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

Posted in: financial planning, irs, itemized deduction.
Tagged: documentation · irs · records

A Few Things for a Single Person to Consider When Planning Social Security Filing

Jul 15th, 2013

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Single man (Photo credit: @Doug88888)

The decision of when to begin receiving Social Security benefits can be a bit daunting, because there are many things to take into account when making this decision.

The basic concept of the lifetime value of benefits taken at various ages is the most common thing to consider, when this is really not as important as you might think. This is especially true for single person – since the benefit reduction and increase factors are designed to achieve a similar lifetime result for the average lifespan.

In other words, if you are an average person with an average lifespan, it won’t make much difference at what age you file for benefits, as you’ll receive approximately the same amount by the end of your average life, whenever you begin receiving the benefits.

However.

Another factor that you need to keep in mind is how Social Security benefits are treated, tax-wise. At a maximum, your Social Security benefit will be taxed as 85% – for every dollar in Social Security benefits you receive, you’ll only owe income tax on 85 cents at most. At the other end of the spectrum, you may not be taxed at all on your Social Security benefits, depending on your total overall income.

For example, Jane, age 62, is retiring. She has a modest pension of $10,000 with a cost-of-living adjustment annually, and her annual expenses are $40,000 per year. Jane has an IRA worth approximately $300,000, and she has a Social Security PIA (benefit at age 66, her Full Retirement Age) of $2,000 per month.

Jane could take her Social Security benefit now, at age 62, at a reduced amount of $1,500 or $18,000 per year. If she did this and she’s receiving the $10,000 pension, she’d also need to withdraw approximately $15,000 from her IRA to make up the difference. When she has the income as described, she will incur income tax of approximately $2,478. This is the approximate amount of tax she’d have on her income for her life.

Another way to arrange Jane’s income would be for her to hold off on taking the Social Security benefits until later, and take more from her IRA each year to make up the difference. This would require withdrawals of approximately $35,000 per year from the IRA. Along with the pension income, this would result in annual taxes for Jane of roughly $4,800.

The good part is that, when Jane reaches FRA, age 66, she could start receiving Social Security benefits at the rate of $2,000 or $24,000 per year. At that point she could reduce her IRA withdrawal to approximately $6,000 per year – and because of the way Social Security is taxed, at this stage she would only have tax of $600 per year. None of her Social Security would be taxed, and this would remain the same for the rest of her life.

Had she delayed even further, to age 70 to begin receiving Social Security benefits, her total benefit would now be $31,680 due to the delay credits. At this point she would not need IRA withdrawals any longer, and she would have no income tax at all for the rest of her life.

Let’s shake up the details a bit more, with Joe’s situation: at age 62, he has annual expenses of $60,000, and a PIA of $30,000 per year – meaning he could receive $30,000 per year ($2,500 per month) if he files at age 66. Joe has an IRA worth $1 million, and no pension.

If Joe starts Social Security benefits at age 62, his benefit will be reduced to 75%, or $22,500. In order to achieve his $60,000 income requirement, he’d need to withdraw roughly $47,000 from his IRA, and his total income tax would be approximately $9,960 – and he’d have a similar tax for the rest of his life.

If Joe instead delays to age 66, his FRA, to begin receiving Social Security benefits, he’d need to take roughly $70,000 from his IRA for those four years, and his tax is approximately $10,928 for those years. At age 66 he’ll have $30,000 in Social Security benefits, which he would need to augment with IRA withdrawals of approximately $37,000. Tax on this income would be down to $7,253, which would be about the same for the rest of his life.

Delaying to age 70 would have an even more profound impact: At this stage Joe would be eligible for $39,600 in Social Security benefits, so he’d only need to withdraw roughly $24,000 per year from his IRA, and the total tax on this income would be down to $3,353 for the rest of his life. The dramatic decrease in tax is due to the fact that, at this income level, less than 50% of Joe’s Social Security benefits are taxed.

Other sources

It should be noted here that in the all of the examples for both Jane and Joe, there is always a possibility that their IRAs might run out of money in their lifetimes with these long-term IRA withdrawal rates. This is far less likely in the cases where they depend on a larger amount of Social Security benefits for income by delaying benefits to later ages.

The examples below don’t make assumptions about rate of return on the IRA assets, as we have also not made any assumptions about Cost-of-Living Adjustments or inflation – all to keep the figures simple to follow.

For the first example with Jane starting SS benefits at age 62 and withdrawing $15,000 per year, assuming that she lives to age 81 she’d need $285,000 in the IRA to start with. If she delays to age 66 to start benefits, her IRA would need to have approximately $230,000 to support her need of $35,000 for four years and then $6,000 for the remaining 15 years to age 81. Delaying to age 70, she’d need a total of $280,000 from her IRA to withdraw $35,000 for 8 years.

If she lives beyond age 81, in the first case she’s only got $15,000 left, and she needs to withdraw $15,000 each year to cover her expenses, or only one year. In the second case she has $70,000 left in her IRA, from which she needs to withdraw $6,000 each year, so it will last a little less than 12 years. In the last case, Jane has $20,000 left in the IRA, but she doesn’t need to withdraw anything at all – so in other words, her income is arranged to last for the rest of her life, with no limitation, plus no income tax!

For Joe – in the first case he’d need $893,000 from his IRA to get him to age 81. The second, he needs $835,000 – four years at $70,000 and 15 years at $37,000. In the last situation, Joe needs $560,000 for the first 8 years, and then $264,000 for the eleven years to age 81, for a total withdrawal of $824,000.

If he lives past age 81, he’s got $107,000 in the first case, from which he needs to withdraw $15,000 per year, leaving him with just over 7 years of withdrawals. In the second case, with $165,000 remaining in the IRA and an annual withdrawal of $37,000, leaving him with just over four years of withdrawals. In the last case, he has $176,000 and needs to withdraw $24,000 annually, or just over 7 years.

So in Joe’s case, he either needs to reduce his expenses or count on the fact that he’ll only live to age 88 (or 85). At any rate, his best outcome would occur by delaying to age 70 – because a larger amount of his required income is guaranteed since it’s Social Security benefits, rather than the finite IRA account which could run out during his lifetime.

Posted on Jul 15th, 2013

by author: jblankenship.

5 comments already - add to the conversation!

Posted in: delayed benefit, delayed retirement credit, security retirement benefits, Social Security, social security tax.
Tagged: delayed retirement credit · Social Security · social security benefits

Holy Priceless Collection of Etruscan Snoods

Jul 12th, 2013

by sraskie.

4 comments

Snood dog (Photo credit: Wikipedia)

Pretty weird title right? It actually comes from the classic Batman TV series starring Adam West and Burt Ward. Burt Ward’s character, Robin was notorious for his exclamations categorizing different objects or dilemmas as righteous.

How does this relate to financial planning? We all have our snoods that we collect or have value to us. When we purchase renters or homeowners insurance, we often assume that our personal property is covered under the specified limits on the policy. Normally this is 50% of the home’s insured value.

But it pays to read the fine print. Most policies will only allow for coverage for certain items and only for specific limits. For example, a typical home insurance policy will cover jewelry only up to $1,000 total – for all of the jewelry you own. In order to have coverage for a specific item of jewelry such as a wedding ring, engagement ring, or necklace an endorsement is required.

Think of an endorsement as a “mini insurance policy” specifically for the item covered. For a wedding ring, it would be a policy within your existing homeowners or renters policy that covers only the ring, subject to its own deductible and often much more broad types of coverage. This means that in a normal home policy without an endorsement one could lose their ring, have the stone fall out, etc. This is known as mysterious disappearance and is generally not covered under the basic home policy.

With an endorsement, the ring could be lost, or a stone could fall out and the endorsement will likely cover that loss – subject to the endorsements deductible which is typically less that the home policy deductible.

The same is true for other items such as art, coins, trading cards, silverware, furs, antiques, firearms, and yes, priceless collections of Etruscan snoods. I have even had friends need a specific endorsement for the grand piano in their living room.

Most insurance carriers will require an independent appraisal to endorse high-ticket items like jewelry, antiques, coins, etc.

Check your policy and make sure your snoods are covered. If not, contact your insurance carrier and see what needs to be done to get them added. Your premiums will undoubtedly increase, but you’ll have peace of mind knowing your snoods are covered.

Posted on Jul 12th, 2013

by author: sraskie.

Posted in: home insurance, Insurance, renters insurance.
Tagged: home insurance · home owners insurance · inland marine · insurance endorsements · insurance riders · jewelry endorsement

What is WEP?

Jul 10th, 2013

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Social secruity (Photo credit: SalFalko)

WEP, in Social Security parlance, is the Windfall Elimination Provision. So, if that’s all you wanted to know, you’re good to go.

You wanted more though, right? Okay, here we go:

WEP is the provision of the Social Security rules that provides for reduction of your Social Security benefit when you are receiving a pension from a job that was not covered by Social Security. Usually these jobs are government-related, including state and federal government employees, teachers, and the like. In addition, pensions from work done in other countries would also fit into this category, as long as the work was not covered by US Social Security.

How it Works

When your Social Security benefit is calculated, if you’ll recall from this earlier article on benefit calculation, your Average Indexed Monthly Earnings (AIME) factor is divided into three portions, bounded by bend points. The first bend point is multiplied by 90% – but if WEP applies, the 90% multiplier is reduced by as much as 50%. The reduction amount can be reduced or eliminated by two additional factors – the amount of your pension from non-covered work, and the number of years of substantial earnings you’ve accrued in your career in jobs covered by Social Security.

If your benefit is fully impacted by WEP, this means that for 2013 your Primary Insurance Amount (PIA) will be reduced by 50% of the first bend point, which is $791 – so the maximum reduction via WEP in 2013 is $395.50.

The reductions apply to your own PIA which then applies to your own retirement benefit, as well as to any beneficiary or spousal benefits that are calculated on your PIA. If you’re receiving a Spousal or Survivor Benefit based on someone else’s record, WEP does not apply. Additionally, if the pension you’re receiving is from someone else’s work – as in, if you’re receiving a survivor’s pension based upon your spouse’s government-related job – WEP does not apply to your Social Security benefits.

Now let’s review the ways that the WEP reduction can be reduced or eliminated from the maximum 50%.

Substantial Earnings

When you have worked in a Social Security-covered job for more than 20 years and the earnings are considered “substantial” by Social Security definition, these earnings can begin to reduce the WEP reduction factor from the maximum. For each year greater than 20 that you’ve had substantial earnings, the 50% factor is reduced by 5%. So if you have had substantial earnings for 30 or more years, the WEP reduction factor is completely eliminated.

Amount of Your non-SS Pension

The other way that WEP impact can be reduced from the maximum is based on the amount of your pension from the non-Social Security-covered job. The total dollar amount of WEP reduction is limited to 50% of the total dollars being received from the non-SS-covered job. So if your pension from this non-SS-covered job is less than $791 (in 2013), then the reduction for WEP will not be at the maximum.

Let’s say your pension from non-SS-covered work is $400 per month. As a result of the maximum cap, your Primary Insurance Amount will only be reduced by $200 (50% of your pension amount).

Posted on Jul 10th, 2013

by author: jblankenship.

Posted in: Social Security, wep, windfall elimination provision.
Tagged: Social Security · WEP · Windfall Elimination Provision

Stretching an IRA When There Are Non-Individual Beneficiaries

Jul 8th, 2013

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Ira and Charlie (Photo credit: Wikipedia)

As we’ve discussed here previously, one of the requirements to enable an inherited IRA to be “stretched” over the lives of the beneficiaries is that all of the beneficiaries must be individuals. That is to say, none of the beneficiaries can be something other than a person, such as a trust (specifically a trust that is not a see-through trust), a charity, or an estate. If even one beneficiary is not a person, then all of the beneficiaries must take distribution within five years.

But there’s a way around this, and it has to do with the timing of distributions.

When an IRA owner dies, there is a key date to know: September 30 of the year following the year of death of the owner. On that date, the beneficiaries are “set” for the IRA, and if available, the Designated Beneficiary is named. It is on this date that the applicable distribution period is defined for the beneficiaries of the IRA. If all of the beneficiaries are persons (not some other entity as described above) and the IRA is not split into separate inherited IRAs for each beneficiary, the oldest beneficiary becomes the Designated Beneficiary. It is the lifetime of the Designated Beneficiary which will determine the applicable distribution period for all beneficiaries. However, if the IRA is split up into separate inherited IRAs for each beneficiary, then all beneficiaries are Designated Beneficiaries, and each separate inherited IRA’s beneficiary will be eligible to use the distribution period referencing his or her own age.

However – as mentioned above, if one or more beneficiary(ies) on September 30 of the year following the year of death of the original owner is a non-person entity, then all beneficiaries must take distribution of their portion of the IRA within 5 years. The date is the key: if distribution of the non-person entity’s portion is completed prior to September 30 of the year following the hear of the death of the original owner, then as of that date there would be only “person” beneficiaries. This would allow for the remaining individuals to split up the IRA into separate inherited IRAs and take distribution over their individual lifetimes, per the IRS’ tables.

For example…

John died at the age of 68 in June of 2012, leaving his IRA and other assets primarily to his two children, Chuck and Sally. However, he also wanted to make sure that his alma mater, Enormous State University, received 1/3 of his IRA, worth $1 million at his death.

If John’s executor does nothing with the IRA assets prior to September 30, 2013, Chuck, Sally, and ESU will have to take distribution of $333,333 each before the end of 2018. This could amount to a considerable tax burden for Chuck and Sally (ESU wouldn’t have to pay taxes as an educational institution), since each would have to withdraw as much as $66,667 each of the five years. It should be noted that the distribution doesn’t have to be evenly split over the five years as long as the account is fully distributed by the end of five years.

On the other hand, if John’s executor were to distribute the 1/3 share to ESU before September 30, 2013, then ESU is no longer a beneficiary of the IRA on the Beneficiary Designation Date. With that fact in place, the IRA has only “individual” beneficiaries, and so the account can be split evenly between inherited IRAs for Chuck and Sally, and then Chuck and Sally can stretch the IRA distributions over their own lifetimes. per the IRS tables.

Posted on Jul 8th, 2013

by author: jblankenship.

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Posted in: inherited IRA, IRA, retirement accounts.
Tagged: inherited IRA · IRA · required minimum distribution

Fees

Jul 5th, 2013

by sraskie.

1 comment

Expenses (Photo credit: Phillie Casablanca)

What you see is what you get – or what you don’t see is what you get. As you start or continue to invest and save for college, retirement, weddings, vacations, and other goals it’s important to know the underlying fees and charges of the products and funds that you’re in. Very often these fees are buried in the minutia of a thick prospectus or in the fine print of your account statement.

Fees are necessary, but excessive fees aren’t. You should be getting what you pay for – but that can be hard if you don’t know what you’re paying.

Let’s take mutual funds for example. On one end you have fees and expenses going to the fund and the manager to try to do the best with your money – which is to earn a decent return (positive or negative) and hopefully beat their benchmark. This is typically a more expensive approach when the manager is trying beat their benchmark as there is more buying and selling of the stock and bonds in his or her fund.

On the other end of the spectrum, you have a passively managed fund or an index fund. These are typically less expensive as the manager doesn’t have to do a ton of work – after all, their fund is essentially mirroring the index – like the S&P 500 or the Barclays Capital Aggregate Bond Index.

So what determines a fair fee? For active and passively managed funds, anything less than one percent is going to be a good start. Think of it this way: if you have $100,000 invested in a fund charging one percent in expenses, that’s $1,000 annually going to the fund company. Half a percent is going to be $500 annually and a quarter percent is $250 and so on. This is on top of how the fund performed. So if the fund lost seven percent, you effectively lost eight percent. If you’ve gained nine percent, your net is eight percent.

Added to the fund expenses are the fees and charges your broker or adviser may charge. Front-end load or commissions are charged by commissioned advisers. These can range from around five percent to one percent depending on the fund for new dollars that come in. There are also 12b-1 fees (often referred to as trails) that are tacked on commissioned funds and these are usually around a quarter percent annually.

Fee-only advisers will charge from a quarter percent to up to two percent in addition to the fund expenses. They may also offer a range of services provided that include the management fees you’re paying such as tax returns, financial planning, and budgeting.

Read your statements, asks lots of questions and make sure you know exactly how much you’re paying.

Posted on Jul 5th, 2013

by author: sraskie.

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Posted in: fee-only, fiduciary.

Important Ages for Social Security

Jul 3rd, 2013

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That Certain Age (Photo credit: Wikipedia)

There are many specific important ages to know as you’re planning your Social Security filing strategy. The ages can become quite confusing and jumbled together as you plan. It’s important to know at what age you can take specific actions, as well as what the consequences can be if you take a particular action earlier than it is appropriate.

These ages are pervasive throughout this blog and my book, but I hadn’t compiled all of the important ages into a single place, so listed below are what I have determined to be the most important ages with regard to Social Security, as well as what is important about that age. Enjoy!

Age	Description
22-62	This is the forty years during which your monthly earnings are compiled to develop your initial Average Indexed Monthly Earnings (AIME). This figure is then used to determine your Primary Insurance Amount (PIA) which is used to calculate your retirement benefit, your spouse’s and dependents’ benefits, survivor benefits for your beneficiaries, and the family maximum benefit amount.
50	The first age at which you can file for survivor’s benefits (also known as widow(er)’s benefits). In order to file for survivor’s benefits at this age, you must be permanently disabled. Benefits at this age will be reduced – to the same amount as if the survivor was age 60 and not disabled.
60	The first age at which you can file for survivor’s benefits if you are not disabled. (see 50 above if disabled) Survivor benefits at this age will be reduced to the minimum amount.
62	The earliest age at which you can begin receiving your own retirement benefit and spousal benefit if you are eligible. Both benefits would be reduced if taken at this age.
62-FRA	Between these ages (starting at age 62 and before reaching FRA), if you file for your own benefit and you are eligible for the spousal benefit (meaning your spouse has filed), you are deemed to have filed for both benefits. Likewise, during this period if you file for the spousal benefit you are deemed to have filed for both benefits.Within the 3 years immediately before FRA, your benefit is reduced by 5/9% each month, or 6.667% per year. If you file more than 3 years before FRA, reduction is 5/12% per month for each month greater than 3 years before FRA, or 5% per year.
66	Full Retirement Age (FRA) for folks who were born during the years 1943 to 1954. This is the first age when you can file for the full, unreduced retirement benefit. You can also file a restricted application for spousal benefits only at this age – if your spouse has filed for his or her own benefit.At FRA, spousal benefits are maximized – there is no increase by delaying receipt of spousal benefits after this age. This is also the FRA for survivor’s benefits if born between the years of 1945 and 1956. This means you’d have no reduction to survivor benefits if you delay filing for them until this age.
66 & 2 months	FRA for retirement benefits if born in 1955 (see 66 for description). FRA for survivor benefits if born in 1957.
66 & 4 months	FRA for retirement benefits if born in 1956, and FRA for survivor benefits if born in 1958.
66 & 6 months	FRA for retirement benefits if born in 1957; FRA for survivor benefits if born in 1959.
66 & 8 months	FRA for retirement benefits if born in 1958; FRA for survivor benefits if born in 1960.
66 & 10 months	FRA for retirement benefits if born in 1959; FRA for survivor benefits if born in 1961.
67	FRA for retirement benefits if born in 1960 or later; FRA for survivor benefits if born in 1962 or later.
FRA-70	Between these ages, if you have not filed for your own benefit (or have suspended), your retirement benefit will increase by 2/3% per month, or 8% per year (12 months).
70	At this age, your delayed benefit is at its maximum level. There are no increases by delaying receipt of benefits past this age.

If I’ve left out any important ages, let me know so that I can add them to the list. Just leave a comment below!

Posted on Jul 3rd, 2013

by author: jblankenship.

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

When is a RMD a RMD?

Jul 1st, 2013

2 comments

Minima Cackling Goose (Photo credit: K Schneider)

I receive quite a few questions from folks looking for clarification on the rules around Required Minimum Distributions upon reaching age 70½, so I thought I’d jot down a couple of facts about them that you may find interesting.

When can I take the distribution?

Looking through some notes from readers I found one where it was asked (this is paraphrased for clarity):

My birthdate is April 10, 1943, so I will reach age 70½ on October 10, 2013. Do I need to wait until October 10 or after to take a distribution so that it is counted as my RMD?

I responded to this question by saying that, to be safe, I suggest the reader wait until after October 10 to take the distribution.

However. (there’s always a however in life, isn’t there?)

I subsequently received a message from a reader (thanks, TAM!) with the following updated information:

It is, in practice, fully believed that the IRS looks at the YEAR you turn 70 1/2 and NOT the birthdate. When reviewing IRS.gov they are very concerned about making sure one gets the RMD by the last date possible and do not really address how soon a person can take it. Such is government! But in practice, if your birthday makes the date you turn 70 1/2 turn out to be 12/31 or 12/30 we generally advise the client to take the RMD during that year to avoid having to take two RMD’s the next year.

I thought TAM’s information might be helpful to folks who are facing this decision. It still won’t hurt to wait, but according to TAM, you could take the distribution any time during that year when you reach age 70½.

How does IRS know I’ve taken the distribution?

This question comes up pretty often as well:

Do I need to send in a form or something to let the IRS know that I’ve taken my required minimum distribution?

When you’re subject to RMD during a particular year (including the year you reach age 70½), the first money that you withdraw from your IRA(s) is considered to be your RMD. As long as you take at least enough distribution from the account to satisfy the RMD requirement, you’re golden.

Your IRA custodian sends a copy of your 1099-R form to the IRS, as well as filing a Form 5498 (to indicate contributions) – so the IRS is well aware that you’ve taken the distribution. They’re also well aware if you do not take distributions, and will be in contact with you to rectify the situation – in the form of a bill for the penalties and taxes. Don’t rely on this as your notification!

Posted on Jul 1st, 2013

by author: jblankenship.

Posted in: IRA, irs, required minimum distribution, rmd.
Tagged: IRA · required minimum distribution · rmd

Medicare Part B

Jun 28th, 2013

by sraskie.

4 comments

English: image edited to hide card’s owner name. author: Arturo Portilla (Photo credit: Wikipedia)

The next letter in our Medicare alphabet soup is Part B. Part B is essentially medical insurance that covers doctor’s services, outpatient care, home health services, and durable medical equipment. It will also cover some other services as well as well as many preventative services.

As far as what doctors will and will not cover Part B depends on whether or not they have agreed to assignment. Assignment is simply your doctor or another health care provider agreeing to be paid directly by Medicare and be willing to accept the payment amount that Medicare decides is the value of the service. Agreement also means the doctor or health care provider cannot charge you any more than what the deductible and coinsurance amounts are.

The basic cost for Medicare Part B for 2013 is $104.90 monthly. Individuals with higher AGI may end up paying more. The table below, courtesy of Medicare.gov shows the increased amount based on AGI.

If your yearly income in 2011 was		You pay (in 2013)
File individual tax return	File joint tax return	You pay (in 2013)
$85,000 or less	$170,000 or less	$104.90
above $85,000 up to $107,000	above $170,000 up to $214,000	$146.90
above $107,000 up to $160,000	above $214,000 up to $320,000	$209.80
above $160,000 up to $214,000	above $320,000 up to $428,000	$272.70
above $214,000	above $428,000	$335.70

The standard deductible for Medicare Part B is $147 for 2103. Once the deductible is met, then any covered individual will pay 20% of any covered service. Medicare will pick up the other 80%. This is all that someone will pay out of pocket for services under a doctor or provider who has an agreement with Medicare. A person may end up paying more if their doctor is not in agreement.

Part B does not cover long term care nor does it cover custodial care. Other excluded services include routine dental and eye care, acupuncture, hearing aids and exams, and elective cosmetic surgery.

To enroll in Part B, you can ether choose to enroll or you may have been automatically enrolled. If you’re already receiving Social Security benefits then you’re automatically enrolled in Part A and B unless you decide to opt out of Part B. Possible reasons you may want to delay Part B coverage would be in the case of if you already have benefits through current employment or a union agreement.

Generally, should you choose to enroll in Part B, you’re allowed to do during the open enrollment periods. Usually you have 8 months to sign up for Part B coverage. Failure to sign up within the 8 month window may lead to you paying a penalty to sign up outside of the enrollment period.

Signing up for Part B also allows you and qualifies you to become eligible for a one-time 6 month open enrollment period for getting a Medigap policy. What does this mean? This means that you now have a guaranteed right to purchase a Medigap policy in your state regardless of your health status. We’ll talk about Medigap in a future article.

Posted on Jun 28th, 2013

by author: sraskie.

Posted in: 2013 tax year, baby boomers, health insurance, Insurance, Medicare, medicare, medicare costs, medicare part b, medicare part b premiums.
Tagged: medicare · medicare part b · part b

Book Review: Control Your Retirement Destiny

Jun 24th, 2013

8 comments

This new book is the first book from my colleague Dana Anspach. Dana has been writing and blogging for quite some time now, primarily as the voice behind Money Over 55 for About.com (www.moneyover55.about.com). Dana also is a practicing financial advisor and respected speaker.

If you’re looking for a nuts-and-bolts, do-it-yourself primer on all things related to retirement, this is your book. Ms. Anspach has put together a very complete overview of all of the areas that you need to consider in order to “Control Your Retirement Destiny”. By following the advice in this book, you can figure out how much money you need to have to retire, where to put it (meaning, what types of accounts to use), how to invest it, and all of the other important topics that you need to know about.

Along the way, you’ll learn what’s important to know about Social Security, taxes, investment placement, annuities, and mortgages, among other things. Dana intersperses her experiences in helping others through these topics, and provides excellent examples to illustrate the topics.

In addition to providing advice, within the book Ms. Anspach provides some excellent worksheets that you can use to map out your own retirement – factoring in the money you’ll need at various points on your journey, pinpointing when you’ll need specific amounts. As you build your worksheets you’ll refine the scenarios, helping you to determine how to generate your retirement income stream in the most efficient and effective manner.

The spreadsheets are pre-filled throughout with an example couple, in order to illustrate how the process has worked for them. You’ll follow this example throughout all of the decision-points, including when to file for Social Security, how to maintain tax efficiency, and planning retirement income and insurance as you plan your retirement.

In addition to all of the advice given throughout, additional resources are provided to aid your efforts, including recommendations for working with an advisor to help you with the process.

I will recommend this book to anyone who is just starting on the process of mapping out retirement. This is particularly so for the person who really wants to have a hands-on approach as they plan retirement – but I think the book will also be helpful for the person or couple who just wants to have a better understanding of the important decisions surrounding retirement.

Posted on Jun 24th, 2013

by author: jblankenship.

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Posted in: Book review, retirement plan, retirement savings plans, Social Security.
Tagged: book review · retirement plan · Social Security

The Real Breakeven Point for Delaying Your Own Social Security Benefit and Taking the Spousal Benefit

Jun 21st, 2013

3 comments

Balanza de la Justicia (Photo credit: Wikipedia)

Recently there was an article that I was involved with where we were reviewing the strategies of taking a restricted spousal benefit and therefore delaying your own benefit versus taking your own benefit. An astute reader (Thanks BL!) pointed out that there was a bit of a flaw in the logic on the costs of delaying, and therefore a significant difference in the breakeven period.

Briefly, the example went as follows:

Say the wife, Michelle, has a PIA of $1,300 and Mike has a PIA of $2,500. They’re both age 66, and Michelle files the restricted app and is eligible to receive $1,250 (half of Mike’s), which is only $50 less than she would receive if she filed for her own benefit. After four years of delay, she has given up $2,400 ($50 times 48 months) but now her benefit is $1,716 – $416 more than she would have received at age 66. At that rate, she makes up the foregone $2,400 in less than six months.

Here’s the problem:

The example assumes that there is a one-time choice to be made between taking the spousal benefit and taking Michelle’s own benefit. In reality, this choice is made every single month after that first month. Michelle is choosing to continue receiving the spousal benefit versus her own benefit. Her potential foregone benefit increases with each passing month! So in other words, the $2,400 that I estimated above was actually very much understated.

After the first month has passed, if Michelle makes the choice to stay with the spousal benefit, the amount of increased benefit that has been foregone is now increased to $58.70 for the current month. This is because the Delayed Retirement Credit (DRC) is 2/3% per month of delay past her Full Retirement Age. So, since Michelle is making the choice every month to continue receiving the spousal benefit, the amount of her own foregone benefit increases every month between FRA and age 70.

For the example at hand, if you consider the increase every month, Michelle is actually foregoing a total of $12,176. This is, as noted, a significant difference from the figure of $2,400 that I used in the original article. The recommendation is the same though, as it still makes sense for Michelle to delay her own benefit until age 70 and receive the spousal benefit during that four years.

The amount of Michelle’s own benefit that she has foregone during this four year period, $12,176, will be made up by her increased retirement benefit that she can receive upon reaching age 70. At this stage (not including Cost of Living Adjustments) she will be eligible to receive $1,716, which is an increase of $466 per month. With this additional benefit amount, Michelle’s breakeven point against the foregone $12,176 is a little less than 30 months, or 2½ years.

Understand that this outcome is specific to the example that I outlined above. The amount of your own benefit and the amount of the spousal benefit will change the outcome and breakeven point for your own circumstances. The other point that is not worked out with this example is the overall couple’s benefit – which is important to work out as well. If Michelle chose to use her own benefit at FRA, Mike could file a restricted application at that point. This would result in a less-optimal outcome, but these projections should be done as well in working out your plan for Social Security benefits.

I hope the original article didn’t cause too much confusion – this should set the record straight.

Posted on Jun 21st, 2013

by author: jblankenship.

3 comments already - add to the conversation!

Posted in: Delayed Retirement Credit, Social Security, social security benefits, Social Security spousal benefit.
Tagged: delayed retirement credit · DRC · Social Security · spousal benefit

Don’t Just Walk by That Dime on the Ground!

Jun 19th, 2013

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The Government Dime (Photo credit: scismgenie)

Have you ever been walking along the street and saw a dime on the ground? Did you just walk right by, or did you stop to pick it up? Heck, it’s only a dime, it’s not hardly worth the effort to bend over, right? But what if it was a dollar? Or a hundred dollars? You wouldn’t just walk by that, would you? What about $1,200?

Unfortunately, many folks do this very thing with their 401(k) plan employer matching funds. Most employers that sponsor 401(k) plans provide a matching contribution when you defer money into the plan. Often this is expressed as a certain percentage of your own contribution, such as 50% of your first 6% of contributions to the plan.

So if you make $40,000 a year and you contribute 6% to the 401(k) plan, that means you’ll be contributing $2,400 to the plan from your own funds, pre-tax. Since your employer contributes 50% of your first 6%, you’ll have an additional $1,200 added to the account for the year.

If you can only afford to contribute 2% (or $800) to the plan, you’re still getting an additional 50% of your contribution added by your employer for a total of $1,200 for the year. It still makes sense to participate even if you can’t maximize the employer contributions.

However, if you choose not to participate at all, you are giving up the extra money from your employer – forever. You can’t go back and get this money later when you think you can afford to. You’re essentially walking by that $1,200 that’s just sitting there on the ground waiting for you to pick it up.

Arguments against

After having this conversation with several folks, I’ve heard many different excuses to not take advantage of a 401(k) plan. The excuses usually fall into a few limited camps, which I have listed a below.

It’s my money! You’re darn right it is! And if you don’t participate in your 401(k) plan you’re throwing some of *your* money away. Many times people believe that when they put money into a 401(k) plan, it’s gone for good. Nothing could be more untrue! The 401(k) plan is your property. All of your contributions and (as long as you’re vested in the plan) the employer contributions are yours to keep. Granted, it’s locked up behind some significant fees and penalties until you reach retirement age (59½ in most cases) – but it’s still yours.

I don’t trust my company – they’ll go bankrupt and lose my money! As noted above, the 401(k) account is yours, not the company’s. Even if the company goes bankrupt completely, as long as you haven’t invested your entire 401(k) plan in company stock (a la Enron), you still have your 401(k) plan intact. They can’t lose your money, in other words! It’s not theirs to lose.

I can’t afford to put money in the plan! These days, money can be pretty tight (but when isn’t it?). Unfortunately, regardless of how much money you make, it’s always possible to spend up to and more than what you bring home each payday. The reverse of this is also true. Within limits, it’s usually possible to make do with less. If your paycheck was a dollar less every payday you’d figure out how to get by, right? How about $78 less?

Using our example from above, for a single person with an annual income of $40,000 per year, before you participate in the 401(k) plan, your total income tax would be approximately $4,054. If you chose to put 6% or $2,400 in your company 401(k) plan, your income tax would work out to $3,694 – $360 less. So your take home pay would only reduce by about $78 per paycheck (if you’re paid every other week). In return for this annual reduction of $2,040 in take-home pay, you’d now have a 401(k) account with $3,600 in it when counting the employer contributions.

Pretty sweet deal, if you asked me (but you didn’t, I just threw this in your face!). For a total “cost” of $78 per paycheck, you get lower taxes PLUS a retirement savings account worth 75% more than what you had to give up. Not too shabby.

One great benefit of participating in a 401(k) plan is that once you’ve made the decision to participate, you are deferring this income before it makes it into your hands. You don’t have to (or get to) make a decision about saving, it’s done automatically. This helps you to get past one of the real difficulties that many folks face with saving: the money always seems to find another place. This way it automatically goes into savings, before it can find another place.

The bottom line

The best and most important way to assure success in retirement savings is to put away more money over time. Of course your investment returns will help, but if you don’t save the money, it can’t produce returns, right? So do yourself a favor and don’t walk past that $1,200 that’s just lying on the ground!

Posted on Jun 19th, 2013

by author: jblankenship.

Posted in: 401 k, qrp, qualified retirement plan.
Tagged: 401 k · qrp · qualified retirement plan

3 things you can do if you’ve filed for Social Security benefits too early

Jun 14th, 2013

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It’s too early for the beach (Photo credit: c@rljones)

I often hear from people who, for whatever reason, decided to file for their Social Security retirement benefit immediately upon reaching 62 (or 66, or whatever age), and now they have found out that this wasn’t necessarily the best option for them to maximize their lifetime Social Security benefits.

There are several things that you can do about this – three that come to mind at the moment. Below we’ll work through each of these ways to fix a situation where you filed too soon.

Pay it back

If it’s been less than 12 months since you filed, it’s possible for you to withdraw your application for benefits and pay back all that you’ve received to date. Once you’ve done this, as far as Social Security is concerned, you never filed. All of your benefit options are intact, just as if you hadn’t filed in the first place.

If your spouse or other beneficiaries began receiving benefits based on your record when you filed for your own benefit, those benefits will cease, and all benefits that your spouse or beneficiaries have received to date will also have to be paid back.

This can be quite costly to do, but the increased future benefits are likely worth the cost.

Work it off

If it’s been more than 12 months since you filed or if the cost to pay it all back is just too much to stomach, there’s another way to sort of re-set your options. This method isn’t as good as the payback option, but it’s the next best available to fix your problem if you are still working (or can get a job) and you’re younger than Full Retirement Age (FRA).

Here’s how it works: if you are under FRA and working while receiving Social Security benefits, for each two dollars above a certain limit ($15,120 in 2013 and adjusted each year) one dollar of benefits will be withheld. For example, if you are receiving $12,000 per year in Social Security benefits and you get a job that pays you $25,000 a year, $4,940 of your benefits will be withheld. Since you’re receiving $1,000 per month in benefits, this means that 5 months per year will be withheld.

Once you reach FRA (where the earnings limit no longer applies) if you have earned that extra amount for four years (thereby giving up 20 months’ worth of benefits) your benefit will be adjusted. The adjustment makes your benefit reduction appear as if you filed 20 months later than when you actually did. So if you originally filed at exactly age 62, your benefit would be reset at FRA as if you filed at age 63 and 8 months. This would have the effect of increasing your benefit by 9.44%.

If you earned enough in your job to eliminate all of your Social Security benefits between age 62 and 66, you would effectively re-set your benefit as if you had delayed filing until age 66.

During the year that you will reach FRA, the earnings limit is different, and it’s applied differently as well. You can earn as much as $40,080 for the year, and each three dollars above that limit will reduce your benefit by one dollar.

It’s important to note that these earnings must be active earnings, such as from a regular job or self-employment. Withdrawals from an IRA, while taxable, are not counted toward the earnings limit and can’t be used to reset your benefits.

Suspend

Although most of the time the concept of suspending your benefit is discussed as a part of the “file & suspend” tactic, where you file and then immediately suspend receiving benefits in one action, you are allowed to suspend your benefits at or after FRA regardless of when you originally filed. So, if you filed for your Social Security retirement benefit early and you decided that it was a mistake, when you reach FRA you have the option of suspending your benefit and allowing the delay credits to accrue on your record.

For example, if you filed at age 63 and collected benefits until you reached FRA at age 66, you could suspend your benefits at that point. If you were receiving a $1,000 benefit from filing at age 63, this was 80% of your PIA, which would have been $1,250. If you suspend at FRA and then re-file at age 70, then your delay credits would be 32% – which would bring your total benefit up to 112% of your PIA, for a new benefit of $1,400.

While your benefit is suspended your spouse and/or beneficiaries will continue to receive their benefits based on your record just the same as if you were actually collecting the benefits (subject to the family maximum). The delay credits, once earned, will not have an effect on those benefits that they’re receiving while you’re alive, but the delay credits will be applied to any survivor benefits that they receive after your passing.

The Combo

You could use the Suspend option in tandem with the Work it off strategy: by earning above the limit each year you’re improving the benefit that you’re eligible for at FRA – and then when you get to FRA you can suspend your benefits to further increase your benefit.

In addition to the above options, if none of them will fit your needs (such as if you don’t have another source of funds to get you by while you suspend and delay), if your spouse has not yet filed you can delay your spouse’s benefits as long as possible in order to maximize that benefit. Of course, this is to assume that your spouse hasn’t already filed too. There are several strategies that could help you to maximize benefits in that case, including filing a restricted application once he or she reaches FRA.

Posted on Jun 14th, 2013

by author: jblankenship.

Posted in: Annual limits, Earnings Limits, file and suspend, Social Security, Social Security spousal benefit.
Tagged: earnings test · Social Security · social security benefits

Family Maximum and File & Suspend

Jun 7th, 2013

2 comments

Radio Maximum logo (Photo credit: Wikipedia)

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

I recently received the following email from a reader:

I am 66 and my wife is 45, and our son is 12. I intend to delay my filing for Social Security benefits until age 70 in order to provide the highest survivor benefit for my wife since I’m so much older than her. But I also realize that my wife and son may be eligible for benefits now if I file and suspend. According to my SSA statement my benefit now at age 66 is $2,576. Since my wife and young son are eligible for 50% of my benefit (after I file and suspend), each should receive $1,288, right? When I talked to the SSA office, they told me that their benefits would be limited by the family maximum benefit, which is $4,323, and they would only receive $873.70 each. I can’t make the numbers work out, are they telling me wrong?

Unfortunately for the above situation, SSA was correct in the calculations – because of how the family maximum benefit and file & suspend work together.

Recall that the family maximum benefit limits all other dependent benefits paid on an individual’s record after the individual’s own PIA is subtracted from the family max figure. Regardless of whether the worker is currently receiving his or her own benefit, the PIA is subtracted from the family maximum benefit amount before calculating all other benefits on that record.

So in the case of the reader who emailed me, when his PIA of $2,576 is subtracted from his family maximum benefit of $4,323, there is a remainder of $1,747. This is all that’s left for dependent benefits, and it’s split evenly among the wife caring for the child under age 16, and the child who is under age 18. In this case, when the child reaches age 16, his mother’s benefit will go away, and he will be eligible for the full $1,288 (adjusted for COLAs and any changes to the father’s PIA from additional work on his record). The child will receive that benefit until he reaches age 18.

It’s important to note that if the father passes away before the child reaches age 18, the family maximum benefit will still apply, but there will be changes to the benefits received. First of all, if the father died before the child reached age 16, the mother and child would each be eligible for a 75% benefit based on the father’s projected benefit at his attained age as of his death. This benefit would be subject to family maximum benefit rules, but since there are only two of them, their combined benefit is still less than the max, so there is no limit and each would receive $1,932 (adjusted for COLAs and delay credits).

After the son reaches age 16, again his mom’s benefit would be eliminated and he would continue to receive the full 75% benefit.

If the original emailer from above had an ex-spouse who would be eligible for benefits (either spousal or survivor’s, depending on the situation) these benefits would NOT reduce the family maximum benefit available to the emailer’s current spouse and child. Plus, the family max calculation does not apply in any way to the ex-spouse’s benefits.

Posted on Jun 7th, 2013

by author: jblankenship.

Posted in: #noTOP, family benefit, family maximum, file and suspend, Social Security.
Tagged: family maximum · file and suspend · Social Security

The Qualified Terminable Interest Property (QTIP) Trust

Jun 5th, 2013

2 comments

Qtip (Photo credit: miggslives)

Often we come up against situations in planning finances for folks where some special tools are necessary. One of those situations, quite common these days, is when one or both members of a couple has children by a prior marriage. The situation brings about some interesting questions when considering how the marital assets will be divided when one member of the couple has passed on.

Daryl has three children by a prior marriage, and his wife Toni also has three children by a prior marriage. Both Daryl and Toni have considerable assets from before their marriage – each has a investments and retirement accounts in their own name: Toni’s accounts are worth $350,000, and Daryl’s accounts are worth $300,000. Given their lifestyle, they will not be needing much of their accounts early in retirement – but it’s quite likely that later in life they may need the accounts for medical care and potentially for nursing facility care.

Under common circumstances, when Daryl passes away, he will leave his assets to Toni, so that she can continue to live the lifestyle that she’s been accustomed to, as well as to ensure that she can afford adequate medical care later in life. But if he bequeaths his entire estate directly to Toni, what happens when she passes? Again, under common circumstances, she would pass along her estate to her children. The problem is, by doing this, Daryl’s children don’t get a share of the estate at all! How can this be straightened out?

One thing would be for Daryl to designate in his will that his estate would be split among Toni and his children, either equally or in some formula. This gives rise to another problem though: what if the portion that he leaves to Toni isn’t enough to cover her living expenses and medical care? His desire to make sure his kids got their fair share has left his wife possibly in dire straits when there was plenty of money available.

Another way to handle this would be for Toni and Daryl to each specify in their wills that the final estate, whichever of the two it would be, would be split among all six of their combined offspring. The problem with this is that after Toni has passed away, Daryl decides to remarry again – and then when re-doing his will he cuts out Toni’s kids, who he has always had a contentious relationship with.

Enter the QTIP

Investopedia defines a Qualified Terminable Interest Property trust as follows:

A type of trust that enables the grantor to provide for a surviving spouse and also to maintain control of how the trust’s assets are distributed once the surviving spouse has also died. Income, and sometimes principal, generated from the trust is given to the surviving spouse to ensure that he or she is taken care of for the rest of his or her life.

This type of trust does exactly what we’re looking for: after Daryl’s death, his assets become the property of his QTIP trust, which provides for Toni to be able to take income (and principal as necessary) from the assets in order to maintain her lifestyle. Upon Toni’s passing, Daryl has declared that his three children will then receive an inheritance of the remaining assets in the QTIP. Toni set up a QTIP for her estate as well, in the event that she pre-deceased Daryl, so that her children could receive a portion of the remaining estate upon Daryl’s death.

QTIP trusts can hold any type of asset, such as investment accounts, farmland, homes, and collectibles. IRAs can be owned by a QTIP trust, but special care needs to be taken when setting up the trust to ensure that the marital deduction is preserved and that the income can be distributed as appropriate to the surviving spouse. It’s usually simpler to pass an IRA directly to beneficiaries, or use a see-through trust to assist with the distribution process.

An important factor to consider when setting up these QTIP trusts is that a qualified trustee should be appointed to oversee the distribution of the assets. This trustee should be a disinterested third party who would be in a position to make good decisions about when and how much of the trust is distributed to the surviving spouse. Without this type of oversight, the survivor could diminish the QTIP first, before his or her own assets, thereby effectively disinheriting the decedent’s children.

You’d think it’s unlikely that something like this would happen, but as I’ve often said – you never really know someone until you are dividing an estate with them. Once the original owner has died, the interested parties often cease to act like relatives and revert to the basics of the transaction: they’re just people splitting up money (or other assets). It pays to get this right, in order to reduce the possibility of one or more parties taking advantage of others.

Posted on Jun 5th, 2013

by author: jblankenship.

Posted in: estate planning, estate tax, IRA, QTIP.
Tagged: estate planning · IRA

Book Review: How to Retire Happy

Jun 3rd, 2013

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“The 12 most important decisions you must make before you retire”

Author Stan Hinden, who is the former syndicated Washington Post “Retirement Journal” columnist, has just released his Fourth Edition of this book. The book is Hinden’s commentary and advice, as well as a sort of journal, as he and his wife Sara entered into and have been living in retirement over the past 17 years. Hinden retired in 1996 at the age of 69, at which time he began writing the “Retirement Journal” column. He was nominated for a Pulitzer Prize in Commentary in 1998 for his work.

This book is an excellent read for folks who are planning toward retirement or have recently retired. Hinden has organized the process into 12 decisions, some of which include: “Am I Ready to Retire?”, “What Should I Do with the Money in My Company Savings Plan?”, and “Where Do I Want to Live When I Retire?”. Mr. Hinden then walks through each of the 12 decisions with his own personal insights and choices, as well as with expert recommendations and commentary on the subjects.

The book is a fairly quick read at 250 pages, and the writing style is simple and conversational. The decision-points that Mr. Hinden discusses are thought-provoking, and he has been diligent to provide sources for additional review at the end of each Decision/Chapter. Topics covered include income taxes, pensions, retirement accounts, Social Security, Medicare, long-term care insurance, and many other categories pertinent to retirees.

The author’s wife, Sara, became afflicted by Alzheimer’s Disease in 2007, which has resulted her needing to be placed in a residential nursing facility as the disease has progressed. This was a particularly difficult section for me as I very much empathized with Mr. Hinden as he was faced with the difficult decisions associated with his wife’s condition. In a similar fashion, the author discusses the issues that he faced with his own health after learning that he needed a four-way heart bypass shortly after his retirement. These insights that are brought forth are very helpful though, as we all must consider that such decisions may likely be a big part of our own lives.

I will recommend this book to any and all folks who are looking for insights as they approach retirement. It will definitely give you additional insight as you take on this next step in your life – what Hinden mentions is likely the “final quarter” of your life. He points out though, that this final quarter needn’t “sound grim. In any football game, the last quarter is often the most exciting. The same can be true of retirement. It is one more chance to add points on the scoreboard of your life.”

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not. If you find the information in this review useful, let me (and McGraw-Hill) know!

Posted on Jun 3rd, 2013

by author: jblankenship.

Posted in: Book review, IRA, Medicare, Social Security.
Tagged: book review · IRA · Social Security

The Crystal Ball

May 31st, 2013

by sraskie.

2 comments

Every so often we get asked by our clients or prospective clients which direction the market is going to go. This is always and entertaining question to get – and some of our “regulars” already know the answer.

Having a bit of a sense of humor (albeit dry sometimes) I’ll joke with clients and tell them that the day they handed out crystal balls in my investment class, it was the one time I called in sick – and you only get one chance at the coveted crystal ball. Thus, I forever lost the opportunity to predict the future of the markets. Darn.

Inevitably, clients laugh and understand the joke – and take away the underlying theme of the jocularity – that we can’t predict the future, especially in securities markets. But this doesn’t mean we can’t plan ahead.

So why do we invest? Why do we save for retirement? Why do we plan for the future? The reason is this: while we can’t predict the future, we can certainly have a great idea of where we are going and where we want to be. We understand that over the long run, it’s likely that our nest egg and the contributions to it over the years will grow, so that when it comes time to retire and actually live the future that we planned for; it’s livable and enjoyable. This is why we plan ahead and this is why people seek out financial planners.

Of course, there are always the worriers and naysayers that say, “What if the market crashes?” “I don’t want to lose all of my money.” “What happens if the market dips next week?” To which the answer is, “Well…what if it does? So what?” A good planner would never put immediate or near-term money at substantial risk.

An appropriate plan and an appropriate planner will take the time to discuss your strategy, goals and based on your aptitude for risk – will properly allocate your investment assets so that fluctuations won’t wipe out your savings.

We can tell you that the market will tank, and the market will recover. And that’s why based on an individual’s plan we allocate and manage accordingly. So, technically we can predict the future (as could anyone in this case), we just can’t tell you the exact dates crashes and recoveries happen (if that were the case, there’d be no need for financial planners).

Another way to think about it is this: your doctor may tell you to eat right, exercise, don’t smoke or abuse alcohol to preserve longevity. The plan is for you to live longer. That being said, you’re still going to get a cold or the flu (analogous to small market dips) or you may get seriously injured in an accident (analogous to a market crash – pun intended). But you (and the market) will recover. We can’t predict when you’ll get a cold or be in an accident or how long recovery will take, but we can plan accordingly.

In an absolute worst case scenario, you could die prematurely (analogous to the financial markets collapsing like a dying star). But overall, we take our doctor’s advice because we’re planning to live a long and happy life. The same is true with professional financial advice. Anything can happen, but we plan for the future.

Posted on May 31st, 2013

by author: sraskie.

Posted in: fiduciary, financial planning, goals, investing, reader questions, retirement, retirement accounts, retirement plan, retirement plans, retirement savings, saving, stock.
Tagged: fiduciary · financial planning · investment · retirement plan · retirement plans · retirement savings

Exceptions to the 10% Early Withdrawal Penalty from IRAs and 401(k)s

May 29th, 2013

33 comments

English: A clock made in Revolutionary France, showing the 10-hour metric clock. (Photo credit: Wikipedia)

When you take money out of your IRA or 401(k) plan (or other qualified retirement plan, such as a 403(b) plan), if you’re under age 59½ in most cases your withdrawal will be subject to a penalty of 10%, in addition to any taxes owed on the distribution. There are many exceptions to this rule though, and the exceptions are not the same for all types of plans. IRAs have one set of rules, and 401(k)s have another set of rules.

The exceptions are always related to the purpose for which the money was withdrawn. The exact same dollars withdrawn do not have to be used for the excepted purpose, just that the excepted expense was incurred.

IRA Exceptions

It is important to know that all distributions from your traditional IRA are subject to ordinary income tax, but some distributions are not subject to the early withdrawal penalty. The list of exceptions for early withdrawals from IRAs is as follows:

Death of the owner of the IRA – if the owner of the IRA dies, the beneficiaries of the IRA can (in fact, must) take withdrawals from the plan without paying the 10% penalty.

Total and permanent disability of the owner of the IRA – if the owner of the IRA is deemed to be totally and permanently disabled. You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.

SOSEPP – With a Series of Substantially Equal Periodic Payments, lasting at least five years or until age 59½ (whichever is longer), there is no 10% penalty applied.

Medical Expenses – if you have medical expenses greater than 7.5% of your Adjusted Gross Income, a distribution from your IRA to cover these expenses (the excess above 7.5% of AGI) will not be subject to the penalty. Any amounts paid by insurance toward the medical expenses reduces the overall expense counted toward the excepted expenses.

Health Insurance Premiums – if you’re unemployed, you can take a distribution from your IRA to cover your health insurance premiums without paying the penalty.

Qualified higher education expenses – amounts withdrawn from your IRA to pay for tuition, fees, books, supplies, and equipment needed for enrollment or attendance of a student at an eligible higher education institution are not subjected to the penalty. In addition, if the student is at least a half-time student, room and board expenses paid for with an IRA distribution would not be subject to the penalty. The amount of education expenses is reduced by any scholarships, grants, and qualified 529 plan distributions; any amount applied to an IRA penalty exception is also not eligible to be used toward education credits, such as the American Opportunity Credit or the Lifetime Learning Credit.

First-time home purchase – amounts withdrawn from your IRA up to $10,000 that are used toward a qualified first-time home purchase are an exception to the penalty.

Qualified reservist distributions – if a reservist who is called to active duty after September 11, 2001 for a period of 179 days or more takes a distribution from an IRA (after the start of active duty and before the end of active duty) the distribution will not be subject to the 10% penalty.

Rollovers – both direct, trustee-to-trustee transfers and 60-day indirect transfers are exempted from the penalty.

Excess contributions – if you have contributed too much to your IRA, you can take out the excess contribution without penalty. However, any growth that is attributed to the amount that you over-contributed will be subject to the 10% penalty and taxes when withdrawn.

401(k) Exceptions

As with the IRA, most withdrawals from a 401(k) or other qualified retirement plan are subject to taxation. Early withdrawals before age 59½ are also subject to a 10% penalty, with some exceptions. The exceptions are as follows:

Death of the participant – this is the same as the exception for an IRA above.

Total and permanent disability of the participant – same as with an IRA.

SOSEPP – same as with an IRA.

Medical Expenses – same as with an IRA.

Qualified reservist distributions – same as with an IRA.

Rollovers – same as with an IRA. However, an indirect 60-day rollover (not a trustee-to-trustee transfer) is subject to mandatory 20% withholding. If the withheld 20% is not transferred within 60 days, this amount may be subject to both taxation and the 20% early withdrawal penalty.

Corrective distributions – just like with an IRA, if you have contributed too much to your 401(k), you can take out the excess contribution without penalty. However, any growth that is attributed to the amount that you over-contributed will be subject to the 10% penalty and taxes when withdrawn.

Separation from service after age 55 – if you leave employment after the age of 55, you are eligible to take distributions from your 401(k) or other QRP without penalty. This is only valid while the funds are still in the 401(k) – if you rollover the funds to an IRA, this option is no longer available. If the participant is a public safety employee (police, fire, or emergency medical technicians), the age is 50 or older.

Qualified Domestic Relations Order (QDRO) – in the event of a divorce, if the 401(k) is to be divided or distributed to the ex-spouse of the participant, withdrawals from the plan by the ex-spouse are not subject to the 10% penalty.

Posted on May 29th, 2013

by author: jblankenship.

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Posted in: 401 k, 401 k 403 b, Early Distribution, eligible rollover distribution, inherited IRA, IRA, qrp, qualified retirement plan.
Tagged: early retirement · IRA · qrp · rollover

Avoid Awkwardness in the Afterlife–Confirm Your Beneficiary Designations

May 24th, 2013

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This is a topic that I cover with all clients, and one that I recommend you for everyone with retirement plans and other accounts with beneficiary designations. Too often we think we have the beneficiary designation form filled out just the way we want it, and then (once it’s too late) it is discovered that the form hadn’t been updated recently – and the designation is not what we hoped for.

I made this recommendation to a client not long ago. He assured me that he had all of his designations set up just the way he wanted. His wife, sitting next to him in our meeting, asked him to make sure – talk to the IRA custodian and get a copy of the designation as it stands today. A bit miffed about it all, he agreed to do so, and did the next day. Guess what he found – as it stood on that day, his IRA beneficiary designation form indicated 100% of his IRA would pass to his ex-wife from 15 years ago! Plus, he had no secondary beneficiaries named, which meant that if the ex predeceased him, HER heirs would be the primaries. Thankfully he had checked on this to avoid this awkward and possibly devastating situation.

Know what was fixed pretty much immediately?

Take the time

You owe it to yourself and your heirs to take the time to review your beneficiary designations and keep copies of them in your “dead file”. This includes IRAs, Roth IRAs, 401(k)/403(b)/457 plans, and other pensions or retirement plans. You also may have POD or TOD (Pay on Death or Transfer on Death) designations on non-retirement accounts – confirm these and keep copies as well.

For your standard retirement accounts, such as IRAs, 401(k)s and the like, you typically have the option of naming a primary beneficiary (or beneficiaries) and a secondary or contingent beneficiary or beneficiaries. It makes a huge difference on these accounts that you name a specific person (or persons) as the primary beneficiary, and a specific person (or persons) as the contingent beneficiary. With IRAs, if you leave the designation blank, you may be taking away important options for your heirs.

If you leave the primary beneficiary designation blank you are leaving the transfer of your IRA up to the custodian’s default designation. Quick! What’s your IRA custodian’s default beneficiary designation?? I didn’t think you’d know.

Often this default is your spouse first, and then your “issue” – meaning your children and other descendants. Other times, the default beneficiary is your estate. In the event that the estate is the default beneficiary, any beneficiaries of the estate will receive the IRA, but they will not be able to utilize the “stretch” option of receiving payout of the account over their remaining lifetimes. This is because the IRS rules state that a “named beneficiary” must be in place in order to use the stretch provision. If no “named beneficiary” exists, the stretch option is not allowed. If the default is your spouse and your issue, these can be treated as “named beneficiary” if they are alive.

Discuss with your heirs

At face value, even though you think your intent for your beneficiary designations is clear, it might not be clear to your heirs. For example, you may have chosen to pass along half of your IRA to your youngest child and only a quarter to the older two children because you believe the youngest child can use the money more than the other two. Or maybe you decided to leave the entire IRA to your oldest daughter, and you want to designate your three sons to split up the farmland – which you believe is an equitable division.

Whatever you’ve decided, especially if there are perceived inequities in your division plan, you should take the time to review your plan with your heirs. If that makes you uncomfortable, there are a couple of things to consider: First, if you’re uncomfortable discussing it with them, imagine how uncomfortable your heirs may be when the time comes to distribute your estate. Maybe it’s not such a good idea after all if it could cause contention among your heirs. Second, if you still believe your split is the right way to go, you should explain your plan to someone – your designated executor would be a good choice. And the designated executor should be a disinterested separate party, someone who isn’t receiving benefit from your estate plan, in order to keep the process “clean”. Otherwise, if one of the heirs is your executor and the executor is perceived to receive preferential treatment, again you’ll have some contention among your heirs.

If there are complex instructions involved, consider making an addendum to your will. Instructions in your will would have no impact on the beneficiary designations on your IRAs and other plans (these pass outside of your estate as long as you’ve made specific designations) but other asset divisions aside from retirement accounts may require explanation for your heirs to understand your intent. Don’t expect that everyone will understand or agree with your thought process when you’re gone. Explaining your thought process in advance will likely help to ensure that your division plan doesn’t result in a family rift.

Take the time to review your beneficiary designations. Make sure that you have the primary beneficiary or beneficiaries that you want, and the percentages that you’d like each to have. Also make sure that you have named contingent beneficiary or beneficiaries in the event that your primaries have predeceased you. Lastly, make sure that you note how division is done after the death of the beneficiaries: per stirpes or per capita.

Posted on May 24th, 2013

by author: jblankenship.

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Posted in: 401 k, 403 b, 457, beneficiary, IRA, qrp, qualified retirement plan.
Tagged: 401 k · IRA · qrp · qualified retirement plan

Per Stirpes / Per Capita–What Does it Mean?

May 22nd, 2013

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Example of per stirpes inheritance (Photo credit: Wikipedia)

When working with your estate planning (even if you don’t realize you are) you may run across the terms per stirpes and per capita. Choose one type over the other and you could have a significant impact on who eventually receives your estate. So what do these two terms mean?

Dictionary.com defines the two terms as follows:

per stirpes – noun; pertaining to or noting a method of dividing an estate in which the descendants of a deceased person share as a group in the portion of the estate to which the deceased would have been entitled.

per capita – noun; noting or pertaining to a method of dividing an estate by which all those equally related to the decedent take equal shares individually without regard to the number of lines of descent.

This probably seems like just so much gunk to you, so let’s look at an example.

Joe has four children, Anna, Benny, Björn, and Agnetha. Anna and Benny have no children. Björn has three boys: Neil, Alex and Geddy; while Agnetha has two boys: Peter and Eric. Joe is planning his estate and he wants to split his assets evenly among his four kids when he dies, and if the any of the kids dies before he does, he wants the grandkids to receive the share of the child that died.

Joe designates each child as an equal beneficiary of his estate, identifying each by name. He then indicates that he wishes for the grandchildren to receive a share in the event that their parent dies before Joe. He’s stuck deciding whether or not to choose per stirpes or per capita for the distribution. Typically the verbiage would be “I leave my assets to my then living descendants, per capita” or “I leave my assets to my then living descendants, per stirpes”.

Let’s look at what will happen if he chooses one type of distribution over the other.

If Joe Chooses Per Stirpes…

… and Anna (with no children) dies before Joe, then Benny, Björn and Agnetha will each receive 1/3 of the estate, and a share would not be created for Anna. The same would be true if Benny dies before Joe – in fact, if both Anna and Benny predecease Joe, Björn and Agnetha will receive 50% shares in the estate, and no shares would be created for Anna or Benny.

On the other hand, if Björn died before Joe, then Anna, Benny and Agnetha would each receive a 25% share, and Björn’s children, Neil, Alex and Geddy would rush to receive 8 1/3% of the estate, or Björn’s 25% share divided into thirds.

If Agnetha died before Joe, her children Peter and Eric could humbly and blindly accept 12 1/2% each, which is Agnetha’s 25% share split in two.

If any of the children of Agnetha or Björn had also predeceased Joe, the division would only be among the living grandchildren, with no provision for the deceased child. That is, unless the deceased child had children of his own, which would be Joe’s great-grandchildren, in which case the great-grandchildren would receive the share of the deceased grandchild. This would continue for all living heirs until the estate is completely distributed.

If Joe Chooses Per Capita…

… and all of the children and grandchildren survive him, each of them would receive 1/9 share. This is because per capita designates that all living descendants, by headcount, split the estate equally.

If any (or several) of the descendants of Joe have predeceased him, the shares would adjust for the remaining number of heirs. For example, if Björn died before Joe, then Anna, Benny, Agnetha, Neil, Alex, Geddy, Peter and Eric would each receive 12 1/2% of the estate. The shares would adjust for any others that predeceased Joe, or for any additional grandchildren or great-grandchildren that may have been born prior to Joe’s death.

Common usage

As you can see, per stirpes results in what most folks consider to be the most fair distribution among heirs. The inequity that comes up when these designations are used is when an heir predeceases the decedent in question (Joe from our example above), he or she would receive no share of the decedent’s estate, not even via his or her own estate. This can be rectified by naming the primary beneficiaries (Anna, Benny, Björn and Agnetha in our example), and then indicating that contingent shares could be designated to their estates if no living heirs, or to their living heirs, per stirpes.

Per capita is not used often, and it can cause some problems. Notwithstanding the fact that your children are penalized if they don’t happen to reproduce while their siblings did, when assets are transferred more than one generation away from the decedent, there can be an additional generation skipping transfer tax (GSTT) applied to the distribution. Sometimes per capita is used by generation, which can result in an even distribution among a particular generation, if that’s your intent.

Posted on May 22nd, 2013

by author: jblankenship.