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

Posted in: Book review.
Tagged: book review

Long Term Care Insurance – Protecting Your Nest Egg

Oct 24th, 2012

by sraskie.

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Long term care is a topic few people know about and a topic even fewer people are prepared to deal with in the future. As the average life expectancy increases in the US, more and more people – from Baby Boomers to X and Y geners – are going to be confronted with the need for and planning for long term care.

According to the Medicare website, about 9 million men and women over age 65 will need LTC this year – that number expanding to 12 million by 2020. According to the Department of Health and Human Services, people who reach age 65 will have a 40% chance of entering a nursing home and 10% of those will stay there for more than 5 years. This, of course, can get expensive. This is where an LTC policy can make sense.

There are two types of LTC policies that a person may obtain: Tax Qualified and Non-Tax Qualified. Non-Tax Qualified policy coverage starts when a person is stated have a medical necessity by a doctor and corresponding insurance company representative. These “triggers” start the claim period and benefits.

Most individuals will purchase Tax Qualified policies. The premiums for these are deductible for income tax purposes (subject to the 7.5% floor) and the coverage goes into effect when a person is incapable of performing at least two out of six activities of daily living – or ADL’s. These ADL’s or policy “triggers” are bathing, eating, dressing, toileting, transferring from bed to chair and continence. Also, substantial cognitive impairment will also trigger a claim.

Although walking is considered an ADL for non-tax qualified policies, it IS NOT an ADL for a tax-qualified policy.

Benefits can range from custodial care, skilled nursing care, home care, hospice care and comprehensive care depending on the type of policy purchased. Premiums will be adjusted accordingly depending on the type, nature and scope of the coverage. Policies will also have different elimination periods (time deductibles) of 30, 60, 90 and 180 days. A longer elimination period will mean lower premiums, but will also mean more time to wait until benefits begin. Here is where an emergency fund can be very useful. 3-6 months of living expenses can help offset a long elimination period.

It should also be noted that Medicare DOES NOT cover custodial care – it is specifically excluded.

From a planning standpoint, not having LTC can quickly erode a lifetime of savings, investing and legacy planning. It can be a useful hedge to help keep a retirement portfolio in place, but can also (if not most importantly) keep undue stress off of a family that may feel obligated to care for a loved-one, if a LTC plan is not in place. It also goes without saying that it is impossible to get an LTC policy once cognitive impairment or an ADL has appeared.

Generally, the optimal time to consider LTC is after the age of 50. However, people may want to consider it earlier if they have a family history of mental illnesses (Alzheimer’s and or dementia) or if family members want to get together and “pool” the premium payments among siblings for their parents. This can assure less stress in the future by not having to feel obligated to take care of a loved one, and can also purchase the best care you’d like to see a loved-one have. It can also mitigate responsibilities of family members who live closer to aging relatives, while others live further away.

If you’re considering LTC, it’s important to ask your questions and do your due diligence. How much does the policy cost, what does it cover, what is the daily benefit, etc., are all excellent questions. You may also consider the financial stability of the company offering the policy and length of coverage as well. Don’t be afraid to ask questions. A competent LTC advisor will be happy to help answer your questions and do the best for your needs.

In the end, you can sleep a little better knowing that you’ve just hedged and protected your future, your legacy and your retirement, while lowering your stress.

Posted on Oct 24th, 2012

by author: sraskie.

Posted in: health insurance, Insurance.

Factors to take into account when planning Social Security filing

Oct 19th, 2012

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As with the overall process of planning for retirement income, there are certain important factors external to Social Security benefits that you need to take into account while planning when to file for benefits. In the list below I will detail some of these factors and why they are important to the process.

Important Factors When Planning Social Security Filing

Pension income. Pension income must be considered with special care when planning your Social Security filing strategy. Often, pensions will increase in value up to a certain age of commencement and then there are no increases after that age. Coordinating your pension with your Social Security benefits can enhance your overall income stream – since a pension is generally a guaranteed source of income for yourself and possibly your spouse.

In addition, since many pensions are not indexed for inflation, meaning that there are no Cost-of-Living-Adjustments (COLAs), it probably makes a great deal of sense to maximize the amount that you can receive from this source. Depending upon your needs, starting Social Security benefits earlier could provide you with the income you need in order to maximize your pension.

Personal Assets. Funds that you have saved over the years can help you to bridge the gap between your current age (if you’re stopping work) and the age that maximizes your Social Security benefits (and pension benefits, as noted above). While it may be difficult to stomach, it may work in your favor to start taking some funds from your retirement plans (IRAs, 401(k)s, and the like) or taxable investment or savings accounts.

This is the reason that you’ve set aside this money over the years – taking distributions from these accounts so that you can delay other benefits may make all the difference. The point is that delaying to increase the amount(s) of your guaranteed income streams is likely very much worth the amount you are taking from the accounts in the long run.

Earnings from working. As you likely have realized, working part time in your retirement could be a good way to maximize your income. As with all income-producing efforts, work, even part-time, can be a very valuable asset. For other types of assets to produce income, there must be a store of value existing in order for the income to flow. In Social Security benefits the store of value is your earnings history; the same goes for pension benefits. With retirement accounts, the amount of savings you’ve built up is the store of value.

Working, at any age, utilizes the store of value of your own experience, skills, and knowledge. Continuing to work produces income from that store of value, income that otherwise would go unrealized.

General health. If your health is declining and the expectation is that your life-span will be somewhat less than the average, this can influence your need to start Social Security benefits earlier rather than later. However, as we’ve discussed in the past, it is not only your own health (e.g., longevity) that is important to consider. The health of your dependent beneficiaries is just as important, if not more so, especially if your Social Security benefit is large enough for others to depend upon it after you’ve passed.

Income requirements. The amount of income that you need to get by and pay your ordinary expenses can also influence your time to file for Social Security benefits. If you just can’t make ends meet using all of your other sources of income, it might be necessary to file for your Social Security benefit before it is maximized.

Posted on Oct 19th, 2012

by author: jblankenship.

Posted in: baby boomers, IRA, Social Security, social security retirement.
Tagged: baby boomers · IRA · Social Security

Investing in Taxable Accounts vs. IRAs

Oct 17th, 2012

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When investing beyond an employer-sponsored retirement plan, you have a choice to make, between using an IRA, a Roth IRA, or a taxable, non-deferred investment account. In making this choice your primary consideration should be the tax implications.

It’s easy to understand the current tax implications: if you invest in a traditional IRA and your contributions are deductible, you are saving the income tax of the deductible contribution. In all other choices, there is no current tax impact. For non-deductible contributions to a traditional IRA, or regular contributions to a Roth IRA, or saving in a taxable account, you are paying income tax as you’ve earned the money, regardless of what you do with it.

The second area to consider tax implications on all of these types of accounts is when there is income produced from the investments within each type of account. Income produced includes capital gains from sales as well as dividends and interest. In an IRA or Roth IRA, when income is produced there is no tax impact, as all tax is deferred. In the case of the taxable investment account there is current impact in terms of dividend taxation or capital gains tax. Presently capital gains are taxed at a maximum rate of 15% – but this could change, depending upon what Congress decides to do.

Many investments in taxable accounts can maintain tax deferral until you sell the security. Mutual funds often distribute capital gains annually, but stocks and ETFs often don’t produce capital gains until you sell the security – so you don’t have to recognize the income until you’re ready to sell.

The other, most important, impact is the rate of tax on your distributions over time. With your taxable account, again you are only subject to the capital gains tax (today at maximum 15%), while in a traditional IRA your deductible contributions and growth on the account will be subject to ordinary income tax rates. These rates max out at 35% (in 2012) but could be as high as 39.6% if the rates are increased in 2013 (and possibly higher).

Roth IRA distributions (as long as they’re after age 59½) have no tax at all – and the same goes for non-deductible contributions to your traditional IRA. Of course, since the non-deductible contributions are likely mixed in with growth and deductible contributions, so the non-taxed portions will be pro-rated with the entire distribution.

With all of this in mind – over the longer term it is very important to put as much of your savings as you can into Roth-type accounts, and then as your current tax situation requires, put money into tax-deferred accounts and/or taxable investments. For most folks, in the long run, the taxable accounts prove to be the best option to choose – at least under current tax law.

Posted on Oct 17th, 2012

by author: jblankenship.

Posted in: 2012 tax year, capital gains tax rates, contribution limit, IRA.
Tagged: capital gains and losses · capital gains tax rates · IRA

Errors on Your Tax Return? Here’s How to Fix Them

Oct 15th, 2012

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Often we discover long after filing that we’ve made errors on our tax returns. And too often the idea of resolving the problem seems too daunting to undertake, so we ignore it, deciding to just let things go. This can cause problems if it turns out that the error results in additional tax owed – so it is usually in your best interests to fix the error and go on with your life. On the other hand, if the error resulted in paying too much tax, you should get what you rightfully deserve (in terms of the overpaid tax.)

Recently the IRS published their Summertime Tax Tip 2012-05 which details tips on how to resolve these errors on your tax return. The actual text of the tip follows:

IRS Offers Tips on How to Fix Errors Made on Your Tax Return

If you discover an error after you file your tax return, you can correct it by amending your return. Here are 10 tips from the Internal Revenue Service about amending your federal tax return:

1. When to amend a return. Generally, you shoudl file an amended return if your filing status, number of dependents, total income, tax deductions or tax credits were reported incorrectly or omitted. Additional reasons for amending a return are listed in the instructions.

2. When NOT to amend a return. In some cases, you do not need to amend your tax return. The IRS usually corrects math errors or requests missing forms – such as Forms W-2 or schedules – when processing an original return. In these instances, do not amend your return.

3. Form to use. Use Form 1040X, Amended US Individual Income Tax Return, to amend a previously filed Form 1040, 1040A, 1040EZ, 1040NR or 1040NR-EZ. Make sure you check the box for the year of the return you are amending on the Form 1040X. An amended tax return cannot be filed electronically.

4. Multiple amended returns. If you are amending more than one year’s tax return, prepare a separate 1040X for each return and mail them in separate envelopes to the appropriate IRS processing center (see “Where to File” in the instructions for Form 1040X). Note from jb: often when you need to file an amendment for a return prior to the most recent year, the amendment may have an impact on the subsequent returns, requiring additional amendments to be filed.

5. For 1040X. The Form 1040X has three columns. Column A shows original figures from the original return. Column B shows the changes your are making. Column C shows the corrected figures. There is an area on the back of the form to explain the specific changes and the reasons for the changes.

6. Other forms or schedules. If the changes involve other schedules or forms, attach the corrected form(s) or schedule(s) to the Form 1040X. Failure to do so will cause a delay in processing.

7. Additional refund. If you are amending your return to get an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund.

8. Additional tax. If you owe additional tax, you should file Form 1040X and pay the tax as soon as possible to limit interest and penalty charges.

9. When to file. Generally, to claim a refund, you must file Form 1040X within three years from the date you filed your original tax return or within two years from the date you paid the tax, whichever is later.

10. Processing time. Normal processing time for amended returns is 8 to 12 weeks.

Posted on Oct 15th, 2012

by author: jblankenship.

Posted in: income tax.
Tagged: income tax

Can I Switch to My Spouse’s Benefit At FRA?

Oct 12th, 2012

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This is a question that comes up pretty frequently, in several different flavors. Basically, here’s the full question:

I started benefits at age 62, and now I’m 66 (Full Retirement Age) – can I switch over to my spouse’s benefit now that I’m age 66? And will it be based on his benefit when he was 66, or his benefit now. (He’s 70 now, and has been collecting benefits since he turned 66.)

There are a couple of questions being asked here, and I’ll cover them one-by-one.

Can I switch to my spouse’s benefit?

The wording here is troubling, because the asker specifically wishes to “switch” to another benefit. If an individual is already receiving retirement benefits, the spousal benefit is not a “switch”, but rather an “addition” to the retirement benefit.

The second issue is implied, and maybe not troublesome to the question at hand. The Spousal Benefit at Full Retirement Age (FRA) is 50% of the other spouse’s Primary Insurance Amount. The implication is that the asker could receive the same benefit as her spouse – and this is not the case. Half of the other spouse’s Primary Insurance Amount (PIA) is the maximum Spousal Benefit.

So here’s how the Spousal Benefit is calculated:

half of the other spouse’s PIA minus your own PIA;
if you’re younger than FRA the result will be reduced to as little as 65%;
if you’re at or older than FRA, there is no reduction to the result of the first step;
the resulting amount is added to your own benefit, to result in your total benefit.

See the article, Social Security Spousal Benefit Calculation Before FRA for more detail on how exactly this all works.

What Will My Benefit Be Based On?

In the example question from above, the asker indicates that her husband filed for his own benefit at age 66, and now he’s age 70. So what amount is a spousal benefit based upon?

In this case, the amount of the spousal benefit would be based upon the amount that the husband is currently receiving – assuming that he had filed at exactly his own age 66, Full Retirement Age. If he filed at exactly that age, his benefit is equal to his Primary Insurance Amount (PIA) – which over the intervening four years has been increased by Cost of Living Adjustments (COLAs).

If the husband in question had delayed his benefit to age 70 to receive the Delayed Retirement Credits (for more on Delayed Retirement Credits, DRCs, see the article A File and Suspend Review at the link), then the spousal benefit that that asker would receive would be based upon the amount that the husband would have received had he filed at FRA, which would have increased by COLAs.

Hope this helps to clear up this question!

Posted on Oct 12th, 2012

by author: jblankenship.

Posted in: Delayed Retirement Credit, DRC, Social Security, Social Security spousal benefit, Spousal Benefit.
Tagged: DRC · Social Security · spousal benefit

The Value of Your Social Security Benefits

Oct 5th, 2012

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As you consider your Social Security benefits and when you might begin to draw them, keep in mind that the benefits you’re receiving are actually akin to an annuity – a stream of income that you will receive from the time you start the benefits throughout your life. As with an annuity, if you live longer than average, you will receive much more than the original value (premium) of the annuity. If you have a way to increase the amount of the stream of income, by delaying start of the benefits, the overall amount that you eventually receive will increase as well (assuming you live longer than average).

Let’s say that your Social Security benefit would be $1,500 at Full Retirement Age. If you started your benefit early at age 62, your benefit would be reduced to 75% of that amount, or $1,125; if you delayed your benefit to age 70, the benefit amount would be increased by 32% to $1,980.

If you started receiving benefits at age 62 and you lived to age 75, the total benefit that you receive over your lifetime would be $189,000 – not including Cost of Living Adjustments. In a similar manner, calculating the total lifetime benefit if you started receiving benefits at Full Retirement Age (FRA, age 66 for folks reaching that age these days) comes out to $180,000 if you live to age 75. Waiting to age 70 to start benefits results in a lifetime benefit (to age 75) of only $142,560.

So if you only live to age 75, it makes the most sense to start your benefits as early as possible. But read on…

What’s interesting about this sort of calculation is that if you live beyond age 75, say to age 80, now your lifetime benefits are starting to be greater by delaying a bit. If you start at age 62, the total lifetime benefit would be $256,500 through age 80; starting at 66 results in $270,000 over your lifetime. Delaying to age 70 still results in a lower lifetime benefit at this age – only $261,360.

So if you happen to live even longer, let’s say to age 90 – now the later you’ve delayed results in the greatest overall lifetime benefit. Starting at age 62 results with a total lifetime benefit of $391,500; 66 amounts to $450,000, and beginning at age 70 yields $498,960.

What about the value of that income stream in today’s dollars?

There’s another calculation that we financial guys do when evaluating things like annuities – it’s known as a Net Present Value (NPV) calculation. Essentially what we do is to take the value of the cash flows and use a set rate of return to determine what amount of money we’d need in order to produce those cash flows at those times in the future.

So, for our example above, using a rate of return of 5%, we come up with the following net present values of the cash flows:

Age to start	NPV to age 75	NPV to age 80	NPV to age 90
62	$133,632	$163,152	$204,404
66	$138,991	$186,834	$253,691
70	$120,598	$198,360	$304,631

As you can see, the NPV increases for your delayed receipt of benefits starting with a lifespan of age 80, and becomes more pronounced if you live even longer. As we saw with the total lifetime benefit, there’s a higher value to the cash flow if you start early only if your lifetime is relatively short – in this case, to age 75.

Conclusion

This is the reason that we financial-types often recommend delaying receipt of Social Security benefits. As the figures above attest, there can be a substantial lifetime benefit increase if you life beyond age 80 – in our example it comes to over $100,000 by changing your start date from age 62 to age 70 and you live to age 90. Of course, if you don’t happen to live beyond age 80 (and who knows how long you’ll live?) starting earlier will likely result in the greater benefit for you in your lifetime.

Given that folks are living longer and longer these days, you should really consider delaying Social Security benefits as your strategy. Keep in mind that we’re only talking about a single person’s benefits – for a couple, the calculations become infinitely more complex, as we have to account for two lifetimes, two potential benefits, and spousal and survivor calculations. We’ll get to that next time…

Posted on Oct 5th, 2012

by author: jblankenship.

Posted in: Delayed Retirement Credit, Early Filing, Social Security, social security retirement.
Tagged: delayed retirement credit · early filing · Social Security

My credit card meets Carly Rae

Oct 1st, 2012

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So, is it just me? I try not to be too terribly difficult to work with. I go along with most requests without any roadblocks, but every once in a while something comes up that just drives me bats.

Problem is, this seems to be something that crops up more and more often. All too often I come across this issue – maybe not every day, but very regularly. What is it that I’m talking about? Let me borrow a line from Ms. Carly Rae Jepson to help explain:

Hey! I just met you…
(And this is crazy)
… but here’s my number,
so call me maybe?

Okay stop being freaked out that I happened to know the lyrics to that song. I just happen to know things, among those things are the lyrics to many a song, inane or otherwise described. Ask anyone who has taken a long road trip with me – included in my repertoire is the complete lyrics of CW McCall’s Wolf Creek Pass. As such, the Pass often makes an appearance on such trips.

It’s all in the cards

Wow, I can sure digress, can’t I? Let’s get back to what I was talking about before – the matter that just drives me crazy these days. I’m talking about credit card processing.

Recently I was signing up for a conference, filling out the form to pay for it. This particular conference had not invested the effort into online processing, opting instead for a Word doc with a simple form to be filled in and emailed. Of course the form asked for all of the pertinent credit card information, including the name on the card, the full card number, expiration date, and zip code. Then, the pie’ce de re’sistance: the CVV code. This is the 3- or 4-digit code from the back of your card.

I recognize why this code is there, it’s for the card not present sort of transactions that we all encounter these days, providing an additional bit of security to ensure that the person using the card actually has possession of the card. I agree with the use of it when necessary, but I also know that it’s not always necessary.

I process credit cards regularly from clients paying for services over the phone, and my processor has clearly noted that use of the CVV code is optional when processing a transaction. Since this is the case, I never require the client to give up this information over the phone. In these circumstances, it serves no purpose (but that’s still not what my problem is).

It’s all about the security itself. In these days of online access for just about everything, it is just irresponsible to request all of this information in a manner that is so unsecured as an email-attached document. In the case of the outfit that is running the conference I mentioned earlier, there is literally no excuse: they have infinitely-adequate resources to enable this transaction to be completed online in a secured fashion.

However, they chose to use the unsecured method of the Word doc. So when I got to the blank requesting the CVV code, I simply wrote to call if absolutely necessary. Not long after I sent the email, there was a response email asking me to call with the code. Busy at the time, I called back a couple of hours later. The person who I needed to talk to had left the office for the weekend, and she had left instructions with her backup to take the number. Still okay with me, until the backup said I’ll just write this down on the application and give it to her on Monday.

Crap. I told her no thanks, I’ll send a check. Which is exactly what I did.

The problem

The problem here is that the CVV code is really your only last defense. If you give that away, especially in a fashion that provides an enduring record, you may as well have sent your credit card over to whoever it is.

When you enter your CVV code in a secured automated processing system, the code is only held for a moment, passed over to the processor and then eliminated. Because of this, if the system you’re using is fully secure, you are not giving up control over the information.

On the other hand, if the numbers are written down, you have given up complete control over your card and its defenses. When this is coupled with the prospect of living on a Post-It note attached to your file over the weekend, you can see why I was squeamish.

Processors are required to only maintain the CVV code until the transaction is complete and, per my own experience, it’s optional.

Here’s my adaptation of Ms. Jepson’s lyrics:

Hey! I don’t know you (maybe you’re in an Internet cafe’ in a third-world country?)…
(and this is crazy)
… but here’s all of my credit card numbers (including my CVV),
so rob me blind, maybe?

How it’s supposed to work

So, back to the thing that drives me bats. It’s actually two things:

If you’re processing credit cards other than over the telephone, go the extra mile and install your processor’s online transaction system in a secured location. This way your system will handle all of the security, and you don’t have to worry about a breach. Better yet, use a third-party secured system such as Paypal or Intuit to handle the processing so that there’s an additional buffer between you as the proprietor and the processor of the information.
If you must handle card transactions offline, do it over the telephone while entering the information into the processor’s system. But by all means don’t ask your customers to submit their last defense information via unsecured email and Word doc attachments. And most of all, don’t leave someone behind to handle this information by just writing it down to be left on your desk over the weekend.

As a consumer, you can insist that only a third-party processor is used (such as Paypal), or even better, you could use one of the virtual or one-time-use credit card numbers. These are available from lots of sources, such as your own credit card issuer, and even paypal contact. The one-time-use card allows you to ensure that the number is only used for that particular transaction and never again. How secure is that??

As it becomes more pervasive in our world we’ll continue to run across these situations. Even though I don’t like to do it, I do give the number out when I know the transaction is being processed directly. But this only happens when there is no secured online option – or better yet, a Paypal option. Absent this, I’d prefer to send a check, or at last resort take my business elsewhere. Or maybe I’ll put in the effort to get on board with the one-time-use card option.

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Posted on Oct 1st, 2012

by author: jblankenship.

Posted in: credit cards, financial planning.
Tagged: credit cards · financial planning

Taking Distributions from Your IRA In Kind

Sep 26th, 2012

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When you take a distribution from your IRA, whether to put the funds in a taxable account or to convert it to a Roth IRA, you have the option of taking the distribution “in kind” or in cash.

In cash means that you sell the holding in the account or simply take distribution of cash that already exists in the account. This is the most common method of taking distributions, and it is definitely the simplest way to go about receiving and dealing with a distribution. Cash is cash, it has only one value – therefore the tax owed on the distribution, whether a complete distribution or a conversion to a Roth account.

On the other hand, if you choose to use the “in kind” option, you might just save some tax on the overall transaction. The reason this is true is due to the fact that the amount reported on your 1099-R for the distribution is the Fair Market Value (FMV) of the distribution.

Quite often, when you have holdings in your IRA that have very limited liquidity or marketability, the actual value on any given date could be discounted quite a bit from the eventual or Net Asset Value (NAV) of the holding.

For example, if you held shares in a limited partnership (LP) that makes investments in leveraged real estate, meaning that the real estate holdings are encumbered by mortgage loans, the value of the overall holding will first be reduced by the outstanding non-recourse (mortgage) loans against the assets. Secondly, if the property is limited in its marketability (and what property isn’t these days?) there could be a reduction in the FMV for liquidity and marketability.

Let’s say that the LP owned several properties that amounted solely to vacant real estate that is to be eventually sold to developers. The property was purchased several years ago with the idea that developers would quickly be willing to purchase and develop the tracts, as the area was growing quickly. Then the property values dropped off drastically and development in the area dried up completely.

When you originally purchased the shares in the LP, you invested $100,000, and your shares are encumbered by an additional loan of $100,000 – so the original NAV of your holdings is $200,000. Now that the property values have dropped off by 40%, your holdings effectively have a value of $120,000. When a qualified appraiser reviews and values the property in the LP, the Fair Market Value (FMV) is set at exactly 60% of the original NAV. In addition, the loan balance against your shares is now down to $90,000.

If you decide to convert your holdings of this LP to your Roth IRA in kind, here’s how the FMV would be calculated for tax purposes: your FMV of the overall holdings of $120,000 (60% of the NAV) minus the encumbrance loan of $90,000, for a total value of $30,000. So this is the amount that is reported on the 1099-R for the value of your holdings being converted.

Then (hopefully), after a year or so, fortune once again smiles on your LP, and developers come a’callin’. Now they’re willing to pay full value plus a premium of 30% on the original values of the properties – for a total of $260,000 value on your shares. So effectively you have a property that cost you a total of $100,000 initially, is now worth $170,000 (your $260,000 minus the $90,000 loan), and you only had to pay tax on $30,000 of the value – the rest is tax free!

Granted, this is an extreme set of circumstances that uses the tax laws to your advantage, but it represents an example that, with some adjustments, could be a real world happening. If you happen to be investing in esoteric-type investments that might have wildy-fluctuating FMVs over time, this could be a good strategy to look into. Just make sure you have a trusted advisor on your side who is familiar with this sort of activity – you don’t want to mess this one up, as the tax and penalty downsides can be substantial.

Posted on Sep 26th, 2012

by author: jblankenship.

Posted in: IRA, ira funds, Roth conversion, roth ira.
Tagged: IRA · roth conversion · roth ira conversion

Tax tips for college expenses

Sep 24th, 2012

1 comment

Most all college students are back on campus by this point but the benefits that you can receive from various tax credits will not become apparent until you pay your taxes next year. It’s important to know what tax credits you may be eligible for early on, so that you keep good records as you pay these college expenses. Recently the IRS published their Summertime Tax Tip 2012 – 25 which details tips for students and parents paying college expenses. The actual text of this tip is listed below.

Back-to-school tips for students and parents and college expenses

Whether you’re a recent high school graduate going to college for the first time or a returning student, it will soon be time to head to campus, and payment deadlines for tuition and other fees are not far behind.

The IRS over some tips about education tax benefits that can help offset some college costs for students and parents. Typically, these benefits apply to you, your spouse or dependent for whom you claim an exemption on your tax return.

American opportunity credit. This credit, originally created under the American Recovery and Reinvestment Act, is still available for 2012. The credit can be up to $2500 per eligible student and is available for the first four years of postsecondary education at an eligible institution. 40% of this credit is refundable, which means that you may be able to receive up to $1000, even if you don’t owe any taxes. Qualified expenses include tuition and fees, course related books, supplies and equipment.
Lifetime learning credit. In 2012, you may be able to claim a Lifetime Learning Credit of up to $2000 for qualified education expenses paid for a student enrolled in eligible educational institutions. There is no limit on the number of years you can claim the Lifetime Learning Credit for eligible student.

You can claim only one type of education credit per student in the same text year. However, if you pay college expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. For example, you can claim the American Opportunity Credit for one student and the Lifetime Learning Credit for the other student.

Student loan interest deduction. Generally, personal interest you pay, other than certain mortgage interest, is not deductible. However, you may be able to deduct interest paid on a qualified student loan during the year. It can reduce the amount of your income subject to tax by up to $2500, even if you don’t itemize deductions.

These education benefits are subject to income limitations, and may be reduced or eliminated depending upon your income. For more information, visit the Tax Benefits for Education Information Center at IRS.gov or check out Publication 970, Tax Benefits for Education.

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Posted on Sep 24th, 2012

by author: jblankenship.

Posted in: american opportunity tax credit, education expenses, income tax credit, lifetime learning credit.
Tagged: american opportunity credit · education tax credits · lifetime learning credit

How is the Social Security Survivor Benefit Calculated?

Sep 21st, 2012

4 comments

This is one of those very complicated and difficult to understand areas of the Social Security universe, but it’s very important to know what amount of benefits a surviving spouse will be eligible for upon the passing of his or her spouse.

There are different rules that apply, depending upon whether or not the late spouse was already receiving benefits based on his or her own record, as well as the age of the surviving spouse when he or she begins receiving survivor benefits.

We’ll look at the easy one first: when the late or decedent spouse was not already receiving benefits based on his or her own record.

When The Decedent Spouse Was Not Receiving Benefits

In the case where the late spouse had not already begun to receive benefits based upon his or her own record, there are three factors that you need to take into account: the age of the surviving widow(er), the age of the decedent at death, and the Primary Insurance Amount (PIA) of the decedent. PIA is the amount that the late spouse would receive in benefits at his or her Full Retirement Age (FRA).

If the deceased was younger than or exactly at Full Retirement Age, then the PIA is the operative amount of benefit for our calculation. In the event that the deceased was older than FRA, he or she would have accrued Delayed Retirement Credits (DRCs) which would have the effect of increasing the benefit amount that the surviving widow(er) is eligible for. These credits are equal to 8% for each year (2/3% for each month) beyond FRA that the deceased spouse lived, up to age 70. Past age 70 there are no additional DRCs.

See below (The Age of the Survivor) for the last portion of the calculation.

The Age of the Survivor

The last factor is the age at which the surviving spouse begins receiving the Survivor Benefits. These can begin as early as age 60, at which point the benefit will be reduced to 71.5% of the benefit determined in the paragraph above. Between age 60 and Full Retirement Age (of the surviving spouse) the amount of benefit increases pro-rata to eventually equal 100% of the deceased spouse’s benefit (determined above). There is no additional increase if the surviving spouse delays receipt of Survivor Benefits after FRA, although these benefits can begin at any age thereafter at 100%.

If the Decedent Spouse Was Already Receiving Benefits

This calculation is much more complicated. When the deceased is already receiving benefits, we need to work through some additional calculations.

To start with, if the late spouse started his or her benefits at or after FRA, then the amount of benefit for our calculation is equal to the actual monthly benefit amount that the deceased was receiving upon his or her death.

On the other hand, if the deceased had started receiving benefits prior to FRA, the amount of his or her benefit would be something less than his or her PIA. If that’s the case, the Social Security rules have determined that the operative amount of benefit might be something more than the amount that the deceased was receiving upon his or her death.

Here’s how it works: Three amounts are calculated – 1) the amount of benefit that the decedent was actually receiving; 2) the reduced benefit based on the PIA of the decedent and the survivor’s age (see the paragraph above “The Age of the Survivor” for details on this calculation); and 3) 82.5% of the PIA of the decedent. These three amounts are listed from lowest to highest, and then the following determination is made: if #2 is less than either of the others (#1 & #3), then that amount is used for the calculations. If #2 is the greatest of the three amounts, then the greater of the other two amounts is the benefit amount used for the calculations.

I realize that computation is very complex and convoluted, so here’s a brief example:

Let’s say that Jane is the surviving spouse, and Dick had started receiving his SS benefit earlier this year at age 62. Jane is now 64. If Dick’s PIA was $2,000, then when he started receiving his benefit at age 62, it was reduced to $1,500.

So, we run our calculations to come up with the three figures: 1) $1,500 (actual benefit that Dick was receiving); 2) the reduced benefit based upon Dick’s PIA and Jane’s age, which calculates to 90.167% times $2,000, or $1,803; and 3) $1,650 (82.5% of Dick’s PIA).

Arranging these figures from lowest to highest gives us 1,3,2. As described above, if #2 is the largest of the three figures, then the larger of the others is the actual benefit – so #3, $1,650, is the amount of the survivor benefit that Jane is eligible for, in these circumstances. This is the maximum amount of Survivor Benefit that Jane is allowed.

Hope this helps to clear up a very complex set of rules!

Posted on Sep 21st, 2012

by author: jblankenship.

4 comments already - add to the conversation!

Posted in: early retirement, Social Security, social security survivor benefits, survivor benefits.
Tagged: Social Security · survivor benefits

Does Your IRA Include After-Tax Money?

Sep 19th, 2012

1 comment

Or: There’s Basis In Them Thar Funds!

If you have an IRA that has certain types of funds in it, you may be in a position to have some of your distributions treated as post-tax, meaning that you will not have to pay ordinary income tax on the distribution as you normally would. But what kinds of money is considered post-tax?

The common way to have post-tax funds in an IRA is to make non-deductible contributions to the account. This occurs when you are not eligible to make deductible contributions due to income restraints, but you still wish to make IRA contributions for the year.

For example, if in 2012 you have income in excess of $112,000 ($68,000 if single) and you’re covered by a retirement plan at work, you can still contribute up to $5,000 (plus $1,000 if over age 50) to an IRA – you just can’t deduct the contribution from your income for tax purposes. See the article on 2012 Retirement Plan Limits for more details on how this works.

Another way to have post-tax funds (also known as “basis” in the IRA) in your IRA is to over-contribute funds without distributing them. This happens if you put in more than the annual limit.

In addition, if you rolled over a retirement plan that included post-tax funds, you’ve established basis in the IRA.

The last way to do this is if you made contributions to the IRA as a qualified reservist – if a reservist called to active duty after September 11, 2001 makes a distribution from a qualified retirement plan (QRP) this can be rolled over into an IRA as post-tax funds without tax or penalty. Commonly this type of distribution is either made as a rollover into a Roth IRA or just taken as cash, so this one probably doesn’t occur very often.

What Happens With the Post-Tax Money?

So, what happens when you have basis in the IRA? Even though you made post-tax contributions to the account, there is likely a portion of the account that is also pre-tax. Any other (deductible) contributions made to the account, as well as pre-tax rollovers from QRPs, and the growth of the funds in the account will be pre-tax when distributed.

In addition, all of your IRAs are aggregated when considering how the money is taxed. So, for example, let’s say you have two IRAs, one with all pre-tax money in the amount of $50,000, and another with $25,000 of basis (post-tax) and $25,000 of pre-tax money. When you take a distribution of $10,000 from either account, the total amount of taxable and non-taxable (basis) is considered to determine the ratio of taxation. Since the total of taxable funds is $75,000, and $25,000 non-taxable, $7,500 of the $10,000 distribution will be subject to tax, and $2,500 will be tax-free.

Posted on Sep 19th, 2012

by author: jblankenship.

Posted in: IRA, ira contribution limits, non deductible ira contribution.
Tagged: IRA · ira contribution limits · non deductible ira contribution

Financial Planning Pyramid: Foundations

Sep 17th, 2012

by sraskie.

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You can’t build a house from the top down, right? Like most solid structures, they start with solid base, a firm foundation. Some of the biggest skyscrapers are started below ground level, well beyond what’s in our view when we look at the behemoths of structures. Can you imagine a skyscraper built on just a foundation of concrete? The first strong wind or tremor would send it toppling. The same process can be applied to financial planning. You have to have a solid base, a firm foundation before you can think about building a portfolio, estate planning, etc.

Generally, the financial planning pyramid starts with the base known as risk management. This includes such risks as auto and home insurance, an emergency fund, life and disability insurance, and a will. Having this solid base protects you from many risks in life, but also protects your plan and your money that you’ve worked so hard to earn and invest. For example, let’s say you’re at fault in an auto accident and are liable for $500,000 in damages. Proper auto insurance liability limits will take care of this amount. If you don’t carry enough coverage or choose to not have insurance, then you are essentially choosing to self-insure – meaning you’ll pay the damages out of pocket. Very few people I know can afford to do this; which is why we transfer that risk to the auto insurance company. This scenario can be made analogous to home insurance, pre-mature death (life insurance), an emergency fund (unexpected expenses from job loss or to pay high deductibles in an insurance policy), and so on. It’s this risk management base that protects our wealth and future wealth and plans, so we don’t have to dip into our IRA, 401(k), etc., and having our financial future being upended.

Another time, I’ll dive into and explore the middle of the pyramid – wealth accumulation and management.

Posted on Sep 17th, 2012

by author: sraskie.

Posted in: fee-only, fiduciary, financial planning, health insurance, Insurance.
Tagged: emergency fund · financial planning · insurance

A Social Security Option Strictly for Divorced Folks

Sep 14th, 2012

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There is a loophole in the rules surrounding how divorced folks’ Social Security benefits are treated. As you may know from other articles you’ve read here and elsewhere, if you were married for at least ten years and you’ve been divorced for two years, as long as your ex is at least age 62, you are eligible to file for a Spousal Benefit based upon the ex’s record. In addition, as long as you fit the circumstances, if your ex passes away before you, you will have access to his or her Social Security benefit amount as a Survivor Benefit. These things are pretty much the same as if you were still married to your ex-spouse.

There’s one rule that is different for ex-spouses than for a married couple – and it has to do with the restricted application for Spousal Benefits.

Restricted Application for Spousal Benefits

If you’ll recall, this is when you have reached Full Retirement Age (FRA, age 66 for most folks these days, but increasing up to 67 between birth years of 1955 to 1962), and at this age you can file strictly for Spousal Benefits if your spouse has already filed for his or her benefits. This allows you to receive a benefit equal to half of your ex’s Primary Insurance Amount (PIA, the amount he or she would receive in benefits at his or her FRA) while allowing your own benefit to accrue Delayed Retirement Credits of 8% per year, as much as a 32% increase.

What’s different for divorced folks is that your ex-spouse doesn’t have to have already filed for benefits in order for you to file the restricted application for Spousal Benefits only. You only need to be divorced, at Full Retirement Age and have not filed for your own retirement benefit.

The fact on its own isn’t really a departure – after all, you wouldn’t want your ex to control when you would have access to benefits that you are eligible for. What’s different is that BOTH spouses can file restricted applications on the other’s record. In the case of married folks, only one can file a restricted application, because there is a requirement for the other spouse to have filed. Since this requirement is not present for divorced spouses, both can file the restricted application.

So, there you have it. The one rule that can be used by ex-spouses that can’t be used by anyone else. It’s not much, but it’s at least something.

Posted on Sep 14th, 2012

by author: jblankenship.

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

Financial Autonomy

Sep 10th, 2012

by sraskie.

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Recently, I had the opportunity to sit across from a couple nearing retirement, and looking for some options with regards to their cash flow needs, possible retirement dates, and the ever-present question, “Do we have enough?” Typically, these conversations involve careful consideration given to a number of different worries, fears and “big” problems that clients face. Frequently I will work with couples who have a hard time agreeing on how much they can spend in retirement, how much the can afford to save, and where to prioritize and allocate the money (to retirement, a wedding, college, etc.).

This couple, however, was different.

Well in position to enter retirement comfortable with little, if any to worry about, the tension between these two spouses could be cut with a knife – it was almost tough to sit through. One would snip at the other, and the other would interrupt while the snipping was happening to snip back. Small jabs, really – and nothing to get too excited about – at least in this practitioner’s opinion. Were they arguing about needing more, where to save, who will work more? Not at all. They were arguing about the little things. One spouse was upset because the other spouse was spending money on a local community newspaper subscription, while the other was upset about spending on something similar.

After about 20 minutes of quasi-hostile bantering back and forth, they asked my opinion. And here’s what I told them:

Autonomy.

I suggested that they each allocate a certain portion of their earnings each month to separate and personal checking accounts. I also suggested that other than knowing the amounts going in each month to each account, they needn’t discuss the purchases they make from their respective, separate accounts – it was their money to do with what they wanted, from newspaper subscriptions to purchasing items for a hobby. The looks on their faces were of genuine consideration of the idea. And they seemed to relax just a bit in their chairs. This couple was brilliant on the big things, but was letting the little things hamper their progress toward their financial planning goals. They left the office saying they would give it a try.

For couples I have recommended this to, the results have been extremely favorable. Many couples often report a sense of freedom, even though they may not feel chained down to their mutual budgets. Some have even reported using the money to buy gifts for the other spouse, relating back to the time when they were dating and such gifts were surprises, not expected and known purchases from the mutual account.

Financial autonomy can be a great tool in financial planning for couples. And sometimes being allowed to have some independent control on the little things, makes working together on the big things tolerable, if not enjoyable.

Posted on Sep 10th, 2012

by author: sraskie.

Posted in: budgeting, fee-only, fiduciary, financial planning.
Tagged: budgeting · fiduciary · financial planning

Clarification on Questions About Spousal Benefits

Sep 7th, 2012

7 comments

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.

Since I’ve been receiving quite a few inquiries about certain aspects of the Spousal Benefit, I thought I’d put up an article with a few definitive statements about this confusing part of the Social Security system.

1. If you are eligible for a Spousal Benefit and you’re under Full Retirement Age, when you file for your own benefit, you are automatically filing for both your own benefit and the Spousal Benefit at the same time. This is known as the deemed filing rule.

By “eligible”, we mean that your spouse has filed for his or her benefit, or filed and suspended.

If you are in the situation above, you cannot file for your own benefit alone, you’ll have to file for both benefits at that time, and both benefits are reduced since you’re filing before Full Retirement Age.

2. The only time that you can file solely for Spousal Benefits is when you are at least at Full Retirement Age and your spouse has filed for his or her benefit (could have suspended). This is known as a restricted application for Spousal Benefits only.

3. You cannot File and Suspend and also file a restricted application for Spousal Benefits only at the same time. This doesn’t mean that one person couldn’t use both provisions at some point, or that two spouses couldn’t use these provisions at the same time – but one person can’t do both at exactly the same time.

4. Two spouses cannot File and Suspend at the same time for the reason of allowing the other spouse to file for spousal benefits. Technically they both could File and Suspend, but doing so would not allow the other to file for Spousal Benefits. There is a little-known side-benefit to the File and Suspend option that could allow you to “unsuspend” and receive all back-benefits up to that point in your life, rather than re-applying and receiving the Delay Credits. This has to be done while you’re alive, but it’s a technical option available.

5. It’s possible for both spouses to at some point each receive a Spousal Benefit – here’s example:

Dick is 66, and Jane is 62. Jane files for her reduced benefit at 62 and Dick, being at FRA, files a restricted application for Spousal Benefits and receives half of Jane’s PIA for the coming four years, until he reaches age 70. When Dick files for his own benefit, now increased by Delay Credits, Jane is eligible to file for the Spousal Benefit increase. So both eventually received the Spousal Benefit in their lifetimes.

Hope these things helped to clear things up. Let me know in the Comments if you have additional questions about Spousal Benefits.

Posted on Sep 7th, 2012

by author: jblankenship.

7 comments already - add to the conversation!

Posted in: Deemed Filing, delayed benefit, DRC, Early Filing, file and suspend, Social Security, Social Security spousal benefit.
Tagged: Deemed Filing · delayed retirement credit · Social Security

Student Loan Interest Rates Won’t Increase, For Now

Sep 5th, 2012

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On June 29, 2012, Congress approved legislation to stop the interest rate on federal subsidized Stafford Loans from increasing from the current 3.4% to 6.8% on July 1, 2012, for new college borrowers. The rate had been scheduled to increase under provisions in the College Cost Reduction and Access Act of 2007. The rate freeze is effective for one year – and will (unless extended) increase to 6.8% on July 1, 2013.

Under the new legislation:

Rates on subsidized Stafford Loans will remain at 3.4% for undergraduates for one more school year, until July 1, 2013.
As of July 1, 2013, undergraduate students with a subsidized Stafford Loan will have a maximum of six year of in-school status when the federal government will pay the interest on the loan while the student is in school. Previously, the government paid the interest for as long as it took a student to get a diploma.

Posted on Sep 5th, 2012

by author: jblankenship.

Posted in: 2012 Calendar Year, education.
Tagged: education expenses · education saving

How to Keep Your Sanity When the World Around You Isn’t

Sep 3rd, 2012

1 comment

In my current re-read of Benjamin Graham’s timeless book “The Intelligent Investor”, I ran across the following paragraph and was immediately struck by the simple, deep truth in the lines:

But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and not more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.

Jason Zweig, in his notes for the Revised 4th edition of The Intelligent Investor writes:

This may well be the single most important paragraph in Graham’s entire book. In these 113 words Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets. If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.

I couldn’t possibly agree more. This is the exact advice that I have given to many folks who become anxious at market downturns and the like. The point is that you should never have money invested that you’ll need in the short term, something like within two years. That money should be placed in rock solid accounts, such as money markets, checking, CD’s, or good ol’ passbook savings accounts.

This allows you to withdraw the money you’ll need without having to concern yourself with current market conditions. The remainder of your investment portfolio is then invested in the normal way, via stocks, bonds, and the like, which you’ll rebalance on an annual basis. As you rebalance, you’ll replenish the short-term account(s) with the coming couple of years’ worth of funds needed (more years if you’re being conservative!).

This doesn’t mean that you’re burying your head in the sand – rather, it means that you’re not allowing short-term “noise” of the market’s fluctuations to cause you to take actions when you’re better off standing still. Use the quote above to reassure yourself when doubts are clouding your judgment: since you’re not forced to sell, you haven’t lost anything.

Posted on Sep 3rd, 2012

by author: jblankenship.

Posted in: Book review, investing, IRA.
Tagged: book review · investment · IRA

How Social Security Earnings Limits Impact Total Family Benefits

Aug 31st, 2012