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

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Roth 401(k) plans have been around for a while now, but here’s something you want to keep in mind about these accounts. When you leave your employer, generally speaking, you should always rollover your Roth 401(k) to a Roth IRA. There may be a few exceptions, but that’s the general advice.

This is primarily due to the Required Minimum Distribution (RMD) requirement that is placed on Roth 401(k) accounts… unlike a Roth IRA, the owner of a Roth 401(k) is required to take minimum distributions (RMDs) beginning at age 72, just like traditional 401(k) and IRA plans. Therefore, at some point before age 72 (often upon separation from service) the owner of the Roth 401(k) should rollover the account to a Roth IRA. But see the caution below!!

Roth IRAs do require the beneficiary to take RMDs after the death of the primary owner, but the distributions are tax free, as would be expected. But otherwise, during the life of the primary owner of the account, there is no RMD required.

A Word of Caution

The Roth 401(k) (and Roth IRA) both require you to have held the account for five years, and a triggering event must have occurred (such as reaching age 59½), before the distribution is qualified and therefore tax-free. The tricky part is that the time in the Roth 401(k) doesn’t count toward time held in a Roth IRA.

So, if you roll over the Roth 401(k) account before you’ve met the five year requirement, all the time that you’ve held that account is wiped out, and the time you’ve held the Roth IRA is the new holding period. If you put the funds into a new Roth IRA, you will have to wait another five years before you can take the money out in a qualified fashion.

If you’d held the Roth 401(k) for five years or longer and a triggering event has occurred, rolling the funds over to a Roth IRA (of any age) allows you to withdraw the funds at any time, for any purpose, without tax.

Posted on Jan 3rd, 2022

by author: jblankenship.

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Posted in: retirement plan, Roth 401(k), Roth IRA.
Tagged: retirement plan

Book Review: Stacked – Your Super Serious Guide to Modern Money Management

Dec 27th, 2021

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Stacked

If you’ve looked for a good book to help you manage your money better, I’m sure you’ve been overwhelmed by all of the possible options out there. The problem with most of these books is that they take a very serious approach to teaching you about money – after all, money is a serious matter, right? And being serious is not a very enjoyable place to be, so unfortunately working through many of the books available can be a real slog.

What if I told you that there’s another option out there, a book that will entertain you, even make you snicker, along with teaching you some very serious things about money?

Today I have the privilege of reviewing a new book by my friend Emily Guy Birken and her co-author, Joe Saul-Sehy. The book is entitled Stacked – Your Super Serious Guide to Modern Money Management. These two folks have taken on the monumental task of keeping you engaged, entertained, and learning all the way through their guide to a quite serious subject – and they’ve done an amazing job!

You might recognize the names – Emily has been writing in the personal finance space for many years now, and Joe has a very successful personal finance podcast, Stacking Benjamins. If you’ve spent any time at all searching through the internet for personal financial guidance, you’re sure to have come across one or the other (or both!) many times. As I understand it, this is the first time they’ve worked together, and they have done a wonderful job, in my opinion.

Throughout the book, you’ll find many new and interesting angles to consider each financial concept – and you’ll find a peppering of interesting factors as well. Who knew you could learn about money management alongside such diverse references as: Oregon Trail, Gordita Supremes, Thomas Jefferson (“stone-cold red headed Tommy Jeff”), Tetris, platform shoes with goldfish in the heels, Veruca Salt, MFs, a Snoopy Sno-Cone maker, beanie babies, a notorious tatoo, fine Michigan wine, as well as David Lee Roth and Brian Wilson (in the same paragraph, no less!).

You’ll also find out the answers to some burning questions that you didn’t even realize you needed to know, such as why you might need to call Sallie Mae “Ms. Mae”, why debt-payoff strategies are so snowy, and what makes a sleeping financial professional exclaim “Past performance is no guarantee of future results” without actually waking up.

Clearly this isn’t your typical money management book. But the lessons within are fantastic, and all of the wonderful sidebars and somewhat silly examples kept me entertained throughout.

Joe and Emily don’t do all of this alone, either. Sprinkled throughout the book are timely advice from Joe’s Mom, who is a surprisingly astute observer of all things financial. In addition, each chapter contains a transcript from the popular Stacking Benjamins podcast, from financial industry and personal finance luminaries such as Jean Chatzky, Paula Pant, David McKnight, Jill Schlesinger, and Farnoosh Torabi, to name a few. With these additions, you not only get Joe & Emily’s view of matters, but some of the finest minds in the personal finance space to boot.

All in, I thoroughly enjoyed reading this book. At 300+ pages, it was a surprisingly quick read, primarily due to the fun and irreverent ways the authors present these serious topics. I highly recommend this book for anyone who has been left cold by the current offerings of money management guides, as well as for anyone who could use another perspective to help them along the way to managing your money. I’ve been in this industry for, well let’s just say a long time, and I picked up a few gems myself!

Kudos, Emily and Joe!

Posted on Dec 27th, 2021

by author: jblankenship.

Posted in: Book review, financial planning, personal finance.

3 Ways of Dealing Without Recharacterization

Dec 20th, 2021

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As of the passage of the Tax Cuts and Jobs Act of 2017, recharacterization of a Roth IRA conversion is no longer an option. What can you do to now, to simulate the benefit had by recharacterization of a conversion?

It should be noted that regular contributions to a traditional or Roth IRA can still be recharacterized – it’s only a traditional IRA-to-Roth IRA conversion that is disallowed.

If you recall, the primary reason that you would want to recharacterize is if you converted funds and then, by the time you pay the tax, the holdings that you converted have dropped in value. So, instead of paying tax on something that is much less in value than previously, for a Roth IRA conversion you can recharacterize the conversion up to October 15 of the following year (see Help Mr. Wizard – I didn’t wanna do a Roth Conversion for more details on recharacterization).

While you can no longer just recharacterize and “reset” things when you face a situation like that with a Roth conversion, there are ways to reduce the risk associated with your Deemed Roth Account Conversion (since you are not eligible to recharacterize the conversion).

For one thing, you could use dollar-cost averaging to spread the risk of market fluctuations over several points in time through the year. Simply split your intended conversion amount into four amounts (or 12 amounts, if you want to do it monthly), and convert one of those amounts each quarter, for example. This way if the market drops through the year, you’re converting funds at the lower values.

Another option would be to spread the date-specific risk over several years, by converting smaller amounts each year. This would also reduce the risk of adverse market results, and spread out the tax over several years (if possible).

Timing the conversion for late in the tax year will give you the opportunity to fully (to a degree) understand the tax impact of the conversion. With little time remaining in the tax year, presumably there will be little in the way of fluctuation. This is the opposite of the recommendations that used to apply, which was to do your conversion early in the year to potentially take advantage of a recharacterization event, or (more hopefully) realize significant gains on a your converted sum.

Yet another choice could be to convert only those assets that have very low volatility, such as bonds. The probability of a major drop in value is much lower for these assets, so your need for a recharacterization would be far less likely. Sell your bond holdings in the IRA, convert the funds over to Roth, and then re-purchase the bond holding again in the Roth IRA.

There are many other, more complicated ways to reduce your risk against such a situation, but these are a few that are easily implemented. Hopefully this will help you in your process of converting retirement plan assets to Roth.

Posted on Dec 20th, 2021

by author: jblankenship.

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

Talking to the Social Security Office

Dec 13th, 2021

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I often recommend talking to the Social Security Administration (SSA), either at your local office or on their hotline, to review your particular situation. But this advice comes with a caveat… you need to know as much as you can about your options, and what you are entitled to do, so that you are well-armed when you speak with the SSA.

This is because the SSA representatives’ default advice is often to recommend the option that provides you the largest benefit today. The reason for this may be because it is in the SSA’s best interest for you to make your move now, because you’re on the phone with them, so you must be interested in getting benefits right away.

This also could be the case because a very high percentage of the eligible benefit recipients do not wish to delay receiving their benefit. So the folks you talk to at the SSA office are playing the averages by assuming that that’s what you want to do.

It is for these reasons that it makes very good sense to know as much as possible about your situation and the options that you have available (and what you are entitled to) before you talk to the SSA. Explain to the representative what you’re planning to do, and have them run the numbers to tell you what your benefits will be in the scenario(s) you’re suggesting.

Use the internet’s resources to find out what strategy works best for your particular situation. If you’re married, for example, there may be coordination strategies to think about. The same is true if you are divorced after at least ten years of marriage and not remarried. If you’re a widow(er) or your ex-spouse has died, even more coordination is available. Learn about your possible strategies and choose the right one for you. Then talk to SSA about it.

It pays to be informed – this is especially important when it’s something as confusing and complicated (with so much potential gain and loss) as your Social Security benefits.

Posted on Dec 13th, 2021

by author: jblankenship.

Posted in: Social Security.
Tagged: Social Security

What to do with a Year-End Bonus

Dec 6th, 2021

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This article originated from a reader question…

Suppose I get a $5000 bonus before the end of the year, would I be better off giving it away or putting it in 401k to avoid tax consequences, putting some in Roth IRA (if I still qualify), paying the tax bill on a conversion of some rollover IRA $$ to a Roth, paying my child’s tuition bill (too late for 529 now) to avoid debt, or replacing the 10-year old heating and A/C system to lower ongoing utility costs?

The specifics of this question are unique to the individual who asked the question, but the reasoning behind the response can be tailored to fit many other circumstances. What follows is an example of the process that I typically go through to assist folks in the process of understanding the impacts of various choices…

Assumptions

To start off, we need to make some assumptions about the situation that will guide us through the process. The reader who posted the question leaves us with a few clues that help us understand his tax situation – he’s made reference to income level with the “if I still qualify” parenthetical comment, so we should assume that the tax bracket for the bonus money is relatively high, close to the limit for Roth IRA contributions, which for 2021 puts him in the 24% bracket. In addition to the marginal tax rate, we’ll assume that the asker is married, filing taxes jointly. We’ll also assume that the asker’s spouse is already contributing to a retirement plan (so a Spousal IRA contribution is not in play). So in all cases the net after-tax bonus is assumed to be $3,800 (24% or $1,200 is used for taxes).

We also assume that in retirement, the tax bracket will be lower than it is currently, making tax deferral today more beneficial – meaning that we want to pay as little tax as we can today if we can pay tax on that income tomorrow.

Other assumptions include: the asker of the question has not maximized his contributions for the year to a 401(k), or a Roth IRA; the child (student) has not exhausted his student loan options, and funds can be borrowed at an unsubsidized rate of 6.8%; the cost of purchasing a new heating and A/C system for the home in question is $7,000; and lastly, there are funds available from other sources to pay for the needed heating and A/C unit or the tuition bill (if a loan is not used).

Analysis (*2021 tax provisions in use)

Donating – This would give you a tax deduction, so it would reduce your overall tax by $912, if he otherwise is eligible for itemization (his total itemized deductions are above $25,100). Otherwise, he can deduct up to $600 without itemizing.

Contribute to 401(k) – In this case, given the relatively high tax bracket, there would be a tax reduction (from all other options) of $1,200, allowing the reader to put the entire $5,000 to work in the retirement account. The assumption here includes the fact that you expect your tax bracket to be lower in retirement than it is presently – since when you take the money out of the 401(k), it’ll be taxed as ordinary income, thereby reducing the benefit of this tax reduction today.

Roth IRA contribution – If the asker of the question has not made his Roth IRA maximum contribution for the year and all other tax reduction and deferral options have been exhausted, this might make a great deal of sense. However, since there are other alternatives to look at, the Roth IRA contribution might not be the best option to use in these circumstances – since the tax cost of the money is relatively high.

Paying the tax on a Roth IRA conversion – Again, given the tax bracket involved here, a Roth IRA conversion is probably not a good idea. This amount of $3,800 could pay the tax for up to $15,833 of Roth Conversion, but as we have discussed in other articles, at the 24% bracket this is a somewhat costly conversion. It is assumed that in retirement his tax bracket could be less than the 24% current bracket – so only a very long period of deferral in the Roth account would prove beneficial.

Paying your child’s tuition – Paying the tuition bill could be a good use of these funds, because you would likely be eligible to use the American Opportunity Tax Credit on the tuition payment, giving you a credit of up to $2,500 directly against your overall tax, although the amount attributable to the net (after-tax) $3,800 would be $2,400 at most. This would eliminate the tax on the bonus altogether and give you an additional $1,200 in tax credit.

Replacing the aging heating and A/C – A 30% tax credit is available on the purchase price of eligible Qualified Residential Energy Property, up to $1,500. The cost of the installation is not allowable for the credit, this would be added to the basis of the property. For the net $3,800 from the bonus, the credit would be $1,140. In addition, assuming that the current system in place is far less efficient than a new system, this might equate to as much as an annual reduction of $200 or more in your annual heating and cooling costs.

Putting it all together…

Now that we’ve looked at the tax benefits of the options available, let’s compare them all side-by-side:

Donation – $912 tax reduction

401(k) – $1,200 tax deferred

Roth Contribution or Conversion – no current tax benefit

Tuition – $2,400 tax credit

Heating & A/C – $1,140 tax credit, plus ongoing $200 reduction in heating/cooling costs

So – the best route to go with this bonus, purely from a tax benefit standpoint, is paying the tuition bill. This would give you all of the withheld tax back, plus an additional $1,200 in tax credits. However, if you already have other funds set aside to use to pay the tuition, you might use those instead, and then use the bonus for one of the other options. (It should also be noted here that, if you haven’t taken advantage of your employer matching contributions in your 401(k), that might be the best possible place to use the bonus money.)

In the case of the heating and A/C system – this is a matter of priority… if the system truly needs replacing (beginning to show signs of failing), then you might put it higher in the priority order above the tuition or the 401(k) plan. For example, the student or the parent could get unsubsidized loans to pay for the tuition bill, since the interest on these loans can be deducted from taxes in the future, and then use the bonus (and the tax credit) to pay for the heating and A/C system.

Other options that you might consider for these funds would be: pay down high interest debt (credit cards, auto loans, or student loans), spend it on your own education (a master’s degree could make a significant difference in your future income), improve your “emergency” fund, or consider starting your own small side business. You could also use a portion of your funds to treat yourself and your family to a vacation, or perhaps some other leisure pursuit that will improve your life or provide other intangible benefits.

Of course, all of these options require you to put your own priority system to work. We’ve covered the tax implications – now it’s up to you to decide what makes the most sense for you. If it is of a high priority for you to make donations to a charity of importance to you, this might be the best option for you.

Posted on Dec 6th, 2021

by author: jblankenship.

Posted in: financial planning, reader questions, tax.
Tagged: financial planning · tax

GPO and WEP – When Do These Apply?

Nov 22nd, 2021

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In earlier articles we talked about the Government Pension Offset (GPO) and the Windfall Elimination Provision (WEP). These two rules within the Social Security Administration’s procedures reflect reductions to Social Security benefits for receiving pension benefits from a job where your salary is not subject to Social Security withholding. Usually these are federal, state, or local government jobs, including teaching jobs at public institutions. The WEP applies to your own Social Security benefit and pension, while the GPO applies to your spousal or survivor’s Social Security benefit and your own pension.

The WEP may impact you if you are receiving a pension from a non-covered job and you also are qualified to receive Social Security benefits based upon your own record. The same holds true for Spousal benefits based on your record – if you are receiving a non-covered pension and your spouse is eligible for Spousal benefits, these can be reduced by the WEP as well. Survivor’s benefits and spousal benefits (where you’re receiving the non-covered pension and the Social Security spousal or survivor benefit is based on your spouse’s record) are NOT subject to the WEP. For 2022 the maximum WEP reduction is $512, but it can be much less (even eliminated) depending on how long you worked in the Social Security-covered job and how much money you made there.

The GPO may impact you if you are receiving a pension from a government job and are qualified to receive Survivor’s or Spousal benefits based upon your spouse’s or ex-spouse’s record. Your Survivor benefit may be reduced by an amount equal to two-thirds of the amount of your pension.

Posted on Nov 22nd, 2021

by author: jblankenship.

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Posted in: Social Security.
Tagged: Social Security

Windfall Elimination Provision (WEP) for Social Security

Nov 15th, 2021

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If you have worked in a job where your pay was subject to Social Security tax withholding, and also have worked in another job where Social Security tax is not withheld, such as for a government agency or an employer in another country, the pension you receive from the non-Social Security taxed job may cause a reduction in your Social Security benefits. This reduction is known as the Windfall Elimination Provision (WEP). It’s named such since it was enacted to eliminate the “windfall” that would otherwise be received by a worker who fit into this description. Without the WEP, the worker would effectively be double-dipping by receiving full benefits from both the pension and Social Security.

This provision primarily affects Social Security benefits when you have earned a pension in any job where you did not pay Social Security tax and you also worked in other jobs long enough to qualify for Social Security benefits. However, federal service where Social Security taxes are withheld (Federal Employees’ Retirement System) will not reduce your Social Security benefits, since Social Security tax is applied to earnings. The WEP may apply if:

you reached age 62 after 1984; or
you became disabled after 1985; and
you first became eligible for a monthly pension based on work where you did not pay Social Security taxes after 1985, even if you are still working.

Here’s How WEP Works

True to form, the Social Security Administration doesn’t make it easy to figure all this out…

You must start out by understanding your Primary Insurance Amount, which begins with your Average Indexed Monthly Earnings (AIME), and then take the Bend Points for the current year into account. For 2022 the first Bend Point is $1,024 and the second Bend Point is $6,172. As we discussed in the article on Primary Insurance Amount (PIA), the amount of your AIME that makes up the first Bend Point is multiplied by 90%; the amount between the first Bend Point and the second Bend Point is multiplied by 32%; and finally any amount above the second Bend Point is multiplied by 15%. These three figures are added up to create your PIA.

However – if WEP applies to your situation and you reached age 62 after 1989, the 90% factor (applied to the first Bend Point) can be reduced to as little as 40%. Effectively, this reduces the PIA by as much as $512 per month (for 2022). The reduction factor was phased in if you reached age 62 between 1986 and 1989.

Exceptions

Again true to form, the SSA has exceptions to the rule. If it turns out that your service in the Social Security taxed job was for 30 years or more and you earned “substantial” wages (substantial is defined as $27,300 for 2022 and has been indexed over the years), then your 90% factor is not reduced at all. If you had substantial earnings for at least 21 years but less than 30 years, the 90% factor is reduced by 5% each year between 21 and 30 years that you had “substantial” earnings in the Social Security-taxed job, starting at 45% for 21 years of substantial earnings.

Additionally, the WEP doesn’t apply to Survivor’s benefits or Spousal benefits (but the Government Pension Offset does). Other exceptions include the following:

You are a federal worker first hired after December 31, 1983;
You were employed on December 31, 1983 by a nonprofit organization that did not withhold Social Security taxes from your pay at first, but then began withholding Social Security taxes from your pay;
Your only pension is based on railroad employment; or
The only work you did where you did not pay social Security taxes was before 1957.

Parting Shots

There is a limit to the amount that your Social Security benefit can be reduced: no matter what your factor has been reduced to (from the original 90%), the resulting reduction cannot be more than 50% of your pension based on earnings after 1956 on which you did not pay Social Security taxes. Likewise, if your AIME is less than the first bend point and all of your PIA is within that 90% bracket, the minimum Social Security benefit is 50% of your original PIA.

And lastly, the WEP also applies to Disability benefits from Social Security, using the same factors.

Posted on Nov 15th, 2021

by author: jblankenship.

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Posted in: federal employees retirement system, primary insurance amount, Social Security, social security administration, social security benefits, social security tax, wep, windfall elimination provision.
Tagged: Social Security

Government Pension Offset for Social Security

Nov 8th, 2021

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There’s a somewhat confusing situation that occurs when a spouse is receiving either a Spousal benefit or a Survivor’s benefit from Social Security while at the same time is receiving a pension from a federal, state, or local government. This is specifically so if the pension being received is from a job where Social Security taxes (OASDI) were not withheld. This situation triggers the Government Pension Offset, or GPO.

What happens is that the Social Security Administration will reduce the Spousal or Survivor’s benefit by a factor equal to two-thirds of the government pension that he or she is receiving. This is called the Government Pension Offset, or GPO (yay, another acronym from the Social Security Administration SSA!) The GPO is often confused with the Windfall Elimination Provision (WEP), but they are different provisions.

Why?

Eligibility for Spousal or Survivor’s benefits are based upon your spouse’s record with the Social Security administration. If your own benefit is greater than the Survivor’s or Spousal benefit, of course you would not be receiving the Survivor’s or Spousal benefit. You can only receive either your own benefit or the Survivor’s or Spousal benefit, whichever is greater.

If you are receiving a pension from a government job that did not require you to have Social Security tax withheld, your own Social Security record doesn’t reflect the income earned from that job. The government pension is designed to take the place of Social Security benefits – at least to some degree. This particular quandary was first addressed in 1977 with the amendments in that year – but it really went too far at that stage.

1977 Amendment

Government pensions from jobs not subject to Social Security tax withholding are designed to be equal to partially pension, and partially compensation intended to replace Social Security benefits for the retiree. In 1977 an amendment was made to the Social Security Act to address the fact that, otherwise, a Spousal benefit or Survivor’s benefit would be compensating the Spouse more than the system originally intended. The 1977 Amendment offset (reduced) the Social Security Spousal or Survivor’s benefit by one dollar for each dollar of pension received from government work that was not subject to Social Security tax. This only applied if the pension was from a job that the Spouse or Survivor worked.

1983 Amendment

In the 1983 Amendment (which is the current set of rules), the Government Pension Offset (or GPO) was improved for Spousal and Survivor’s benefits. Instead of the original dollar-for-dollar offset, now the Social Security Spousal or Survivor’s benefit is only reduced by two-thirds of the government pension amount. This more accurately reflects the fact that the government pension is part pension and part compensation to replace the Social Security benefit.

When Does the GPO NOT Apply?

It’s possible that your particular situation may provide for your Spousal or Survivor’s benefit to not be impacted by the Government Pension Offset. Listed below are several situations that will permit the GPO to not apply:

If you are receiving a government pension that is not based on earnings;
If you are a state or local employee whose government pension is based on a job where you were paying Social Security taxes
- on the last day of your employment and your last day was prior to July 1, 2004; or
- during the last five years of employment and your last day of employment was July 1, 2004 or later. Depending upon the circumstances, fewer than five years could be required for folks whose last day of employment fell between July 1, 2004 and March 1, 2009 inclusive.
If you are a federal employee, including Civil Service Offset employee, who pays Social Security taxes on your earnings. (A Civil Service Offset employee is a federal employee who was rehired after December 31, 1983, following a break in service of more than 365 days and had five years of prior civil service retirement system coverage);
If you are a federal employee who elected to switch from the Civil Service Retirement System (CSRS) to the Federal Employees’ Retirement System (FERS) on or before June 30, 1988. If you switched after that date, including during the open season from July 1, 1998 through December 31, 1998, you need five years under FERS to be exempt from the GPO;
If you received or were eligible to receive a government pension before December 1982 and meet all the requirements for Social Security Spousal benefits or Survivor’s benefits in effect in January 1977; or
If you received or were eligible to receive a federal, state or local government pension before July 1, 1983, and were receiving one-half support from your spouse.

Unlike WEP, there is no way to work your way out of the impact, other than the aforementioned final five years covered option.

Posted on Nov 8th, 2021

by author: jblankenship.

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Posted in: government pension offset, GPO, Social Security.
Tagged: government pension offset · gpo · Social Security

Combining IRAs with Other Retirement Plans

Nov 1st, 2021

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Quite often, we are faced with multiple options for retirement savings. With these decisions, it is important to understand what options are actually available to you – such as, can you contribute to both a 401(k) or 403(b) plan and an IRA in the same year?

Combinations

If you have a retirement plan available to you at your employer (401(k), 403(b) or traditional pension), depending upon your income you may be able to contribute to an IRA (a traditional, deductible IRA) in the same year. See Facts & Figures for the income limits.

Depending on your own circumstances, these income limits may be relatively low, so the likelihood of having the deductible IRA available to you is limited. On the other hand, the income limits for Roth IRA contributions are much higher, so for most this is a viable option.

If your income is higher than the limits for a Roth IRA contribution, you still have another option available to you: non-deductible traditional IRA contribution. In this contribution there is no income limit at all. The primary value you receive from this sort of contribution is in the tax deferral that any growth in your account receives – as your investments accrue growth (hopefully) you will not have to pay tax on that growth until you withdraw the funds.

In addition, there are often cases where you may have more than one employer plan available to you. The limitation here is that you can contribute fully to either a 401(k) plan or a 403(b) plan up to the limit, but only one limit applies to all of these plans you may have available to you. Depending upon your employer, you may also have a 457 (generally only available to governmental units) with a separate annual limit available to you.

Regarding mixing Roth IRA and traditional IRA (either deductible or nondeductible), you also have only one annual contribution limit available to you for all IRA contributions. The combination of all IRA contributions cannot be greater than that limit.

All of these limitations also apply to the catch-up provisions for folks age 50 or better. Use the following table to help you better understand the combinations of accounts that are available to you. To use the table, you first determine which type of account you presently have available to you in the left column – and then move across that row in the table to see which other additional accounts are available to you and with what limitations (the numbers refer to the footnotes below the table). If the answer in the box is “Yes”, you can, without income limitation, contribute to the other plan.

	401k	403b	457	IRA	Roth	Nondeductible
401k	1	1	Yes	2	3	Yes
403b	1	1	Yes	2	3	Yes
457	Yes	Yes	Yes	Yes	Yes	Yes
IRA	2	2	Yes	4	4	4
Roth	3	3	Yes	4	4	4
Nondeductible	Yes	Yes	Yes	4	4	4

Footnotes:
1: a single contribution limit applies for the year, no matter how many 401(k) plans you are eligible to participate in
2: within income limits, if you are eligible for a 401(k) or 403(b) plan, you may also be eligible to contribute to a deductible IRA
3: within income limits, participation in a 401(k) or 403(b) plan has no impact on Roth IRA contributions
4: for all IRA contributions (Roth, traditional deductible or nondeductible) contributions are limited by the annual limit.

Spousal IRAs

If your spouse is not employed by an employer that sponsors a retirement plan (including a traditional pension), you may be able to make either a traditional deductible IRA contribution or a Roth IRA contribution – up to the limit for the year for all IRA contributions for this individual. This assumes that you have the earned income to support that IRA contribution (and any of your own, if this is applicable).

Posted on Nov 1st, 2021

by author: jblankenship.

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Posted in: 401 k 403 b, combinations, contribution limit, employer plan, IRA, retirement plan, retirement plans, retirement savings, roth ira contribution, roth ira contributions, traditional deductible ira, traditional ira contribution.
Tagged: IRA · retirement plan

How to Bypass Mandatory Withholding on a 401(k) Distribution

Oct 18th, 2021

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Just ferinstance, let’s say you need to take a withdrawal from your 401(k) plan – and you’re eligible, either by way of your plan allowing in-plan distributions or the fact that you’re already retired (but you still have the money in your former employer’s 401(k) plan). But here’s the rub: when you take a distribution from a 401(k) plan, the IRS requires that the plan administrator withhold 20% from the distribution. If it’s a significant amount being withheld, it can be a long time before next April when you file your tax return to get the withholding refunded (as long as you’ve covered the tax in some fashion).

Is there are way around this withholding? Of course there is – I wouldn’t tease you like that!

Getting Around the Mandatory Withholding

Cutting to the chase: if you had your money in an IRA and took a distribution, the IRS would not require withholding. But how do you get it to the IRA? Didn’t I just say that the IRS require withholding when you take money out of the 401(k) plan?

Well – not in all cases. If you do a trustee-to-trustee transfer (also knowns as a direct rollover) to an IRA, no withholding is required. So, as long as you do this correctly, you can effectively take the distribution and you don’t have to have any withholding at all. Of course, since you’ll eventually be taxed on the distribution, you probably should have something withheld, but depending on your circumstances, the rate of the withholding may be something far less than 20%. You might even make up the difference (again, depending on the circumstances) by increasing your W4 withholding, or making an estimated tax payment from other sources.

Once you’ve completed the direct rollover to the IRA, you’re free to take a distribution at any time.

Since IRAs are not subject to the mandatory 20% withholding by the IRS, and further since a direct, trustee-to-trustee rollover from a 401(k) plan is also not subject to the mandatory withholding, you can bypass the withholding requirement in the described manner. Just make sure you have a plan to cover the tax on the distribution somehow.

Posted on Oct 18th, 2021

by author: jblankenship.

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

The Primary Insurance Amount (PIA)

Oct 11th, 2021

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Just because there can be some confusion over the PIA, I am writing this particular article to (hopefully) help reduce the confusion. In an earlier article – Social Security’s PIA – What is this? – we worked through how PIA is calculated, I’m just giving it another treatment here, to help clarify.

Primary Insurance Amount

As you know from the other article, the PIA is based upon your Average Indexed Monthly Earnings (AIME), which is the average of your highest 35 years of earnings, indexed for inflation, and expressed as a monthly figure. The AIME then has bend points applied in the year that you reach age 62, in order to calculate the Primary Insurance Amount (PIA).

This PIA is equal to the projected benefit amount that you would receive if you started benefits upon reaching your Full Retirement Age (FRA). The actual amount that you receive if you take your benefit at FRA would likely be different due to Cost of Living Adjustments (COLAs) that would be applied between age 62 and FRA – but the PIA is not changed.

The only way that the PIA is adjusted from the original calculation is if the projection has changed. The projection made at your age 62 assumes that you continue working, earning the same amount as your last reported year, and as such your AIME is not changed during that period. If you happen to have already worked your 35 years by that point and do not work after age 62, your PIA will be pretty close. But your PIA will be adjusted if you work from age 62 to FRA and your earnings are either 1) greater than one of the other 35 years used in your AIME at age 62; or 2) being added to the AIME calculation because you didn’t have a full 35 years of earnings when the PIA was calculated at age 62.

Likewise, if you do not work from age 62 to FRA or you work for lower wages than your AIME projection assumed (and you had fewer than 35 years of earnings as of age 62), your PIA at FRA could actually be a bit lower than the original projection. This might happen because your original PIA calculation depended on your future earnings being equal to your most recently-reported earnings, replacing lower or zero earnings years in your current history.

Calculating Benefits

When your actual benefits are calculated, your PIA is the starting point. Then all COLAs are applied, if you’re older than age 62. After this, your age when you initiated benefits is taken into account – if it was before FRA, there will be a reduction; if after FRA, an increase. This increase or decrease is applied against the COLA-adjusted-PIA, resulting in your monthly benefit amount. That’s all there is to it.

Posted on Oct 11th, 2021

by author: jblankenship.

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Posted in: PIA, primary insurance amount, Social Security.
Tagged: Social Security

How to Check Your Social Security Benefits

Oct 4th, 2021

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A reader of this blog recently suggested that it might be helpful to include an article on how to check up on your Social Security benefits. Long ago, we used to receive a paper statement of Social Security benefits in the mail each year, but that has changed. Now, you might receive a mailed paper statement right around your 60th birthday, but it’s very simple to check your benefits at any time via Social Security’s website.

It’s quite simple to check out your up-to-date information in the Social Security system – at least the retirement estimates. Simply go to the Social Security website, and select “Create Your Own my Social Security Account Today” – if you haven’t already created your own account. If you have already created an account, just skip down to Checking Your Benefit.

You’ll then be asked to fill in your information, including your Social Security number, birth date, and other pertinent information. Following the instructions, you’ll soon have your my Social Security account created.

Checking Your Benefit

Now you can log in to the account. This will be a two-step verification process, where they’ll send you a code on your email that you’ll have to submit in order to complete the login process. Then you’re in!

Once you’ve logged in, you can look at your Social Security statement, in order to estimate your retirement benefits and other possible benefits, as well as to review your earnings history to make sure all of the information is correct. The information on earnings in the statement is condensed, but you can view the complete earnings history via the online system (not a .pdf as the statement is).

You can do lots of other things once you’ve set up your account, including filing for benefits when you’re ready to do so. You can order a replacement card, estimate your retirement benefits in various scenarios, and much more.

So that’s all there is to it! Reviewing your Social Security benefits regularly is a good idea, so you can get a good idea of what benefits you can expect, as well as note how recent earnings has an impact on the future benefits estimates.

Posted on Oct 4th, 2021

by author: jblankenship.

Posted in: Social Security.
Tagged: Social Security

Order of Roth IRA Account Distributions

Sep 27th, 2021

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You may never have thought about this, but when you start to take money out of your Roth IRA account(s), there is a specific order to which the distributions are attributed. You might not think it makes a difference, but it does – specifically as it applies to any distributions that are not qualified, and whether or not there is a penalty involved.

Of course, by qualified, the IRS means any distributions that are made after the account has been established for 5 years and one of the following applies:

you are at least age 59½ years of age;
the distribution falls under the exception for a first time home purchase;
the distribution occurs due to the account owner’s complete disability; or
the distribution occurs after the death of the account owner.

There are other exceptions, which you can read about in the article – 19 Ways to Withdraw IRA Funds Without Penalty.

Otherwise, your distribution could be subject to the 10% early withdrawal penalty – but this is where the ordering rules come in. As you know, commonly your Roth IRA distributions will be tax-free – but this is only when they are qualified distributions (as described above). When you take money out of your Roth IRA account in a non-qualified fashion (e.g., prior to age 59½), a portion of the distribution may be subject to penalty.

Ordering Rules

You may recall that, since there is no special tax treatment (i.e., no deduction) for your regular Roth IRA contributions, you can withdraw these contributions at any time for any reason, without tax or penalty. This is the first part of the IRS’ special ordering rules. Withdrawals from your Roth IRA account are attributed as follows:

Excess contributions (when you’ve contributed more than you’re legally allowed for a year)
Regular contributions
Conversion and rollover contributions, on a first-in first-out basis (total conversions and rollovers from the earliest conversion/rollover year first). See Aggregation (grouping and adding) rules, below. Take these conversion and rollover contributions into account as follows:
1. Taxable portion (the amount that was required to be included in gross income because of the conversion) first, and then
2. Nontaxable portion (any amount that was not taxed upon conversion or rollover).
Earnings on contributions.

Disregard rollover contributions from other Roth IRAs for this purpose. These are considered in the same fashion as they would have been in the originating account – so if it was a conversion originally, it’s still considered a conversion for purposes of the ordering rules.

Aggregation (grouping and adding) rules. Determine the taxable amounts distributed (withdrawn), distributions, and contributions by grouping and adding them together as follows.

Add all distributions from all your Roth IRAs during the tax year together.
Add all regular contributions made for the year (including contributions made after the close of the year, but before the due date of your return) together. Add this total to the total undistributed regular contributions made in prior years.
Add all conversion and rollover contributions made during the year together. For purposes of the ordering rules, for example, in the case of any conversion or rollover in which the conversion or rollover distribution is made in 2021 and the conversion or rollover contribution is made in 2022, treat the conversion or rollover distribution as distributed before any other conversion or rollover contributions made in 2022.

Disregard any amount withdrawn to correct an excess contribution (including the earnings withdrawn) for this purpose.

Penalty

So, with the above ordering rules in mind, as you take money out of your Roth IRA, only the part that represents the growth in the account, plus any amount that was converted less than five years prior, will be subject to the 10% penalty (unless you meet one of the exceptions). These funds are the last in the ordering process, so you won’t be charged the penalty until you have distributed all of the non-penalized funds.

Posted on Sep 27th, 2021

by author: jblankenship.

Posted in: retirement plan, Roth conversion, roth ira, roth ira account, roth ira conversion.
Tagged: IRA · retirement plan

No, You Can’t Contribute Stocks to Your IRA

Sep 20th, 2021

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Have you ever wondered – “Hey, I have this taxable stock account with my favorite stock (or mutual fund, or bond, or CD, or what-have-you). Can I just transfer the stock over to my IRA as an annual contribution?”

In a word, NO. Contributions to IRAs are only allowed in cash. In order to complete the contribution, you’d have to liquidate the security holding, paying any tax on capital gains, and then use the cash proceeds to make your contribution.

The reason for this is simple – if you contribute the actual stock to an IRA from an account that is not already tax-deferred, any built-in gain escapes taxation. If the contribution was to a Roth account, there would never be taxation (under most circumstances), and you’d be trading capital gains taxation for ordinary income tax deferral and future taxation in the case of a traditional IRA.

Keep in mind, this doesn’t apply to rollovers – even the indirect “60-day” rollovers. You can rollover securities holdings from one IRA (or qualified retirement plan) to another IRA in-kind. If it’s done indirectly (not a trustee-to-trustee transfer), the same securities must be used with the roll-in.

So, for example, if you had an IRA with $50,000 worth of ABC stock, you could distribute the stock (transfer in-kind, rather than cashing it out) to a taxable account, and then within 60 days contribute (again, in-kind) the same stock to another IRA. During that 60-day period, you could do any number of things, such as collect interest or receive a dividend from the stock, which would be taxed at dividend rates. As long as you complete the transfer of the exact same stock within the 60-day window, there is no tax owed on the transfer.

Let me point out that I don’t recommend this sort of activity, I’m just explaining that it is possible.

Posted on Sep 20th, 2021

by author: jblankenship.

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

Avoiding Taxation of 401(k) Loan

Sep 13th, 2021

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Hopefully you already know this – if you have a loan from your 401(k) plan and you leave employment, either on your own or if you’re terminated, the loan is considered a distribution from your plan, and therefore taxable. It’s important to note – this only applies when you leave employment.

Here’s an example: you have a 401(k) plan with a balance of $200,000. You wish to take a loan from the plan in order to pay for your child’s college tuition – and so you take a total of $20,000 from the plan. It’s your intent to pay this off over the course of the next couple of years with the proceeds from some appreciated stock – you were delaying the sale of the stock since the stock is poised to run up quickly in the next year or so. Unfortunately, two months later your company decides to let you go – downsizing and all, you know.

Rather than calling the 401(k) loan due and payable immediately, the loan is classified as a distribution – meaning that, not only are you out of a job, you’ve got an extra $20,000 of income that will be taxed now, money that you’ve already spent on tuition. If you’re under age 55 (yes, 55, since you’re eligible to take a distribution after age 55 without penalty after leaving employment), the funds will also be subjected to the 10% early distribution penalty. Topping off the fun facts here is that you likely didn’t think to have any additional tax withheld or an estimated tax payment made, so you’ll likely get hit with a penalty for under-withholding of tax when you file.

So what can you do?

Since you have the appreciated stock (or really, funds from any other source), you can roll over the substituted funds into an IRA. The rule used to be that this had to occur within 60 days, but since the beginning of 2018, you have much longer to take care of this rollover. You can actually delay this rollover until your tax filing deadline for the year, including extensions, as you complete the rollover without penalty. This will effectively negate the distribution, and no tax or penalty will be owed.

Of course, if you sell appreciated stock you will owe tax on the capital gains – but presumably this is far less than the ordinary income tax (plus the penalties!) on the loan. If the capital gains tax is significant you’ll want to either adjust withholding for the remainder of the year and/or make estimated payments of tax in order to avoid the penalty for under-withholding. If you’ve delayed the rollover into the following year (2022 in our example), you can avoid the capital gains taxation until the end of that tax year as well.

Rounding out the example, let’s say you took the loan in January of 2021, and in March you were let go from your employer. You actually have until October 15, 2022 (yes, next year!) to fully rollover the loan balance into an IRA in order to avoid the taxation and penalties associated with the distribution. If you encountered capital gains taxes in producing the money to rollover, you could wait until as late as October of 2023 to pay that tax.

You should consider the additional impacts of taking this distribution – see the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k) for more details on what you need to keep in mind as you make a rollover from your 401(k).

Posted on Sep 13th, 2021

by author: jblankenship.

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

Valuation for Roth IRA Conversions

Sep 6th, 2021

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You’ve read all about Roth IRA conversions, and you know a lot about the questions that one must resolve in order to make one of these conversions work out for you. But have you considered how the valuation rules will impact your decision process?

Valuation of your IRA

If you have IRAs that contain both pre-tax and post-tax contributions and you’re looking to take a distribution (such as for a Roth Conversion), you know that you have to look at all IRAs in aggregate in order to determine what amount of the distribution is taxable and how much is tax-free. But when do you determine the valuation of the account?

It’s kinda tricky – and probably not what you were thinking. Your IRA balances are determined as of the end of the tax year in which the distribution occurs – so if you make your distribution in 2021, the balance as of 12/31/2021 is what is used to determine your IRA balances. This amount will include any amount that has been distributed to you in 2021, either in the form of a cash payout, or as a conversion to a Roth IRA.

For example, if you had two IRAs, one that is completely taxable (all deductible contributions and growth), totaling $20,000, and the other is made up of $10,000 in non-deductible contributions and $10,000 in growth and other deductible contributions. The total value as of December 31 is $40,000, with $10,000 being non-deductible or after-tax contributions. So any distribution you made during the tax year from either of these IRAs would be 25% tax free (since 25% of the accounts is after-tax).

Simple Enough, Right?

Well, maybe not. The problem with the valuation method comes in when you consider what happens over the course of the year – especially if you’ve made a distribution early in the year.

How about if you had the accounts mentioned above in the example, and nothing had changed as of January 15. You enact the conversion at that time… and then time goes on, and your investments perform as they might throughout the year. Then on December 31 of the current year, your IRAs are now worth a total of $50,000 – and your non-taxable portion is still only $10,000. Since this has occurred, now only 20% of your conversion will be tax-free, which may make a difference in your computations. In this case you have the comfort of knowing that your original conversion amount may have grown in value (assuming similar growth in all accounts), so the new growth since the conversion will receive tax-free Roth treatment.

And what if, after the conversion your accounts reduce in value? Adjusting our example, let’s say as of December 31 the accounts are now worth a total of $30,000. This means that a higher percentage of your conversion distribution was non-taxed, a total of 1/3 at this point. This might be to your advantage (less tax paid) but it also might mean that you’re paying tax on an amount greater than the value of your accounts – especially if your account(s) downturn continues. In a case like that, in the past you would have until October 15 of the following year to recharacterize the conversion in order to not have the tax bill on the lower amount. Unfortunately, since recharacterization has been eliminated from Roth conversions, you are now stuck with the situation as it is.

So as you can see, the timing of your conversion versus the timing of the valuation of your IRA accounts can have a large impact on the way your Roth Conversion plays out for you. Consider this information wisely as you plan your conversion strategy…

Posted on Sep 6th, 2021

by author: jblankenship.

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Posted in: IRA, Roth conversion, tax.
Tagged: IRA · tax

Payback When You’ve Earned Too Much

Aug 30th, 2021

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In an earlier post, we talked about the Social Security Earnings Test, which is applied when you are receiving your benefit early (before Full Retirement Age) and you earn over certain limits. Briefly, in the years before the year you reach FRA, when you earn salary in excess of the limit, the Social Security Administration will withhold your benefit in an amount equal to $1 for every $2 over the specified limit. In the year that you will reach FRA, the reduction is equal to $1 for every $3 over the limit. (See the original article at this link for details on how this works.)

While a portion of your benefit is, in fact, withheld for the earnings, there is an eventual “payback”… when you reach FRA, your reduced benefit is recalculated, eliminating those months when your benefit was withheld. The recalculation is done as if you delayed filing for the number of months that your benefit was being withheld.

There’s a misconception that you actually receive back the dollars that were withheld due to your over-earning. That’s not how it works – you actually get credit back for the months when your benefit was withheld. This is much the same as how the “do-over” option works, except that you’re not paying it back to the SSA, they’re just never giving it to you.

So, for example, let’s say you took your benefit at age 62 (reducing the benefit to 75% of your PIA) and you had earnings that caused the SSA to withhold four months’ worth of benefit each year for the four years between age 62 and 66. When you reach FRA you would actually improve your benefit by 7.22% – because your reduction would be adjusted to 82.22% of your PIA.

Posted on Aug 30th, 2021

by author: jblankenship.

Posted in: Earnings Limits, earnings test, Social Security.
Tagged: Social Security

Social Security Earnings Test

Aug 23rd, 2021

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photo credit: jb

As you know, you can receive Social Security retirement or survivors benefits and continue working. If you happen to be less than Full Retirement Age (FRA) and you earn more than the earnings test, your benefit will be reduced. (Note: these reductions are not really lost, you will get credit for the withheld benefits at FRA.)

Earnings Test

If you’re at or older than FRA (age 66 if born between 1946 and 1954, ranging up to 67 if born in 1960 or later) when you begin receiving retirement or survivors benefits, you may earn as much as you like and your benefit will not be reduced. If, however, you are younger than FRA, your benefit will be reduced $1 for every $2 you earn over $18,960 (in 2021) before the year of FRA. The Social Security benefit will be reduced by $1 for every $3 you earn over $50,520 in the year of FRA, up until the month you reach FRA. These limits are adjusted every year with cost-of-living indices.

The income we’re talking about here is W2 (employee) income or self-employment income, referred to as earned income. Non-earned income, such as interest, dividends, pensions, retirement withdrawals, or rents received are not included for the purpose of the earnings test. Plus, in the first year that you start benefits, only that earned income after you’re receiving benefits is counted, on a monthly basis. Any income received before you start receiving Social Security benefits is not counted toward the earnings test.

For example, let’s say your benefit is $700 per month ($8,400 for the year) and you are 63 years old, starting benefits at 62. You work part-time and earn $22,000 during the year, which is $3,040 more than the earnings test. The Social Security Administration will withhold a total of $1,520 from your benefit ($1 for every $2 over the limit). This is done by withholding your Social Security benefit for three months, January through March of the following year – for a total of $2,100 being withheld. Beginning in April you’ll receive your full $700 benefit. In January of the next year you’ll receive $580 extra for the additional amount that was withheld above the $1,520. If you advise SSA of your income expectation in the coming year, the withholding will be done during the year of the income, rather than the following year. If your actual income differs from the expected income you reported, it will be “trued up” in January of the following year.

If this was the year you’ll reach FRA – for example in June, and your earnings through May were $52,000 ($1,480 more than the limit), $494 would be withheld from your $8,400 benefit which is accomplished by withholding your first check of the year, and the additional $206 will be refunded to you in January of the following year.

First Year

In your first year of Social Security benefits, you can earn as much as you like before you start to receive benefits. Then, for each month after you start your Social Security benefit, you are limited by the monthly amount (listed above) divided by 12. For 2021 that is $1,580 per month.

So, if you’re under FRA and worked for 8 months of the year in 2021 and started Social Security benefits in September, you can earn up to $1,520 each month (September thru December) without benefits being withheld. If you earn above that limit in any month, for each $2 over the limit, $1 will be withheld. This will occur with your first check(s) in the following year.

For every year thereafter (until your FRA year), the earnings test is applied on an annual basis, rather than monthly. So as long as you don’t go over the $18,960 limit (for 2021) you have no benefits withheld. As with the monthly test, for each $2 over the limit, $1 will be withheld.

FRA Year

In the year that you’ll reach FRA, there is an annual limit applied to your earnings. If you’re reaching FRA in August 2021, you are limited to earning no more than $50,520 prior to the month you reach FRA. For every $3 over that limit, $1 will be withheld.

Starting with the month you reach FRA, there are no earnings limits.

Posted on Aug 23rd, 2021

by author: jblankenship.

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Posted in: benefit, earnings test, Social Security, social security retirement, survivors.
Tagged: earnings test · Social Security

Using Capital Gains and Losses to Help With a Roth Conversion

Aug 16th, 2021