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Why is there GPO (Government Pension Offset) in Social Security?

Oct 19th, 2020

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Photo credit: coop

If you are (or were) married and you have worked in a domestic (US-based) government job where your earnings are not subject to Social Security taxation, you probably are familiar with the Government Pension Offset, or GPO. (You may also be interested in WEP – Windfall Elimination Provision – as well, but that’s another subject.) Have you ever learned just why GPO is a factor in Social Security calculations for many folks? In another article we reviewed why there is a WEP, but there are differences between WEP and GPO, so we’ll cover those first.

GPO versus WEP

You might think GPO and WEP go hand-in-hand. And for many folks, if you’re affected by one of these, likely you may be affected by the other as well. But they’re two distinctly-different provisions.

WEP, as we’ve discussed elsewhere, impacts the calculation of your own retirement benefit, by reducing the first bend point factor in calculating your Primary Insurance Amount, or PIA. See last week’s article for more details on how WEP affects your PIA.

GPO, on the other hand, affects benefits that you can receive as a spouse – either a Social Security spousal benefit that you can receive while your spouse is living, or a Social Security survivor benefit (aka “widow(er)’s benefit”) that you receive when your spouse has passed away.

The other primary difference between WEP and GPO triggering is that GPO can only be triggered by a pension from a US-based governmental entity where Social Security taxes were not withheld. WEP can also be triggered by a pension from a foreign government based on wages that were not subject to US Social Security taxation.

GPO calculation

GPO reduction is a much simpler calculation as well. If you are receiving a pension from a US-based governmental entity (based on earnings not subject to Social Security taxation) and your spouse has a Social Security retirement benefit, GPO will likely apply.

Let’s walk through an example of a non-GPO-impacted couple first:

Sid and Nancy are married, and are both reaching FRA this year. Sid worked outside the home for his entire career in a Social Security-taxed job, while Nancy worked sporadically outside the home but was primarily present to raise and home-school their four children. As a result, Sid has a Social Security retirement benefit coming to him at his Full Retirement Age (FRA) in the amount of $2,600. Nancy’s sporadic Social Security-based employment earnings has produced a relatively small Social Security retirement benefit in the amount of $500 at FRA.

Because of the difference in the amount of Sid’s retirement benefit and Nancy’s retirement benefit, Nancy is entitled to a spousal “excess” benefit, in the amount of $800. This brings her total Social Security benefit up to 50% of Sid’s benefit, or $1,300. This is how it works when there is no GPO involved.

For an example including GPO, let’s say Simon worked as a teacher in a school district that provides a pension and his earnings were not subject to Social Security taxation. Simon’s wife, Beth, worked in Social Security-related jobs her entire career, and as such has a Social Security benefit of $2,500 per month coming to her. Simon’s teacher pension amounts to $2,100 per month.

By virtue of the fact that Simon is married to Beth, he is entitled to a spousal benefit based on Beth’s earnings. This spousal benefit is 50% of the amount that Beth could receive upon reaching her Full Retirement Age – and that amount is $2,500. So Simon is entitled to a spousal benefit of $1,250 – 50% of $2,500.

However, GPO is in play, since Simon is receiving the teacher’s pension in the amount of $2,100. The GPO offset is 2/3 of the amount of the pension – which is $1,400 – which effectively wipes out the spousal benefit altogether for Simon.

The reason that this offset is in place is because of the original reason that spousal benefits were created. Spousal benefits are intended to make up the difference for many couples between their lifetime earnings amounts. When this was initially created, the family dynamic quite often had one spouse working outside the home while the other worked within the home (at least a portion of his or her career), raising the family and taking care of domestic chores. As a result, very often the spouse who didn’t work outside the home had no (or a very small) Social Security retirement benefit when it came time for retirement.

The same applies to Social Security survivor benefits. In the case of Sid and Nancy, when Sid dies (if he dies first), Nancy becomes entitled to a survivor’s benefit equal to the benefit that Sid was receiving prior to his death. When Nancy starts receiving that $2,600 benefit, her own benefit and the spousal excess benefit are terminated, so her final total Social Security benefit at this point is $2,600.

On the other hand, if Beth were to die before Simon, he would be (prior to GPO) entitled to a survivor’s benefit equal to the Social Security benefit that Beth was receiving prior to her death, or $2,500. However, since Simon is receiving a pension from a governmental entity based on wages that were not subject to Social Security taxation, GPO applies to the survivor benefit as well. Just the same as with the spousal benefit, GPO offsets the survivor benefit by 2/3 of the amount of the pension that Simon is receiving, or $1,400. This leaves Simon with a survivor benefit in the amount of $1,100 ($2,500 minus $1,400).

Why is there a GPO?

Much the same as with the WEP, GPO was put in place to avoid “double-dipping” in two different retirement activities. If GPO wasn’t in place, in our examples from above, Simon would have been entitled to a survivor benefit equal to Beth’s Social Security retirement benefit, while at the same time continuing to receive his full teacher’s pension. Contrast that with the treatment that Nancy receives – she has to give up her own Social Security benefit (and the spousal benefit) in order to receive the survivor benefit. This is the “double-dipping” that GPO eliminates, or helps to somewhat mitigate.

The reasoning is that the governmental pension is designed to take the place of Social Security for that employee. If there was no offset, the spousal and survivor rules, which are designed to help out a spouse who had a smaller earnings record over his or her lifetime. Since the governmental employee was outside of the Social Security system, his or her Social Security record is artificially small, and without the GPO would result in an unfair distribution.

Different from WEP, there is no way to earn your way out of GPO impact. As you probably know, if you’ve worked in Social Security-covered jobs earning “substantial earnings” for enough years, WEP can be reduced or eliminated. There is no such provision for GPO. And this makes sense, because GPO is not factored based on your own Social Security record. GPO is factored totally based on the amount of your pension from the governmental entity.

When you’re collecting a governmental pension, GPO applies to any Social Security spousal or survivor that you may be eligible for, whether for your current spouse or an ex-spouse

One additional factoid – GPO is only triggered based on your receiving a pension based on your own work. So, if Edie is receiving a survivor’s pension that her spouse Jonathan had earned from his work with the state government, this pension will not trigger GPO for Edie. (Incidentally, this survivor’s pension would also not trigger WEP for Edie either). So in this case, Edie can receive the survivor pension (with whatever offset the pension requires) in addition to her own Social Security benefit without triggering GPO.

Posted on Oct 19th, 2020

by author: jblankenship.

Posted in: government pension offset, GPO, Social Security.

Why is there WEP (Windfall Elimination Provision) in Social Security?

Oct 13th, 2020

6 comments

During your career you may have worked for a governmental agency or a foreign employer where there was no Social Security tax withheld from your earnings (Job A). At the same time or at some other point, you may also have worked in a job that was covered by Social Security (Job B). The end result is that now you’re ready to retire, and you will collect a pension from Job A, and you’re also eligible to collect Social Security benefits based on Job B. But the Social Security benefits are being reduced because of something called WEP – Windfall Elimination Provision. Why is this WEP even in existence?

You’ve probably heard that this provision prevents “double-dipping” in retirement benefits from two systems. That’s true, but it doesn’t really explain why WEP is a factor for many retirees. In order to understand why WEP even exists we need to understand how Social Security works.

PIA calculation

As explained in other articles on this site, your Social Security benefit is calculated by determining your Primary Insurance Amount, or PIA. Your PIA is the basis for determining your Social Security benefit amount at various ages. If you file for Social Security retirement benefits at your Full Retirement Age (FRA), your benefit amount will equal to the PIA. If you file before FRA, the benefit will be less; filing after FRA results in a higher benefit above the PIA.

The PIA derives from another figure, known as the Average Indexed Monthly Earnings, or AIME – which is effectively your average earnings over your top 35 years of earnings in your career, with an index applied.

Once you know what your AIME figure is, bend points are applied to calculate your PIA. Let’s say Janice has an AIME of $6,000 and she reached 62 in 2020. For Janice, the bend points are $960 and $5,785. And, if WEP is not involved, her PIA is calculated as follows:

The first $960 of the AIME is multiplied by 90%: $960 X 90% = $864

The amount of Janice’s AIME that is greater than $960 but less than or equal to $5,785 is multiplied by 32%: $5,785 – 960 = $4,825 X 32% = $1,544

The amount of AIME that is above $5,785 is then multiplied by 15%: $6,000 – $5,785 = $215 X 15% = $32.25

These three results are then added together, producing Janice’s PIA: $864 + $1,544 + $32.25 = $2,440.25, rounded down to $2,440.20.

Similarly, if Andrea’s AIME was $2,000, the calculation would go like this:

$960 X 90% = $864

$2,000 – $960 = $1,040 X 32% = $332.80

None of Andrea’s AIME was above $5,785, so the third is zero.

Adding together, we get Andrea’s PIA of $864 + $332.80 + $0 = $1,196.80

Now, I didn’t bring you here to work through math problems, there’s actually a point to all of this. Look at the two figures we came up with in the two examples above. From Janice’s $6,000 AIME, we produced a PIA of $2,440.20, while from Andrea’s $2,000 AIME, we produced a PIA of $1,196.80.

Janice’s PIA is 40.67% of the AIME, while Andrea’s PIA is 59.84% of the AIME. This means that Andrea’s potential Social Security benefit will replace almost 50% more of her income as opposed to the rate that Janice’s Social Security benefit will. True, Janice still has the higher benefit coming to her, but she earned 3X as much over her lifetime than Andrea did (and therefore paid in 3X as much tax).

This is a quick illustration of how Social Security prioritizes benefit replacement at lower levels of average lifetime income. The lower your AIME over your lifetime, the greater percentage of your pre-retirement income will be replaced by Social Security benefits. If your AIME was exactly (or less than) $960, you would expect a PIA of 90% of your AIME.

At the other end of the spectrum, the more you earn over your lifetime, the less your pre-retirement income will be replaced by Social Security. Once your AIME goes above the second bend point (in this case, $5,785), each additional dollar added to the average for your lifetime will only increase your PIA by 15 cents.

We’re not here to argue whether or not this is fair, just to explain how the system works. The Social Security benefit calculation is specifically designed to be weighted toward greater income replacement at the lower income levels, and far lower income replacement as average income increases.

Enter non-Social Security-taxed earnings

Now that we have a handle on how Social Security benefits are calculated in the normal circumstances, let’s add a new wrinkle to the picture: what if the individual had earnings from a non-Social Security-taxed job in the mix?

Let’s say we have Lucy, also turning 62 in 2020, who also has an AIME that is $2,000 – but Lucy didn’t produce this relatively low AIME by working in lower paying jobs. She produced this AIME because she had worked in non-Social Security-taxed jobs for most of her career, and then at the end of her career she worked in the private sector, just long enough to produce the proper number of Social Security credits to qualify for benefits (40 quarters, or 10 years). Since the AIME is calculated based on your top 35 years of earnings, and Lucy only has 10 years of earnings, her AIME is considerably low by comparison to the actual earnings. She was actually earning pretty high income during those 10 years, but the averaging mechanism brings down the AIME. If not for WEP, Lucy could wind up with the same PIA as Andrea – even though she only participated in the Social Security system for only 10 years and the rest of her career her income was not subject to Social Security taxation.

This is a quandry – it’s not right that Lucy should get the same benefit as Andrea. After all, Lucy is also collecting a pension from her non-SS-taxed job on top of the Social Security benefit. True, Lucy should get some Social Security benefit, but her income replacement level for those 10 years of earnings should not be at the upper end of the spectrum as Andrea’s are.

WEP addresses this problem by reducing the first bend point multiplier. In the case of Lucy, the first bend point is reduced to 40% (instead of 90%). The other multipliers remain the same, because the main thing the provision is addressing is the lowest levels of income replacement. So here’s how Lucy’s PIA is calculated:

40% of the first bend point: $960 X 40% = $384

32% of the second: $2,000 – $960 = $1,040 X 32% = $332.80

None of her AIME is above $5,785: $0

Adding them all together, we get $384 + $332.80 + $0 = $716.80

So Lucy’s income replacement from Social Security is 35.84%, while Andrea’s was nearly 60%. This is how and why WEP works the way it does.

Making it fair

There are a few situations when strict application of the WEP calculations is unfair to the benefit recipient. For one, if the individual has earned within the Social Security system alongside the non-covered job for many years, the WEP calculation penalizes this person unfairly. Additionally, if the pension or Social Security benefit is small, the WEP calculation unduly penalizes the individual as well.

So what if Lucy’s $2,000 AIME was produced over 35 years of side-jobs instead of over the relatively short 10-year timeframe illustrated above? Assuming that those 35 years of earnings were “substantial” by Social Security’s definition, then the WEP impact would be eliminated from her PIA calculation, and Lucy would have the exact same PIA as Andrea. She’d collect that amount plus her pension from the non-covered job. For more details on how this works, see this article about substantial earnings.

On the other hand, what if Lucy’s pension from the non-covered job was somewhat low? What if, for example, Lucy worked in the governmental job for 10 years, then raised her children for 20 years, during which she didn’t earn any outside income, and then after the kids were all in high school she went back to work over the intervening 10 years in a Social Security covered job?

In a case like this, assuming that the pension earned from the non-covered job is relatively small, there is a limitation on the impact that WEP can apply to Lucy’s PIA. If her pension from the non-covered job was, for example, $500 a month, then the WEP reduction is limited to half of the amount of the pension. Everything else remaining the same from the earlier example, Lucy’s PIA would be calculated as:

40% of the first bend point is $384; this is a reduction of $480 from the original bendpoint rate of 90%, therefore, this reduction is capped at 50% of her pension amount, or $250. The resulting first bend point is $864 – $250 = $614.

32% of the second bend point: $332.80

None of the AIME is above $5,785: $0

Adding together, Lucy’s PIA is now $614 + 332.80 + $0 = $946.80. This is an income replacement rate of 47.34% – still less than Andrea’s, but not as low as when Lucy’s pension is larger.

Likewise, if the original (non-WEP-impacted) PIA is relatively low, there is another cap put in place to ensure that WEP doesn’t reduce the PIA to an amount less than 50% of the original PIA (before WEP). So, if Maria, who also worked in a non-SS-covered job for most of her career, but only earned enough in SS-taxed jobs to produce an AIME of $800, her PIA would be calculated like this:

Original PIA calculation is: 90% X $800 = $720. 50% of that amount is $360; WEP applied is 40% X $800 = $320. Since $320 is less than half of the “original” PIA calculation, the default is $360, 50% of the original PIA.

None of the AIME is above $960 or $5,785, so $0 and $0.

Maria’s PIA is $360 + $0 + $0 = $360. This is a replacement rate of 45% of Maria’s AIME of $800.

The point

The point of all of this is to explain why the WEP provision exists in the first place. Social Security was never designed to provide the same amount of income replacement to all individuals participating in the system. The Social Security benefit calculations are designed to specifically replace income at a higher rate for folks at the lower end of the lifetime earnings spectrum.

When an individual only participates in the Social Security system for a relatively short period of time, the average earnings are artificially lower due to the averaging method. If this is because he or she was working in a non-covered job for the rest of his or her career, the benefit calculation would give this individual a high income replacement based on this artificially low average income. WEP provides a method to adjust the benefit calculation so that income replacement is more appropriate to the circumstances.

Posted on Oct 13th, 2020

by author: jblankenship.

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Posted in: PIA, primary insurance amount, Social Security, wep, windfall elimination provision.

Mistakes With NUA

Oct 5th, 2020

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Photo credit: jb

In another article on this site we discussed the concept of Net Unrealized Appreciation, or NUA for short. It’s a complicated affair, fraught with potential mistakes – several of the most important mistakes with NUA are listed below.

Mistakes With NUA

Moving too quickly – if you roll over your funds from the Qualified Retirement Plan (QRP) without first checking to see if there can be a benefit from the NUA treatment of company stock in the QRP, you’ve lost the chance to do so. Always check for NUA possibility within the QRP before making any rollover moves.

Not moving quickly (completely) enough – if you have determined that NUA treatment can benefit your situation, you must move ALL of the funds from the QRP within the same taxable year. If you moved your NUA stock out first and planned to rollover the rest of the account into an IRA or other employer plan, you must follow through within the tax year. Delaying even one day beyond the tax year end will break the NUA option and cause the distributed stock to be fully taxable.

Taking RMDs or other distributions in an earlier year – if you retired in an earlier year, and began taking Required Minimum Distributions (RMDs), once that tax year ends and you have not taken your Lump Sum Distribution to enact the NUA option, you no longer have the NUA option available to you. This is due to the fact that the NUA option is available ONLY after a triggering event, and the entire balance must be withdrawn in a single tax year. If another triggering event were to occur – such as disability or death – then the NUA treatment could still be available.

Photo credit: jb

Selling out of NUA-potential stock in the QRP – if you have significant holdings of your company’s stock in your QRP, chances are at some point you’ll get nervous about holding too much stock in a single company. Obviously, you don’t want to overexpose yourself to a volatile stock – but it may not make sense to sell all the stock while it’s still in the employer plan, either. If the stock has appreciated over a significant period of time, you might want to maintain a position simply to take advantage of the NUA treatment.

On the other hand, if you’re concerned that the stock is going to drop like a rock, (remember Enron? Worldcomm? CitiGroup? Countrywide?) you should ignore the concept of NUA altogether. You shouldn’t let the tax “tail” wag the financial responsibility “dog”. Besides, if the stock drops there might not be any appreciation to apply the NUA treatment to anyhow.

Not understanding NUA – if you don’t understand it completely, your chances of getting it right are low. This is a very strict set of rules (aren’t they all though?) and simple moves in the wrong direction can break the option altogether, potentially causing a major tax hit.

It’s also important for your heirs to understand NUA – or make sure that they will work with your NUA-savvy advisor before they make any moves. One matter that might trip up your heirs: NUA-treated stock does not receive a step-up in valuation upon inheritance. It retains the original basis when distributed.

Posted on Oct 5th, 2020

by author: jblankenship.

Posted in: Early Distribution, investing, IRA, retirement plan, tax.
Tagged: IRA · retirement plan · tax

Up to 41% of “miscellaneous” denied Social Security benefits not being reviewed

Sep 28th, 2020

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Photo credit: jb

Many, if not most, applications for Social Security benefits are approved without any issues. But often, an application is denied, for legitimate reasons. Maybe you don’t have the requisite number of credits on your account for benefits, or something similar. But also, many times, benefits are denied without a specified reason. When this happens, the Social Security Administration staffer working on the case will apply a code of “miscellaneous suspense” to the record.

The suspension of benefits can happen either at the point of initial application, or upon a review of the record at some point. For the latter, the individual may have been receiving benefits for quite a while, and then suddenly the benefit is suspended. Apparently quite often, this happens because there is a piece of information missing from the file (or what’s on file is incorrect). In such cases there is a followup process in place to generate a letter or some communication with the benefit recipient to clarify and correct the information on file so that benefits can be resumed.

This “miscellaneous suspense” code is problematic, for a couple of reasons: first, because it is not regularly audited, this code can be used in cases where it is not the appropriate code; second, and more important, the “miscellaneous suspense” code does not have an automatic followup process to make sure that whatever the reason for the suspension of benefits is being addressed (if it can be).

Recently the SSA published the results of an audit by the Office of Inspector General (OIG), who regularly audits various components of the federal government. This particular audit was focused on the “miscellaneous suspense” code and whether follow-up had been performed appropriately on those records with this suspense code.

Background

As briefly described above, SSA employees are tasked with keeping information in benefit recipients’ records up-to-date. Sometimes a beneficiary no longer meets the criteria to receive benefits, and when this is the case, SSA suspends benefits to the recipient. When benefits are suspended, the SSA employee identifies the issue to be resolved (to resume benefits) by inputting one of dozens of situation-specific suspense codes on the beneficiary’s record. From the audit report:

For example, when SSA does not have a beneficiary’s correct address, an employee suspends benefits using a code that indicates SSA must obtain the correct address and update its records.

As mentioned previously, there is also a “miscellaneous suspense” code which can be applied if there is not a specifically-identified code for the situation. The purpose of the “miscellaneous suspense” code is for the very limited situations where no other suspense code could apply to the case.

For all other suspense codes, since they are for a specific type of situation, there is a systematic follow-up process. If an address is incorrect, the SSA has a process to reach out via all available means to determine what the correct address information should be.

However, since the miscellaneous suspense code is for “unknown” situations, it is incumbent on the SSA employee to manually create a follow-up alert to resolve whatever the situation is that created the suspense.

To create a group for auditing, OIG identified 2,525 total records in the Social Security beneficiary records that had had benefits suspended using the miscellaneous suspense code (between the dates of January 2015 and December 2018). From those 2,525 records, 100 were chosen at random to review in-depth.

The Audit

First the good news: out of the sample of 100 records reviewed, 59 had been properly followed-up, and either benefits resumed or continued suspense if the problem was not able to be resolved. So nearly 60% of the time, the system is working the way it should.

However (and now the bad news): this means that 41% of the cases had not been properly followed-up on. This resulted in an estimated $748,000 in benefits that had been continued in suspense for these beneficiaries. When that is extrapolated to all possible date ranges, OIG estimated that 21,000 beneficiaries have had approximately $378 million in benefits in suspense that have not been properly followed-up on. This is a very big deal if you’re one of those 21,000.

Further information from the audit indicates that, of those 41 of 100 that were not followed-up on, 22 of them had the miscellaneous code applied improperly, and some other specific code (with an automatic follow-up) should have been used.

As of the writing of the report, only 10 of the 41 records had been resolved; that is, 31 of the 41 have not been followed-up on yet. Presumably these will be reviewed soon. For the complete report, follow this link to the OIG Audit report.

SSA notes that there are two issues at play here: 1) There is no automatic follow-up process to ensure that miscellaneous codes are reviewed and resolved; and 2) There are no management reports to determine if the “miscellaneous suspense” code is being mis-used by SSA employees.

So it’s in your hands if you’ve been affected by this.

What should you do?

If you have had your benefits denied or suspended and you don’t know exactly why, you should follow up with Social Security to find out why. It’s possible that you’re one of these 21,000 people who have had the “miscellaneous suspense” applied, which was either never followed up on or was erroneously coded in the first place.

You need to find out the actual reason why your benefits were suspended. If it turns out that your situation is correctly identified and you are not eligible for the benefit, then you’re only out the time to check into it. But it could be that it’s a matter of record-keeping or updates to information, incorrectly coded as “miscellaneous” and never followed up on. In that case, work with SSA to correct the record as you can and (maybe!) get your benefits resumed.

Posted on Sep 28th, 2020

by author: jblankenship.

Posted in: Uncategorized.

5 Free Activities to Explore While Social Distancing

Sep 25th, 2020

by sraskie.

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During the lockdown and required social distancing it’s common to feel cooped up and restless. Finances may be strained, and we may feel the need to lockdown our own spending. During this time, and raising two daughters, it was a great way to become creative with activities that didn’t cost a thing but were a HUGE investment in building relationships. If you don’t have kids, you can still do these with friends or family.

Take an adventure walk. We like to take walks frequently. However, there are times when I will set certain challenges on the walks or learning outcomes to build more into it. For example, I may tell my kids to keep a look out for coins (we find a lot), or with fall coming, gather five different leaves of trees in the neighborhood. We’ll then identify them when we get home. Sometimes, it’s identifying different birds based on plumage or call.

Listen to music. Believe it or not, your kids will likely be interested in the music you like. You may even like theirs – but if not, at least take the time to have them show you why they like it. Explore new music genres together. Research the history of the songs, their composers, the lyrics, etc.

Play games together (or make up your own). This can be a great time to teach patience, strategy, or overall to just goof around and have fun. A recent creation in our home was marshmallow baseball. Bag of marshmallows (baseballs), plastic kitchen utensils (bats), pillows (bases). And the best part – edible baseballs!

Chances are you have plenty of books around the house waiting to be read. There’s no better time than now to dig into them. Share what you’re reading with your kids and have them share their reading interests with you. Short on books? Head to the public library – plenty of great reading there.

Making meals together can be a great way to bond. Many restaurants are still closed – that can be a good thing. Staying at home and cooking together allows you to learn new recipes, techniques, and try different foods you might not have tried otherwise. Not good at cooking or baking? Now’s the time to learn.

Posted on Sep 25th, 2020

by author: sraskie.

Posted in: coronavirus.
Tagged: free activities

Just Starting Out – Resources to Help With Money Stuff

Sep 21st, 2020

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Photo credit: jb

A recent college graduate approached me recently to ask about saving and investing. He had begun investing using one of the micro-brokerage apps, and had a few questions about getting started with saving and investing.

We briefly talked about saving concepts, including emergency funds, goals for saving activities and whatnot, as well as the concept of diversification. But I knew that the brief amount of time we had available to talk would not be enough to answer all of his questions. In addition, although at one time I was in his very shoes (starting his first “real” job, living on his own, etc.), it was in a very different time and place. For example, he didn’t have to worry much about being eaten by dinosaurs – which was a primary concern for me right out of college.

I also didn’t have the internet available to me. The closest we had to the resources of the internet was a library, and the comparison between the internet and a local library is laughable, of course. Yes, one might find a lot of useful information at the library, but the amount of time required to find it was enormous by comparison to a Google search today. Plus, the internet has opened up avenues to millions of additional voices, whereas in the old world we mostly had the academics (primarily) to draw knowledge from.

The downside of that Google search is that you don’t often know for sure if the source of the information you’ve found is legitimate, or if it’s a scam, or worse, just some random spewing of someone’s manifesto.

So I called upon my friends and colleagues at FinCon to give me some ideas of resources to share with my friend. FinCon, in case you don’t know, is a community of financial content creators. By “content creators”, think in terms of blogs, podcasts, and video-logs (like YouTube, Instagram, and TikTok). The mission of FinCon is:

To help personal finance content creators and brands create better content, reach their audience, and make more money.

Part of the “help” that FinCon provides is the structure of a community where ideas and resources are shared among creators from widely-diverse walks of life. I’ve found the FinCon community to be extremely creative, helpful, and resourceful, giving new perspectives that I had never considered, even as a long-time member of the financial professional community. As you’ll see from the suggestions, there are many diverse points of view, and lots of fantastic advice given, as well as knowledge to be gleaned from the creators.

Below, in no particular order, are the suggestions received from the FinCon community to my request for “all-purpose content for a recent college graduate”. Hope you find some nuggets here that are helpful to you!

Blogs

Plutus

One of the first stops on the list of sources of good financial information is the Plutus Foundation. You can read in-depth about the Plutus Foundation on their website. In a nutshell, Plutus (a charitable organization) exists to foster and promote the creation of financial media to enhance financial literacy, education and empowerment. Part of the fostering and promotion activities includes awards that are presented annually to many different categories of financial content creators.

For a list of this year’s nominees, check out the 11th Annual Plutus Awards Finalists. These are the cream of the crop, in categories ranging from Best Content Series to Best Generational Financial Literacy Content to Best New Personal Finance Blog, with many, many other categories in between (27 categories altogether). The winners will be announced in a virtual format (yeah, thanks 2020!) on November 13, 2020.

The finalists list is linked to the actual content, so spending time among these nominated entries is an excellent place to start your journey to find financial education and guidance.

One of the authors nominated in the Best New Personal Finance Blog category (Lauren Keys) reached out to me to tell of an article that she’d written that seems to fit the request for my friend very well:

… my Financial Roadmap resource is geared specifically at helping take young people from college to financial independence in just 6 steps.

The blog is Trip of a Lifestyle, and the article is Financial Roadmap: Save Money, Travel Tons, & Retire Young. I particularly like the fact that the guidance offered here is flexible enough that it can fit into many different overall financial strategies, from the extreme “retire by 35” to the more pedestrian “I just want to be comfortable and retire at 65” as well as everything in between. There are action-oriented checklists to help along the way as well.

Wealthtender

Wealthtender is a website that

exists to help people discover the most trusted and authentic professionals and educators in the finance community.

As such, Wealthtender curates a directory of personal finance blogs and other content, and part of this curation is a list of new blogs to keep an eye on. You can find the current year’s list of Finance Blog Startups to Watch in 2020 at this link. Previous list members are also available, and these also present a fantastic place to locate some very valuable financial content all in one place.

The College Investor

Robert Farrington, author at The College Investor, brings forth the following article as especially useful for the recent college graduate: How To Start Investing In Your Twenties After College For 22 – 29 Year Olds

This article is a one-stop shop, a primer that gives you pretty much everything you need to know and think about as you start off on your financial life. Robert covers whether an advisor is needed, what kinds of account to start with, how much to invest, and allocation (among other things). I believe this single article is probably the best place if you have little time to work with, to provide yourself with a base foundation of knowledge about getting started in investing.

Youtube

Youtube has become one of the fastest-growing areas where financial advice content is created of late. Apparently the video presentation is a compelling way to receive this information, and the numbers seem to back it up. There are thousands upon thousands of videos covering pretty much anything you can imagine in the financial sphere.

Magic of Finance

One channel in particular that I was directed to (from my FinCon query) is Andrei Jikh’s Magic of Finance. Andrei has a very relatable style, and he presents some very interesting concepts in detail, in short, bite-sized videos (running around 10-15 minutes on average).

The Bemused

Another channel pointed out is The Bemused. This channel is produced by Akeiva and Meshack, a young couple (aged 22 and 24), who are

… passionate about helping people like us adult with their finances.

I especially liked the fact that Akeiva and Meshack are wide-open and relatable with their own financial journey, sharing their wins and stumbles along the way. They talk about everything from paying off a car, to decisions about finances as they plan to get married, along with paying student loans, and all sorts of topics of interest.

If video is your favorite way to receive content, these are great channels to check out to find great financial content.

Podcasts

If your lifestyle fits in more with listening to podcasts, you don’t have to look far to find lots of content in this medium. (I’m not a big fan of podcasts or video-logs, I prefer to read my content, but I’m not the target here, right?)

Young Money

One podcast that was suggested that should fit the recent college graduate’s needs is Young Money. Creator Tracey Bissett (a Chartered Financial Analyst) has generated a boatload of content on a myriad of topics.

This mode of content, as is pretty common, is a bit more lengthy than the YouTube articles, generally running from 15 to 30 minutes in duration. Creator Tracey Bissett covers the gamut of financial advice, from evaluating your financial situation, keys to success (regarding love & money), to a series called Adulting 101 – as well as all points in between. Tracey gives great, actionable advice, that can fit into many situations across the spectrum of needs.

Find Your Freedom

Another suggested podcast, Find Your Freedom, is specifically targeted toward

lifestyle design + financial independence for twentysomethings

Find Your Freedom’s creator Becky Blake shares her own personal story about her financial journey from paying off student debt, to reaching financial independence, to traveling the world, having created her dream life. Some of the content is podcast, and some is by way of the Twenty-Free blog, which is a common theme I’ve seen among podcasters. Becky shares her insights the topics that she has encountered, either personally or through coaching clients.

In particular, I enjoyed the topics that provided guidance on defining and designing your “ideal life” – one of the most important aspects of starting out in the financial world. Without well-defined goals, it’s hard to determine what you’re aiming for, so setting your goals should be a high priority.

Final Thoughts

As with any compilation, I don’t intend for this to be all-inclusive. The above listing is simply the result of my query to my colleagues in the FinCon community. Just knowing that the FinCon annual Expo often has 2500+ attendees tells me that there are many thousands of content creators that aren’t on this list, and many may fit the bill for my college graduate friend just as well or even better.

If you have a particular resource, whether it’s a blog, podcast, video-log, or some other medium, that you think would meet the needs of my friend (and the others reading this!), please leave your description and link in the comments below. Please no spamming – I’ll allow only one link to each (legitimate, financial guidance-oriented) source with as many comments as each source commands, unless it gets out of hand at which time I’ll shut down comments altogether. No commercial pitches either, these will be removed – this is about sharing content, not pitching products or schemes.

Posted on Sep 21st, 2020

by author: jblankenship.

Posted in: financial planning, investing, personal finance.

Just Starting With Retirement Savings? Get All the Credit You’re Due!

Sep 14th, 2020

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Photo credit: jb

You probably already realize that setting up a systematic savings plan is critical to providing yourself with financial security in the future. There are

tax benefits to simply making contributions to an IRA or a 401(k) – you’ll be able to deduct (or simply not include) those funds in your taxable income come tax time. In addition, the tax-deferred growth of these funds will provide you with a source of income for the future.

But did you realize that there are other tax credits available for certain taxpayers making contributions to retirement plans? It’s called the Saver’s Credit (formally known as the Retirement Savings Contributions Credit), and it’s available for folks who meet certain eligibility requirements who have made contributions to retirement savings plans during the tax year.

Eligibility

Depending upon your filing status, there is a limit to the amount of income that you can have earned in order to take the credit. If your Adjusted Gross Income (AGI) is less than the amount below for your filing status, you are eligible to take at least part of this credit (these are 2019 figures, updated annually).

Married Filing Jointly – $64,000
Single, Married Filing Separately, or Qualifying Widow(er) – $32,000
Head of Household – $48,000

In addition to the income limits, you must have been born before January 2, 2002 (for tax year 2019), therefore age 17 or older for the calendar year. You must also not have been a full-time student during the calendar year, and you cannot be claimed as a dependent on another person’s return.

Amount of Credit

If you fit the eligibility requirements and you made contributions to an IRA (including a Roth IRA), 401(k) or 403(b) (including designated Roth accounts), governmental 457 plan, SEP or SIMPLE plan, or certain other plans, you may be able to take a credit of up to $1,000 ($2,000 if filing jointly). The credit that you’re allowed is determined by both your income and the amount of the contribution that you’ve made, limited to $2,000 for singles and $4,000 for married filing jointly.

In general if you’re married and filing jointly, you can receive up to 50% credit (limited to $2,000 for married filing jointly) if your AGI is below $38,500. This credit gradually reduces down to 10% of your contribution as your AGI increases to the upper limit of $64,000. For Head of Household filing status, the 50% credit (limited to $1,000) applies if your AGI is $28,875 or below, and the upper limit is $48,000, at which point your credit is 10% of your contribution. For all other filing statuses, the 50% credit is available for an AGI below $19,250 and reduces to 10% at the upper limit AGI of $32,000. Again, these figures are for 2019, to be updated when the 2020 figures become available.

It is important to note that this credit is not fully refundable – your ordinary tax (plus any AMT) minus Foreign Tax credit, Credit for Child and Dependent Care Expenses, and Education Credits limits the Saver’s Credit further (see Example 3 below).

Examples

Example 1 You’re single and have an AGI of $23,000, and have made IRA contributions of $2,000 for the year. You do not have any additional credits to claim (those listed above). According to the schedule (found in Form 8880) you are eligible for a 10% credit on up to $2,000 of contributions to your IRA, or $200, as long as your tax is at least $200.

Example 2 You’re married and you file jointly, and you have an AGI of $32,000, and have made contributions to your employer’s 401(k) plan of $5,000 for the year and your spouse has made $2,500 in contributions to his IRA. You also do not have any additional credits to claim. According to the schedule, you are eligible to take the maximum credit of $2,000 – which is 50% of the eligible $2,000 portions of your contributions to the retirement plans for the year, as long as your tax is at least $2,000.

Example 3 You file as Head of Household, you have an AGI of $22,000, have made $1,500 contributions to your employer’s 401(k) plan and have child care credits of $500 – and your total tax before credits is $635. According to the schedule, you can take a Saver’s Credit of $135, as your net tax after the child care credit is $135. If you had not had the child care credit, you would have been eligible for a Saver’s Credit equal to 50% of your contributions, or $750 – but since your tax is less (at $635), your Saver’s Credit is limited to $635, your total tax liability.

Last Few Comments

One final wrinkle: you also have to take into account any distributions that you’ve taken (or will be taking up to the due date of the return) for two years prior to the year of the credit or during the year of the credit. This is to keep you from taking a distribution from your IRA, and then making a contribution of that amount back into the account in order to claim the credit.

Other than that, I think this is a great credit – and lots of folks who could take advantage of it aren’t aware of it. It’s a very good incentive to get started in a retirement plan, specifically when income is low and retirement planning isn’t the highest priority. This credit is in addition to all of the other tax benefits that you can receive from contributing to retirement plans.

Most software programs for tax preparation account for this credit automatically these days. But it pays to check up on what the program is doing for you just to make sure you get the credit you deserve!

Posted on Sep 14th, 2020

by author: jblankenship.

Posted in: 401 k, head of household, IRA, retirement plan, retirement savings plans, roth ira, saver's credit, tax, tax credits.
Tagged: IRA · retirement plan · tax

Social Security Eligibility

Sep 8th, 2020

2 comments

In order to be eligible to receive Social Security benefits – retirement, disability, or survivor benefits – a worker must earn eligibility to receive the benefits. The general rule of thumb is that for full benefits, the worker must earn at least 40 quarters of Social Security credit within the system.

For retirement benefits, you must have the full 40 quarters of Social Security credit earned – no partial benefit is available if you only have, for example, 39 quarters of credit earned.

Social Security Credit

A quarter of Social Security credit is earned for each $1,410 earned (in 2020). This amount is generally indexed each year – for example, the amount of earnings for a credit in 2019 was $1,360. So if a worker earns at least $5,640 in 2020, four quarters of credit are earned with the Social Security system.

Minimum Credits (disability only)

If you become disabled before age 62, disability benefits may be available to you if you have at least six quarters of credits earned. Of course, these benefits will be reduced from the maximum, based upon how many credits you happen to have earned.

If you become disabled before age 24 you need only 6 quarters (credits) during the three years before you become disabled in order to be eligible for disability benefits. And if you are between age 24 and 30 inclusive, you will need to have earned credits equal to half the time between age 21 and your current age in order to qualify.

If you’re age 31 or older you need to have earned 20 or more credits for eligibility. This number of credits increases up to the point where you are 62 upon the onset of your disability, when you’ll need at least 40 quarters, or 10 years’ worth of credits.

Posted on Sep 8th, 2020

by author: jblankenship.

Posted in: disability benefits, retirement, Social Security, social security benefits, social security credit, survivor benefits.
Tagged: Social Security

20 Questions About 529 Plans

Aug 24th, 2020

3 comments

Photo credit: jb

Below is a reprint of an interaction that I had with an anonymous individual several years ago on a web bulletin board, as I thought the 20 questions that the individual listed might be interesting to you. I’ve reviewed the list and updated responses where laws have changed or where I was more snarky than necessary in my response. Let me know if you have more questions to add to the list!

Keep in mind as you read this, the questions are one individual’s specific concerns about his situation. The person asking the question has simply put this list of questions out on a public bulletin board hoping for responses – that’s part of why some of the questions aren’t fully answered or clarified, since the original poster didn’t come back to clarify his questions or respond to my responses…

The original questions are numbered, and my response is italicized.

1. Is there any income limit for parents to be able to qualify/ participate in the 529 plan.

No, there are no income limitations for eligibility to contribute to a 529 plan or to take qualified tax-free distributions from a 529 plan.

2. We are thinking about initiating the plan with Iowa/ Virginia (as we heard from some our contacts have done it) – Even if we move out of CA to another state – can it still be used?

Yes – there is no residence requirement for participation in a 529 plan. Many facets of state-specific plans are reserved for folks who file a tax return in that specific state, such as deducting the contribution amount from the state income tax return.

3. Is it possible to roll over from 1 state 529 plan to another state – any charges/ fees?

Yes, it is possible. Fees will depend upon the plan chosen. Generally rollovers are restricted to once per year.

4. Assume that the child does not get educated here in the USA, can the funds be used for International education – Canada, France, Singapore, India ?

The funds could be used for international education, but if the school is not accredited in the US, you’ll pay a penalty and taxes on the growth of the fund if you withdraw funds for this purpose, which is not considered a Qualified Higher Education Expense (QHEE).

5. What are the annual contribution limits – per child/ couple/ family?

In general, this is up to the plan, and the limits range between $235,000 and $500,000, depending on the state. In order to maintain simplicity, most folks limit their annual contribution to the annual gift exclusion limit ($15,000 per child per parent in 2020), while some utilize the special 5-year front-load gift limit ($75,000 per child per parent in 2020). If you contribute more than the gift exclusion limit, you’ll need to file a gift tax return and possibly pay tax on the gift.

Having said this, though – many states limit tax benefits to $10,000 per child per year. This will be different on a plan/state basis. If you’re investing in an out-of-state plan, this won’t matter to you.

6. What is the process to take out the funds in the middle? Would there be any penalties?

You contact the plan to make a distribution from the plan. There would be penalties and taxes due on the growth in the account. Depending upon state tax benefits (and the plan you’re using), there may be state taxes and/or penalties involved as well, since some states require recapture of any deduction benefit that was provided for contributions.

7. Is it possible to have a 529 in more than 1 state? Are there any restrictions?

Yes, you may have 529 plans in more than one state. Primary restriction that I can think of would be the gift tax exclusions noted earlier. Otherwise there is no reason you couldn’t have several states’ plans.

8. Is it possible to move $ across funds? Are there any restrictions/ charges?

Again, this depends upon the plan. If your question is “can I move money around to other funds/allocations within the same 529 plan?”, then the answer is yes, but depending upon the plan, there are likely restrictions, such as rebalancing can only be done once every 12 months.

If your question is “can I move money around to other 529 plans?”, the answer is yes, but I believe you need to move the entire account (roll over) when you do this, and I believe you are limited to one such rollover in twelve months.

9. What happens if I loose the $ in account? Are there chances of loosing?

You have a smaller balance at the end of the month than you did at the beginning of the month.

Of course there are chances of losing money – just the same as any investing activity. This of course will depend upon your investment allocation decisions. The more risky your choices, the more likely you are to lose (and gain) money.

10. Who holds control in a 529? What happens if a beneficiary is no longer part of the family (God Forbid !!)? Etc or something happens to the contributor?

The owner of the account (you, your spouse, etc.) has control over the beneficiary of the account, and so you can change the beneficiary as you see fit. If something happens to the contributor (and by this I assume you mean the owner – yourself), hopefully you’ve chosen an appropriate contingent owner to manage the funds in your absence. Otherwise it is probably up to state statutes to determine management.

11. Is there any age restrictions in using this 529 $ for the beneficiary or can it be used at any age?

No restriction on the age of the beneficiary.

12. What happens if there is left over’s & I am not able to use it?

This partly depends upon why there is left over money: if this is due to the fact that the student received scholarships, then you are allowed to distribute an offsetting amount (same as the scholarship) from the 529 account, to the extent that the scholarship monies are used for QHEE. This distribution must take place in the same year that the expenses are paid.

If there are funds remaining in the account due to the death or disability of the primary beneficiary, you are allowed to remove the funds from the account without penalty. You must pay tax on the growth of the account, but no penalty.

If there are funds remaining in the account because the cost of school for that beneficiary was less than you anticipated, you have two choices: roll the funds over to a new beneficiary, or take a distribution and pay the tax/penalty. The rollover can be done to anyone who is a member of the original beneficiary’s family. Qualified family members include the beneficiary’s siblings, parents, children, first cousins, nieces and nephews, among others.

13. Can I pass this to my brothers / sisters children? & is there any limitations? Can the funds be used for self/ spouse?

Yes – as long as the new beneficiary is related to the original beneficiary as described in #12.

14. Can the 529 funds or any left over’s be used by the next generation?

Yes.

15. Does having a 529 account mean, one cannot initiate a UTMA/ UGMA, Coverdall etc?

No, a 529 account does not exclude eligibility to utilize those vehicles. Funding those plans may be limited by gifting limitations as described previously.

16. I was reading an article & vaguely recall a # $239,000 (Is this the total $ contribution or the $ balance on the account (attributed due to appreciation/ dividends etc).

I don’t know – I don’t vaguely recall reading that article. The limits are going to be different for each plan. See #5.

17. Are (qualified/ nonqualified) withdrawals exempt from state taxes?

Depends upon the plan. Most qualified withdrawals are exempt for most states’ tax. Nonqualified withdrawals may or may not be exempt from state taxes – look at your state’s tax laws and the plan information.

18. How does the process work? Should I prepay for the university & give a receipt to the 529 plan? or will the 529 pay the university directly? Will it cover only University fees/ registration/ dorm/ living? Clothing, Books?

Again, take this up with your specific plan. In general, you can either pre-pay or make a withdrawal to pay the amount(s). Just keep good records. In general your QHEE will include tuition, fees and books. Room/board may also be covered, depending upon the plan in question.

In my experience, I have always found it simplest to send the distribution directly from the plan to the school to pay for expenses. This way there is only one set of accounting to maintain.

19. Is the 529 applicable for school also? or Undergraduate/ Graduate/ PhD?

Okay, what are you asking here? 529 plans are generally for post-high school education expenses, which includes undergrad, grad, and PhD studies, as well as non-degree pursuing education. The Tax Cuts and Jobs Act of 2017 also made provision for the use of up to $10,000 annually for tuition for public, private or religious elementary or secondary schools.

20. Is anyone aware of any state tax inventives for the state of CA?

No – at least not this particular anyone.

Posted on Aug 24th, 2020

by author: jblankenship.

3 comments already - add to the conversation!

Posted in: 529, education.

IRA Rollover Waiver Denied When Funds Used as a Loan

Aug 17th, 2020

5 comments

Photo credit: diedoe

A recent Private Letter Ruling (PLR) from the IRS may be of interest to IRA owners who are thinking about using IRA funds as a short-term loan. There are a couple of factors in this ruling that you need to understand if you’re looking to use IRA funds for a short-term loan (hint: it’s not recommended!).

PLR 202033008 was issued August 14, 2020. The taxpayer had, upon the advice of his real estate agent, taken a withdrawal from his IRA in order to purchase a home. At the time, his old home had not yet sold, so he needed a cash source to make the down-payment on his new home. To make a long story short, the taxpayer’s old home sale completed after the 60-day rollover window. When he tried to re-deposit the withdrawal (actually only a portion of the original amount) into the IRA, his IRA custodian informed him that this rollover was not allowed since it was past the 60-day window.

The request for ruling suggested that the taxpayer was unaware of the 60-day window, and neither his real estate agent nor his IRA custodian informed him of this restriction. Therefore, the taxpayer asserted that the lack of notice (about the 60-day limit) from either the agent or custodian constitutes an error on the part of a financial institution, and he should be allowed a rollover waiver.

In the PLR, the IRS notes that, unlike retirement plans, there is not a requirement of an IRA custodian to provide this information, and thus does not rise to the level of an error.

Additionally, IRS asserts that the purpose of such a rollover (within 60 days) is intended to facilitate portability between qualified plans, including IRAs. This provision was not intended in any way to facilitate a short-term loan, and so this usage was inconsistent with the intent of the legislation.

Since the reason for missing the 60-day window was not a financial institution error, and further that the withdrawal was not used for the intended purpose (solely to rollover into another account), the IRS denied the request for waiver of the 60-day limitation for this taxpayer.

The moral of the story is this: if you’re planning to use IRA funds as a short-term loan, don’t miss the 60-day rollover window! This taxpayer’s actions would have worked out okay if he had only completed his rollover within that time period.

Better yet – don’t try to use IRA funds as a short-term loan. If your only option to complete a transaction is to use funds from the IRA, you should either just withdraw the funds and consider the action complete (and plan to pay the taxes and penalties). Then, if it happens to turn out that you’re able to complete a rollover within the 60-day window, good for you! If not, at least you planned for this.

The other option is to give the transaction a “pass” until your situation will support it without having to lean on the troublesome short-term loan.

Also: Don’t let a real estate agent advise you on your IRA. That’s not his (or her) job.

Posted on Aug 17th, 2020

by author: jblankenship.

5 comments already - add to the conversation!

Posted in: IRA, ira funds, plr, rollover.

Is It Time to Rethink the Emergency Fund?

Aug 14th, 2020

by sraskie.

8 comments

For the longest time in wealth management the recommended amount of money to have in an emergency fund has been three to six months of non-discretionary expenses (mortgage, rent, utilities, groceries).

Typically, three months was the recommendation for a single individual or married couple with dual incomes. Six months was generally for married couples with one income earner.

Every so often, something comes along challenging conventional wisdom, and that can be a good thing. In this case, it’s a pandemic that’s changing how we think – about many things.

The pandemic has wreaked havoc on many lives. People have been laid off, lost jobs, are working less hours, losing income. Those with emergency funds have seen them dry up, and those that didn’t have them to begin with were worse off.

For the future, it may be wise to consider a longer (more money) emergency fund. For example, we can consider an emergency fund of nine to twelve months, perhaps longer. In fact, many retired individuals have emergency funds of twelve to twenty-four months.

Granted, retired individuals are using their emergency funds to wait out market volatility, but in a sense, working individuals are using their funds to wait out employment and income volatility.

In both situations, the longer the emergency fund the less likely individuals will have to dip into their retirement savings either when markets are down (retired individuals), when saving for retirement (working individuals), or both.

To calculate how much you need, simply look at all your non-discretionary expenses, add them together, and multiply by 9, 12, 24, etc. The reason I say non-discretionary expenses is because we can cancel TV services, subscriptions, stop dining out, etc. in an emergency.

Once you’ve got the amount you’ll need, start saving. It may take some time, but a good goal would be to save a month’s worth at a time – thus in nine months, you’d have a 9-month emergency fund and so on.

Finally, put your emergency funds in a safe place such as an FDIC insured savings account. Don’t keep them in a safe at home (most insurance companies will not reimburse you if it lost, stolen, or destroyed), and don’t put it in risky assets such as stocks, bonds, real estate, etc.

You want easy access to this money, without worrying that when an emergency arrives, your funds have dropped from volatility.

Posted on Aug 14th, 2020

by author: sraskie.

8 comments already - add to the conversation!

Posted in: emergency fund.
Tagged: emergency fund

Inherit an IRA? Don’t forget to name a beneficiary!

Aug 10th, 2020

2 comments

Photo credit: diedoe

After the death of a loved one, there are many things that you have to deal with, not the least of which is handling your own emotions and grief over the loss. In addition to this very difficult transition, there often are lots of financial things to take care of as well. One of those matters is to make sure you have your own beneficiary designations properly assigned to any inherited IRAs or other retirement plans.

As with any IRA, if you haven’t properly designated a beneficiary, you’re dependent on the IRA custodian’s rules (and often your state probate rules) to determine where the IRA should go at your own passing. It only takes filing a form (generally) to make sure this is accomplished. Then you can move on with all of the other “stuff” that you need to deal with.

For an example of what might go wrong… imagine that you’ve inherited an IRA from your mother. First of all, you’ll likely need to either set up an account titled as an inherited IRA (or sometimes just re-titling the original account is adequate). Then you’d assign a beneficiary or beneficiaries, and perhaps a contingent beneficiary or beneficiaries, to the account.

Let’s say you’ve set up your inherited account, and your intent is to pass along this IRA, split evenly among your three children. One of the first questions you need to answer is “What happens if one of the three kids dies before I do?”

Depending on how you’ve designated this, the account could be split evenly between the two remaining children (this is called “per capita” designation). Or, another way to deal with this is for the account to still be split 3 ways, with the deceased child’s estate retaining ownership of one third (this is known as “per stirpes” designation).

If you don’t make a choice between these two (per stirpes or per capita), your IRA custodian’s default rules will apply, which may result in a split that you didn’t intend.

If you’ve chosen per capita distribution and all three children pre-decease you, your contingent beneficiary designation will apply. If you haven’t designated a contingent beneficiary, again, the IRA custodian’s rules and your state probate law will apply. Most often this means that your estate will be the beneficiary, and your estate’s heirs will have claim to the account.

Let’s complicate things a bit further: how about if you’re in the process of a drawn out divorce, and you haven’t yet set up your inherited IRA beneficiaries (to the three children) just yet. What happens if you die in the meantime? Most state probate laws would direct the inherited IRA to your (still legal) spouse, if your beneficiary designations aren’t in place yet.

Timeliness of the designation is critical in a case like this, as well as many other circumstances. Take the time to get this out of the way, and review it every once in a while (annually is good) to make sure your wishes are still reflected in your beneficiary designations.

Posted on Aug 10th, 2020

by author: jblankenship.

Posted in: Uncategorized.

IRA Transfer to HSA: Does This Make Sense?

Aug 3rd, 2020

1 comment

Photo credit: coop

In our discussion of Health Savings Accounts (you can see Part 1 here, and Part 2 here), it was mentioned that one possible method for contributing to a HSA is by way of a once-in-a-lifetime tax-free transfer from an IRA. The question is: Does this make sense? When would you want to use this one-time option?

Does This Make Sense?

The reason that the question of “does it make sense?” comes up is because when you are eligible to make contributions to your HSA, you can deduct those contributions from ordinary income. In the case of the tax-free transfer, no deduction is allowed – in fact the income isn’t included at all, so therefore there is no deduction.

For many folks, the deduction against earned income (above the line; that is, this deduction impacts Adjusted Gross Income and Modified AGI, therefore impacting all sorts of other calculations) is more valuable than any benefit of a one-time tax-free transfer.

If the IRA is the only source of funds that you have available to make the contribution, you’re probably just as well off to take the distribution, pay the tax, and then take the deduction for the HSA contribution in many cases. This option is available to you every year, not just once in your life. If you are under age 59½ you will owe the 10% early withdrawal penalty in addition to the ordinary income tax, of course.

Other Cases

So when would it make sense to use this one-time tax-free transfer? I can think of a couple of cases where this might be the right move:

If you are under age 59½ and you have no other funds available to make a contribution to your HSA, using the rollover/transfer from your IRA would bypass the 10% early withdrawal penalty. I would think you’d want to make this your last resort if you’re in that position.
If you are in a position where you are eligible to take the distribution from your IRA (you’re over age 59½) but showing the income on your tax return will impact some other external calculation – such as financial aid for college, creditors, state income tax, health insurance, or an ex-spouse.

Bottom Line

The bottom line of all this is: if you have other current income, use those funds to make your deductible HSA contribution. If you have no other source of funds beyond your IRA and you are over age 59½, take the distribution from your IRA as taxable income and then make the HSA contribution from there. As a last resort, if you are under age 59½ and have only your IRA as a source of funds to make a contribution to your HSA – then it might make sense to do the one-time IRA-to-HSA tax-free transfer.

NOTE: It is important to note that this one-time option does not increase the amount that you can contribute to your HSA, nor does it allow you to make a contribution if you are otherwise ineligible to make such a contribution.

If you can think of other situations where the tax-free rollover from your IRA to your HSA might make sense, please leave a comment below!

Posted on Aug 3rd, 2020

by author: jblankenship.

1 comment already - add to the conversation!

Posted in: health insurance, IRA, tax.
Tagged: IRA · tax

Why Most People Are So Bad At Stock Picking (and what does Howie Mandel have to do with it?)

Jul 20th, 2020

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Photo credit: jb

You know the old game show “Deal or No Deal”, right? If you aren’t familiar with it, here’s a basic rundown of the premise: the contestant is faced with 26 briefcases, each with a dollar amount inside, ranging from one penny up to one million dollars. At the beginning of the show, the contestant chooses one of the cases as her prize. Howie Mandell was the original host of the show – I don’t know if it still exists these days but it’s a classic example.

The amount in the case she has chosen remains secret until the end of the show. Then the contestant begins eliminating the remaining 25 cases – first in groups of larger numbers, then fewer at a time, and finally one at at time. As the cases are chosen, the amount in each case is revealed. At the end of each round of reveals, a mysterious character called “the banker” offers the contestant a sum of money to drop out of the game.

The amount that the banker offers seems random, but it is actually relative to the amounts that have yet to be revealed: if more high-dollar amounts are remaining to be revealed (which means a high-dollar amount could be in the contestant’s prize case), a relatively higher amount is offered. If the amount offered is attractive enough to the contestant, she can choose to take that amount, quit the game and walk away. If the contestant refuses the offer, she will have to choose another case and reveal the amount.

As the match progresses, often we see the contestant choosing cases that reveal high dollar amounts in them – which prompts the banker’s offer to reduce. Even when faced with seemingly impossible odds against her, when this situation occurs, the contestant often becomes a risk-taker – more so than you would normally expect.

This is because the contestant feels as if she has already lost something (the earlier offer from the banker) and somehow she must make up the loss by continuing the game in spite of the odds becoming less and less that there is a large amount in her chosen prize. Statistics will rule, and on average the contestant walks away with a much smaller prize than expected.

So what does this have to do with investing?

Quite often we see the same sort of behavior in the stock market: always trying to do better than the average, folks will use all kinds of methods, including paying extra to get the top dog stock picker’s advice – because they’re sure they can beat the market. And then, if the chosen stock shoots up in value, the investor hangs on, knowing that if it went up 10% it is bound to go up another 10%. But what happens when the stock goes on up to 20%? Yep, hang in there, cuz it’s bound to keep up.

Then suddenly the stock pulls back, and now is down 5% from the original investment – what happens now? This is just like when the banker on Deal or No Deal reduces his offer: the investor feels like she’s lost something that she already had in hand, so she begins to take even more risks. Perhaps she’ll buy some more of the stock – again, knowing she’ll make up the losses with future gains. But it rarely works out for the hapless investor.

The problem is that the investor didn’t go into the investment with a plan – and the same would hold true for a contestant on Deal or No Deal. If you decided that you were shooting for a 10% return from this particular stock, you’d have sold out at that level and could have gone looking for the next great option. Without a plan, you never know when to get out of the position.

A Plan!

If a contestant were to go into the show with the plan that she’d like to do better than average – the first time the banker offered more than $131,477.50, she should take it. ($131,477.50 is the average of all the amounts in suitcases.) That would be an excellent strategy to take, especially when you consider the fact that 20 of the 26 cases have less than the average of all the cases taken together.

As an investor, the odds are much better for you, using history as a guide. If our investor chose to take a shortcut and get a return that is at least the average of the stock market – since in the last 40 or 50 years the stock market has only returned a negative roughly 20% of the time, using the average would assure you of a positive return 80% of the time. That’s much better than the results of the average Joe or Jane who plays an active stock picking game.

To get the average of the overall marketplace, the investor can choose to invest in broadly-diversified indexes, covering domestic and global markets. This is a very cost-effective way to achieve the average – and with such a strategy you don’t have to worry about when to get in or get out, or even shout “NO DEAL”. Go for it, and hang on for the wild ride of average returns. And if you want a fist-bump, fine, come by my office, I’ll be happy to oblige.

Posted on Jul 20th, 2020

by author: jblankenship.

4 comments already - add to the conversation!

Posted in: financial planning, investing.
Tagged: financial planning

The day I was asked if I buy and sell gold

Jul 13th, 2020

2 comments

Photo credit: jb

I was recently walking down the street and came across a man with a table set up, right on the sidewalk. He had gold and silver coins on it, each in its own special plastic case. Apparently he was attempting to sell some of his collection. I didn’t engage him, just walked around his table, where a couple of other folks were standing talking to him.

I’m pretty sure he knew me and what I do, because as I passed by he stopped his conversation with the others and asked “Do you buy and sell gold?”. I politely told him no, that I didn’t deal in metals at all.

“Wrong move, bud! Gold has outperformed the stock market for the last wawh-wah, wawh, waah…” (somehow he had turned into Charlie Brown’s teacher by this point).

Not wanting a confrontation, I just smiled politely and went on my way. After all, anything that I had to say about the subject was likely to result in a disagreement at best, and possibly turning away his potential customers.

I don’t begrudge the man for his particular choice of investment. For all I know, he may be very successful at it. He may even have multitude of different investing activities, giving him a well-diversified portfolio. Good for him! It’s just not for me.

Had I taken him up on his challenge, I would have brought out two particular points about why I don’t buy and sell gold:

Gold’s value is difficult to determine. Gold is only worth what a prospective buyer is willing to offer. Granted, in non-coin form there is a somewhat agreed-upon value in the global marketplace for gold, but that value fluctuates (sometimes wildly) and is not relative to the utility of the investment.

On the other hand, stocks have a value based on the future earnings potential of the company or companies. These values also vary (sometimes wildly) as well, but in general the value is relatively constant. One can easily look at the inherent value versus the value the marketplace has put on the stock to determine if it is currently underpriced or overpriced. With gold you don’t have an underlying stream of income (gold produces no income) to help determine its price.

If I were to buy a coin from this man for his tagged $20 price, in order for me to make money on it I’d need to convince someone else that it was worth something more. Chances are, the $20 price is either at or above the retail price for the coin, and since I’m not a coin expert I don’t know the difference. I’m simply taking his word for the fact that the coin is worth what he’s charging me for it.

I could do some research on that particular coin. Once I do, maybe I’ll find that it’s only worth $15 if I were to take it elsewhere (like an exchange) to sell. Or perhaps I’d find that an exchange might be willing to buy it from me for $22.

The likelihood of finding a coin that is underpriced in such a circumstance is pretty low. After all, the guy at the table has been doing this for a while – he knows what he paid for the coin, and he knows what he needs to sell it for to make a profit. He also knows what an exchange will pay for the coin, and he’s priced his coin above that. Obviously he wants to maximize his profit.

So as the buyer of a gold coin, I’m disadvantaged. I don’t know what the coin is worth without taking time to research about it. And going into a transaction without knowing the worth of the item is a big mistake.

The primary difference between gold and common stocks is that in buying gold you are speculating that someone in the future will be willing to buy it from you for a higher price. With common stocks, you have an understanding of the underlying company’s potential to earn a profit, which in turn should result in either a higher future price for the stock, or a dividend paid out to you as the owner of the stock, or both.

Gold doesn’t earn a profit. You must rely on the actions of future buyers and their opinion of gold’s value to determine whether you’ll make money or lose money.

You must store and secure your gold. If you own gold coins or bars, you need to find a place to put it where it will be secure from thieves. You also need to be able to get to it pretty quickly if you find a buyer for your coin. This can result in some significant costs over time.

Warren Buffett says of gold:

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it.

You might need to install an alarm system on your home or office (wherever you keep the gold). And you might have to invest in a safe – something heavy-duty enough that a thief couldn’t just pick it up and walk away. Plus, gold is heavy. It doesn’t take a lot of coins to result in some pretty serious weight – making moving it around harder, as well as possibly requiring structural adjustments to the building where you store it.

Of course, you could always rent a safe deposit box for your gold – but then again, if you’re a prepper you probably don’t trust the “system” enough to put your hoard in the hands of some bank. Besides, once the apocalypse occurs, how are you going to get your gold out of the bank?

On the other hand, with stocks (in non-apocalypse times) you don’t have to find a place to store them (unless you have stock certificates, and that’s pretty rare these days). In addition, pretty much any business day you can buy or sell stocks, and you don’t have to worry about whether your den floor will be sufficient to hold the weight. You also don’t have to worry about being robbed while you’re moving your item from your safe place to the hands of the new buyer.

In the event of some potential apocalypse, I figure there’s little likelihood that pre-event money of any kind will have much value. I think we’ll all have to work out for ourselves how to survive – and carrying around bags of gold is probably not the way this will work anyway. I’m not trying to poo-poo the prepper movement – it’s just not how I’m spending my time. How does that line from Larry Norman go…?

A piece of bread could buy a bag of gold…

Conclusion. The only reason to buy gold is to re-sell it. It’s the valuation issue that causes the most problems for gold. If you can’t find someone to buy your gold for what you think it’s worth, you either have to accept a loss, or wait until another buyer comes along. Sometimes you don’t have the luxury of time to wait. If you need money right away it’s not like you could stop by the grocery store with your bar of gold and shave off a few milligrams to buy your loaf of bread.

With stocks, even though there may be fluctuations in prices, there are also earnings from the underlying company to add to the mix. You might be caught in the same circumstance as with the gold, where the market is lower than your original cost for the stock, but presumably you’ve also had some earnings over time. Since there is economic activity associated with the company, at least you’ve got something earning you money over time, not just sitting there taking up space and costing you money to secure it (as with gold).

Also, with gold you may find yourself in the position (for example) of setting up a table on a street corner to try to attract buyers for your holdings. With stocks you don’t have to go to this extreme. Although, now that I think about it, I suppose that may be some of the attraction to holding gold. You can sell it outside of a systemic marketplace and potentially hide your profits from taxation since it’s likely a pure cash transaction. But I’m sure that doesn’t happen often, right?

Speaking of taxation, (in the US, anyhow) under our current system, capital gains from stock holdings are taxed at a maximum rate of 20%, depending on your overall income (can be as little as 0%). Gold on the other hand, is considered a “collectible” (whether in bars or coins) and is taxed at up to 28%. As with all matters, the tax tail should not wag the investing dog, of course.

Posted on Jul 13th, 2020

by author: jblankenship.

Posted in: gold, investing.

Taxes when Re-depositing IRA Withdrawals

Jul 6th, 2020

3 comments

Photo credit: jb

If you take a withdrawal from an IRA (or pretty much any tax-deferral mechanism, such as a 401(k) account), under some circumstances you may be able to re-deposit the money back into the original account, or one with similar characteristics. One such circumstance is in tax year 2020, when the CARES Act has given the opportunity to re-deposit RMDs within a certain timeframe. (Click the link for more information on Re-depositing RMD in 2020.)

What kind of tax impacts are there for re-deposits?

To understand the tax impacts of re-depositing IRA withdrawals, you must first determine what is the exact nature of the withdrawal. The withdrawal could be made up of all tax-deferred money, or it could be partly tax-deferred and partly pre-taxed contributions. In addition, the distribution could be completely made in cash to you, or a portion of the distribution could have been directed elsewhere, such as withheld for income tax purposes or sent to a charity as a Qualified Charitable Distribution (QCD).

It should be noted that the re-deposits discussed here are rollover deposits – not regular annual contributions. Regular contributions do not impact withdrawals in the same manner as rollover deposits. These are two separate activities – and they can occur in the same tax year.

All funds tax-deferred. If the entire distribution was made up of tax-deferred money, if you re-deposit the entire amount into the source account or another tax-deferred account, there will be no tax consequences (assuming you do so in a timely manner). At the end of the year, your 1099R will show a distribution, but if the re-deposit is into the same account, the entire distribution will be indicated as non-taxed.

However, if you only re-deposit a portion of your distribution, anything left over will be considered taxable income.

For example, if you withdraw $10,000 from your IRA, and you’re otherwise eligible to rollover those funds (either in the “normal” 60-day manner or under the CARES Act rules), if you only re-deposit $5,000, then at the end of the year you’ll get a 1099R indicating a $5,000 taxable withdrawal from your IRA. This amount will be included as ordinary income on your tax return.

If you re-deposit the entire $10,000, then you’ll have no taxable income attributed to this withdrawal.

Some funds pre-taxed, otherwise tax-deferred. If some of your withdrawal comes from non-tax-deferred contributions, the portion that was not tax-deferred is not included as taxable.

Sometimes we make non-deductible contributions to IRAs or 401(k) accounts. When a withdrawal is taken from an IRA and there are non-deductible contributions included, each dollar of withdrawal is partly taxable and partly tax-free. If you re-deposit the entire withdrawal, you’ll only be able to re-deposit the tax-deferred portion into a traditional IRA. The remaining non-deductible portion may be converted to Roth IRA or simply kept as untaxed funds.

Part of the money directed elsewhere. If you directed a portion of your withdrawal to go somewhere else, such as withheld for taxes or directed to a QCD, a special problem comes up. How do you re-deposit the money into your IRA if you don’t have it?

Generally, unless you talk the charity out of the money, you’re either going to have to pay tax on the difference, or come up with the money from another source.

For example, let’s say you took a $10,000 withdrawal from your IRA, and had 20% withheld for taxes. This is a common situation for folks meaning to re-deposit RMD from 2020, for example.

This means that you only received $8,000 of the distribution – and you won’t see the withheld money until you file your tax return next year. Using the example of 2020, you need to re-deposit your RMD before the end of August.

If you don’t have another source of funds to come up with the additional $2,000 withheld for taxes, at the end of the year your 1099R will indicate a taxable distribution of $2,000. Granted this is money withheld to pay taxes, so a 100% withholding rate should be plenty to pay the tax on this $2,000 distribution (with a significant amount available for refund or to pay tax on other earnings).

However, the money for the re-deposit doesn’t have to be the exact same dollars that came out of the IRA. If you have $2,000 sitting in a passbook savings account, you could use that money to include with your $8,000 net withdrawal in order to make the complete re-deposit. If you make the complete re-deposit, at the end of the year this activity will result in zero taxable income.

Posted on Jul 6th, 2020

by author: jblankenship.

3 comments already - add to the conversation!

Posted in: CARES Act, IRA.

Re-depositing RMD in 2020

Jun 29th, 2020

6 comments

Photo credit: diedoe

With the passage of the CARES Act earlier this year, changes were made to the Required Minimum Distribution (RMD) rules. Effectively, anyone who would normally be required to take a distribution from an IRA (plus 401(k), 403(b) or governmental 457 plan) is allowed to skip the distribution for tax year 2020. Inherited plans of the same varieties (which also include Roth-type accounts) are also afforded the same option to skip. Lastly, if you were first required to begin RMDs in 2019 (thus with a required beginning date of April 1, 2020) but had not taken the distribution until 2020, your RMD is waived for this period as well.

We covered a lot of the ground on the RMD changes in 2020 due to CARES in the article Required Minimum Distributions for 2020. Now we have more guidance that wasn’t available when the original article was published almost 3 months ago.

Recently the IRS issued additional guidance on this waiver of RMD. The guidance was published via Notice 2020-51, and the most significant matter (in my opinion) that had not been previously addressed is that of re-depositing RMD that were already taken in 2020.

The problem is that, when the CARES Act was passed into law, it was already several months into the tax year. Many people have their RMDs set up to take a withdrawal every month, spreading the income over the year. Because of this, by the time the CARES Act was passed, more than two and a half months had passed, and so many folks had taken as many as three distributions from their accounts already.

The original information published with CARES provided no special relief regarding re-depositing RMD in 2020, so we were left with the “regular” rules. These rules allow for a rollover contribution to an IRA (or other account) as long as you complete the rollover within 60 days of the distribution. This still doesn’t solve the problem for someone who took his first distribution in January and perhaps another in February, only to find out that he didn’t need to as of mid- to late-March.

In addition, the “regular” rules disallow the rollover of more than one amount (IRAs only) during any 12 months. So if you took 3 distributions in early 2020 (before CARES was passed), you would normally be allowed to only re-deposit one of the RMDs, not all three.

IRS Notice 2020-51

The IRS published additional guidance recently to resolve this situation. Two things were changed regarding re-depositing RMD in 2020:

Any amount taken as RMD in 2020 may be re-deposited (rolled over) into a qualified plan (IRA, 401(k), etc.) by August 31. This adjustment removes the 60-day limitation on rollovers. Inherited account RMDs must be deposited back into the originating account.
Any amount taken as RMD in 2020 may be re-deposited (rolled over) into an IRA without regard to the one-rollover-per-year rule.

Note that the rules indicate “any amount taken as RMD”. This means that amounts over and above the required minimum distribution for the year are not subject to these two new provisions.

For example, if your RMD for 2020 is $11,500 and you have set up a distribution of $1,000 per month, you would have received $3,000 in RMD distributions by the time CARES was passed. And you might not have stopped the automatic distribution for a couple of months after that. So let’s say you’ve distributed $5,000 in RMD for the year, and you’ve decided that you don’t need that money (and you’ve stopped the distributions for the remainder of the year). You’re allowed to re-deposit the entire $5,000 back into your IRA, as long as you do it by August 31, 2020.

However, if instead of monthly withdrawals you had taken a full distribution of $12,000 (extra amount just to make it certain you’ve covered your RMD for the year), you can only re-deposit $11,500 – the amount of your required minimum distribution for the year. Any amount may be re-deposited, up to the required minimum for the year.

Posted on Jun 29th, 2020

by author: jblankenship.

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Posted in: CARES Act, required minimum distribution, rmd, rmds.

Open a Roth IRA for Your Child

Jun 22nd, 2020