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The “Fiscal Cliff”

Aug 29th, 2012
by jblankenship.
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What is the “fiscal cliff”? It’s the term being used by many to describe the unique combination of tax increases and spending cuts scheduled to go into effect on January 1, 2013. The ominous term reflects the belief by some that, taken together, higher taxes and decreased spending at the levels prescribed have the potential to derail the economy. Whether we do indeed step off the cliff at the end of the year, and what exactly that will mean for the economy, depends on several factors.

Will expiring tax breaks be extended?

With the “Bush tax cuts” (extended for an additional two years by legislation passed in 2010) set to sunset at the end of 2012, federal income tax rates will jump up in 2013. We’ll go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%). The maximum rate that applies to long-term capital gains will generally increase from 15% to 20%. And while the current lower long-term capital gain tax rates now apply to qualifying dividends, starting in 2013, dividends will once again be taxed as ordinary income.

Additionally, the temporary 2% reduction in the Social Security portion of the Federal Insurance Contributions Act (FICA) payroll tax, in place for the last two years, also expires at the end of 2012. And, lower alternative minimum tax (AMT) exemption amounts (the AMT-related provisions actually expired at the end of 2011) mean that there will be a dramatic increase in the number of individuals subject to AMT when they file their 2012 federal income tax returns in 2013.

Other breaks go away in 2013 as well.

  • Estate and gift tax provisions will change significantly (reverting to 2001 rules). For example, the amount that can generally be excluded from estate and gift tax drops from $5.12 million in 2012 to $1 million in 2013, and the top tax rate increases from 35% to 55%.
  • Itemized deductions and dependency exemptions will once again be phased out for individuals with high adjusted gross incomes (AGIs).
  • The earned income tax credit, the child tax credit, and the American Opportunity (Hope) tax credit all revert to old, lower limits and less generous rules.
  • Individuals will no longer be able to deduct student loan interest after the first 60 months of repayment.

There continues to be discussion about extending expiring provisions. The impasse, however, centers on whether tax breaks get extended for all, or only for individuals earning $200,000 or less (households earning $250,000 or less). Many expect there to be little chance of resolution until after the November election.

Will new taxes take effect in 2013?

Beginning in 2013, the hospital insurance (HI) portion of the payroll tax–commonly referred to as the Medicare portion–increases by 0.9% for individuals with wages exceeding $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately).

Also beginning in 2013, a new 3.8% Medicare contribution tax is imposed on the unearned income of high-income individuals. This tax applies to some or all of the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately).

Both of these new taxes were created by the health-care reform legislation passed in 2010–recently upheld as constitutional by the U.S. Supreme Court–and it would seem unlikely that anything will prevent them from taking effect.

Will mandatory spending cuts be implemented?

The failure of the deficit reduction supercommittee to reach agreement back in November 2011 automatically triggered $1.2 trillion in broad-based spending cuts over a multiyear period beginning in 2013 (the formal term for this is “automatic sequestration”). The cuts are to be split evenly between defense spending and nondefense spending. Although Social Security, Medicaid, and Medicare benefits are exempt, and cuts to Medicare provider payments cannot be more than 2%, most discretionary programs including education, transportation, and energy programs will be subject to the automatic cuts.

New legislation is required to avoid the automatic cuts. But while it’s difficult to find anyone who believes the across-the-board cuts are a good idea, there’s no consensus on how to prevent them. Like the expiring tax breaks, the direction the dialogue takes will likely depend on the results of the November election.

What’s the worst-case scenario?

Many fear that the combination of tax increases and spending cuts will have severe negative economic consequences. According to a report issued by the nonpartisan Congressional Budget Office (Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012), taken as a whole, the tax increases and spending reductions will reduce the federal budget deficit by 5.1% of gross domestic product (GDP) between calendar years 2012 and 2013. The Congressional Budget Office projects that under these fiscal conditions, the economy would contract during the first half of 2013 (i.e., we would likely experience a recession).

It’s impossible to predict exactly how all of this will play out. One thing is for sure, though: the “fiscal cliff” figures to feature prominently in the national dialogue between now and November.

The foregoing post was brought to you by Broadridge/Forefield.

Posted on Aug 29th, 2012
by author: jblankenship.

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Posted in: #noTOP, 2012 Calendar Year, 2012 tax year, capital gains rate, financial planning.

Book Review: The Malign Hand of the Markets

Aug 27th, 2012
by jblankenship.
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Subtitle: The Insidious Forces on Wall Street that are Destroying Financial Markets – and What We Can Do About It

The Malign Hand of the Markets

This book, written by Duke Professor of Psychology, Biology and Neurobiology John Staddon, provides a quite interesting view of the way our markets are impacted by the “malign hand” – a play on the “invisible hand” described by Adam Smith in his book “Wealth of Nations”.

Briefly, the Invisible Hand Theory describes how an unknown force allows the market to self-balance – the self-interest of the individuals making up the marketplace has a beneficial impact on the overall marketplace, even though the individuals in the marketplace are only interested in their own benefit.

But we’re not here to talk about Invisible Hand, but rather the Malign Hand.  Staddon explains that individual self-interest may have a negative impact to the overall marketplace.  One example of this is in the tragedy of the commons – where a finite amount of resources, let’s say for example fish in the sea, are harvested by a set number of fishermen.  For each additional fish caught, the fisherman makes more money.  Self-interest leads the fishermen to catch more and more fish, and for a while that means they all make more money.  After some time has passed, the number of fish available begins to dwindle, enough that none of the fishermen is making enough money to live on.

Once this has happened, preservation measures must be taken in the form of regulation, limiting all fishermen to a severely reduced catch.  This regulation drives some of the fishermen out of the market, and gradually the fishery recovers (hopefully) to a point that sustains the fewer remaining fishermen with an adequate living.

Mr. Staddon argues that the tragedy of commons, which has many faces in our financial industry, is brought on by the way our system of regulation (and de-regulation) has evolved over time.  This system results in feedback loops that end up reinforcing the wrong kinds of behavior – behavior that actual exacerbates the situation, rather than restoring balance to the market.

Many diverse disciplines are used to help explain how the reinforcement process works: biology, psychology, behavioral economics, and philosophy.  This leads to some very interesting theories on how things work in our system.  However, this does not lead to a light read – it’s pretty heavy indeed.  For those who endeavor to take it on, it’s interesting to read Staddon’s takes on how it all plays out.

Staddon isn’t a believer in Efficient Market Theory, and he takes many opportunities to poke holes in it.  Instead, he believes that the EMT only goes part-way to explaining how the market works – and that the rest of the story is left unexplained since there is inherent unpredictability in the market.  This is further enhanced (in Staddon’s explanation) by the fact that value in the marketplace is not a consistently easily-identified figure, and in order for a market to be efficient, measures must be easily and concretely identified.  Efficiency infers a ratio – and without a way to identify the figures as inputs, a ratio cannot be useful.

I found this book to be very insightful in explaining how governmental influence has not regularly been helpful.  One of the examples was particularly interesting: How the fiscal policies and excess (deficit) spending of FDR’s administration during the Great Depression actually prolonged the economic problems rather than improving them as has often been attributed.  The improvements to the economy didn’t actually come about until the US entered WWII – which continued the deficit spending, but it also put into play severe austerity measures on the populace, while at the same time putting more people to work.  Upon the end of the war, unemployment was at manageable levels and the consumer public had an intense pent-up demand to consume.  It was these factors that eventually turned around the economy.  Staddon points out that forced austerity measures aren’t readily accepted by the public, so something like this isn’t likely to be artificially employed to resolve our current economic situation.

All in all I enjoyed the book – even though it is a relatively heady read – and I recommend it to anyone who would like more insight on our economic situations, past and present.  Staddon also provides some examples of regulatory changes that could be made to help resolve current economic issues.  He’s given me a lot of fuel for future research on the topic – I suspect that there are many other sides to the arguments he’s posed.

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

Posted on Aug 27th, 2012
by author: jblankenship.

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Posted in: Book review, economic update.
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Maximizing Your Pension Using Term Life Insurance

Aug 22nd, 2012
by jblankenship.
1 comment
Tree in Winter

There are many, many ways that life insurance can be used.  Sometimes it is to replace lost income, when a wage earner dies during his or her working years.  Other times it may be to help pay taxes on a large estate upon the passing of the second spouse in a couple, so that your heirs can receive the full fruits of your labors and won’t have to worry about a tax haircut.

Another use for life insurance is to help you to maximize a pension.  I know, everyone believes that pensions have gone the way of the buggy-whip.  That may be the case for many folks, but I still find a lot of people retiring these days who have a traditional pension.

For those of you who are familiar with pensions, you’ve probably seen the payout options that are typically available: lump sum, single life annuity, joint and 100% survivor annuity, joint and 50% survivor annuity, and so forth.  We’ll focus on just two of these options: a single life annuity, versus a joint and 100% survivor annuity.

For an illustrative example, we’ll say that the single life annuity would pay out at a rate of $40,000 per year, while the joint and 100% survivor annuity would pay at a rate of $33,000 per year.  The retiree is 62. (Note to the insurance professionals out there: I pulled those numbers out of the air, they may or may not represent realistic annuity payout rates!)

Naturally, you’d like to receive the higher amount from the pension – but the risk that you take is that your survivors would have to get by without that pension income. And if you happened to die relatively soon after leaving the job, this could turn out to be catastrophic for your surviving spouse (and family, if you have other dependents).

You might actually be able to get by on the lower amount, and that would provide your surviving spouse with the same benefit over his or her lifetime as well – but it would be nice to have a leetle bit extra.  One way to do this would be to use term life insurance.

If you took out tiered (or laddered) term life insurance policies to cover an approximately 20 years, this could cover any shortfall if you happened to die during that 20-year period.  During that time, receiving an extra $7,000 per year from your pension, you could use $2,000 (and gradually less, as your tiered policies expire) to pay the premium on the policy, and then you’d have an additional $5,000.  If you saved the difference at an average of 5% return, this would equate to a $165,000 savings by that time.  Even if you didn’t save the extra, your portfolio should have grown by that much, assuming that you’re maintaining some willpower over your spending.

At any rate, if you happen to outlive the averages and live beyond age 82, every year that you receive the pension is extra money.  If you die earlier, your term policies will pay out to your surviving spouse, providing him or her with the funds to continue with the same or a similar standard of living afterwards.

A pension-maximization strategy isn’t for everyone!  Several factors need to be in your favor:

  • The increase in pension is more than enough to pay the insurance premiums
  • Your health must be good enough to qualify you for the additional insurance policy(s)
  • Your spouse must know how to handle the insurance proceeds if you die first
  • Keep in mind that if the pension is increased, taxes on that retirement income will also increase – to the amount you receive may be less than you think
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Posted on Aug 22nd, 2012
by author: jblankenship.

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Posted in: life insurance, retirement plans, retirement savings plans.
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The Roth 401(k) Plan

Aug 20th, 2012
by sraskie.
2 comments
David Lee Roth

Many hard working Americans have access to a defined contribution retirement plan called a 401(k). Essentially, a 401(k) is a retirement savings vehicle provided by employers to their employees as a means for the employee to save for retirement, often with the employer providing a “match” of the employee’s contributions up to a certain percentage.

As of January of 2006 (a result of EGTRRA 2001), employers can now offer employees the Roth 401(k) as part of their 401(k) plan. Before we get into the advantages of the Roth 401(k), let’s briefly look at how the regular 401(k) works. Employees that have access to a 401(k) are generally allowed to contribute up to $17,000 (2012 figures, indexed annually) per year to their 401(k). Employees aged 50 and over are allowed an additional $5,500 (again, 2012 figures, indexed annually). Employee salary deferrals are taken from the employee’s earnings on a pre-tax basis – meaning the amounts going to the 401(k) are not taxed and thus allowed to grow tax deferred in the 401(k) until needed or required to be withdrawn at 70½ (RMDs). When withdrawn, they are then taxed at ordinary income tax rates.

Enter the Roth 401(k).

With a Roth 401(k), an employee’s salary deferrals are taken after the paycheck has been taxed – meaning after tax money goes into the Roth 401(k) account and is allowed to grow tax-deferred and qualified withdrawals are income tax free. Like its regular 401(k) counterpart, the Roth 401(k) requires RMDs to be taken at age 70½.

The Roth 401(k) offers an employee many advantages. The first is that an employee may make more money than would allow him or her to contribute to a Roth IRA. There are no such income restrictions or phase-outs in a Roth 401(k). Additionally, an employee can choose to save money to their Roth 401(k) if they feel they may be in a higher tax bracket at retirement or if they feel tax rates will increase in the future. Also, the maximum contribution to a Roth 401(k) is $17,000 annually versus $5,000 annually for a Roth IRA. Those age 50 or over are allowed to put in an additional $5,500 into their Roth 401(k), whereas those same people are only allowed an additional $1,000 for their Roth IRA. Finally, when an employee retires, they are allowed to roll their Roth 401(k) to a Roth IRA – without taxation or penalty, and avoid RMDs (remember Roth IRAs do not have RMDs).

The first place to check to see if you can take advantage of the Roth 401(k) is with your HR representative. Should you have access to this option, see if your employer will match your contributions to the Roth 401(k). The Roth 401(k) can make a lot of sense for those wanting to save even more money on a tax-advantaged basis.

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Posted on Aug 20th, 2012
by author: sraskie.

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Posted in: IRA, retirement plan, Roth 401(k), Roth IRA.
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Average Indexed Monthly Earnings Years

Aug 17th, 2012
by jblankenship.
2 comments
Panneau Aime la Plagne

We’ve discussed the AIME (Average Indexed Monthly Earnings) calculation before, and it’s not like anything has changed about those calculations.  It turns out that the calculation process can be a bit confusing (shocked? I think not).

The AIME is calculated using what’s known as the “base years”, which are those years between your age of 22 and 62 that occurred after 1950 (I realize most folks needing to know about this didn’t need that 1950 reference, but it’s part of the rules, so I included it).  Of those 40 years, only the 35 years with the highest earnings are used to calculate the AIME.  The earnings for each year is indexed (see the original article for details) and then the earnings are averaged.

One of the questions that comes up is how years after age 62 are handled in this process.  If earnings in subsequent years are greater (after indexing) than earnings in the earlier “top 35” that was used for the calculation, your AIME can be recalculated, which might make a change to your PIA.  So working past your age 62 can have a positive impact on the benefit that you (and possibly your family) can receive.

See the earlier article about the Primary Insurance Amount (PIA) calculation for how the AIME is used to generate the PIA.  Bear in mind that additional earnings may not have a dramatic impact on your PIA.  This is because (using 2012 figures) any amount of your AIME between $767 and $4,624 are included at the rate of 32%, and AIME amounts above $4,624 are included at only 15%.  Therefore, increases to your AIME above those amounts have only a minimal impact on your PIA.

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Posted on Aug 17th, 2012
by author: jblankenship.

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Posted in: Social Security, social security benefits, social security retirement.
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Book Review: Low Fee Socially Responsible Investing – Investing in your worldview on your terms

Aug 15th, 2012
by jblankenship.
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Low Fee Socially Responsible Investing

Today I’m reviewing a book written by a friend and colleague, Tom Nowak, CFP®.  Tom is passionate about Socially Responsible Investing (SRI) and he has written a great overview of the concept.  He introduces some very good tools that the average investor can use, either on your own or to help guide conversations with your advisor.

But SRI concepts are available in many forms from many sources – what makes Tom’s book unique is that he develops a framework that allows the individual investor to implement SRI strategies (or for that matter, any investment strategy reflecting a particular worldview) in a very cost-effective manner.

Mr. Nowak starts out with a discussion of fees and how they can have a major impact on your overall investment returns.  As you may already know, any reduction that you can achieve on the fees that your investment activities cost you will be returned directly to your bottom line.  Tom outlines the options that you can use for investing, pointing out the pros and cons of each alternative.  Certain alternatives are more cost effective at various asset levels – and these alternatives are discussed and reviewed at length.

Next, the author outlines his recommended approach for the Ultra-Low Fee SRI portfolio.  Interestingly, as Tom points out, this sort of approach could be used for literally any worldview, including SRI in its many forms as well as, for example, whatever you might call the exact opposite of socially-responsible (socially irresponsible? sin-oriented? college fraternity house oriented?).

Tom then follows up with a chapter with Q&A on the approach, which provides excellent insights to help you implement such a strategy.  After that chapter is a chapter for your advisor to review as you look to implement your strategy.  Advisors can learn quite a lot from reading what Mr. Nowak has to say – I’ve found his insights quite valuable over the years, and the chapter presents his insight very well.

All in all, I think this is a great book for any investor to read – regardless of whether or not you are looking to implement an SRI investing approach.  Advisors have a lot to learn from Tom’s approach as well, for helping your clients to implement investment approaches that reflect the client’s particular worldview.  Tom does a wonderful job of explaining how to implement very low-cost investment strategies using readily-available tools and investment products.

Tom’s passion for the subject shows through in the book – do yourself a favor and spend some time learning about Tom and his excellent ideas.

Posted on Aug 15th, 2012
by author: jblankenship.

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Posted in: Book review, fiduciary, financial planning, investing, socially responsible investments.
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Selling Your Home? IRS Offers Tax Tips

Aug 13th, 2012
by jblankenship.
2 comments
gains

With the real estate market beginning to turn around a bit, many people are buying new homes and selling their old homes.  Recently the IRS published their Summertime Tax Tip 2012-14, which outlines several tips you should be aware of when selling a home.

The actual text of the Tax Tip is presented below:

Ten Tax Tips for Individuals Selling Their Home

The Internal Revenue Service has some important information for those who have sold or are about to sell their home.  If you have a gain from the sale of your main home, you may be able to exclude all or part of that gain from your income.

Here are 10 tips from the IRS to keep in mind when selling your home.

1.  In general, you are eligible to exclude the gain from income if you have owned and used your home as your main home for two years out of the five years prior to the date of the sale.

2.  If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).

3.  You are not eligible for the full exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.

4.  If you can exclude all of the gain, you do not need to report the sale of your home on your tax return.

5.  If you have a gain that cannot be excluded, it is taxable.  You must report it on Form 1040, Schedule D, Capital Gains and Losses.

6.  You cannot deduct a loss from the sale of your main home.

7.  Worksheets are included in Publication 523, Selling Your Home, to help you figure the adjusted basis of the home you sold, the gain (or loss) on the sale, and the gain that you can exclude.  Most tax software can also help with this calculation.

8.  If you have more than one home, you can exclude a gain only from the sale of your main home.  You must pay tax on the gain from selling any other home.  If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

9.  Special rules may apply when you sell a home for which you received the first-time homebuyer credit.  See Publication 523, Selling Your Home, for details.

10. When you move, be sure to update your address with the IRS and the US Postal Service to ensure you receive mail from the IRS.  Use Form 8822, Change of Address, to notify the IRS of your address change.

For more information about selling your home, see Publication 523, Selling Your Home.  This publication is available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

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Posted on Aug 13th, 2012
by author: jblankenship.

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Posted in: capital gains and losses, income tax.
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“Swim With Jim” Radio Interview by Jim Ludwick

Aug 10th, 2012
by jblankenship.
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I recently had the honor of being interviewed on the radio by Mr. Jim Ludwick, a colleague that I admire and look up to a great deal.  Jim is a CERTIFIED FINANCIAL PLANNERTM professional, and his practice is based in Odenton, Maryland with additional offices in Washington, DC, Santa Barbara, California, San Mateo, California, and New York City.  Jim also is a fellow member of the Garrett Planning Network.

In the interview we talk very briefly about some of the important factors of Social Security that baby boomers need to address as they plan for Social Security benefits.

You can follow Jim’s radio program on BlogTalkRadio; his channel is Swim With Jim.

 

Listen to internet radio with Swim with Jim on Blog Talk Radio

To hear the interview, click the “Play” button above.

In the interview I mention that it can be helpful to have an advisor work with you to understand your Social Security benefits.  Members of the Garrett Planning Network are uniquely positioned to help in such matters, as we operate on an hourly basis providing financial advice, unlike most of our financial industry brethren (and sistren).  Seek out your nearest Garrett Planning Network member if you need help!

Posted on Aug 10th, 2012
by author: jblankenship.

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Posted in: Social Security, social security retirement, Social Security spousal benefit, social security survivor benefits.
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Wealth Defense: When Should You Start Social Security Benefits?

Aug 8th, 2012
by jblankenship.
1 comment

The foregoing is a re-post of an article that I wrote which was included in The Motley Fool’s Rule Your Retirement newsletter.  Enjoy!

Want to double a chunk of your retirement income? It’s easy — just delay taking Social Security by about six years!

OK, so it’s not really that simple. The time to apply for Social Security benefits is different for each individual; there is no magical “best age” for everyone. Thus, to maximize your benefit, it’s important to understand the consequences of choosing to apply at different ages.

It all starts with the most important age: your full retirement age, or FRA (see table below). If you receive your Social Security retirement benefit before your FRA, the benefit will be reduced. The biggest reduction is at age 62, the earliest you can begin receiving benefits (except for widows and widowers, who can begin survivors’ benefits at 60).

Year of Birth Full Retirement Age
1943-1954 66
1955 66 and 2 months
1956 66 and 4 months
1957 66 and 6 months
1958 66 and 8 months
1959 66 and 10 months
1960 and later 67

The more you delay applying for benefits after your FRA, up to age 70, the more your benefit will increase. At 70, the benefit no longer increases. To show how age affects Social Security, the table below displays estimated annual benefits for a person born on June 1, 1950, who earned $60,000 last year (all amounts are in future, or inflated, dollars).

Worth the Wait?

Age Annual Benefit
62 $13,764
64 $17,064
66 $21,300
68 $26,796
70 $33,048

The SSA employs really smart actuaries who have the very fun job of poring over death statistics (which may or may not involve midnight visits to cemeteries — I can’t divulge my sources). These actuaries aim to coordinate the reductions and increases with average life expectancy so that it shouldn’t matter when you take your benefit; it should work out about the same no matter when you start. But average life expectancy hasn’t quite caught up with actuarial estimates. So, since the average life is slightly less than the crossover point, it’s a bit in your favor to start early if you’re the average person who lives to the average life expectancy.

Factors to Consider

Despite what the actuaries say, there are times to delay taking Social Security to increase the chances that you’ll receive the most bang from your benefits.

Will you live longer than average? About one of every four people age 65 today will live past age 90; one in 10 will live past age 95. So if your family leans past the occasional octogenarian, add longevity to your equation. When delaying benefits, the break-even point usually ranges from age 78 to 82. It’s no coincidence the average life expectancies for men and women in the U.S. are about 76 and 81, respectively.

Will you continue working? You can receive Social Security while still earning a paycheck, but doing so before your FRA could reduce your monthly benefit, depending on how much you’re earning. This is made up for when you reach FRA, but it’s important to know so that you can plan for the benefit reductions. Also, if you continue to work while receiving benefits, you’ll continue accruing credit for your annual wages. If you have earlier years on your record with low (or no) wages, your benefit could increase.

Do you really need the money? If you’re ill, have a shortened life expectancy, or face limited resources, it may be necessary to take Social Security early. The financial calculations I do for my clients always assume the recipient will live to at least 80 and can use other resources until age 70. If one or both of these circumstances is not the case for you, it probably makes more sense to take your benefits earlier.

Do you have a spouse or dependents? The age you apply for benefits locks you into a benefit base for the rest of your life. (Technically, you can get a do-over within 12 months of filing if you give back all the money.) Your benefit base might affect your spouse’s benefit, both when you’re alive and if you die first. The benefit base can also determine payments to other family members. We’ll delve more into this next month, when we explore strategies for maximizing family benefits.

Let the Numbers Do the Talking

Want to see how application age can affect your benefit? The SSA has a collection of online Social Security calculators to help estimate your benefit amounts at various ages, which can help you in your decision-making.

Posted on Aug 8th, 2012
by author: jblankenship.

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Posted in: Deemed Filing, Delayed Retirement Credit, file and suspend, Social Security, Social Security spousal benefit, social security survivor benefits.
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The 403(b) and 457(b): A One-Two Punch for Retirement

Aug 6th, 2012
by sraskie.
3 comments
403 B's

Many non-profits, public schools, universities, state governments have access to either a 403(b) or a 457(b) retirement plan. Both the 403(b) and the 457(b) are retirement plans that these institutions can offer employees in addition to or in lieu of a defined-benefit pension. For ease of simplicity, think of these plans as a 401(k), but for non-profits. We won’t get into the minutia of exactly how they’re different here.

Like their 401(k) counterpart, the 403(b) and the 457(b) allow their owners to defer from their salaries up to $17,000 annually, on a pre-tax, tax-deferred basis. For those aged 50 and over, the IRS allows an additional $5,500 age-based catch-up contribution. These numbers are for 2012, they are indexed annually for inflation.

There is a select group of people that may have access to both the 403(b) and the 457(b). For these chosen few, there is an opportunity to save even more money. Here’s why: Let’s say you work for two employers, one is a for-profit that offers a 401(k) and one is a non-profit that offers a 403(b). By law, you are allowed to put in $17,000 total among both accounts – meaning $17,000 aggregated between the two accounts. So you could put in $9,000 in the 401(k) and $8,000 in the 403(b), and other different combination as long as your total between the two doesn’t exceed $17,000. For the age based catch-up, the aggregate between the accounts cannot exceed $22,500.

Now, let’s say you have access to both a 403(b) and a 457(b). Technically speaking, the 457(b) is considered a non-qualified plan – meaning it isn’t subject to certain ERISA requirements. One of those requirements it’s exempt from is the aggregation rule. What does this means for the chosen ones? It means that they can now contribute $17,000 to the 403(b) and another $17,000 to the 457(b) – for a total of $34,000, annually!

As you can see, these numbers can really add up especially if you’re nearing retirement and wanting to save all you can. It also comes in handy if you’re expecting a contract buy-out at retirement and or have unused vacation or sick time coming your way. No need to take that as a lump sum and have it taxed. Simply defer it to your 403(b), and once your 403(b) is full, move the remainder to your 457(b) or vice versa.

Talk to your employer to see what they offer and see if you’re one of the lucky ones!

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Posted on Aug 6th, 2012
by author: sraskie.

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Posted in: 403 b, Annual limits, qualified retirement plan, retirement plans, retirement savings plans.
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Increase Your Social Security Benefit After You’ve Filed: File and Suspend Doesn’t Have to Be All at Once

Aug 3rd, 2012
by jblankenship.
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Suspended

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.

We’ve discussed the File and Suspend activity many times on this blog, but most of the time we refer to the activity as happening all at the same time.  This is because very often we’re talking about one spouse setting the table for the other spouse to begin receiving Spousal Benefits.

There is another situation where File and Suspend could be used – you could earn delayed retirement credits after you had already started receiving your retirement benefits by suspending your benefit.  You must be at least Full Retirement Age (FRA) when you do this, but it could work in your situation.

Say for example, you started receiving your benefit at age 62.  At that point you were retired, and you intended to just play golf for the rest of your life.  After about 180 holes a week for the first two years, you decide that you’d rather poke yourself in the eye than listen to the same old stories from your duffer buddies again, and you go back to work.

As you return to work, it turns out that you’re earning much more than the earnings limits allow, and as such your retirement benefit is completely withheld.  There’s not much you can do about it since you’re only 64 at this point, so you just let SSA do their thing – knowing that you’ll get your payback in credits for those months when your benefit was withheld after you reach FRA.

But, when you reach FRA, you’re still working – and you don’t need the Social Security benefit to live on.  At this point you could Suspend your application and stop receiving benefits altogether (since you haven’t been receiving them anyhow) and begin accruing Delayed Retirement Credits (DRCs) on your benefit.

If your FRA was 66, you could accrue 32% (8% per year or 2/3% per month) in DRCs.  Your new benefit would be calculated in a rather convoluted fashion by reducing the benefit for the two years that you received them (between ages 62 & 64) and then increasing the benefit by the 32% of DRCs.

So if your Primary Insurance Amount (the unreduced benefit that you would have received at FRA) was $2,000, since you had 24 months of early benefits the first part of the calculation would be to reduce that $2,000 by 13.34% (6.67% per year).  Then that amount would be increased by the DRCs that you accrued, 32%.  So:

$2,000 times 86.66% times 132% equals $2,287.80

The total benefit that you could receive at age 70 would be $2,287.80 – although your PIA could have adjusted due to your additional earnings, if those earnings replaced lower earning years on your record.

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Posted on Aug 3rd, 2012
by author: jblankenship.

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Posted in: #noTOP, Delayed Retirement Credit, DRC, Earnings Limits, file and suspend, Social Security.
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Take Your RMDs From Your Smallest IRA

Aug 1st, 2012
by jblankenship.
2 comments
small toad

Here’s a strategy that you could use to simplify your life: when you’re subject to Required Minimum Distributions (RMDs) after age 70½, you have the option of taking separate RMDs from each IRA that you own OR you could take all of your RMDs from one account if you like.

As long as you calculate your RMD based upon all of the IRAs that you own, you are free to take the full amount of all of your RMDs from one single account (or several accounts) if you wish.  And keep in mind that the “I” in IRA stands for Individual – so you can’t aggregate your IRAs with your husband’s, for example.

By doing so, you could eliminate the smaller account(s) if you wish, thereby reducing paperwork (fewer accounts and statements).  As well, you don’t have to keep track of as many accounts for estate planning. But then again, you might have chosen to have multiple accounts in order to leave certain amounts to separate groups at your passing.  If that’s the case, you can choose to take your RMDs from each individual account, reducing each account by a small amount each year.

Keep in mind that this only applies to IRAs.  If you have 401(k) plans or other non-IRA retirement accounts that also have RMD requirements, those amounts must be specifically taken from those accounts.  This can be another reason why rollover from the qualified retirement plan into an IRA can be beneficial.  You can also eliminate the smaller IRAs by rollover as well.

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Posted on Aug 1st, 2012
by author: jblankenship.

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Posted in: IRA, qrp, qualified retirement plan, required minimum distribution, retirement, rmd.
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Book Review: Abnormal Returns – Winning Strategies From the Frontlines of the Investment Blogosphere

Jul 30th, 2012
by jblankenship.
2 comments
Abnormal Returns

I wasn’t sure what to expect when I opened this book.  After all, the subtitle could lead one to expect some sort of sensationalistic attention-grabbing sort of “get rich quick” scheme.  I was pleasantly surprised, to say the least.

I had not read any of author Tadas Viskanta’s writings prior to this book (I’ve since resolved that shortcoming – see Abnormal Returns, you won’t be disappointed!), so I didn’t realize how insightful and reasoned Mr. Viskanta’s commentary could be.  What he has produced in this book is an excellent overview of the components of the investment environment these days.  This book should be required reading for anyone who is investing these days – especially for the non-professional investor who is going it alone, without a professional advisor.

The author starts off with a thorough explanation of the concepts of Risk and Return, and then explains the basics of Stock (Equity) and Bond investments.  These first four chapters provide a sound basis for a better understanding of investing – these are easily-understood explanations with real-world examples.

Building on the foundation of those chapters, Viskanta then explains Portfolio Management, with particular attention given to measurement of results against benchmarks.  Additionally, the problems associated with leveraged investments and illiquidity in investments are discussed at length – including how to avoid these problems.

Mr. Viskanta then explains the problems that the individual investor experiences with Active Investing.  As I’ve mentioned regularly, active investors are most often unsuccessful when compared to passive, index-oriented investors – and this premise is underscored with Viskanta’s explanations.

In the next section the book, Mr. Viscanta provides a thorough explanation of Exchange Traded Funds, Global Investing, and Alternative Investments – all important components of today’s investment world.  Then to round out the book, there are chapters on investor behavior, better use of the media (hint: pay no attention!), and what we can learn from the “lost decade”.

All in all, an excellent book.  I recommend this book regularly to folks who are hoping to build a foundation of knowledge about investing.

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

Posted on Jul 30th, 2012
by author: jblankenship.

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Posted in: Book review, investing, investment, Links.
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Why It Can Be So Important to Delay Social Security Benefits

Jul 27th, 2012
by jblankenship.
1 comment
BH Delay

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.

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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.
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Deducting Job Search Expenses On Your Tax Return

Jul 23rd, 2012
by jblankenship.
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Job Search

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.

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Posted on Jul 23rd, 2012
by author: jblankenship.

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Posted in: income tax, itemized deduction.
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The Restricted Application for Social Security Spousal Benefits

Jul 20th, 2012
by jblankenship.
2 comments
Restricted Area

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.

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Posted on Jul 20th, 2012
by author: jblankenship.

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Posted in: file and suspend, restricted application, retirement benefits, social security benefits, Social Security spousal benefit, Spousal Benefit.
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The Difference Between IRA Contributions and Rollovers

Jul 18th, 2012
by jblankenship.
2 comments
Contribution Box

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.

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Posted on Jul 18th, 2012
by author: jblankenship.

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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.
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Tips for Summer Jobs From the IRS

Jul 16th, 2012
by jblankenship.
1 comment
Reel lawn mower

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.

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Posted on Jul 16th, 2012
by author: jblankenship.

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Posted in: education expenses, financial aid, income tax, IRA, Roth IRA.
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Guidance on Qualified Charitable Contributions From Your IRA For 2012

Jul 11th, 2012
by jblankenship.
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United States Congress

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.

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Posted on Jul 11th, 2012
by author: jblankenship.

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Posted in: #noTOP, 2012 tax year, IRA, QCD, required minimum distribution, rmd.
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Important Factors When Planning Social Security for Couples

Jul 6th, 2012
by jblankenship.
4 comments
picnic

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).

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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.
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