IRAs – you can read up on the reasons to leave your money in the 401(k) in the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k).

On the flip side, there are certain things that you can’t do in a 401(k) (or other Qualified Retirement Plan) that you can ONLY do with an IRA while you’re under age 59½.

IRA-Only Options

With an IRA, there is no penalty for withdrawal for (click the link following each for more detail):

Health Insurance Premiums while unemployed – §72(t)(2)(D)
Qualified Higher Education Expenses – §72(t)(2)(E)
Qualified First-Time Homebuyer Expenses – §72(t)(2)(F)
Qualified Reservist Distributions – §72(t)(2)(G)

And none of those are available without penalty from your 401(k). Of course you would have to pay tax on the distribution, but otherwise you can take the money from your IRA for these purposes.

In addition, setting up a Series of Substantially Equal Periodic Payments (SOSEPP) is generally easier to qualify for and to set up from an IRA than from a 401(k), so this may be an additional reason to consider rolling over.

Posted on Mar 6th, 2023

by author: jblankenship.

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Posted in: 72t, Early Distribution, IRA, retirement plan.
Tagged: IRA · retirement plan

Tax Diversification for Investments

Feb 20th, 2023

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Photo credit: jb

In past articles I have advocated the concept of spreading your tax-treatment out – so that you have money allocated in three major types of accounts: deferred tax (such as IRAs and 401(k) plans), tax-free (Roth IRAs), and capital gains taxable accounts. The reason behind this is that our fine government has this tendency to change the rules, and often. By spreading your tax treatment out you can help to ensure that funky new rules don’t throw off your entire retirement investing plan. In addition, having multiple modes of taxation can give you much flexibility in planning your income for tax purposes, once you get to the distribution phase of life.

The trick to all of this is to think about the timing of contributions to each kind of account… of course there are no hard and fast rules to determine what’s best for each kind of plan. Below is a discussion of some of the factors that you should consider as you balance out your tax treatment.

Early in life…

Early in your investing career it may makes a lot of sense to load as much of your savings into your 401(k) or other tax-deferred savings vehicle as possible, in order to maximize the benefit from tax savings up front. The biggest reason for this (beyond the tax savings) is so that you take advantage of your employer’s matching benefit, along with deferring taxes on your income as it increases over time.

If your tax bracket is really low though, you might want to utilize the Roth option in your 401(k) and maxing out your Roth IRA during this earliest, lowest-taxed time of life. A bit later when your tax bracket has increased somewhat, the tax reduction benefits of traditional 401(k) contributions and IRA contributions will be more valuable.

Later in your career when your income is higher, maximizing contributions to tax-deferred accounts will have a greater benefit to you from a tax savings standpoint. This is assuming that you expect for the taxes you’ll pay later during retirement will be lower due to your diversification of tax treatment.

As mentioned, as your income supports it you should begin making contributions to your Roth IRA as soon as possible. This is partly due to the restrictions on income around investing in Roth IRAs – but mostly because you are paying tax at lower rates in your lower-earning days than you might later on in your career when your income increases.

And then on top of it all, when your income has grown to a point that you can maximize the other options (401(k) and Roth), you should begin investing in an account that is taxed by capital gains tax. This will give you the third leg of the tax-diversification stool. Since capital gains are presently taxed at a much lower rate than ordinary income – which is what your IRA or 401(k) distributions are taxed at – it makes a great deal of sense to have some of your money invested in these accounts as well.

Later in life…

Later on in your life, as you come near to that point where you will have to begin taking Required Minimum Distributions (RMDs) from your IRA and 401(k) accounts, it might make sense to take significant portions of those accounts and either convert them to Roth accounts or capital gains taxed accounts. The preference would be to place the funds distributed into a Roth IRA as a conversion, especially if you are in a position where you will not need access to the funds for some time and therefore can benefit from tax-free growth of the account. You may also want to balance those conversions to Roth with some non-tax-deferred investments as well – because you never know what may happen with the tax code. Either way, Roth conversion or distribution and re-investment in a taxable account, you’ll pay income tax when you withdraw the funds from your tax-deferral account such as a 401(k) or traditional IRA.

It’s (very!) possible, given the government’s need to increase tax revenues to pay for things like COVID giveaways, that there could be changes in the works for how tax-deferred plans are taxed. Just a few options that have been put forth in recent memory include:

extra taxes on IRA assets (this was in place back in the mid-80’s)
changes to the minimum distribution rules to require faster distribution or to eliminate “stretch” capabilities (this happened with the SECURE Act)
adding investment restrictions, such as requiring a portion of IRAs to be invested in “socially responsible” investments (not as likely but you just never know)
nationalization of retirement accounts – e.g., governmental takeover of all IRA and 401(k) plans in exchange for a superannuization plan like some socialized countries use (also somewhat unlikely but again, there’s always a however in life)

Yet another option, especially if you have very few assets outside your IRAs and 401(k) plans, you can reduce your taxable estate (when normal folks have an estate tax again, that is) by taking extra distributions from your IRA or 401(k) and making gifts to your children and grandchildren. You could place the assets in a trust that represents a completed gift, or give the money directly to your future heirs – this way you are able to see your children and grandchildren enjoying the fruits of your labors while you’re still living.

Posted on Feb 20th, 2023

by author: jblankenship.