April 30, 2018 By

Q&A: If you’re putting money in a 401(k) and an IRA at the same time, be ready for the taxes

Dear Liz: I recently returned to a regular 9-to-5 job after freelancing for several years. I contributed the maximum amount to an IRA while self-employed and continued to do so after starting my new job. I was surprised to learn when doing my taxes this year that I could not deduct my IRA contributions because I was also contributing to my company’s 401(k) plan.

Other than increase my 401(k) contributions at the expense of future IRA funding, are there any actions I can take?

Answer: The ability to deduct IRA contributions when contributing to a workplace retirement plan phases out once your modified adjusted gross income reaches certain limits. For single filers, the deduction starts to phase out at $63,000 and disappears at $73,000. For married couples filing jointly, the phase-out is from $101,000 to $121,000.

Your next move depends on your goals and situation. If you’re primarily concerned with reducing your current tax bill and you’re likely to be in a lower tax bracket in retirement, as most people will, then you should funnel more money into your 401(k) rather than funding your IRA.

If, however, you expect to be in the same or higher bracket in retirement, or if you want more flexibility to control your tax bill in your later years, consider contributing to a Roth IRA in addition to your 401(k). Roths don’t offer an up-front deduction, but withdrawals in retirement are tax free. Also, unlike 401(k)s and traditional IRAs, there are no minimum required withdrawals in retirement.

There are income limits on the ability to contribute to a Roth IRA. For single people, the ability to contribute phases out between modified adjusted gross incomes of $120,000 to $135,000 in 2018. For married couples filing jointly, the phase-out is between $189,000 and $199,000.

Filed Under: Investing, Q&A, Retirement Tagged With: , , ,
April 30, 2018 By

Q&A: The idea here is not to cheat public servants

Dear Liz: Thanks for your column about Social Security claiming strategies. Here’s a further complication you didn’t address. If the surviving spouse is a teacher in many states, access to survivor’s Social Security benefits is further restricted (if not entirely blocked) by a misogynistic, anti-teacher ruling dubbed the windfall elimination provision, which perhaps was a backlash against the women’s liberation movement of the 1970s and 1980s.

Any clarification on the windfall elimination provision’s inconsistent application and its impact on my widow’s fixed income will be greatly appreciated.

Answer: The explanation is actually a lot more prosaic.

The windfall elimination provision and a related measure, the government pension offset, were not designed to rob public servants of benefits other people get. Instead, the provisions were meant to keep those who get government pensions from getting significantly bigger benefits than people in the private sector.

The provision that would reduce and possibly eliminate your spouse’s survivor benefit is actually the government pension offset. The offset, like the windfall elimination provision, applies to people who get pensions from jobs that didn’t pay into the Social Security system. (Some school systems, as well as other state and local government employers, have opted out of Social Security and provide their own pensions instead.)

If both you and your spouse had only Social Security and no government pensions, one of your two Social Security checks would stop at your death. After that, your spouse would get one check — the larger of the two checks the household received — as a survivor benefit.

If the government pension offset didn’t exist, your widow c​ould receive two checks: a survivor benefit equal to your Social Security benefit, plus her pension. She potentially would be getting a lot more from Social Security than those who paid into Social Security their entire working lives.

The windfall elimination provision, meanwhile, applies to people who have government pensions but also worked in jobs that paid into Social Security.

When people don’t pay into the system for several years because they have jobs with government pensions instead, their annual Social Security earnings for those years are reported as zero. Because Social Security is based on ​workers’ 35 highest-earning years, those zeros make it look like they have lower lifetime earnings than they actually did.

That’s a problem because the Social Security system is progressive, replacing more income for lower-earning workers than for higher-earning ones. Without adjustments, people with pensions would look like lower earners than they actually were. They would wind up with bigger Social Security checks than someone who had the same income in a private-sector job that paid in a lot more in Social Security taxes.

These provisions are complicated and hard to explain, which is part of the reason some people jump to the conclusion they’re being denied something others are getting. In reality, the provisions were meant to make the system more fair.

Filed Under: Q&A, Retirement Tagged With: , , , ,
April 23, 2018 By

Q&A: Don’t run out of money in retirement: Here’s how much to use per year, and why

Dear Liz: I am confused about “safe withdrawal rates” from retirement accounts. I’ve read that withdrawing 4% of savings each year is the gold standard that financial planners utilize to ensure that life savings are preserved in retirement.

However, if the Standard & Poor’s 500 index returns on average 8% a year, and if the life savings are locked down in a mutual fund that is indexed to the S&P 500, then shouldn’t the annual withdrawal amount, to preserve those savings, be 8%? Limiting my withdrawals to 4% means my retirement would be pushed several years down the road. Can you clarify?

Answer: It’s good you asked this question before you retired, rather than afterward when it might have been too late.

You’re right that on average, the S&P 500 has returned at least 8% annualized returns in every rolling 30-year period since 1926. (“Rolling” means each 30-year period starting in 1926, then 1927, then 1928, and so on.)

But the market doesn’t return 8% each and every year. Some years are up a lot more. And some are down — way down. In 2008, for example, the S&P 500 lost about 37% of its value in a single year.

Such big downturns are especially risky for retirees, because retirees are drawing money from a shrinking pool of assets. The money they withdraw doesn’t have the chance to benefit from the inevitable rebound when stock prices recover. Bad markets, particularly at the beginning of someone’s retirement, can dramatically increase the odds of running out of money.

Inflation also can vary, as can returns on cash and bonds. All these factors play a role in how long a pot of money can be expected to last. The “4% rule” resulted from research by financial planner William Bengen, who in the 1990s examined historical returns from 1926 to 1976. Bengen found there was no period when an initial 4% withdrawal, adjusted each year afterward for inflation, would have exhausted a diversified investment portfolio of stocks and bonds in less than 33 years.

Some subsequent research has suggested a 3% initial withdrawal rate might be better, especially for early retirees or those with more conservative, bond-heavy portfolios.

Free online calculators can give you some idea of whether you’re on track to retire. A good one to check out is T. Rowe Price’s retirement income calculator. But you’d be smart to run your findings past a fee-only financial planner as well. The decisions you make in the years around retirement are often irreversible, and what you don’t know can hurt you.

Filed Under: Q&A, Retirement, Saving Money Tagged With: , , ,
April 23, 2018 By

Q&A: Deciding when to claim Social Security benefits

Dear Liz: In a recent article you discussed delaying Social Security benefits and wrote that for married couples, only the higher earner needs to wait until age 70 to get the largest possible check. I don’t understand the logic behind that statement.

I have always been told to wait until 70 to collect; however, my husband is the higher wage earner. Wouldn’t I still benefit from waiting until 70? If he is a few years younger than me, does that make a difference? If I don’t have to wait until 70, I am all for collecting at 66.

Answer: As you know, each year you delay boosts the check you get by roughly 7% to 8%. That’s a guaranteed return you can’t match elsewhere and why many financial planners encourage clients to delay claiming if they can. The “break-even” point — where the benefits you pass up are exceeded by the larger checks — can vary depending on the assumptions you make about investment returns, inflation and taxes. Generally speaking, you’ll be better off delaying until at least 66 if you live into your late 70s. If you delay until age 70, when your benefit maxes out, you’ll pass the break-even point in your early 80s.

None of us has a crystal ball, of course, and planners make the argument that Social Security should be viewed as longevity insurance: The longer you live, the more likely you are to spend your other assets and depend on your Social Security for most or all of your income. Given that reality, it makes sense to maximize that check.

That’s true for all individuals claiming Social Security, but married couples have another complication. When one dies, the other will have to get by on a single check — the larger of the two checks the couple was receiving. That’s the check that should be maximized, so it’s more important that the higher earner delay than that both spouses delay.

If you want a more detailed discussion of the issue, read financial planner Michael Kitces’ blog post “Why it rarely pays for both spouses to delay Social Security benefits” at kitces.com.

Filed Under: Q&A, Retirement, Social Security Tagged With:
April 16, 2018 By

Q&A: What’s better, collecting Social Security early or blowing through retirement savings?

Dear Liz: I am married and six months away from my full retirement age, which is 66. I have not filed yet. My wife started collecting Social Security at 62 but does not get very much. We are both in excellent health and have longevity in the genes. We don’t own a home. I have around $960,000 in diversified investments. I take out around $7,000 to $8,000 a month to meet my monthly expenses. Fortunately, the markets have been good, helping my portfolio, but I am not counting on that to continue at the same pace.

Doesn’t it make more sense to be taking less money out each month by starting Social Security now? I know I would receive less money than waiting until 66 or later, but between my check and the spousal benefit my wife could get, I would reduce my annual living expense withdrawals from my account by close to 50%. This would give my portfolio more opportunity to grow, since I will not be taking out so much every month.

I wish I could cut my expenses or could earn more income but cannot at this point. I am shooting for not taking more than 5% a year out of the portfolio going forward.

Answer: You’re right that something needs to change, because your withdrawal rate is way too high.

You’re currently consuming between 8.75% and 10% of your portfolio annually. Financial planners traditionally considered 4% to be a sustainable withdrawal rate. Any higher and you run significant risks of running out of money.

Some financial planning researchers now think the optimum withdrawal rate should be closer to 3%, especially for people like you with longevity in their genes. Chances are good that one or both of you will make it into your 90s, which means your portfolio may need to last three decades or more.

So even if you start Social Security now, you’ll need to reduce your expenses or earn more money to get your withdrawals down to a sustainable level.

Generally, it’s a good idea for the higher earner in a couple to put off filing as long as possible. The surviving spouse will have to get by on one Social Security check, instead of two, and it will be the larger of the two checks the couple received. Maximizing that check is important as longevity insurance, since the longer people live, the more likely they are to run through their other assets. Your check will grow 8% each year you can delay past 66, and that’s a guaranteed return you can’t match anywhere else. In many cases, financial planners will suggest tapping retirement funds if necessary to delay filing.

But every situation is unique. Your smartest move would be to consult a fee-only financial planner who can review your individual situation and give you personalized advice.

Filed Under: Q&A, Retirement, Social Security Tagged With: , , ,
April 16, 2018 By

Q&A: The ins and outs of inherited IRAs

Dear Liz: I have questions about inherited IRAs. A friend has designated me and three others as beneficiaries of her IRA. Is this to be considered community property with my husband? How can I inherit this as “sole and separate property”? Must taxes be paid on this? Also, may I give gifts of cash to relatives beforehand rather than naming them as recipients of my IRA and burdening them with taxes? If I do not name survivors to my IRA, what happens to my hard-earned money after I die?

Answer: Inheritances are considered separate property in every state, including community property states. If you commingle the funds — by depositing a withdrawal in a jointly held checking account, for example — then that money potentially becomes community property. You should consult a tax pro or financial planner about the rules governing non-spouse inheritors, since they’re somewhat complicated. You’ll pay income taxes on withdrawals from regular IRAs you inherit, but typically not from Roths.

You’re welcome to give anyone as much as you want, and they won’t have to pay taxes on the gift. You could owe taxes if you give away enough money, but that’s unlikely. You have to file a gift tax return if you give more than $15,000 per recipient in a given year, but you won’t actually pay gift taxes until the amounts you give away over that annual exclusion limit exceed your lifetime limit, which is currently $11.2 million.

If you’re concerned about taxes, though, naming people as IRA beneficiaries is often a smarter tax move than not doing so and having your estate inherit the money.

If your estate is the beneficiary, the money typically would have to be paid out to your estate’s heirs — and taxed — faster than if specific people were named. Your heirs might have to empty the account within five years, or the IRA custodian may opt to distribute the whole amount to the estate in one taxable distribution. Naming people, on the other hand, may allow the option of stretching the IRA, which means taking distributions over their lifetimes. The tax-deferred money that remains in the account can continue to grow. This is another topic to discuss with your advisor.

Filed Under: Inheritance, Q&A, Retirement Tagged With: , ,
March 19, 2018 By

Q&A: Here are some tips for getting more retirement money into accounts with tax advantages

Dear Liz: My wife and I are about 35. I’m self-employed and contribute to a SEP IRA. My wife contributes to a workplace retirement plan. We don’t qualify to contribute to Roth IRAs. In order to get more money into retirement accounts, would you recommend doing back-door Roth contributions? What else is there to do to get retirement money into accounts that will have a tax benefit now or later?

Answer: Roth IRAs don’t provide an upfront deduction, but withdrawals are tax-free in retirement. That makes them especially enticing to people who expect to be in the same or higher tax bracket in retirement — mostly higher-income people and good savers.

People who earn more than certain limits, however, are prohibited from contributing directly to a Roth IRA. For 2018, direct Roth contributions aren’t allowed for people whose modified adjusted gross incomes exceed $199,000 for married couples filing jointly or $135,000 for single filers.

Several years ago, however, Congress eliminated income limits on who was allowed to convert a regular IRA to a Roth IRA. That change created the back-door Roth strategy, in which a high-income taxpayer contributes to a regular IRA and then converts the money to a Roth.

The strategy works best for people who don’t already have a large IRA filled with pre-tax contributions and earnings. When you convert all or some of an IRA to a Roth, you have to pay a proportionate amount of income taxes on the conversion based on all of your IRA holdings. If you don’t have an existing IRA and don’t deduct the IRA contribution, you’ll owe little if any taxes on the conversion.

The IRS hasn’t specifically blessed or banned the back-door Roth strategy, so it remains somewhat controversial. Many investing and brokerage sites promote it. Some proponents, however, recommend letting several months pass between the contribution and the conversion. The idea is to avoid IRS scrutiny by making the transactions appear to be separate decisions rather than one clearly meant to get around the contribution limits.

If you want to stay out of gray areas and potentially contribute more cash to your retirement, consider setting up a solo 401(k). This version of the popular workplace plan is meant for self-employed business owners with no full-time employees other than themselves and their spouses. Plan participants under age 50 can contribute up to $18,500 a year. Those 50 and older can contribute up to $24,500. The plan can have a Roth and an after-tax contribution option in addition to a pre-tax option. In addition, the business can make a 25% annual profit-sharing contribution (or 20% if the business is a sole proprietorship or single member LLC). The combined maximum of participant and business contribution is $55,000 for those under 50 and $61,000 for those 50 and older.

If you’re able to contribute more than these amounts each year, consider a traditional defined-benefit pension. Those involve considerable set-up and ongoing costs, so consult a tax pro to see if it’s a good fit.

Filed Under: Q&A, Retirement, Taxes Tagged With: , , ,
March 19, 2018 By

Q&A: Identify the goal for rolled-over account

Dear Liz: I retired from civil service in 2014. Upon retirement, I requested that my Roth IRA funds be sent to a bank. The funds have been earning 0.6% interest. Is it possible to move the funds to another bank or elsewhere to earn a higher rate? Or, should I leave the funds at the bank until an unforeseeable emergency occurs?

Answer: It’s not clear from your letter whether you withdrew money from your Roth or simply had the whole thing transferred from one custodian to another (the bank). Either way, you’re free to move your money elsewhere. If the money is still inside the Roth, you’d move the Roth. If it’s outside, you’d just move the funds.

Before you do anything, though, figure out your goal for this money. If it’s your emergency fund, then it needs to be kept safe and liquid. An FDIC-insured bank account is likely the best bet, and many online banks are offering somewhat higher rates than you’re getting now.

If you want this money to grow, however, you’ll need to take more risk with it. That typically means investing a portion of it in stocks and bonds. If that’s your goal, look for a discount brokerage or low-cost mutual fund provider. If you’re new to investing, books such as Kathy Kristof’s “Investing 101” or Eric Tyson’s “Investing for Dummies” could be helpful.

Filed Under: Q&A, Retirement Tagged With: , , ,
March 12, 2018 By

Q&A: At retirement, should you roll your 401(k) into your IRA? Think about these factors

Dear Liz: I turned 70 last week and therefore I am leaving my part-time job after about 13 years. No big deal, but now that I am retiring I have a 401(k) worth about $60,000 and an IRA that is somewhere around $50,000. Should I roll my 401(k) account into my IRA or just let it sit there collecting dust? I do understand that at age 70½ I am supposed to start withdrawing some of the funds, but am not sure how much. It seems 70 years creeped up on me.

Answer: Years have a nasty habit of doing that.

You mentioned that you’re retiring because you’ve achieved a certain age. Few jobs have mandatory retirement ages, though. If you don’t retire, you can continue putting off required minimum distributions from your 401(k). You would still have to take minimum distributions from your IRA, unless your employer allows you to roll that money into your 401(k) plan.

But we’ll assume you’re happy with your decision. Rolling your 401(k) into your IRA isn’t necessarily the best option. What you should do next depends on the details of both accounts.

Most large-company 401(k)s allow retirees to take regular distributions, including required minimum distributions, from the plans. These plans also tend to offer low-cost institutional funds that may be a much better deal than those you can access as a retail investor with an IRA. If you’ve got a good 401(k) that allows retirement distributions, there may be no need to move your money.

If your employer’s plan doesn’t allow such distributions, don’t automatically assume your current IRA provider is the best choice, especially if it’s a full-service brokerage or insurance company. Compare the fees of the investment options with what’s available from a discount brokerage. Transferring all your retirement money to a lower-cost provider can help you keep more money in your pocket.

Calculating your required minimum distributions isn’t difficult. The IRS has tables on its website, and in Publication 590, to help you figure out how much money to withdraw. Various sites have calculators as well.

One caveat: If you keep your IRA and 401(k) separate, you’ll have to calculate required minimum distribution separately for each account and withdraw those amounts from each account, says Mark Luscombe, principal analyst for taxes and accounting at Wolters Kluwer. That’s different from the rules when you have multiple IRAs. When you have more than one IRA, you calculate the required minimum distribution based on the total of all your IRAs but are allowed to take the distribution itself from any one of them.

Filed Under: Q&A, Retirement Tagged With: , , ,
February 19, 2018 By

Q&A: When rolling your 401(k) into an IRA isn’t a good idea

Dear Liz: I have just retired. I have a 401(k) from work. Do I keep it as is or do I roll it over into an IRA?

Answer: Investment companies and their representatives like to push the idea of rollovers as the best option, but that may profit them more than it does you.

Leaving your money in your employer’s 401(k) has several potential advantages. Many 401(k)s offer access to institutional funds, which can be much cheaper than the retail funds available to IRA investors. Workplace retirement plans also offer unlimited protection from creditors if you’re sued or forced to file bankruptcy. An IRA’s bankruptcy exemption is limited to $1,283,025, and protection from creditors’ claims varies by state. (In California, for example, only amounts “necessary for support” are out of reach of creditors.)

If you retired early, you can access your 401(k) without penalty at age 55. The typical age to avoid penalties from IRA withdrawals is 59½.

You may opt for a rollover if your 401(k) offers only expensive or poorly performing options. Even if you decide to roll over the rest of your 401(k), though, get a tax pro’s advice before you roll over any company stock. You may be better off transferring the stock to a taxable account now so you can let future appreciation qualify for capital gains rates. Ask your tax pro how best to take advantage of this “net unrealized appreciation.”

Filed Under: Q&A, Retirement Tagged With: , , ,