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

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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

4 comments

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.

4 comments already - add to the conversation!

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

3 comments

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.

3 comments already - add to the conversation!

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.

4 comments already - add to the conversation!

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

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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.

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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

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Low (or Zero) Tax Rate

If an individual is in a situation with a very low tax rate, a Roth Conversion could be a good idea – especially if the situation with the low tax rate is due to change in the future.

An example would be if Joe, a 30-year-old, finds himself taking a year off to go to school and pick up the last few hours of his Master’s degree. Joe has had a good career in sales for the past several years, and he put $100,000 into his former employer’s 401(k) plan. The account grew to $150,000 by this year, when Joe has started going to school, intending for his Master’s degree to allow him to advance further in his career. Joe also has a fairly significant taxable investment account, some of which he plans to use for living expenses, but he also has some extra money in the account which could be used to pay taxes on a Roth Conversion.

Since Joe supports himself and he is a single filer, he should consider converting a portion of his 401(k) account (all pre-tax money) to a Roth IRA. This is because, having no other income for the tax year, the first $9,750 of income that he claims on his tax return will have zero tax (for 2012) because of the standard deduction and personal exemption. After that, his next $8,700 of income claimed is taxed at 10%, for a tax cost of $870 for a total conversion of $18,450 – an effective rate of 4.7%.

He could further convert up to an additional $26,650 at the 15% rate, for a total converted amount of $45,100. The total tax cost of his conversion would be $4,868, for an effective tax rate of only 10.8%. Taking this a step further, the 25% tax rate would be used for up to $50,300 more of conversion. This would result in a total of $95,400 being converted, and a total tax of $17,443 – for an effective tax rate of only 18.3%.

Since Joe expects that his income in the future will be much higher – into the six-figures category, it probably makes sense for him to convert as much as possible in these lower tax brackets while his income is actually zero for the year. Even though it will cost him $17,443 from his taxable account to pay the tax, this is a far lower rate than he could expect to pay on withdrawals from this account in the future.

It should be noted that one of the very important factors in this scenario is that Joe has other funds from which to pay the tax. If he didn’t have this money available from a source other than his IRA, a portion of the IRA would have to be used to pay the tax. This would result in imposition of the 10% early withdrawal penalty in addition to the tax on the distribution. The additional cost of this distribution would weaken the position and increase the overall cost of the conversion.

Conclusion

Posted on May 23rd, 2012

by author: jblankenship.

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

What is Meant by Half Years of Age?

May 21st, 2012

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If you’ve paid much attention to the rules around retirement plans (IRAs, 401(k)s, and others), you’ve probably noticed that there are a couple of rules that refer to ages that include “½”. So what does this mean??

Well, quite literally, this means 6 months after you reach a certain age. The two primary ages with “½” included are 59½ and 70½. So, to be age 59½, means that you reached your 59th birthday six months prior to that date. Likewise, to be age 70½ means that you reached age 70 six months prior to that date.

These two ages are for different purposes and are (naturally) treated differently.

Age 59½

The rule using age 59½ is for one of the exceptions to the penalty for early withdrawals from your IRA or 401(k) plan: once you’ve reached that age (and not before that age) you can take withdrawals from your IRA or 401(k) plan without limits (401(k) plans may also require a separation from service).

Here is an important point: this rule is specifically applied ONCE YOU REACH AGE 59½, and not before. In the year that you will reach this age, any withdrawals taken from the account before you reach age 59½ will be subject to the 10% penalty if no other exceptions apply.

Age 70½

The rule using age 70½ is regarding Required Minimum Distributions (RMD), as well as limiting contributions to an IRA. For RMDs, the requirement is simply that you must begin taking the required distributions for the year in which you’ll reach age 70½. (You can actually delay the first distribution until April 1 of the following year, but the distribution is based on the year when you reach age 70½.)

Note that this is different from the way the 59½ rule works: it’s simply the year in which you’ll reach age 70½, not the specific date that you reach age 70½. So if your birthday is between January 1 and June 30, your age 70½ year is the year that you reach 70 years of age. If your birthday is between July 1 and December 31, your age 70½ year is the year that you’ll be reach 71 years of age.

The same holds true for contributions to an IRA: in the year that you’ll reach 70½, you are not allowed to make contributions, and you are not allowed to make contributions thereafter.

You Don’t Have to Count Days

The good news is that you don’t have to count days. For the purposes of these rules, the half year is the same date, six months later. For a birthdate of May 11, the half year is reached on November 11 of that same year. For odd circumstances, such as August 31, of course you’ve reached the half year on February 31 of the following year. Actually, I believe the rule is that you reach that milestone on March 3 – I’d use this date if you are in this situation, just to be certain.

Posted on May 21st, 2012

by author: jblankenship.

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Posted in: 72t, Early Distribution, employer plan, IRA, qrp, retirement accounts, rmd.
Tagged: 401 k · early retirement · IRA · qualified retirement plan

2013 Social Security Wage Base Projected

May 18th, 2012

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Cardpunch operations at U.S. Social Security Administration

jb update 10/16/2012: The wage base for 2013 was confirmed at $113,700.

The Social Security Administration trustees recently projected the wage base for 2013. This is the maximum amount of wage income that an individual earns for the year that is subject to Social Security withholding tax. For 2013, this amount is projected at $113,700.

The new amount is $3,600 more than the 2012 wage base, which is set at $110,100, for an increase of 3.27%. Keep in mind that this is only the increase in the taxed wage base, and there is little correlation between this and any potential increase in benefits for the year.

Future years’ estimated wage bases are projected as follows:

2014: $117,900

2015: $123,000

2016: $128,400

These are only projections, each year in October the SSA trustees will set the amount for the coming year.

Posted on May 18th, 2012

by author: jblankenship.

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Posted in: #noTOP, 2013 tax year, Social Security, social security administration, social security tax.
Tagged: Social Security · social security administration · social security tax

Penalties for Failure to File or Pay

May 14th, 2012

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Exterior of the Internal Revenue Service office

When you don’t file your tax return or if you don’t pay the tax owed on time, the IRS has specific penalties that are applied to your account. Recently the IRS issued their Tax Tip 2012-74, which lists eight facts about these penalties. The actual text of the Tax Tip is listed below:

Failure to File of Pay Penalties: Eight Facts

The number of electronic filing and payment options increases every year, which helps reduce your burden and also improves the timeliness and accuracy of tax returns. When it comes to filing your tax return, however, the law provides that the IRS can assess a penalty if you fail to file, fail to pay, or both.

Here are eight important points about the two different penalties you may face if you file or pay late.

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty.
The failure-to-file penalty is generally more than the failure-to-pay penalty. So if you cannot pay all the taxes you owe, you should still file your tax return on time and pay as much as you can, then explore other payment options. The IRS will work with you.
The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes.
If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes.
If you request an extension of time to file by the tax deadline and you paid at least 90 percent of your actual tax liability by the original due date, you will not face a failure-to-pay penalty if the remaining balance is paid by the extended due date.
If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Posted on May 14th, 2012

by author: jblankenship.

Posted in: irs, tax, tax deferral, tax preparers.
Tagged: irs · tax deferral

Inherited IRA Multiple Beneficiary Example

May 9th, 2012