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Why It Can Be So Important to Delay Social Security Benefits

Jul 27th, 2012

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It seems like every time I write an article about Social Security benefits that includes a recommendation to delay benefits, I get a lot of responses from well-meaning folks who disagree, sometimes vehemently, with the conclusions.

There are several points of view that I see in the responses, all believing that you should start taking benefits as soon as you’re eligible:

you never know how long you’re going to live;
Social Security is going broke, we all know it;
IT’S MINE, DADGUMMIT, THEY OWE IT TO ME; and
it’s all part of a huge conspiracy;
among other reasons too numerous to mention.

Believe me, I have no reason to recommend that people do something that isn’t in their best interests. As a financial planner, my job is to help folks do things that are in their best financial interests all the time. Sometimes those things that I recommend run counter to generally-accepted ideas, and sometimes the recommendations have certain assumptions or specific situations that must occur in order for them to work out the way we’ve planned. But in all situations, the clients’ best interest is being met.

I don’t have an argument for IT’S MINE, DADGUMMIT, THEY OWE IT TO ME, other than to point out that this is an emotional response to a non-emotional decision. This is a financial decision you’re making – it’s important to weigh the facts before making a choice. Read on, we’ll get to the specifics of how to weigh the facts a bit later.

I also don’t have an answer to the conspiracy theory. I just believe that it’s most likely not. Feel free to think that’s a pollyanna way of looking at it, but that’s my position. Maybe someday I’ll be proven wrong – but I’m going to continue not believing that somehow, someone else is benefiting from folks delaying Social Security.

I have addressed the concept of Social Security going broke in other articles. Briefly, since it’s funded by tax receipts it can’t “go broke”. Benefits can be reduced, or taxed at a greater rate than currently, or the tax rates could increase – but the system can’t “go broke”.

So that leaves the point of view that you never know how long you’re going to live. I agree, there’s no way to know. What we have to work with are averages – we know that on average most of us will live until somewhere around age 80, but that means some of us will die much sooner, some will die much later. This is a conundrum – similar to Pascal’s Wager.

In Pascal’s Wager, we are to choose if God exists or if God does not exist (there is no in-between). The gain by choosing that God exists is infinite, everlasting life in paradise, and the cost by choosing so is giving up worldly desires for the finite period of your earthly life. The gain by choosing that God does not exist is present satisfaction with worldly desires. (This isn’t intended to be a theological discussion, so please excuse my brevity in explanation.)

Similar to Pascal’s Wager, if we choose to assume that we’ll live beyond the average, we’ll gain considerable benefits by delaying – and the cost is foregone benefits in our earlier years. If it turns out that we die earlier than age 80, we will certainly have given up some overall benefits. So we will have to make a decision.

In the context of all the things that I help folks to make decisions about, I often equate Social Security benefits to an investment account or IRA. In doing so, we must figure out just what a Social Security benefit is worth, in real money, at various ages. This is a relatively simple exercise using a spreadsheet to determine the Net Present Value of future cash flows. In other words, how much money would I have to have in order to produce the same income as my Social Security benefit?

So let’s develop an example: a person has potential Social Security benefits of $18,000 per year if he starts benefits at age 62, or $24,000 per year if he starts at age 66, or $31,680 if he delays to age 70. If he lives to age 82, these cash flows have Net Present Values of $299,035, $334,611, and $350,389, respectively, assuming a 5% rate of return on the underlying investment.

Given that the average person between the ages of 55 and 64 has something like $65,000 in savings, those values are pretty darned substantial, no matter how you look at them. But the values can climb – especially if you are married and your spouse will be depending on your benefits after you pass.

Using the example from above, let’s say that the couple are presently ages 62 and 59 (doesn’t matter which one is older, husband or wife). For the purpose of clarity, let’s say that the wife is the older of the two, and she’s also the higher wage earner over her lifetime – so her benefit is larger. She lives to age 82, but he is only 79 at that time. If he lives to age 82, her benefit will be paid out over an additional 3 years – and so then the Net Present Value of the benefit streams equates to $332,726, $383,155, and $419,547 respectively.

The point to all of this is that the delayed benefit is worth substantially more than the earliest benefit – in our first example more than $50,000, and almost $87,000 more in the one where the spouse lives a few years longer. Given that the present value of the cash flow of the Social Security benefit can be increased to be worth nearly 7 times the value of the average retiree’s overall savings, which is akin to doubling the value of the savings amassed by age 70, if it’s at all possible to delay benefits, you should do so.

On the other hand, if in our example the couple lives only until the youngest is age 75, the delayed benefit still pays off – the amount of money you’d need for each of the options is $250,981 at age 62, or $251,747 at age 70. If both members of the couple died at any point earlier than that, starting early pays off better in the long run.

So if you’re in a health situation where you don’t expect for you and your spouse to live beyond your respective age(s) 75, then perhaps you should start your benefits as early as possible. If you live any time longer than that, it’s in your best interest to delay – especially the higher-earning spouse’s benefit – as late as you can.

Keep in mind, the tax benefits of Social Security have not been factored into this equation, nor have annual cost-of living adjustments. Also, each person or couple’s situation is different, so it pays to work with a professional on your decisions about Social Security.

Posted on Jul 27th, 2012

by author: jblankenship.

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Posted in: delayed benefit, Delayed Retirement Credit, early retirement, Social Security, social security benefits, social security survivor benefits, survivor benefits.
Tagged: delayed benefit · Social Security · social security survivor benefits

Deducting Job Search Expenses On Your Tax Return

Jul 23rd, 2012

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Searching for a job can get expensive. These days, let’s face it, if it’s not you, someone you know is on the hunt for a new job. Did you realize that at least some of those expenses can be deducted on your income tax return?

Recently the IRS distributed their Summertime Tax Tip 2012-06, which discusses some of the important facts you need to know about tax-deductible job search expenses. I’ve added a few explanatory comments to help you get more out of the Tip. The text of the Tip can be found below:

Job Search Expenses Can Be Tax Deductible

Summertime is the season that often leads to major life decisions, such as buying a home, moving or a job change. If you are looking for a new job that is in the same line of work, you may be able to deduct some of your job hunting expenses on your federal income tax return.

Here are seven thing the IRS wants you to know about deducting costs related to your job search:

1. To qualify for a deduction, your expenses must be spent on a job search in your current occupation. You may not deduct expenses you incur while looking for a job in a new occupation. (jb note: It is generally expected that by occupation, the real meaning is “field” – so a waitress could look for work as a restaurant manager, for example.)

2. You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income, up to the amount of your tax benefit in the earlier year. (jb note: they mean up to the amount that you deducted in an earlier year, not the tax benefit)

3. You can deduct amounts you spend for preparing and mailing copies of your resume to prospective employers as long as you are looking for a new job in your present occupation.

4. If you travel to look for a job in your present occupation, you may be able to deduct travel expenses to and from the area to which you travelled. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity unrelated to your job search compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primariliy to look for a new job.

5. You cannot deduct your job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one. (jb note: Nowhere in the Code are you going to find a definition of “substantial”. These cases are apparently each taken one-by-one and the situations considered individually, so there is no official guidance on what constitutes “substantial”.)

6. You cannot deduct job search expenses if you are looking for a job for the first time.

7. The amount of job search expenses that you can claim is limited. To determine your deduction, use Schedule A, Itemized Deductions. Job search expenses are claimed as a miscellaneous itemized deduction and the total of all miscellaneous deductions must be more than two percent of your adjusted gross income.

Posted on Jul 23rd, 2012

by author: jblankenship.

Posted in: income tax, itemized deduction.
Tagged: income tax · itemized deduction

The Restricted Application for Social Security Spousal Benefits

Jul 20th, 2012

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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.

One provision of Social Security benefits that is relatively unknown is the restricted application for Spousal Benefits. This provision allows a person to apply for benefits based upon his or her spouse’s record while delaying receipt of benefits based upon his or her own record.

The restricted application is only available when three factors have been met:

1 – the individual filing the restricted application has reached Full Retirement Age (FRA); and

2 – the individual has not filed for his or her own Retirement Benefit; and

3 – the individual’s spouse has filed for his or her own Retirement Benefit (could have filed and suspended)

An Example

Dick and Jane are ages 62 and 66, respectively. Dick filed for his own benefit at age 62, and Jane would like to delay her benefit to age 70, to achieve the maximum delay credits. Since Jane is at FRA (factor 1), has not filed for her own benefit (factor 2), and Dick has filed for his own retirement benefit (factor 3), Jane is eligible to file a restricted application for Spousal Benefits only.

Since Jane is at Full Retirement Age, the Spousal Benefit that she will receive is going to be equal to 50% of Dick’s unreduced benefit. Since Dick has filed early, he will be receiving a reduced benefit – approximately 75% of the amount he would have received at FRA. So Jane’s ultimate Spousal Benefit in this case will be roughly 2/3 of Dick’s current benefit.

Once Jane reaches age 70, she can now file for her full benefit, with the maximum delay credits applied (32%). Dick will be 66 at that time (or thereabouts) and so he will be eligible to apply for a spousal benefit – as long as 50% of Jane’s PIA (the amount she would have received if she filed at FRA) is greater than Dick’s PIA. So if Dick’s PIA was $800 and Jane’s PIA was $2,000, Dick’s overall benefit could be increased by the difference, $200, at this time. If Dick is younger than Full Retirement Age when Jane files, his Spousal increase could be reduced from that $200 offset if he files before he reaches FRA. For more on how the reductions for Spousal Benefits works, see Social Security Spousal Benefit Calculation Before FRA.

How About Ex-Spouses?

An ex-spouse can use the restricted application as well – provided that he or she was married to the former spouse for at least 10 years and has not remarried. One thing that’s different about a divorced person’s situation is that the ex-spouse doesn’t have to have filed (factor 3) – the ex only has to have reached age 62 and thus is eligible to file. In addition, if the former spouse has not filed for his or her own benefit, the couple must have been divorced for at least two years when he or she files for Spousal Benefits.

If there was more than one ex-spouse who fits all of the requirements, the individual can choose the Spousal Benefit that is the largest.

Posted on Jul 20th, 2012

by author: jblankenship.

Posted in: file and suspend, restricted application, retirement benefits, social security benefits, Social Security spousal benefit, Spousal Benefit.
Tagged: restricted application · retirement benefits · Social Security · spousal benefit

The Difference Between IRA Contributions and Rollovers

Jul 18th, 2012

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Often there is confusion about what constitutes a “contribution” and a “rollover” into an IRA. This post is intended to clear up the difference.

While both activities are technically contributions, there’s a major difference between the two. The most significant of the differences is that with a regular annual contribution there are several limits imposed that can be quite restrictive.

Annual Contribution Limits

For an annual contribution to a traditional IRA or a Roth IRA, you are limited to the lesser of $5,000 or your actual earned income for the year. If you have no earned income, you’re not allowed to make an annual contribution to an IRA. Above that amount, if you happen to be 50 years old or better, you can add $1,000 more to your annual contribution (2012 figures).

Astute readers will point out that there is the option for a spouse to make a spousal IRA contribution in the event that one member of the couple has low or no income for the year. As long as the other spouse has earned income, IRA contributions are allowed on behalf of the other spouse up to the limits mentioned above.

In addition, if the taxpayer has a retirement plan available in his or her job, there are further income limits that impact deductibility of traditional IRA contributions. For 2012, the limit is Modified Adjusted Gross Income above $92,000 (for married filing jointly) or $58,000 for single filers. Above these limits, deductibility is gradually reduced to zero when the Modified Adjusted Gross Income (MAGI) is at $112,000 (or $68,000 for singles).

For Roth IRA contributions, if the MAGI is greater than $183,000, contributions are not allowed for those who are married filing jointly. For Single filers, the limit is $125,000.

Rollovers

Rollover contributions don’t have an annual limit. You can rollover literally as much as you like from a qualified retirement plan (QRP) or IRA into another IRA. In addition, there is no requirement to have had earned income for the year when making a rollover.

In addition, rollovers have no impact on your annual contribution amounts and vice versa. You can rollover any amount without having to worry about annual limits, and then you can make regular annual IRA contributions up to the limits mentioned above.

Conversions

You are further allowed to convert any amount that you wish from a traditional IRA or QRP into a Roth IRA without limits and without impact to annual contributions. The problem is that you have to pay tax on pre-taxed amounts that you convert, and this can amount to a sizable tax burden – all pre-tax amounts converted to Roth IRA are subject to ordinary income tax.

Conclusion

So the major difference between annual contributions and rollover or conversion distributions is that annual contributions represent “new money” being contributed into the IRA or Roth IRA account. Rollovers are simply the transfer of money that was already in a tax-deferred account, into another tax-deferred account. Or in the case of a Conversion, this is the transfer of existing tax-deferred funds into a tax-free Roth IRA.

Limits on contributions do not apply to rollovers or conversions; the two types of money are not related in any way.

Posted on Jul 18th, 2012

by author: jblankenship.

Posted in: 401 k, contribution limit, conversion, Earnings Limits, eligible rollover distribution, employer plan, IRA, ira contribution limits, qrp, qualified retirement plan, Roth conversion, Roth IRA.
Tagged: contribution limit · IRA · qualified retirement plan · roth ira

Tips for Summer Jobs From the IRS

Jul 16th, 2012

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With summer in full swing, many young folks are working in temporary jobs for the summer. There are a few things that you need to know about these temporary jobs that the IRS (and I!) would like you to know. Recently the IRS produced their Summertime Tax Tip 2012-13, which provides important information for students working in summer jobs. I have added an extra couple of tips after the original IRS text that may be useful to you as well.

The original text of the Tip is below:

A Lesson from the IRS for Students Starting a Summer Job

School’s out, but the IRS has another lesson for students who will be starting summer jobs. Summer jobs represent an opportunity for students to learn about the tax system.

Not all of the money they earn will be included in their paychecks because their employer must withhold taxes.

Here are six things the IRS wants students to be aware of when they start a summer job.

1. When you first start a new job you must fill out a Form @-4, Employee’s Withholding Allowance Certificate. This form is used by employers to determine the amount of tax that will be withheld from your paycheck. If you have multiple summer jobs, make sure all your employers are withholding an adequate amount of taxes to cover your total income tax liability.

2. Whether you are working as a waiter or a camp counselor, you may receive tips as part of your summer income. All tips you receive are taxable income and are therefore subject to federal income tax.

3. Many students do odd jobs over the summer to make extra cash. Earnings you receive from self-employment – including jobs like baby-sitting and lawn mowing – are subject to income tax.

4. Even if you do not earn enough money to owe income tax, you will probably have to pay employment taxes. Your employer will withhold these taxes from your paycheck. If you earn $400 or more from self-employment, you will have to pay self-employment tax. This payes for benefits under the Social Security system that are available for self-employed individuals the same as they are for employees that have taxes withheld from their wages. The self-employment tax is figured on Form 1040, Schedule SE, Self-Employment Tax.

5. Food and lodging allowances paid to ROTC students in advanced training are not taxable. However, active duty pay – such as pay received during summer camp – is taxable.

6. Special rules apply to services you perform as a newspaper carrier or distributor. You are treated as self-employed for federal tax purposes regardless of your age if you meet the following conditions:

You are in the business of delivering newspapers.
All your pay for these services directly relates to sales rather than to the number of hours worked.
You perform the delivery services under a written contract which states that you will not be treated as an employee for federal tax purposes.

If you do not meet these conditions and you are under age 18, then you are generally exempt from Social Security and Medicare tax.

My Additional Tips

In addition to the tips that the IRS has given above, I have two more tips to add to the list:

7. If your income is going to be rather low, enough that you will not owe income tax for the year, you can use the special exemption provision, by writing “EXEMPT” in the box on line 7. This is allowable if you had a right to a refund of all tax withheld last year (if applicable) and you expect a refund of all tax withheld this year (if any is withheld). Using the exemption provision, your income will only be subject to withholding for Social Security and Medicare tax.

8. Since most of the time summer jobs pay relatively low amounts, it can be especially advantageous to utilize a Roth IRA for saving some (or all) of your earnings. You’re allowed to contribute the greater of your total income or $5,000 to a Roth IRA each year. Since your tax rate on this summer income is low or possibly zero, this represents a very low cost way to fund a Roth IRA. An added benefit is that funds in a retirement plan (such as a Roth IRA) are not counted toward federal financial aid calculations. This can help out when you’re applying for financial aid for college. See Roth IRA for Youngsters for more details.

Posted on Jul 16th, 2012

by author: jblankenship.

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Posted in: education expenses, financial aid, income tax, IRA, Roth IRA.
Tagged: education expenses · income tax · IRA · roth ira

Guidance on Qualified Charitable Contributions From Your IRA For 2012

Jul 11th, 2012

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January 1, 2013 update: Passage of the American Taxpayer Relief Act of 2012 has extended the QCD through the end of 2013. See this article for more details.

In past tax years (through the end of 2011) there was a provision available that allowed taxpayers who were at least age 70½ years of age to make distributions from their IRAs directly to a qualified charity, bypassing the need to include the distribution as income. The law allowed the taxpayer to use a distribution of this nature to satisfy Required Minimum Distributions (RMDs) where applicable.

This law expired at the end of 2011, but in years past Congress has acted very late in the year and retroactively reinstated this provision. For more detail on how this provision (if not reinstated) can impact your taxes, see the article Charitable Contributions From Your IRA – 2012 and Beyond.

Guidance For 2012

If you are one of the folks who would really like to utilize the Qualified Charitable Contribution (QCD) provision for 2012, especially if you are hoping to use the distribution to satisfy your RMD for the year, read on. In the event that Congress should happen to act on this to extend the provision late in the year, you’ll want to delay your RMD as late as possible. This means that you shouldn’t take any other distributions from your IRAs earlier in the year.

If you’re hoping to use the QCD but you don’t want to use it to satisfy your RMD for the year, you can take as many distributions as you like, but you’ll want to wait until late in the year (probably mid-December) before you make the planned charitable contribution.

The last time that Congress extended this provision, they did it on December 10th. As long as you make your distribution by December 31, it will still count toward the current tax year, so if you’re hoping to use QCD you can delay to that date if necessary. Practically speaking, if Congress hasn’t acted by Christmas Eve, a change won’t likely occur after that.

Posted on Jul 11th, 2012

by author: jblankenship.

Posted in: #noTOP, 2012 tax year, IRA, QCD, required minimum distribution, rmd.
Tagged: IRA · QCD · required minimum distribution · rmd

Important Factors When Planning Social Security for Couples

Jul 6th, 2012

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Planning for Social Security benefits for a couple can be complicated. There are many factors to consider, including the amount of benefits each member of the couple is entitled to at various ages, as well as the relative ages of the spouses to one another. Other factors include whether or not one member of the couple (or both) will earn wages past age 62, as well as longevity: the potential of the couple (at least one member) living past normal life expectancy.

Longevity is one of the most important factors to consider – and for a couple this isn’t as straightforward as it is for one person. According to the National Association of Insurance Commissioners’ Annuity 2000 table, a couple who are both age 50 stand a 50% chance of one member living to at least 91 years of age. For another example, if the husband is 62 and the wife is 59, again there’s a 50% chance that one will live another 31.7 years, where either she reaches 90.7 or he lives to 93.7.

This is because the possibility of both members of a couple dying at or about the usual life expectancy is lessened when both lives are considered. Therefore, planning for Social Security benefits for a couple is not simply a duplication of the effort involved with planning for one person – given that the benefits of the member of the couple with the higher lifetime benefit amount has a half chance of continuing on beyond the life of one member.

Maximizing Benefits

If the lifetime over which the benefit is being paid out is less than or equal to the normal life expectancy (roughly 78 to 80 years of age), the way to maximize benefits is to increase the number of years that the benefit is paid out. This is done by starting this benefit as early as possible, or age 62.

However, if the lifetime over which the benefit is being paid out is more (by more than a year or two) than normal life expectancy, maximizing benefits is accomplished by increasing the relative size of the benefits being paid. You do this by delaying the start of benefits to age 70, the age when your benefit amount is at its peak.

Generalizations

Armed with the knowledge we have from above, we can make a few generalizations about choices of when each member of the couple should file. The assumption in these scenarios is that one spouse lives to an age less than or equal to the average life expectancy, and the other lives for at least a few years beyond that point in his or her own life. Later we’ll discuss the implications where both spouses have a diminished expectation of lifespan.

For many (but not all) couples, it is a relatively simple choice to maximize each person’s benefit over the period of time that it is expected to be paid out. Since the Survivor Benefit rules allow the spouse with the lower lifetime benefit credit to switch over to the benefit of the higher-earning spouse at the death of the higher-earning spouse, it is expected that the higher benefit of the couple will be paid out over the longest period of time. And with that in mind, since we are assuming that one or the other in the couple will live for some time after normal life expectancy, the higher benefit should be maximized by taking it at age 70.

Additionally, since we’re assuming that one member of the couple is going to live only to normal life expectancy, maximizing the lower-wage-earning spouse’s benefit is accomplished by starting as early as possible, at age 62.

Also, depending upon the relative ages of the couple, as well as the relative size of the benefits, using the above strategy will open up possibilities for using Spousal Benefits (we won’t go into this right now though).

Non-Generalized Circumstances

In many cases however, the above strategy is not the optimum way for planning benefits. Many times the relative ages of the couple prompt for a different strategy, or the life expectancy of one or the other is diminished. Below are a couple of examples where a different tack is warranted.

Couple is more than four years apart in age and HWES is younger If the expectation is that the HWES (Higher-Wage-Earning Spouse) will outlive the LWES (Lower-Wage-Earning Spouse), and further that the LWES will possibly live beyond the normal life expectancy (for example, since many times the LWES is a woman and women have longer life expectancies), it might make more sense for the LWES to delay filing for benefits to Full Retirement Age (FRA) or later.

When the HWES reaches FRA, since the LWES has already filed for benefits, the HWES can file a restricted application for Spousal Benefits only. This will provide the couple with additional benefits while allowing HWES to continue delaying filing for benefits to age 70.

This strategy maximizes both the LWES benefit and the HWES benefit, providing for each benefit to be received for the longest possible time. In addition, we are maximizing the time that the allowable Spousal Benefit is received.

For example, if a couple is 62 (LWES) and 52 (HWES), when the LWES reaches normal life expectancy (around age 80), then HWES will be 70. If LWES lives even a couple of years beyond that age, LWES benefits would have been maximized over the couple’s lifetime if LWES starts benefits later, and the later the better. Working with the averages, having the LWES start benefits at FRA may be the best way to attempt maximizing. Either way, when the HWES reaches FRA, since the LWES has already filed for benefits, the HWES can file a restricted application for Spousal Benefit while continuing to accrue delay credits.

Couple both have a diminished expectation of life span In a case like this, both members of the couple have a health issue or family history that leads them to reasonably believe that they each will live to an age less than approximately 80.

With a shortened life span for both, each should begin receiving benefits as early as possible, at age 62. When eligible, the LWES should also begin Spousal Benefits as early as possible, in order to maximize this benefit for the few years it will be available.

However, if the relative ages of the two is significantly different, it could be beneficial for the HWES to delay benefits, if HWES is older. For example, if the couple is age 52 (LWES) and 62 (HWES), when HWES reaches age 70, the LWES will be 60. Given our assumption that each member of the couple will die by approximately age 80, the HWES’s benefit will be received for as much as 20 years (16 to 18 years is the break-even point).

Posted on Jul 6th, 2012

by author: jblankenship.

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Posted in: Early Filing, file and suspend, retirement benefits, Social Security, social security survivor benefits, Spousal Benefit, survivor benefits.
Tagged: Social Security · spousal benefit · survivor benefits

Annual Gift Tax Exclusion Increases in 2013

Jul 2nd, 2012

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All individuals have the opportunity to give gifts annually to any person without having to file a gift tax return. For 2012, the amount of the annual exclusion is $13,000.

This means that anyone can give a gift of up to $13,000 to any person for any reason without worrying about possible gift tax implications. A married couple can double this amount to $26,000.

In 2013, this annual exclusion amount will increase to $14,000 ($28,000 for couples).

For amounts given in excess of the annual exclusion amount, every individual has a lifetime exclusion amount, against which the excess gifts are credited. For 2012, the lifetime exclusion amount is $5,120,000. This lifetime exclusion amount is one of the tax law provisions that is set to expire at the end of 2012, along with the other “Bush Tax Laws”.

If allowed to expire, the lifetime gift tax exclusion amount will revert to the 2001 amount, which was $1,000,000. It’s hard to guess exactly how Congress will handle this particular provision, but it is anticipated that the majority of the Bush Tax Laws will be extended intact.

Posted on Jul 2nd, 2012

by author: jblankenship.

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Posted in: #noTOP, 2013 tax year, gift tax.
Tagged: gift tax

IRS Cracking Down on IRA Rules

Jun 27th, 2012

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It seems that some of the rules the IRS has put in place with regard to IRAs have not always been watched very closely – and the IRS is stepping up efforts to resolve some of this. According to the article in the WSJ, IRA Rules Get Trickier, an estimated $286 million in penalties and fees were uncollected for 2006 and 2007 tax years’ missed distributions, over-contributions, and the like.

The title of the article is a bit misleading, because the rules are not changing or getting “trickier”, the IRS is just going to be paying closer attention to what you’re doing with your account. This is set to begin by the end of this year, after the IRS delivers their report to the Treasury on how to go about enforcing the rules more closely.

The first rule being monitored more closely is the contribution rule – for 2012, you’re allowed to contribute the lesser of $5,000 or your earned income, plus an additional $1,000 if you’re over age 50. If you contribute more than the limit for the tax year, you will be subject to an over-contribution excise tax of 6% for each year that you leave the over-contribution in the account. Over-contribution can also occur if your income is above the annual limits for your particular IRA.

One way to resolve over-contribution is to simply remove the excess funds from the account. You need to make sure that you also remove any growth or income attributed to the over-contribution as well. Another way to resolve this is to attribute the over-contribution to the following year’s contribution. You would still owe the 6% excise tax for the prior year, but using either of these methods would get you back in shape.

Another rule is the minimum distributions rule. If you are over age 70½ and you fail to take the appropriate minimum distribution for a particular year, there is a 50% penalty applied for the amount not distributed.

Resolving missed minimum distributions is a bit more difficult than the over-contribution, which can be a problem for inherited IRAs as well as an IRA owned by someone over age 70½. This is especially true if you have missed more than one year of distributions, since each succeeding year depends upon the prior year’s distributions, and the calculations can get pretty messy. See Unwinding the Mistake in the article at the link for more on how this is done. (The article applies primarily to inherited IRAs, but the method is the same for all excess accumulations, i.e., not taking timely distributions.)

Neither of these rules has a statute of limitations, so if your account is in error by one of these rules, you should take steps to resolve it as soon as possible – delaying further will only increase the penalties and interest charges.

Posted on Jun 27th, 2012

by author: jblankenship.

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Posted in: #noTOP, Annual limits, contribution limit, IRA, minimum distributions, required minimum distribution, rmd.
Tagged: contribution limit · IRA · required minimum distribution · rmd

A Few Upcoming Tax Changes to Keep in Mind

Jun 25th, 2012

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As 2013 draws ever nearer, we need to keep a few potential tax changes in mind. These items are subject to change – they’ve changed in the past at the last minute, so there’s no reason to believe they won’t change again – but if they don’t we should be planning ahead.

Flex-Spending Health Accounts

If your employer provides you with a Flex-Spending Account for healthcare expenses, there will be some changes coming up in 2013. This is the kind of account where you set aside a sum of money each payday, pre-tax, that can be used throughout the year on deductibles, non-covered medical expenses, and co-pays.

Beginning in 2013, these plans will be limited to a total of $2,500 per year in salary deferral. This comes about as a part of the Obama-care legislation. Currently there is no cap on contributions to these plans, although some employers place a cap on their own plans, often in the neighborhood of $5,000.

Along with this cap, there are presently several provisions working their ways through Congress to eliminate the “use it or lose it” feature of these plans. In the past, if you set aside more money than you actually used for non-covered healthcare costs, you would forfeit that extra money. This was put into place to discourage the use of these plans as a salary deferral vehicle. It’s not at all clear how the new provision(s) will work at this time – but it is expected that any funds not used by the end of the tax year would be distributed to the employee and taxed as ordinary income, without penalty. Other options could include a carryover of the funds to pay for future healthcare expenses.

Capital Gains Tax Rates

Again this year, the so-called “Bush Tax Provisions” are set to expire. When (if) that happens, Capital Gains tax rates will climb up to their previous levels of 10% for those in the 10% and 15% tax brackets, and 20% for those in the upper tax brackets. Currently those rates are 0% and 15%, respectively.

With this in mind, we want to pay close attention to the law changes. If it looks like these rates are going to increase, we should strongly consider realizing capital gains for those cases where the tax increase will have a significant impact. This is especially true if you find yourself presently in the 0% capital gains bracket.

Income Tax Rates

Along the same lines as the Capital Gains rates, if the Bush Tax Provisions expire, ordinary income tax rates will also increase in 2013. This may make Roth Conversions, for one item, a special consideration in 2012. Again, we’ll want to pay close attention to what Congress is doing toward the end of the year. I wouldn’t expect for anything at all to happen before the Presidential election, so we won’t have a lot of time to act if the current rates are not to be extended.

Posted on Jun 25th, 2012

by author: jblankenship.

Posted in: #noTOP, 2013 tax year, capital gains, capital gains tax rates, flex-spending, income tax, newsletter.
Tagged: capital gains and losses · capital gains tax rates · flex-spending

Health Savings Account Limits for 2013 Published

Jun 20th, 2012

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The IRS recently distributed information about the adjustments to Health Savings Accounts (HSAs) for 2013. These limits adjust annually based upon inflation calculations (if inflation is present).

For 2013, the annual contribution limit for self-only coverage is $3,250, which is an increase of $150 over the figure for 2012. For an individual with family coverage, the limit in 2013 is increased by $200 to $6,450.

The deductibles for HSA accounts are also increased in 2013: $1,250 for self-only coverage, and $2,500 for family coverage. This is an increase of $50 and $100 for each deductible, respectively.

Lastly, the out-of-pocket expense limit for self-only coverage is $6,250 in 2013, an increase of $200. Family coverage out-of-pocket maximum is $12,500 (up from $12,100 in 2012). This limit is for deductibles, co-payments, and other amounts, but not premiums.

Posted on Jun 20th, 2012

by author: jblankenship.

Posted in: #noTOP, 2013 tax year, contribution limit, hdhp, health insurance, health plans, health savings account, high deductible health plan.
Tagged: hdhp · health savings account · HSA

RMDs Don’t Have to Be Taken in Cash

Jun 18th, 2012

2 comments

But…

It’s a little-known fact that distributions from an IRA or a Qualified Retirement Plan can be taken in kind, rather than in cash. You can in any circumstance take distribution from the account of stocks, bonds, or any investment that you own, just the same as if it were cash.

The downside to this is determining valuation for the distribution. You could value the distribution on the day of the distribution by opening price, closing price, average price, or mean between the day’s high and low prices. Where you really get into trouble is when the security that you own is very thinly-traded, such as a small company or very infrequently-traded bonds. These can be very hard to value on the date of distribution, and as you might recall, the value of a distribution for Required Minimum Distributions (RMDs) must be valued appropriately in order to ensure that the minimum has been met.

In general, it is probably in your best interests to take the distribution for RMDs in cash – so that valuation isn’t an issue at all.

There Can Be An Upside

In some cases, especially where the securities held are more easily valued, it can be beneficial for you to take these distributions in kind. By doing so, you will have the advantage of remaining fully-invested (no lag time between selling the holdings in one account and purchase in the new account). Then there’s the obvious situation where you are hoping to use NUA treatment – those distributions must be in-kind (but NUA treatment doesn’t generally apply with RMDs). You also would achieve the benefit of not having to pay commissions on the sale and purchase of the securities, if these would happen to apply in your case.

Another situation where taking a distribution in kind can be useful is precisely the one we described above as a negative. If the security is hard to value due to some limiting factor such as light trading, you could take a distribution of an applicable percentage of the security, along with cash representing the appropriate percentage from the remainder of the account and thereby satisfy the RMD. Later, when the security becomes more easily valued (such as maturity for a bond) you can sell the security for cash as needed.

Posted on Jun 18th, 2012

by author: jblankenship.

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

What Is Net Unrealized Appreciation?

Jun 11th, 2012

2 comments

We’ve discussed how to utilize the Net Unrealized Appreciation (NUA) treatment of distributions from your qualified retirement plan (also known as QRP, meaning 401(k), 403(b), and other plans) – one of the earlier articles on Net Unrealized Appreciation can be found at this link.

Even though the process is explained in the earlier article, we didn’t discuss just what exactly can be treated with the NUA option. How do you determine what part of the distribution can be treated with capital gains treatment?

In order to determine what is to be treated as unrealized appreciation, we need to define what has to be treated as ordinary income from such a distribution. Briefly, the way that the NUA option works is that you take a complete distribution of your QRP account within one tax year – and you have the option to treat a portion of your account distribution with capital gains. The portion that can be treated as capital gains is the amount of growth that has occurred in the value of company stock (your company, the one that you have the retirement plan with).

Not all of the company stock in your account is necessarily available for NUA treatment. This is where we’ll define what cannot be treated in that fashion. The following items cannot be used for NUA, and they make up the basis of the company stock in your account:

Your contributions to the plan that are attributable to the employer stock
Your employer’s contributions to the plan, attributable to the employer stock
The Net Unrealized Appreciation in the stock attributed to employer contributions

Those three items will be taxed as ordinary income in the year that the distribution occurred. So, the only thing that is left, Net Unrealized Appreciation of the company stock purchased with your own contributions, can be taxed with capital gains tax – instead of ordinary income tax, as all other pre-tax distributions from the plan are treated.

This is not an all-or-nothing provision. You have the option to elect NUA treatment for only a portion of your overall distribution from the account. Everything else could be rolled over into another QRP or an IRA, further deferring taxation.

Holding period

The stock distributed from the employer plan that you’ve elected to use NUA treatment on is treated as having been held for greater than one year. Therefore, the growth that is distributed (the NUA) will have the characteristic of long-term capital gains tax treatment. Additional gains beyond the initial NUA have a holding period that begins with the date of distribution – so it could be short-term or long-term capital gains, depending on when you take the distribution.

Posted on Jun 11th, 2012

by author: jblankenship.

Posted in: IRA, net unrealized appreciation, NUA, qrp, qualified retirement plan.
Tagged: IRA · net unrealized appreciation · NUA · qrp

Additional Factors About Survivor Benefits

Jun 8th, 2012

6 comments

Seems like there is always something to learn. No matter how much you know and study a subject, it seems there are always factors that are uncovered that you weren’t aware of – and I find this sort of thing from time to time. Recently, I have been made aware of a couple of factors that I had misunderstood previously about Social Security Survivor Benefits – thanks to my friend Dana Anspach, who blogs over at MoneyOver55.About.com. Thanks Dana!

Limit on Reductions to Survivor Benefits

The first factor is one that I wasn’t even aware of – regarding how reductions on Survivor Benefits work in a very specific situation. The situation is when the deceased spouse was not at least at Full Retirement Age and he or she was receiving retirement benefits as of the date of death.

In this situation, the amount of benefit that is used to begin the calculation for Survivor Benefits is the greater of

The deceased spouse’s actual benefit; or
82.5% of the deceased spouse’s PIA

As such, in this particular set of circumstances, the starting point for determining Survivor Benefits cannot be less than 82.5% of the deceased spouse’s PIA.

Amount of Survivor Benefit Available

The second factor that I wasn’t clear about is where the deceased spouse was, again, not at least at Full Retirement Age (FRA) but in this case he or she was NOT currently receiving retirement benefits as of the date of death.

The part that needs to be clarified is that the deceased spouse’s age isn’t a factor in determining the amount for the base factor unless he or she would now be older than FRA had he or she survived to the date that the widow(er) applies for Survivor Benefits.

In other words, when the deceased spouse was not receiving retirement benefits and he or she would not have attained FRA by this date, the Survivor Benefit is calculated based on 100% of the PIA of the deceased spouse. The Survivor Benefit is not reduced based upon the deemed attained age of the decedent.

On the other hand, if the deceased spouse was at least FRA or older than FRA as of the date of death and not receiving benefits, the Survivor Benefit amount will be based upon the decedent’s PIA plus the applicable credits for delay beyond FRA. The Delayed Retirement Credits are accrued up to the month of death.

In either case, the age of the surviving spouse is a factor – if the surviving spouse is less than his or her own Full Retirement Age (FRA), reductions will be applied to the starting factor mentioned above, based upon the age of the surviving spouse.

Corrections Applied

I’ve gone back through previous articles to update any language that was contrary to these additional factors, but I may have missed some – let me know if you find any others. Hopefully this hasn’t caused any major difficulties for you.

Posted on Jun 8th, 2012

by author: jblankenship.

6 comments already - add to the conversation!

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

What to do When You Receive a Letter from the IRS

Jun 4th, 2012

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No matter how diligent you are, mistakes happen. And sometimes the mistakes are made by the IRS. Or possibly there’s just some additional information required. Whatever the case, you have received a letter or notice from the IRS. Scary stuff, right?? Maybe, but just receiving a letter from the IRS isn’t an immediate cause for alarm.

Just because you’ve received a letter from the IRS doesn’t mean you did something wrong. The IRS has been wrong before, and as mentioned above, there are lots of reasons that might cause them to send you a notice – not all of them are necessarily bad.

The IRS recently published their Tax Tip 2012-73, which lists “Eight Facts to Know if You Receive an IRS Letter or Notice”. The text of the Tip is below.

Eight Facts to Know if You Receive an IRS Letter or Notice

The IRS sends millions of letters and notices to taxpayers for a variety of reasons. Many of these letters and notices can be dealt with simply, without having to call or visit an IRS notice.

Here are eight things to know about IRS notices and letters.

There are a number of reasons why the IRS might send you a notice. Notices may request payment, notify you of account changes, or request additional information. A notice normally covers a very specific issue about your account or tax return.
Each letter and notice offers specific instructions on what action you need to take.
If you receive a correction notice, you should review the correspondence and compare it with the information on your return.
If you agree with the correction to your account, then usually no reply is necessary unless a payment is due or the notice directs otherwise.
If you do not agree with the correction the IRS made, it is important to respond as requested. You should send a written explanation of why you disagree and include any documents and information you want the IRS to consider along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the upper left of the notice. Allow at least 30 days for a response.
Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right of the notice. Have a copy of your tax return and the correspondence available when you call to help the IRS respond to your inquiry.
It’s important to keep copies of any correspondence with your records.
IRS notices and letters are sent by mail. The IRS does not correspond by email about taxpayer accounts or tax returns.

For more information about IRS notices and bills, see Publication 594, The IRS Collection Process. Information about penalties and interest is available in Publication 17, Your Federal Income Tax (For Individuals).

Posted on Jun 4th, 2012

by author: jblankenship.

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

Investing Truths

Jun 1st, 2012

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This list of factors about investing is part of a document that I often provide to my clients as we’re working with investment planning. The list isn’t intended to be exhaustive, but rather representative of some of the truisms that I have found to be helpful over the years.

Add your own truisms to the list and I’ll put this up as a separate page to include your comments as well!

Investing Success Factors

Time is the most important factor relating to an investment plan’s success. There is no substitute for starting early and maintaining regular contributions to your savings.

Diversification, among asset classes, sectors, and tax treatment, is the second-most important factor relating to an investment plan’s success. The old adage “Don’t put all of your eggs in one basket” applies here.

Keeping expenses down, by utilizing low-cost investment vehicles such as no-load mutual funds and exchange-traded funds, is another very important factor in an investment plan’s success. When you pay extra money in commissions, loads, and management fees, this money is lost to you forever and will not work toward your investment goals.

The principal cause of changes in investment prices is a change in consensus expectation for the future.

Past performance is no indication of future results. Investment returns can only be made in the future – it is impossible to buy past returns.

When you work with a financial advisor, you are not paying for tips, secrets, or inside information. You are paying for knowledge and reason applied to your specific circumstances. Investors who utilize a financial advisor have generally increased odds for success in investing. However, increasing your odds does not mean you will be 100% successful.

Count on its

I refer to the next group of truisms as the “count on its” – meaning, these are things you need to expect as you undertake investing:

The value of opportunities that you’ve missed will always exceed the value of those opportunities that you take. It’s a matter of perception – the grass is always greener on the other side of the fence.

Sometimes we will buy an investment that will immediately go down in value right after we buy. Other times we will sell an investment that will immediately afterward rise in value. It happens, and there’s nothing you can do about it besides sticking with your plan.

Get used to uncertainty. Like it or not, every investment decision is based purely upon reasoned guesses about the future.

That’s my list – add your Investing Truths in the comments below. I’m interested in seeing other perceptions!

Posted on Jun 1st, 2012

by author: jblankenship.

Posted in: financial planning, investing, IRA.

What If My Employer Doesn’t Match My 401(k) Contributions?

May 30th, 2012

2 comments

Should I continue to make contributions to my 401(k)? Is there something else that I should make contributions to instead?

As you may recall, the recommended order for retirement savings contributions is normally as follows:

401(k) contributions up to the amount that the company matches
max out your Roth or traditional IRA contributions for the year (as applicable)
max out the remainder of the available 401(k) contributions
make taxable investment contributions

In the situation where your employer doesn’t match your contributions to a 401(k) plan, the order of contributions is more appropriate if you bump up the Roth or traditional IRA contributions. In other words, just eliminate the first bulletpoint.

Now, the choice of Roth IRA versus the traditional IRA for your contributions is dependent upon your income and the tax impacts. For example, you would not be eligible to make a deductible traditional IRA contribution if your Modified Adjusted Gross Income (MAGI) is greater than $112,000 (if you’re married and filing jointly), or $68,000 if you’re single. (Contribution limits are for 2012 tax year.)

Since the deductible traditional IRA has the ability of being deducted from your income, making your contribution there could decrease taxes. If you’re in a position to take advantage of this, you should probably go this route. In the case where you’re married and your spouse isn’t covered by a retirement plan – either he doesn’t work outside the home or his employer doesn’t have a retirement plan – you can make a deductible IRA contribution for your spouse as well if your MAGI is less than $183,000.

On the other hand, if your MAGI is greater than $112,000 (MFJ) or $68,000 (Single), a Roth IRA contribution might be the best first option for retirement savings contributions. The Roth IRA contribution is available to you if your MAGI is less than $183,000 (MFJ) or $125,000 (Single). The Roth IRA contribution doesn’t reduce taxes for you currently – but in the future your distributions from the account can be tax-free if qualified.

If you don’t fit into those income categories, you still have the option of making non-deductible contributions to a traditional IRA for the tax year. Again, there’s not a tax benefit in the current year, but there are benefits to making such a contribution – such as the ability to convert the funds from this traditional account to a Roth IRA later – that will make the contribution worthwhile.

The reason that the use of either a Roth IRA or a traditional IRA is the first choice (if available to you) over a non-matched 401(k) plan is because with the IRAs, you have much better control over your costs, investment choices, and fewer restrictions on non-qualified distributions.

The 401(k) still offers the greatest amount of tax-deferral – up to $22,500 if you’re over age 50, $17,000 otherwise – versus a maximum contribution of $6,000 ($5,000 if under age 50) for the IRAs. This is the reason that the 401(k) account is still a good choice for making retirement savings contributions, even if your employer doesn’t match your contributions. So if you have more money to contribute to your retirement savings than the initial $5,000 (or $6,000 if over age 50), the 401(k) should definitely still be a part of your plan.

Posted on May 30th, 2012

by author: jblankenship.

Posted in: Annual limits, contribution limit, IRA, ira contribution limits, qrp, qualified retirement plan, Roth IRA.
Tagged: 401 k · IRA · ira contribution limits · qualified retirement plan

Ideal Roth Conversion Candidate – Protecting Non-Taxation of SS Benefits

May 25th, 2012

1 comment

This is the second in a series of posts about Ideal Roth Conversion Candidates. See the first post, Low or Zero Tax, at this link.

One of the planning options that most all folks have available to them is the Roth IRA Conversion. For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA. With this transaction, if any of the funds in the original account was pre-tax, that amount would be included in income as potentially taxable in the year of the Conversion.

As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances. A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too great for the result. Detailed below is one specific circumstance that indicates a Roth IRA Conversion is a good move – although each individual needs to consider his or her situation carefully, because every situation is unique.

Protecting Non-Taxation of Social Security

In this situation, the individual has a very low taxable income, low enough that she would not likely need to include Social Security benefits as taxable income, once she begins receiving the benefits. However, once she reaches age 70½ and Required Minimum Distributions (RMDs) are necessary, the amount of these distributions will increase her overall provisional income to a point where Social Security benefits will be taxable at the fullest rate, 85%. Converting a portion of the IRA to Roth IRA will help to keep the RMDs low enough that SS benefits can be taxed at a lower (or zero) amount.

For example, Jane is 60, single, and has retired. She intends to begin receiving Social Security benefits of $24,000 at her full retirement age of 66. She needs a total of $40,000 each year to live on. She presently withdraws that amount from her IRA on an annual basis. Her IRA balance at this point is $600,000.

If she did nothing about converting to Roth, when she reaches 70½ the amount of her RMD will be large enough to bump up her provisional income to a point where her Social Security benefits will be taxable at the maximum 85% rate. This comes about because her balance in the IRA (after withdrawals and annual increases averaging 5%) is roughly $557,000 at her age 70½.

If, however, Jane began a process of converting a small portion of her IRA to Roth IRA each year between now and when she reaches age 70½, she could reduce the size of her traditional IRA and therefore reduce the size of her future RMDs to a point where the tax impact on her SS benefits is eliminated. In our example, if Jane withdrew an additional $15,000 from her IRA and converted the after-tax portion to a Roth IRA, this would reduce her IRA balance to a point where the RMD (when required at age 70½) would be low enough that her SS benefits would no longer be subject to taxation at all.

This series of conversions brings her Traditional IRA balance down to approximately $359,000. At the same time, she has amassed a Roth IRA with a balance of approximately $148,000 – so her total of the two accounts is approximately $507,000. The tax cost of the conversions and the lost income/appreciation on the money used for taxes makes up the difference.

This conversion would cost her an additional $3,750 per year for ten years, but the effect of non-taxation of her future SS benefits would be a reduction in future tax of $5,100 – for the rest of her life. With this in mind, approximately 10 years later, at her age 80, this strategy would have paid off. If she died prior to that age, the Roth Conversion would have cost more than the benefit.

Note: the figures used in the examples do not include inflation, and are purposely rounded for simplification. Real-world results will differ, perhaps significantly, from this example.

Conclusion

There are many other situations when a Roth Conversion makes a lot of sense, the above is one example of a very good scenario for the conversion. As I mentioned previously, each individual’s situation will be different and may or may not result in the same decision to convert or not. Watch for more examples in future posts!

Posted on May 25th, 2012

by author: jblankenship.

1 comment already - add to the conversation!

Posted in: conversion, IRA, Roth Conversion, Social Security.
Tagged: IRA · roth conversion · Social Security

Ideal Roth Conversion Candidate – Low or No Tax

May 23rd, 2012