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

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Tagged: charitable contribution · income tax · irs

A Tax-Free Roth Conversion Question of Timing

Apr 4th, 2012

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Fern Overgrowth (Photo credit: MightyBoyBrian)

We’ve discussed here in the past about how it is (at least under present law) a perfectly legal maneuver to make a non-deductible contribution to a traditional IRA and then at some point later convert the same contribution to your Roth IRA (see Is it Really Allowed? for more). If you have no other IRA accounts, this conversion to Roth can be a tax-free event, especially if there has been no growth or gains in the investments in the account.

However (and there’s always a however in life) I recently came across a situation that was sent to me by a reader, where he wanted to do such a conversion, but he also wanted to rollover some money from his 401(k) plan into an IRA. The question is in the timing – understandably, if he does the conversion from the traditional IRA to the Roth IRA, there will be no tax on the conversion, since he doesn’t have any other IRA accounts.

As we know, when taking distributions from an IRA (such as for a conversion) the taxability of the distribution depends upon the total amount of money in all IRAs, and how much is pre-tax versus how much is post-tax.

Here’s an example: Joe has an IRA with deductible contributions of $4,000 and subsequent growth of $1,000. He is no longer eligible for deductible contributions to his account, and he also is not eligible for contributions to a Roth IRA, both due to his income level. He wants to make a non-deductible contribution of $5,000 to the IRA and then later convert the money to his Roth IRA. When he does the conversion, his $5,000 conversion will be partly taxed – since half of his total IRA is non-deductible contributions, every dollar he converts is 50% taxed, and 50% tax-free.

So, if Joe did the same thing except that he starts out without an IRA, and when he converts $5,000 from his traditional IRA to the Roth IRA, the entire amount of the conversion will be tax-free. Maybe.

Back to the question that the reader posed. What happens, tax-wise, if he does the non-deductible contribution and then later converts the money to Roth, and then later in the same tax year he rolls over his 401(k) plan into an IRA?

Here’s what happens: The Roth Conversion will be partly taxable. Let’s say the 401(k) rollover is for $10,000. At the end of the year, when the taxpayer files his tax return he’ll include a Form 8606. On Form 8606 will be a determination of the amount of his distribution(s) from his IRA that is deemed non-taxable for the year. This is done by developing a fraction against which his distributions are multiplied. The fraction is as follows:

Total Non-Deductible Contributions / (Year-End Account Balance + Distribution Amounts + Outstanding Rollovers Not Yet Completed)

The key to this equation that makes his Roth Conversion partly taxable is the fact that the divisor of the equation includes his Year-End Account Balance – not the account balance at the time of his conversion.

So, in the reader’s question, the equation looks like this:

$5,000 / ($10,000 + $5,000 + 0) = 33.33% or 1/3

In other words, only 1/3 of the conversion amount will be tax-free given the circumstances. If the rollover from the 401(k) plan is delayed to the following tax year, the full amount of the conversion distribution would have been tax-free, all other things remaining the same.

Posted on Apr 4th, 2012

by author: jblankenship.

Posted in: conversion, investing, IRA, irs, qrp, rollover, Roth Conversion, Roth IRA.
Tagged: conversion · IRA · roth conversion · roth ira

IRS Helps You Out When Your Boss Doesn’t Pay You Back For Expenses Related to Your Job

Apr 3rd, 2012

by Jim.

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Employee Transfer (Photo credit: Wikipedia)

When you have to pay for certain expenses in order to do your job, sometimes (if you’ve got a good employer!) your company will reimburse you for those expenses. On the other hand, sometimes they don’t reimburse you for those expenses. Did you know that you can deduct those expenses (to a certain extent) from your income when you file your tax return? And in some cases, when your employer reimburses you, you still need to fill out additional tax forms in order to keep from being taxed on the reimbursements.

The IRS recently published their Tax Tip 2012-54, which details how to go about deducting these expenses, and what expenses are qualified for deduction. Below is the text of the Tax Tip in its entirety.

Employee Business Expenses

Some employees may be able to deduct certain work-related expenses. The following facts from the IRS can help you determine which expenses are deductible as an employee business expense. You must be itemizing deductions on IRS Schedule A to qualify.

Expenses that qualify for an itemized deduction generally include:

Business travel away from home
Business use of your car
Business meals and entertainment
Travel
Use of your home
Education
Supplies
Tools
Miscellaneous expenses

You must keep records to prove the business expenses you deduct. For general information on recordkeeping, see IRS Publication 552, Recordkeeping for Individuals available on the IRS website at www.irs.gov, or by calling 1-800-TAX-FORM (800-829-3676).

If your employer reimburses you under an accountable plan, you should not include the payments in your gross income, and you may not deduct any of the reimbursed amounts.

An accountable plan must meet three requirements:

You must have paid or incurred expenses that are deductible while performing services as an employee.
You must adequately account to your employer for these expenses within a reasonable time period.
You must return any excess reimbursement or allowance within a reasonable time period.

If the plan under which you are reimbursed by your employer is non-accountable, the payments you receive should be included in the wages shown on your Form W-2. You must report the income and itemize your deductions to deduct these expenses.

Generally, you report unreimbursed expenses on IRS Form 2106 or IRS Form 2106-EZ and attach it to Form 1040. Deductible expenses are then reported on IRS Schedule A, as a miscellaneous itemized deduction subject to a rule that limits your employee business expenses deduction to the amount that exceeds 2 percent of your adjusted gross income.

For more information see IRS Publication 529, Miscellaneous Deductions, which is available on the IRS website at www.irs.gov, or by calling 10800-TAX-FORM (800-829-3676).

Posted on Apr 3rd, 2012

by author: Jim.

Posted in: #noTOP, education expenses, income tax, income tax credit, tax credits.
Tagged: income tax · income tax credit · tax credits

Book Review: The Wall Street MBA

Apr 2nd, 2012

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This book, by Mr. Reuben Advani, sets out to cover much of the pertinent information required in an MBA program within its pages, and I think it does a good job of meeting this goal. Mind you, I don’t have an MBA degree so I can’t say with certainty that the goal is accomplished, but I’d have to say that the book does an excellent job of hitting all of the important points of required knowledge, specifically as it relates to investing and individual company valuation. I liked this book, but then again I’m kind of an out-of-the-ordinary accounting/investing geek.

Where I have some confusion with this book is in understanding who is the target audience. The problem is that the subject matter gets pretty involved in accounting principles that can be overwhelming to the average individual – potentially so much that the average individual may lose interest. On the other hand, if an individual is a professional who already understands these concepts well enough to follow the book, then that individual probably doesn’t need this book, except as a refresher.

Perhaps the mid-point between a novice and a professional is the target audience. Someone who has a passing understanding of accounting and investing principles, but who needs a more in-depth explanation of how the principles interact to help with investing activities.

Mr. Advani starts off with a comprehensive overview of basic accounting, which can be helpful if you’ve never had an accounting course or if you need a review. Mingled in with this overview is an example company, which helps to understand the principles as they are explained. After that, Advani reviews how this knowledge of accounting can be used to help you understand the relative health of a company as you consider it for investment. Again, this is good information to know, but I’m not positive that it would be all that useful to the average investor.

One problem that the average investor has when encountering this information is the supposition that knowing how to understand the value of a company is going to somehow make investing in individual companies something of an exact science. Anyone who has spent much time considering investments, whether as a professional or as an individual investor, can attest to the fact that investing is far from an exact science.

Any number of bad things can happen to an otherwise healthy company – whether it is a downturn in the sales cycle, corruption in the boardroom, labor strife, or the overall economy causing issues. No matter how much effort is put into reviewing the accounting and valuation of a company, these and may other possible uncontrollable things can cause problems for the company. It is for this reason alone, the single company’s exposure to risks, that the average investor is not well-served by individual company investing.

Having said all that though, I still believe that this book is a very good resource for the individual who finds him- or herself in a position of reviewing company’s annual report for whatever reason. I think Advani does a good job of explaining all of these principles in a format that is understandable to the person with little background with this sort of review. In particular I liked the final couple of chapters, where Mr. Advani gives a rundown of the principles of investing in currencies, real estate, and commodities – areas that often don’t get much attention in explanation.

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 Apr 2nd, 2012

by author: jblankenship.

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

About to Graduate? Learn How to Save!

Mar 27th, 2012

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Hey, soon-to-be-graduates: as you begin to make your way out into the world of full-time employment, you’ll soon be faced with many, many “grown up” ways to spend the money you’ll be earning. You’ll of course have rent, insurance, food and clothing, maybe a car payment, and you’ll want to use some of that new-found money to blow off steam, however you choose to do that – maybe fulfilling a lifetime dream of getting “beaked” by Fredbird, for example.

If you’re on top of your game, you’ll may also be thinking about saving some of your earnings. Here, you’ll have a bundle of options to choose from – regular “bank” savings accounts, 401(k) plan (or something similar) from your employer, and IRA accounts, both the traditional deductible kind and the Roth kind (hint: the Roth kind is what I want you to pay particular attention to).

Side note: even if you’re not actively thinking of saving money at this stage, chances are you’ll begin thinking about savings activities soon, and definitely at some point in the next 40 years, since saving toward retirement is pretty much YOUR own responsibility. In the next few years you’re going to be thinking about buying a home, possibly marriage and a family, and other longer-term kinds of things that require significant amounts of money. If you start on the savings process and get it into your mindset early, you’ll be miles ahead of your peers, and you’ll probably have built up a significant savings by the time you’re ready for these goals.

As you think about savings activities and all of these types of savings accounts, it’s important to gather knowledge about the features and benefits of the various accounts and how this will play into deciding what’s the best place to put your savings.

Emergency Savings

Briefly reviewing the accounts I listed, you might start with a regular savings account at a bank. You probably have a checking account of some type, so you can open a savings account at that same institution as well. This account could be used for developing an emergency fund. This is so that, when you need new tires for your car, or you need to put down a deposit on a new apartment, you’ll be able to use these funds for that purpose, rather than using a credit card or otherwise going into debt.

Another very good reason to have an emergency fund is to help you get by if you should happen to find yourself unemployed. I’d suggest putting enough into your emergency fund to cover your monthly expenses for at least 3 months. If you’re conservative you might put as much as a year’s worth of expenses into the account – in either case, maintain that level over time, in tandem with your other savings activities. This saving can be done automatically, via automatic transfer from your checking account, for example. By automatically saving, you won’t have to *decide* if you’re going to save – it will happen without you having to make a decision.

There are no significant tax benefits with a savings account, so your saving activities should include some of the other plans that you have available.

Retirement Saving – 401(k)

Next, once you’ve begun your emergency fund, you should begin thinking about longer-term saving. If you have a 401(k) plan available via your employer (or a comparable plan, such as a 403(b) or a 457 plan), you should consider taking advantage of this. This is especially true if your employer offers a “matching” program – where the employer will put money into the account as you put money into it. Often this matching is done either on a dollar-for-dollar basis up to a certain percent, or on a percentage of contributions.

For example, the company might match your contributions dollar-for-dollar up to 3% of your salary – meaning that if you put 1% of your salary into the account, the company will also put 1% into the account on your behalf. You can put as much as 3% (for this example) into the account and the company will match it. You will be eligible to put more in the account than what the company matches, but at this stage you might want to limit it to matched amount (more on this in a bit).

The other example that I gave is where the company matches on a percentage basis – this might be expressed as 50% matching up to a 6% employee contribution. If this was the case, when you put in 1%, the company would match your contribution with a .5% contribution. If you put in 4%, the company would match it with 2%, and so on, up to a 3% match for your 6% contribution.

The benefit of this kind of account is that, as you contribute money to the account, it’s taken out of your paycheck PRIOR to income tax, which will then reduce your taxable income for the year. The money in the account (including the employer matches, which you’re also not taxed on in the current year) is then invested, hopefully growing over time. The growth in the account is likewise untaxed, until you take the money out of the account. At that time, you’ll pay ordinary income tax on the money that you take out of the account.

The downside to this kind of account is that, generally, the money that you put into the account is more or less locked up until you reach age 59½. While there are ways to get at the money before that point, the real purpose of this account is to save toward retirement, so any money you put into your 401(k) plan should be considered very long-range savings.

Retirement – Traditional IRA

If you don’t happen to have a 401(k) plan available at your employer, another option to consider for longer-range saving is the Traditional IRA. The way this works is that you open the IRA account and put up to $5,000 (and when you are over age 50, you can put an additional $1,000) into the account each year. Then, when you file your income tax return for the year, you are eligible to deduct that contribution amount from your income (subject to limits).

After that, the Traditional IRA acts pretty much like the 401(k) plan described before: your savings (hopefully) grows via investments and no tax is owed until you take the money out of the account – usually at age 59½ or later. At that time you’ll pay ordinary income tax on the money as you withdraw it. As with the 401(k) you *could* take the money out earlier, but generally there would be penalties for doing so. As such, the Traditional IRA should be for your longer-term savings.

Retirement and other goals – Roth IRA

FINALLY – we’ve gotten to the account that I brought you here to talk about: the Roth IRA.

A Roth IRA is a little bit like the savings account, in that it doesn’t present any tax savings for you as you put money into it (like the Traditional IRA or the 401(k) plan does). However, the real tax benefit comes as your account grows over time – when you take the money out after age 59½, there is no ordinary income tax owed on any of the money that you withdraw!

This is a big deal. You can put in as much as $5,000 per year (same as the Traditional IRA), and as that money grows over time, you won’t have to pay tax on it if you leave it in the account until age 59½. If you started saving $5,000 per year in a Roth account at age 22 and continued this until you were 42, I’ve illustrated how this could eventually become $33 million over time.

Possibly even a bigger deal is that you can use the Roth IRA as a sort of emergency fund, in addition to a retirement fund. The money that you’ve contributed to the Roth IRA over time can be withdrawn at any time for any purpose, without tax or penalty. The investment growth is restricted (like the other retirement accounts mentioned above, to age 59½ or older), but the money you contribute is unrestricted! This could give you that extra amount that you need for a down-payment on a home, for example.

It’s best to be very judicious in your use of this privilege, since the account is primarily for retirement – but it’s nice to know that you have this option available.

Conclusion

Let’s say that you have started a new job making $30,000 a year. After taxes are taken out, you have something on the order of $1,800 left each month. Taking care of rent, insurance, car payment, and all the other things you have to pay (don’t forget the “beaking”!), leaves you with $200 a month for saving.

Let’s say you earmark $50 for your emergency savings. Then, your employer provides a 3% matching plan for your 401(k), which amounts to $75 per month. Keeping things simple, let’s say that this leaves you with $75 for other savings activities. A Roth IRA is an excellent place to put this additional money.

The reason that a Roth IRA is the preferred place to put your excess savings money is because of the tax rate that you’re in at the present. The savings in tax would be something on the order of $11.25 if you put this additional $75 into a Traditional IRA or a 401(k) plan, and then you’d have your money locked up until retirement. Since you’re already (rightly) taking advantage of the 401(k) plan (and doubling your money via the employer match), using the Roth IRA provides you with an additional way to save with a diversified tax treatment.

All in all, the Roth IRA presents you with a very cost-effective way to save money over time, especially when you’re at the lower end of the tax brackets.

If you’re needing a few more reasons to go with the Roth IRA, try this: if you’re going to grad school, your contributions in your Roth IRA account could be used to help pay for school, but at the same time – retirement accounts in general are not included as sources when calculating financial aid. Plus, as you make contributions to a Roth IRA (also to other retirement accounts), depending on your income level you may be eligible for the Saver’s Credit. This is up to a 50% tax credit for your contributions to a retirement plan, including the Roth IRA.

Full Disclosure: That’s my daughter Emma being “beaked” by Fredbird. She’s a soon-to-be graduate of Western Illinois University, Class of ’12, and proud owner of a Roth IRA.

Posted on Mar 27th, 2012

by author: jblankenship.

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Posted in: 401 k, 403 b, contribution limit, investment, IRA, qrp, Roth IRA, saver's credit.
Tagged: 401 k · contribution limit · investment · IRA · roth ira

Smoke, Mirrors, and Alphabet Soup

Mar 19th, 2012

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A bowl of alphabet soup nearly full, and nearl...

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In an environment of Ponzi schemes and financial scandals many Americans have lost trust and confidence in the financial profession; seems like there are some financial advisers that have been helping themselves, more than their clients. To fight back against this trend of lost trust and skepticism, advisors are being more creative with credentials, some of which can be earned with minimal or no study and can be bought with a couple hundred dollars. A quick look at the Financial Industry Regulatory Authority’s web site (FINRA) (http://apps.finra.org/DataDirectory/1/prodesignations.aspx) shows over one hundred and twenty different credentials being used by advisors to build creditability and trust. I’m sure there are many more not tracked by FINRA.

Professional certifications arose decades ago as a way for people in various industries to identify qualified practitioners. It’s always good to know that our doctor has an MD or our account is a CPA. In the financial realm, many well-established credentials, including the Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP^®) designations, require long study, demand continuing education and enforce strict codes of ethics. In order to become a CFP^®, for example, one must meet the following requirements:

1) A bachelor’s degree or higher from an accredited college or university

2) Three years of full time financial planning experience

3) Complete a CFP^® board registered program or hold one of the following

CPA
ChFC
Chartered Life Underwriter (CLU)
CFA
Ph.D. in business or economics
Doctor of Business Administration
Attorney’s License

4) Successfully complete the 10 hour CFP^® certification exam

5) Complete 30 hours of continuing education every two years.

Increasingly, I suspect, financial advisers are using dubious designations as marketing tools to win back the trust of older, wealthier clients. Some of the more popular are those that use the term “senior” in their name. Some examples are: certified senior adviser, certified senior consultant, certified senior specialist, certified senior financial planner, chartered senior financial planner and chartered adviser for senior living. I get confused when hearing all the “senior” designations and am left wondering, do the advisors who hold these, really have any special education or experience working with seniors, or do they just want you to think they do?

To confound the issue even more many designations sound similar (and I think this is intentional) for example, the certified retirement financial adviser, or CRFA, sounds similar to the CFA designation. But the CFA requires roughly 900 hours of study in accounting, economics, ethics, finance and mathematics, and only 42% of candidates pass its three required exams, a process that can take several years. The CRFA, by contrast, requires that students pass one exam consisting of 100 multiple-choice questions, for which 40 to 75 hours of preparation is typically sufficient preparation.

In much the same way, the CSFP, or chartered senior financial planner, credential could be confused with the certified financial planner, or CFP^®, designation. The CFP^®, established in 1972, requires that students pass the equivalent of 15 credit hours of college-level courses, culminating in 10 hours of exams. The CSFP, launched in 2003, requires a three-day review course and the passing of one two- to three-hour exam.

Over the last few years the term “Wealth Management” has become popular with advisors as a way to attract wealthier clients. It didn’t take long for a list of wealth management designations to appear.

WMS – Wealth Management Specialist
CWC – Certified Wealth Consultant
CWS – Certified Wealth Strategist
AWMA – Accredited Wealth Management Advisor
CWM – Chartered Wealth Manager
CWPP – Certified Wealth Preservation Planner

While some of these designations may be good for consumers by giving their advisor specific knowledge and experience, many will turn out to be marketing gimmicks employed by advisor to attract wealthier clients.

Credentials are used because they help advisers make more money. A 2007 study by FINRA’s educational foundation determined that 46% of older investors were more likely to accept financial guidance from someone with a professional designation – and 17% of investors would be more receptive to advice from a “certified adviser for senior investing,” even though such a credential doesn’t exist.

Buyers beware when it comes to initials behind someone’s name. According to the American Academy of Financial Management, based in New Orleans, the things to look for are these: accredited degrees, licenses, or master’s degrees from government-recognized or accredited programs or educational institutions with concentrations in Finance, Investments, Securities, Economics, or Accounting. These requirements make individuals eligible for Professional Designation. You can also check out designations yourself by calling the issuing organization and finding out what the requirements are – you might be surprised by what you find.
Steven Young, CFP^® (XZ$, LMNOP, EIEIO)

Posted on Mar 19th, 2012

by author: jblankenship.

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Posted in: financial planning, guest, Uncategorized.

Early Social Security Filing Examples

Mar 16th, 2012

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Most of the examples that you see indicate that filing for Social Security benefits as late as possible is the best way to go. However, this is not always the case, given that you’re receiving the benefit (albeit at a reduced rate) for a longer period of time. Let’s work through some examples to show how this works. This article will only deal with single individuals – we’ve covered spouse benefits in several other articles, it’s time to provide some guidance for single folks.

Example 1, Filing at 62 vs 66

John is single, age 62, and his benefit at Full Retirement Age (FRA) has been estimated at $2,000, so his benefit at age 62 would be $1,500, or 75% of the amount at FRA. If he takes the benefit now, he’ll receive $18,000 per year for the next four years. (COLAs have been eliminated in this example to keep it less confusing.)

If he is in a position where he doesn’t necessarily need the money, he could invest the funds as he receives them. If he invested those funds at a 5% fixed rate, when he reaches age 66 he’ll have a total of approximately $81,461. He’ll also continue to receive the same $18,000 year-after-year.

Now, let’s assume at this age that John needs the $2,000 for living expenses. If he uses the current $1,500 of Social Security benefits and supplements it with his “stash” he’s built up over the previous four years, letting the remainder grow at interest, it will take twenty years before he’s run out of the stash account.

The problem is, once John has done that now, he’ll be stuck with an income that is $500 less (in today’s dollars) than what he needs. If he has no other resources, such as a 401(k), pension, or IRA, he’s in a pickle.

If John was somehow able to generate 7% from his savings, he’ll buy himself another four to five years, but that’s really it.

Example 2, Filing at age 62 vs 70

Same facts as Example 1, but now we’ll compare the outcome if John is able to hold off to age 70, at which point his benefit would be increased to $2,640.

Running the numbers again, upon reaching age 70, John’s savings account at 5% will have grown to approximately $171,884. Now, if John’s income requirement is still only $2,000 per month, his side account generates enough interest (at 5%) to sustain over time without depleting it. (This assumes that he is financially in a position to delay, using other sources to cover his expenses up to age 70.)

However, if John had delayed receiving his benefit to age 70 and then began using $2,000 for expenses and banking the rest in the same type of savings account, he’d still have more money in the account if he started early benefits – for fifteen years, to his age 85. From that point forward, it would be more beneficial to have waited to age 70.

Example 3, Filing at age 66 vs 70

Again, same facts, but John waits to file at Full Retirement Age (FRA), age 66, and puts the full amount of his benefit in the same savings account at 5% interest. Now, when he reaches age 70, the savings account has grown to more than $106,000.

He still only needs $2,000 to live on – and when compared to delaying up to age 70, since he is able to save a portion of the larger, full benefit, he is able to build up his savings account, but the “wait ‘til 70” account doesn’t become larger than the “file at 66” account until he reaches more than 93 years of age!

Conclusion

In these examples, which I’ll admit are far from comprehensive, we can see that longevity makes all the difference. If you live a very long life, it makes more sense to delay, assuming you can cover your expense needs in the meantime.

In many cases though, the individual cannot wait, needing the money earlier. In addition, most folks take a view that they’ll not likely live to the age needed in order to make the delay option pay off. So – all things considered, it might be better for you to file earlier, as always, depending upon your circumstances.

Leave your own situations in the comments section below (not too complicated though!), and I’ll gather some of the more common situations and show how some tactics might play out at differing filing ages.

Posted on Mar 16th, 2012

by author: jblankenship.

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

What types of accounts can I rollover into?

Mar 14th, 2012

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OMG IRA (Photo credit: girlonaglide)

When you have money in several accounts and you’d like to have that money consolidated in one place, the question comes up – Which type of account can be tax-free rolled over into which other type of accounts?

Thankfully, the IRS has provided a simple matrix to help with this question. At this link you’ll find the matrix, sourced from IRS Publication 590.

In terms of explanation, here are a few rules to remember:

You can generally rollover one account of any variety (IRA, Roth IRA, 401(k), and so on) into another account of the exact same type.

You can rollover a Traditional IRA into just about any other tax-deferral plan, including 401(k), 403(b), 457(b), as well as a SEP IRA. The same goes for each of the accounts in reverse as well as between all of these types of accounts. In general, employer plans such as 401(k), 403(b) and 457(b) plans are not eligible to rollover until the employee has left the job.

You can also rollover any of these accounts into a Roth IRA – but you’ll have to pay tax on the rollover amount. This is known as a Roth Conversion.

A SIMPLE IRA generally cannot accept a rollover of any other type of account (other than another SIMPLE IRA) into the account. On the other hand, a SIMPLE IRA can be rolled over into any of the other tax-deferred plans – IRA, 401(k), 403(b), 457(b) or SEP IRA – but only after the SIMPLE IRA has been established for at least two years.

A Designated Roth Account (DRAC), which is part of a 401(k), 403(b), or 457(b) plan, can only be rolled over into another DRAC or a Roth IRA. Likewise, a Roth IRA is only eligible to be rolled over into another Roth IRA.

Posted on Mar 14th, 2012

by author: jblankenship.

Posted in: drac, IRA, qrp, qualified retirement plan, retirement plans, rollover, Roth 401(k), Roth IRA.
Tagged: IRA · qrp · rollover · roth 401 k · roth ira

Mortgage Debt Forgiveness and Taxes

Mar 12th, 2012

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When you have a debt canceled, the IRS considers the canceled debt to be be income for you, taxable just like a paycheck. There are cases where you don’t have to include all of it though, and mortgage debt forgiven between 2007 and 2012 may be partly excepted from being included as income.

The IRS recently issued their Tax Tip 2012-39, which lists 10 Key Points regarding mortgage debt forgiveness. Below is the actual text of the Tip.

Mortgage Debt Forgiveness: 10 Key Points

Canceled debt is normally taxable to you, but there are exceptions. One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant (ITA) available on the IRS website to determine if your canceled debt is taxable. The ITA tax you through a series of questions and provides you with responses to tax law questions.

Posted on Mar 12th, 2012

by author: jblankenship.

Posted in: 2008 Tax Year, 2009 tax year, 2010 Tax year, 2011 tax year, 2012 tax year, income tax, irs, mortgage debt.
Tagged: income tax · irs · mortgage

Calculating the PIA

Mar 9th, 2012

5 comments

WOMEN’S HISTORY MONTH (Photo credit: mademoiselle louise)

In determining your retirement benefits from Social Security, as well as those of any dependents who may claim benefits based upon your record, the Primary Insurance Amount, or PIA, is an important factor. The PIA is the amount of benefit that you would receive if you began receiving benefits at exactly your Full Retirement Age, or FRA. (see this article for information about determining your FRA).

The PIA is only one of the factors used in determining the actual amount of your retirement benefit – the other factor being the date (or rather your age) when you elect to begin receiving retirement benefits.

So, how is PIA calculated?

There are several factors that go into the calculation of the PIA. You start off with your Average Indexed Monthly Earnings (AIME – which we defined in this article about the AIME). Then, we take into account the bend points for the current year. For 2016 the bend points are $856 and $5,157. Here’s the calculation:

the first $856 of your AIME is multiplied by 90%
the amount between $856 and $5,157 is multiplied by 32%
any amount in excess of $5,157 is multiplied by 15%

Note: these are the figures for 2016. Each year the bend points are increased slightly (or most years they are), and so the PIA calculation may change.

So let’s work through a couple of examples:

Our first retiree is age 62 in 2016, and is hoping to begin taking Social Security benefits immediately upon eligibility – to get what’s coming to her. Her AIME has been calculated as $6,500. Applying the formula, we get the following:

first bend point: $770.40 ($856 * 90%)
second bend point: $1,376.32 ($5,157 – $856 = $4,301 * 32%)
excess: $201.45 ($6,500 – $5,157 = $1,343 * 15%)
For a total PIA of: $2,348.10 ($770.40 + $1,376.32 + $201.45 = $2,348.17 rounded down)

The second example retiree also is age 62 in 2016. His AIME has been calculated as $4,000. Applying the formula:

first bend point: $770.40
second bend point: $1,006.08 ($4,000 – $856 = $3,144 * 32%)
excess: $0
For a total PIA of: $1,776.40 ($770.40 + $1,006.08 = $1,776.48 rounded down)

You should note that the PIA is always rounded down to the next multiple of $0.10.

And that’s it. As mentioned, your PIA is the basis for many of your benefit calculations. The bend point amounts also control the amount of reduction the the Windfall Elimination Provision can have – for 2016 the maximum reduction for WEP is $428 per month.

Posted on Mar 9th, 2012

by author: jblankenship.

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Posted in: primary insurance amount, Social Security, social security benefits, Social Security spousal benefit, social security survivor benefits.
Tagged: primary insurance amount · Social Security

The Rollover

Mar 7th, 2012

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You’ve heard it millions of times – on the radio or tv – “when you leave your job, you should roll over your retirement account”. You may know that it makes sense (or at least you assume it makes sense, otherwise why would these folks admonish you to do so?), but do you know why it’s important? And do you have the first clue as to how to accomplish a rollover?

Why rollover? Among the reasons that it is important to rollover your retirement account when you leave employment is that you want to have control over your money. If you leave the account with the former employer, you are effectively handing over a portion of the control of your money to the administrator.

This administrator’s primary job is to ensure that the plan remains as effective and efficient as possible, for your former employer. Your interests are not taken into account at all, and in fact, many activities that the administrator undertakes (and subsequently charges the cost of to the plan accounts) are of no benefit to you whatsoever, as a former employee. By rolling your funds over to a self-directed IRA, you can make sure that the costs associated with your account’s maintenance are directly benefiting your own account.

In addition, by rolling over your retirement funds into an IRA, you now have more flexibility in the investment choices that you can utilize. Remember how your employer’s qualified plan only had five or ten mutual funds to choose from? Now, you can invest in just about any fund, stock, bond, or ETF available in the marketplace, plus some that you can dream up on your own.

How to roll over? We’ve covered (albeit briefly) the “why”, so now we’ll cover the “how”. It’s actually pretty simple, as long as you follow a couple of important rules. Both of these are related to maintaining the tax-deferred nature of your investment.

The first rule is that you should always have an account set up to receive the monies before requesting the withdrawal from your current plan. If you don’t have a place to put the money, the plan administrator will assume that you’re taking a “cash out” distribution, and they’ll withhold 20% tax on the withdrawal. The way to resolve this is to ensure that your withdrawal paperwork (with your old account) indicates a “direct rollover” is occurring. At the same time, your deposit paperwork with your new account will indicate the same. The old plan administrator may still send a check to your home address, but it will be made out to the new account custodian.

The second rule is related to the first, but this is one that you can foul up even if you’ve gotten the paperwork filled out correctly: your rollover must occur within the span of 60 days, or you’ll be penalized as if you withdrew the money to cash out the plan – 10%, plus ordinary income tax on the withdrawal.

As I indicated earlier, the current (old) plan administrator may send you a check for your rollover, made out to the new custodian – but it’s up to you to make sure that you get the check sent to the new plan custodian as soon as possible, so that there’s no danger of taking more than 60 days to complete the roll over.

The entire process is simple enough, following the steps below:

1. establish your new account
2. request a “direct rollover” withdrawal from your old plan
3. receive the rollover check
4. submit the check with the appropriate “direct rollover” deposit slip at your new account.

As you can see, the process is straightforward, but if you don’t pay close attention to what’s going on, or if one of your plan administrators (either the new one or your old one) has a special “twist” to the process, it can become a mess.

Note: steps 3 and 4 are not required if the transfer is done in a trustee-to-trustee manner, meaning that the old account administrator sends the funds directly to the new account trustee, and you never see a check. This is one of the most common ways to ensure that you don’t miss the 60-day window. For more information, see An IRA Owner’s Manual.

Posted on Mar 7th, 2012

by author: jblankenship.

Posted in: Early Distribution, eligible rollover distribution, employer plan, IRA, qrp, retirement plans, rollover.
Tagged: eligible rollover distribution · IRA · qrp · rollover

Tax Credits That Can Increase Your Refund

Mar 5th, 2012

4 comments

The IRS recently issued their Tax Tip 2012-41, which lists out some of the tax credits that are refundable. Most tax credits are not refundable, meaning that if the amount of the credit is more than your tax for the year, the credit is limited only to the amount of your tax.

For example, if you had tax payable of $1,500 and then had Education Credits, Energy Credits, and/or Foreign Tax Credits amounting to more than $1,500. Your credits will be limited to $1,500 since that’s your tax payable and the credits are not refundable.

On the other hand, there are a few credits that are refundable, as listed below in the actual text from Tax Tip 2012-41.

Four Tax Credits that Can Boost Your Refund

A tax credit is a dollar-for-dollar reduction of taxes owed. Some tax credits are refundable meaning if you are eligible and claim one, you can get the rest of it in the form of a tax refund even after your tax liability has been reduced to zero.

Here are four refundable tax credits you should consider to increase your refund on your 2011 federal income tax return:

1. The Earned Income Tax Credit is for people earning less than $49,078 from wages, self-employment or farming. Millions of workers who saw their earnings drop in 2011 may qualify for the first time. Income, age and the number of qualifying children determine the amount of the credit, which can be up to $5,751. Workers without children may qualify as well. For more information, see IRS Publication 596, Earned Income Credit.

2. The Child and Dependent Care Credit is for expenses paid for the care of your qualifying children under age 13, or for a disabled spouse or dependent, while you work or look for work. For more information, see IRS Publication 503, Child and Dependent Care Expenses.

Note: this credit was incorrectly identified in the IRS Tax Tip as refundable. It is not refundable – sorry for the confusion.

3. The Additional Child Tax Credit is for people who have a qualifying child. The maximum credit is $1,000 for each qualifying child. You can claim this in addition to the Child and Dependent Care Credit. The Child Tax Credit is non-refundable, but if you qualify you can utilize the Additional Child Tax Credit to receive the remainder of the non-refundable credit as a refund. See IRS Publication 972, Child Tax Credit for more details.

4. The Retirement Savings Contributions Credit, also known as the Saver’s Credit, is designed to help low-to-moderate income workers save for retirement. You may qualify if your income is below a certain limit and you contribute to an IRA or workplace retirement plan, such as a 401(k) plan. The Saver’s Credit is available in addition to any other tax savings that apply. For more information, see IRS Publication 590, Individual Retirement Arrangements (IRAs).

Note: this credit was incorrectly identified in the IRS Tax Tip as refundable. It is not refundable – sorry for the confusion.

There are many other tax credits that may be available to you depending on your facts and circumstances. Since many qualifications and limitations apply to various tax credits, you should carefully check your tax form instructions, the listed publications and additional information available at www.irs.gov. IRS forms and publications are available on the IRS website at www.irs.gov and by calling 800-TAX-FORM (800-829-3676).

Posted on Mar 5th, 2012

by author: jblankenship.

4 comments already - add to the conversation!

Posted in: 2011 tax year, EITC, income tax credit, IRA, qualified retirement plan, saver's credit, tax credits.
Tagged: 2011 tax year · EITC · income tax credit · tax credits

Example Using Spousal Benefits and Delayed Retirement Credits for Social Security

Mar 2nd, 2012

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Note: with the passage of the Bipartisan Budget Act of 2015 into law, File & Suspend and Restricted Application have been effectively eliminated for anyone born in 1954 or later. If born before 1954 there are some options still available, but these are limited as well. Please see the article The Death of File & Suspend and Restricted Application for more details.

This particular situation was presented to me by a reader. Since the facts represent a fairly common situation that we haven’t addressed here in the past, I thought I’d present it here for discussion.

Here’s the original question (altered a bit for clarity):

My wife and I are age 65 & 67 respectively. We’re both still working part-time, and my wife has now 20 years of earnings on her Social Security record. At this point her PIA is approximately 45% of my PIA, and increasing with each additional year of earnings added to her record. We are in a position to delay retirement benefits to age 70 to increase our Delayed Retirement Credits (DRCs) to the maximum. What is a good strategy for us to maximize Social Security retirement and Spousal Benefits?

Given that the wife in this example has a PIA equal to something less than half of the husband’s PIA, once the wife reaches FRA she can begin receiving the Spousal Benefit alone, which would amount to 50% of the husband’s PIA. The husband will need to file and suspend in order for her to do this, but as we know, this will have no negative consequence to either of the retirement benefits in the future.

As the wife’s own benefit increases due to her additional work record and the Delayed Retirement Credits (DRCs), her own retirement benefit will continue to increase in value. Eventually there will be a crossover point when the Spousal Benefit is actually less than her retirement benefit. At that time she can choose to switch over to her retirement benefit (instead of the Spousal Benefit) or she could continue to receive the Spousal Benefit and earn DRCs.

As it turns out for this couple, the crossover point will occur when they reach the ages of 68 and 70. At that time, he will go ahead and file for his retirement benefit since it has maxed out the DRCs; she will probably continue to receive the Spousal Benefit and allow her own retirement benefit to continue accruing DRCs.

It should be noted that if she chooses to switch over to her own retirement benefit at some point, her husband could file solely for the Spousal Benefit based upon his wife’s record – if he is under age 70. Once he reaches age 70 there is no further increase to his retirement benefit from DRCs, so he may as well go ahead and take his retirement benefit.

Posted on Mar 2nd, 2012

by author: jblankenship.

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

5 Facts You Need to Know About Your Retirement Plan

Feb 29th, 2012

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Many of us are covered by one or more types of defined contribution retirement plans, such as a 401(k), 403(b), 457, or any of a number of other plans. What many of these plans have in common is that they are referred to as Cash Or Deferred Arrangements (CODA), as designated by the IRS. These plans are also often referred to as Qualified Retirement Plans (QRPs). Each type of plan has certain characteristics that are a little different from other plans, but most of them have the common characteristic of deductibility from current income and deferred taxation on growth. (Note that this list of plans does not include IRAs. IRAs have certain characteristics that are completely different from QRPs, and vice-versa.)

1. Each dollar you defer is worth more than a dollar. It’s true. As you defer money into your retirement account, each dollar that you defer could be worth as much as $1.54. How, you might ask?

Since you are not taxed on each dollar that has been deferred into the retirement account, your “take home” pay only reduces by the amount that is left over after taxation. For example, if you’re in the 25% income tax bracket, generally your income will only reduce by 75¢ for every dollar that you defer into your retirement plan. Therefore, the 75¢ that you’ve effectively “spent” is worth 33% more ($1.00) in your retirement account.

If you happened to be in the 35% income tax bracket, this works out to a 54% increase in the value of each dollar deferred. This doesn’t even take into account the potential for matching dollars from your employer!

2. Matching – FREE MONEY. Well, it’s not exactly free, you must defer some funds in order to take advantage of it, but other than that, your employer is actually chomping at the bit to give you this money. The reasons can be far-reaching, but the point is that it’s literally yours for the taking (and totally yours if you’re vested in the plan). It should be noted that some companies do not match your funds at any level in a plan.

So, what should you do about this? If you aren’t currently participating in your company’s 401(k) or other deferred compensation plan and they match your funds, you are throwing money away by not participating. Depending upon the options in your plan, you could be turning your back on as much as a 100% return on your investment – guaranteed! Everyone should take advantage of AT LEAST the matched portion of your deferred compensation plan. After that, it may make good sense to put money aside in a Roth IRA (up to the maximum annual amount), before adding more to your deferral to max out your 401(k).

3. Don’t Overload On Company Stock. Even (especially?) if you’re in a company where the stock has experienced dramatic increases in recent history, you need to make sure that your overall exposure to any one company is limited. A rule of thumb that I use is: no more than 5% of your overall net worth should be invested in any one company. If you are inclined to have a larger stake in your company because you work there and enjoy the sense of ownership, I wouldn’t put any more than 10% in that stock. The figure is doubled for the company that you work in because, at least presumably, you are more in tune with the value and internal events of that company and could make adjustments if an event were coming up that could seriously impact your holdings.

Of course, the reason behind this is to limit your exposure to the ebb and flow of a single company’s stock price. For example, what if you held stock in one company that amounted to 30% of your overall net worth, and that stock took a major hit of a 25% price reduction? This one event would have the impact of yanking down your net worth balance by 7.5% – quite a serious impact, to say the least. The folks at Enron (and countless other dot-com craze companies) found out the hard way how much damage can be done by having too large of an exposure in a single company.

4. Diversify, diversify, diversify. Most of us understand the concept of diversification, but how do you actually accomplish it?

In order to properly diversify, you need to review the available investment choices in your plan, and then use those choices to spread your investments among capitalization categories (large-cap and small-cap), as well as between value-oriented and growth oriented, as well as domestic companies and international companies. You should also consider what amount of fixed-income investment (bonds) makes the most sense in your portfolio.

Keep in mind, diversification doesn’t simply mean you put an equal amount of money in each available choice of investment. Each person needs to consider this individually, in respect to their overall portfolio and risk tolerance, including assets held outside of the deferred compensation plan, such as other IRAs or taxable accounts. You need to make a decision as to what allocation makes the most sense for you and apply it across all of your accounts. If you’re fairly young and have a lot of years to grow your funds (as well as recover from any downturns), you can probably take on a greater amount of risk. If you’re nearing retirement, most likely your risk profile will be much less risky.

5. Don’t Take A Loan. No matter how tempting it is, taking a loan out from your qualified retirement plan in more cases than not, results in derailing your hard work in saving and building up your account. Not only are you strapped with having to pay back the funds to your account (with interest), but you have also given up whatever growth might occur within your account (since the funds are being used for another purpose).

Experience tells us that you would be much better off to temporarily suspend or reduce your contributions to your retirement plan in order to save up money instead of taking a loan from your retirement plan. It may take a little while longer, but you’ll probably appreciate it a bit more as a result of your saving.

Posted on Feb 29th, 2012

by author: jblankenship.

Posted in: 401 k 403 b, employer plan, qrp, qualified retirement plan, retirement accounts, retirement plans.
Tagged: 401 k · employer plan · qrp · qualified retirement plan · retirement accounts

11 Facts About the Child Tax Credit (2011)

Feb 27th, 2012

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The IRS recently issued their Tax Tip 2012-29, which provides some key points about the Child Tax Credit.

Below is the text of the tip:

The Child Tax Credit is available to eligible taxpayers with qualifying children under age 17. The IRS would like you to know these eleven facts about the Child Tax Credit.

Amount With the Child Tax Credit, you may be able to reduce your federal income tax by up to $1,000 for each qualifying child under age 17.
Qualification A qualifying child for this credit is someone who meets the qualifying criteria of seven tests: age, relationship, support, dependent, joint return, citizenship and residence.
Age Test To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2011.
Relationship Test To claim a child for purposes of the Child Tax Credit, the child must be your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes your grandchild, niece, or nephew. An adopted child is always treated as your own child. An adopted child includes a child lawfully placed with your for legal adoption.
Support Test In order to claim a child for this credit, the child must not have provided more than half of his/her own support.
Dependent Test You must claim the child as a dependent on your federal tax return.
Joint Return Test The qualifying child cannot file a joint return for the year (or files it only as a claim for refund). Note: this means that a qualifying child can file a joint return if only filing it for a refund – for no other purpose, no other credits, etc..
Citizenship Test To meet the citizenship test, the child must be a US citizen, US national or US resident alien.
Residence Test The child must have lived with you for more than half of 2011. There are some exceptions to the residence test, found in IRS Publication 972, Child Tax Credit.
Limitations The credit is limited if your modified adjusted gross income is above a certain amount. The amount at which this phase-out begins varies by filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax and any alternative minimum tax you owe.
Additional Child Tax CreditIf the amount of your Child Tax Credit is greater than the amount of income tax you owe, you may be able to claim the Additional Child Tax Credit.The Additional Child Tax Credit is not available for any of the Child Tax Credit that was reduced by MAGI Limitation (#10) – this credit is only to replace any Child Tax Credit limited by the amount of tax you owe. In other words, although the Child Tax Credit is not a refundable credit, any amount limited by the non-refundability can be replaced by the Additional Child Tax Credit.
The Additional Child Tax Credit is applied for via Form 8812, and the maximum additional Child Tax Credit is as follows:

Taxpayers with one or two children. The lesser of:
* The disallowed portion of the regular child tax credit, or
* 15% of the taxpayer’s earned income in excess of $3,000

Taxpayers with three or more children. The lesser of:
* The disallowed portion of the regular child tax credit, or
* The larger of:
* 15% of earned income in excess of $3,000.
* FICA and Medicare tax paid minus earned income credit.

Posted on Feb 27th, 2012

by author: jblankenship.

Posted in: #noTOP, 2011 tax year, income tax, income tax credit, tax credits.
Tagged: 2011 tax year · income tax · income tax credit · tax credits

8 Things to Consider Before Rolling Over Your 401(k)

Feb 22nd, 2012

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K’nex (Photo credit: -Snugg-)

Employers have been giving us lots of opportunities to make this decision of late: when leaving an employer, whether voluntarily or otherwise, we have the opportunity to rollover the qualified retirement plan (QRP) such as a 401(k) from the former employer to either an IRA or a new employer’s QRP.

This decision shouldn’t be taken lightly – although often it is the best option for you. Moving to an IRA gives you much more control over your destiny, so to speak, by allowing you to choose from the entire universe of allowable investment choices. Using your new employer’s QRP can give you a better sense of control over the account as well, although the flexibility of an IRA is generally preferable to another QRP.

But sometimes it makes the most sense to leave your money in the old plan. Listed below are eight possible reasons that you might want to do just that.

If you are happy with your former employer’s plan, consider it well-managed, low cost, and possibly with some investment options that are not readily available (such as desirable mutual funds that are closed to new investors), you may want to leave the plan intact. This would be especially beneficial if you don’t have another employer plan to roll over into, or you are squeamish about establishing your own IRA.
If you have commingled deductible and non-deducted IRA contributions in your outside IRA accounts, having an active 401(k) plan can help you to “separate” the deductible IRA assets from the non-deducted. See this article for more information. Essentially this benefit gives you a way to bypass the “little bit pregnant” rule wherein the IRS treats all IRA funds pro-rata taxable and non-taxable when making distributions… a common issue when doing a Roth IRA conversion, for example. If you don’t have an active 401(k) plan available, this option is lost.
If you have an investment in your former employer’s stock in your 401(k), you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover. The point is, if you’ve taken even a partial rollover of your 401(k) in a prior year, the NUA treatment is no longer available to you.
If you think you may be returning to this employer, it might make sense to leave your funds where they are. This is especially true for government employers with section 457 plans – due to the nature of these plans’ ability to provide you with retirement income without penalty much earlier than an IRA or a 401(k) plan could. With the vagaries of governmental policy changes, if you’ve withdrawn and closed your account and come back to work for the same agency, the old plan may no longer be available to you since you’re a “new” participant.
If you’re in the year when you’ll reach age 55 or older, and are not moving to a new employer (either retiring or undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty. If you move these funds over to an IRA, this option is lost.
On the off-chance that you might need a loan from your retirement funds, you should know that IRAs do not have this provision. Retain at least some balance in the plan if you might need this option – but also you should check with your plan administrator to see if this option is available for non-employee plan participants, because it might not be (and actually, it likely is not). But keeping in mind #4, if you’ve maintained a healthy balance in the plan and you return to work with this same employer, you’d have a much larger account to work with if you needed to borrow.
Funds in a 401(k) account are protected by ERISA – and as such are generally not available to creditors. Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy. At any rate, ERISA protection is pretty much an absolute, so this is yet another reason you might consider leaving funds in a former employer’s 401(k) plan. Funds moved from an ERISA-protected account can carry the protection on, but new contributions to the account do not.
Take your after-tax contributions out first, if your plan happens to include these. If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts. You can convert these contributions directly over to a Roth IRA in most cases. This is because the 401(k) isn’t subject to the “little bit pregnant” rule alluded to earlier. Once you’ve removed the after-tax contributions and put them into a Roth IRA, you can then rollover the rest of your 401(k) if it makes sense.

Posted on Feb 22nd, 2012

by author: jblankenship.

Posted in: 401 k, 401 k 403 b, employer plan, IRA, qrp, qualified retirement plan, Roth Conversion.
Tagged: employer plan · IRA · qrp · qualified retirement plan

Book Review: Investment Mistakes Even Smart Investors Make

Feb 13th, 2012

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Investment Mistakes Even Smart Investors Make

This book is a must read for all investors. Author Larry Swedroe has demonstrated once again how he has a full understanding of the average investor’s situation, by listing 77 real-life mistakes that all of us have encountered at one time or another.

What’s more, Mr. Swedroe also takes the time to provide examples of where the mistakes listed have damaged investors’ situations, as well as to show how the investors could have avoided the mistakes.

Larry Swedroe, for the uninitiated, is a best-selling author of many books which explain his concepts of investing – including The Only Guide series, The Quest for Alpha, and others. These books cover primarily passive investing, or investing without active management, and as such he is a sort of guru in the self-managed investment world.

The listed mistakes in this book include everything from hindsight bias (believing after the fact that a particular occurrence was predictable) to believing that there are experts who can predict the future, as well as believing “this time it’s different”.

The list of the types of mistakes is broken up into four categories: Understanding and Controlling Human Behavior is Important for Investment Success; Ignorance is Not Bliss; Mistakes Made When Planning an Investment Strategy; and Mistakes Made When Developing a Portfolio.

Anyone who owns an IRA or invests in a 401(k) can benefit from this list of mistakes. Often these mistakes can be a part of our investing life without even knowing it – like having too many eggs in one basket (it’s not as easy realize as you think), or being too conservative (it’s easier to do than you think). Swedroe’s insights are helpful in explaining how the mistake can come to pass, as well as how to avoid these mistakes in the future.

All of this is designed to help you to become a better, more successful and less-stressed investor… all the way down to the last mistake – Do You Keep Repeating the Same Mistakes? Do yourself a favor and pick up a copy – it will be well worth the effort and your investing habits will be much better off for it.

Posted on Feb 13th, 2012

by author: jblankenship.

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

Working While Receiving Social Security

Feb 10th, 2012

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[Hank Gowdy, Dick Rudolph, Lefty Tyler, Joey Connolly, Oscar Dugey (baseball)] (LOC) (Photo credit: The Library of Congress)

For many folks, starting to receive Social Security as early as possible is important – even if they’re still actively working and earning a living.

Something happens when you do this though: depending on how much you’re earning, you will be giving up a portion of the Social Security benefit that you would otherwise receive. Up to the year that you will reach Full Retirement Age, for every two dollars that you earn over the annual limit ($14,640 for 2012, or $1,220 per month), your Social Security benefit will be reduced by one dollar.

Then in the year you will reach Full Retirement Age (FRA) there is a different income limit – actually $3,240 per month. For every three dollars over that limit, your Social Security benefit will be reduced by one dollar – up until the month that you actually reach FRA. Once you’ve reached FRA, there is no income limit, and you can earn as much as you want, without any of the reductions that are applied to earnings prior to FRA.

These reductions aren’t lost – you’ll actually get credit for them later on at FRA. So if you’re earning enough (for example) to reduce your benefit down to a point where your benefit is eliminated, you’ll get credit for that “lost” month once you reach FRA.

As you most likely already know, your Social Security benefit is reduced based upon the number of months prior to FRA that you’ve applied for and begin receiving benefits. For every month that your benefit is eliminated (or reduced and withheld by SSA) prior to FRA, these months will be credited back to your account, reducing the number of months that were originally used to calculate your reduced early retirement benefit.

As with all of these explanations, an example is in order. Dick, age 62, has a Primary Insurance Amount of $2,000. When he files for benefits at age 62 his benefit is reduced by 25%, to $1,500. Dick is still working, and his job pays him $60,000 per year ($5,000 per month). With that income, Dick’s Social Security benefit will be reduced by $2 for each dollar over $1,220 that he earns. So $5,000 minus $1,220 equals $3,780, so his benefit will be reduced by $1,890 – more than his benefit. This means his benefit will be completely withheld.

When Dick reaches FRA, assuming he’s continued earning at that same pace up to that point, he will begin receiving his benefit at the same amount as if he had waited until FRA to apply for the benefit. This is because he’s gotten credit back for all of those months that he had his benefit withheld.

Why would Dick do this, you might ask? One reason might be if he had dependents, such as his wife and/or children, that could receive benefits based on his record if he’s actively filed. Even though his benefit is being withheld, the dependents’ benefits can continue – these benefits are limited by the income of the individual receiving them. So if his wife was receiving Spousal Benefits based on his record, she would have the same earnings limits as listed above, and the same goes for the children.

Posted on Feb 10th, 2012

by author: jblankenship.

Posted in: earnings test, Social Security, social security benefits, social security retirement.
Tagged: earnings limits · social security benefits · social security retirement

Ordering Rules for Roth IRA Distributions

Feb 8th, 2012

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Tax (Photo credit: 401K)

Did you know that there is a specific order for distributions from your Roth IRA? The Internal Revenue Service has set up a group of rules to determine the order of money, by source, as it is distributed from your account. This holds for any distribution from a Roth account.

Ordering rules

First, over-contributions or return of your annual contribution for the tax year. This means that if you’ve made a contribution to the Roth IRA in the tax year, the first money that you withdraw from the account will be the money that you contributed that year. If you over-contributed to your account a prior year. Growth on this over-contribution or annual contribution needs to be removed at this time as well, with tax and penalty paid as required.

Second, regular annual contributions to the account. The next money that comes out is the total of all of the money you’ve contributed to the Roth IRA over the years. Of course, this is reduced by all previous distributions from the account. This amount would include rolled over contribution amounts from other Roth IRA or Roth 401(k) accounts. Growth (interest, capital gains, or dividends) on these contributions comes out later.

Third, tax-free converted amounts from IRAs or 401(k) accounts would be distributed. Only the amount of the conversion is counted at this point. As with the contributions, the growth or earnings within the account comes out last.

Fourth, conversion amounts that were taxed at the time of the conversion are distributed.

Fifth and last, earnings, capital gains, and growth on your contributions will be distributed. This is everything left in the account after the other categories of funds have been removed.

Here’s an example: Jane, age 50, has a Roth IRA with a balance of $50,000. She has made annual contributions to the account over the years in the amount of $25,000 – part of which was a contribution this tax year of $5,000. She also made a conversion into this account with $10,000, all taxed, from an IRA a couple of years ago.

When Jane takes money out of the account, she can remove this year’s contribution of $5,000 first of all – no tax on that distribution. After that, the remaining $20,000 of contributions to the account would come out, also tax free. This money is followed by her conversion of $10,000. If it’s been less than five years since the conversion, there will be a 10% penalty on the conversion since she’s under age 59½. Any withdrawal above and beyond $35,000 would represent growth and earnings on the account, which would also be subject to the penalty since she’s under age 59½.

Posted on Feb 8th, 2012

by author: jblankenship.

Posted in: contribution limit, conversion, IRA, ira contribution limits, Roth Conversion, Roth IRA, roth ira contributions.
Tagged: contribution limit · IRA · roth ira · roth ira conversion

Avoid Email Scammers Claiming to be IRS

Feb 6th, 2012

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The IRS recently produced Tax Tip 2012-08, which talks about scams you need to be aware of, really heinous contacts where the scammers pretend to be the IRS. But here’s the key: the IRS doesn’t use email as the regular communication to deliver notices of deficiency, requests for additional information, and the like. The IRS is big about the paper notice – you’ll recognize it immediately, with the official IRS seal and all.

The information that the IRS presents is good to know, you should be familiar with what they have to say.

Here is the text of the tax tip:

Don’t be Scammed by Cyber Criminals

The Internal Revenue Service receives thousands of reports each year from taxpayers who receive suspicious emails, phone calls, faxes or notices claiming to be from the IRS. Many of these scams fraudulently use the IRS name or logo as a lure to make the communication appear more authentic and enticing. The goal of these scams – known as phishing – is to trick you into revealing your personal and financial information. The scammers can then use your information – like your Social Security number, bank account or credit card numbers – to commit identity theft or steal your money.

Here are five things the IRS wants you to know about phishing scams.

The IRS never asks for detailed information like PIN numbers, passwords or similar secret access information for credit card, bank or other financial information.
The IRS does not initiate contact with taxpayers by email to request personal or financial information. If you receive an email from someon claiming to be the IRS or directing you to an IRS site:

Do not reply to the message.
Do not open any attachments. Attachments may contain malicious code that will infect your computer.
Do not click on any links. If you clicked on links in a suspicious email or phishing website and entered confidential information, visit the IRS website and enter the search term ‘identity theft’ for more information and resources to help.

The address of the official IRS website is www.irs.gov. Do not be confused or misled by sites claiming to be the IRS but ending with .com, .net, .org, or other designations instead of .gov. If you discover a website that claims to be the IRS but you suspect it is bogus, do not provide any personal information on the suspicious site and report it to the IRS.
If you receive a phone call, fax, or letter in the mail from an individual claiming to be from the IRS but you suspect they are not an IRS employee, contact the IRS at 1-800-829-1040 to determine if the IRS has a legitimate need to contact you. Report any bogus correspondence. You can forward a suspicious email to phishing@irs.gov.
You can help shut down these schemes and prevent others from being victimized. Details on how to report specific types of scams and what to do if you’ve been victimized are available at www.irs.gov. Click on “phishing” on the home page.

Posted on Feb 6th, 2012

by author: jblankenship.