February 3, 2020 By

Q&A: Retirement plans by the numbers

Dear Liz: At the moment I contribute to a 403(b) retirement plan at work. I have another 403(b) with a former employer, but haven’t contributed to it since I changed jobs several years ago. Should I contribute to both rather than just one? Also, my current employer offers a deferred compensation plan, but they don’t offer a match. Should I contribute to that or stick to the 403(b)s?

Answer: Once you leave a job, you can’t contribute to its workplace retirement plan. You could leave the money where it is, or perhaps transfer it to your current employer’s plan. Rolling it over to an IRA, though, could give you access to a wider variety of investments at a lower cost. Fees for 403(b) plans tend to be higher than for their workplace cousins, 401(k)s, and the investment options are typically more limited as well.

You also may want to contribute to the deferred compensation plan. These plans allow you to make deductible contributions that can grow tax-deferred, much like a 403(b), 401(k) or other retirement plan. But unlike other retirement plans, there’s typically not a 10% federal penalty for early withdrawals (although the money will still be taxed as income). Having some money in a deferred compensation plan could give you additional flexibility in the future.

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Filed Under: Q&A, Retirement Tagged With: , ,
February 3, 2020 By

Q&A: Something to leave out of your disaster kit: Original documents

Dear Liz: My wife and I are having a disagreement regarding documentation for our disaster recovery kit. She wants to put in hard copies of drivers’ licenses, credit cards, financial records, including bank and equity accounts. I think that all we need are account numbers, because the financial institutions will hold actual documentation in safer places, away from any disaster that may hit our community. I’m worried that someone may find these documents and use them nefariously, especially if we’re away from home during a catastrophic event. How much disaster planning is too much?

Answer: Security expert Avivah Litan said you have a point.

“The risks are higher than the benefits when it comes to storing hard copies of sensitive documents,” said Litan, vice president and distinguished analyst at research firm Gartner Inc.

Litan recommends storing the account numbers in a disaster recovery kit and keeping an original document that proves your identity (such as your driver’s license or passport) with you at all times in case of disaster. She suggested storing electronic copies of vital documents in a secure online storage account from a reputable provider. That way you’ll have access to what you need regardless of where you are.

Also consider allowing others to get access to the account if something happens to you. Some services allow you to appoint a trusted person who could be granted access in case you’re dead or incapacitated, or you could share your password in advance with that person.

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January 27, 2020 By

Q&A: Survivor benefits and earnings tests

Dear Liz: In a recent column, you suggested someone might not want to apply for early survivor benefits if they were still working because earnings over $18,240 will be reduced by $1 for every $2 earned. I don’t understand the logic. One can still earn $18,240, plus half of additional earnings plus the survivor benefit. Why do you recommend it is better to not apply?

Answer: You’ve misunderstood how the earnings test works.

When you apply for Social Security benefits before your own full retirement age and continue to work, your benefit — not your pay — is reduced by $1 for every $2 you earn over a certain limit, which in 2020 is $18,240.

Let’s say your survivor benefit is $1,000 a month, or $12,000 a year. If you earn $32,240 a year, that’s $14,000 over the earnings test limit. Your $12,000 benefit would be reduced by $7,000 — half of $14,000. You’d get $5,000 a year or $416.67 a month.

Now let’s say you earn $42,240, or $24,000 over the limit. Half of $24,000 is $12,000. Your $12,000 benefit is completely offset by the earnings test, reducing your check to zero.

The earnings test disappears at full retirement age, which is somewhere between 66 and 67, depending on when you were born. After that point, your earnings no longer impact your benefit amount.

Filed Under: Q&A, Social Security Tagged With: , , ,
January 27, 2020 By

Q&A:Don’t make this mistake with your retirement savings

Dear Liz: My wife and I are in our mid-40s and planning to buy what likely will be the last house we’ll purchase. I’ve decided to withdraw around $15,000 from my IRA to buy down the rate, which will guarantee returns in the form of interest savings, even if those will be less than the returns I would earn if I left the money in the account. My real question is about our current house. We owe around $77,000 on a house that could likely fetch in the low $200,000 range. I’ve looked at it up, down and sideways. Would it make more sense to rent, sell, or rent then sell after a couple of years to avoid the capital gains tax?

Answer: Sometimes it can make sense to buy down a mortgage interest rate by paying more upfront if you plan to stay in the home for many years. The deals vary by lender, but you might pay 1% of the loan amount (one point) to get a rate that’s 0.25% lower, or 2% (two points) to get the rate reduced by 0.5%. For example, paying two points on a $200,000 mortgage, or $4,000, could lower the rate from 4.5% to 4%. You would drop the monthly payment about $59, and it would take you nearly six years for the slightly lower monthly payments to offset what you paid upfront.

You complicate the math, though, when the money used to buy down the rate comes out of a retirement account. That money is taxed as income and would likely be penalized as well because you aren’t yet 59½. (There’s an exception to the penalty for first-time home buyers who withdraw up to $10,000, but they’ll still owe income tax on the withdrawal.) The tax bill varies according to your tax bracket and your state, but you can expect it to equal roughly one-quarter to one-half of the amount withdrawn.

In addition to the tax bill, you’ve also given up future tax-deferred returns on the money. And because most people’s incomes drop in retirement, you’re probably paying a higher tax rate than you would if you withdrew the money later.

A good rule of thumb is to consult a tax pro before you take any money out of a retirement account. The rules can be complex and it’s easy to make an expensive mistake. A tax pro also could advise you about the tax implications of renting vs. selling, although you might also want to talk to anyone you know who’s a landlord about what’s involved with renting out a property.

The simplest solution may be to sell your current home and use the equity to reduce the size of the loan you’ll need on the next residence, rather than raiding a retirement fund to get a slightly lower rate.

Filed Under: Q&A, Real Estate, Retirement, Taxes Tagged With: , , ,
January 20, 2020 By

Q&A: New Secure Act changes some retirement rules

Dear Liz: At age 70½, when I must withdraw money from my IRA, may I donate those dollars to a charitable organization without paying tax on the withdrawn funds?

Answer: The short answer is yes, but you should know there have been some recent changes to retirement plan rules.

Required minimum distributions now start at 72, thanks to the recently enacted Setting Every Community Up for Retirement Enhancement (Secure) Act. If you turned age 70½ in 2019 and started your required minimum distributions, you should generally continue, but talk to a tax pro.

Also, you can now make contributions to your IRA after age 70½, as long as you’re still working. You must have earned income at least equal to the amount you contribute.

The law didn’t change when you can begin making qualified charitable distributions from your IRAs. Once you reach 70½, you can donate up to $100,000 each year directly from your IRA and the donated amount will not be included in your income.

If you make IRA contributions after age 70½, though, those contributions are deducted from the amount you can donate.

Filed Under: Q&A, Retirement Tagged With: , ,
January 20, 2020 By

Q&A: A tricky Social Security plan

Dear Liz: In a recent column, you described the difference between withdrawal and suspension of Social Security benefits. I am 64 and want to take Social Security for two months to get out from under a few one-time bills. I’ll then withdraw my application and pay back the money. Do I understand that I’d have 12 months to pay back the funds? Is this something that can be done every 12 months? I see it as an interest-free short-term loan. Of course this only works if the money is paid back.

Answer: The answer to both your questions is no. You’re allowed to withdraw an application only once, and it must be in the 12 months after you start benefits. Once you submit your withdrawal request, you have 60 days to change your mind. If you decide to proceed, you must pay back all the money you’ve received from the Social Security Administration, including any other benefits based on your work record such as spousal or child benefits, plus any money that was withheld to pay Medicare premiums or taxes. In other words, you have a two-month window to pay back the funds, not 12 months.

If you can’t come up with the cash, you’d be stuck with a permanently reduced benefit. You could later opt to suspend your benefit once you’ve reached your full retirement age, which is between 66 and 67. (If you were born in 1956, it’s 66 years and four months.) At that point, your reduced benefit could earn delayed retirement credits that could increase your checks by 8% for each year until the amount maxes out at age 70.

There are a few situations in which starting early and then suspending can make sound financial sense, but a short-term cash need is not typically one of them.

Filed Under: Q&A, Social Security Tagged With: , ,
January 20, 2020 By

Q&A: How to keep tax benefits when renting out your primary residence

Dear Liz: If my wife and I sell our primary residence of 12 years, I understand we can exclude up to $500,000 in home sale profits from taxes. But if we rent it for a year or two, then sell, have we lost that tax break by converting it to income property?

Answer: As long as you lived in the property at least two of the five years before the sale, you can use the home sale exclusion that allows each owner to protect $250,000 of profits from taxation.

You would pay capital gains rates on profits above that amount, but a big home sale profit could have other tax implications.

If you’re covered by Medicare, for example, profits above the exclusion amounts could temporarily increase your monthly premiums. This is because the income-related monthly adjustment amount, which is added to premiums when modified adjusted gross income exceeds $87,000 for singles or $174,000 for married couples.

If you might be affected, you’d be smart to consult a tax professional to see if there’s a way to structure the sale to reduce these effects.

Also, renting property has its own set of tax rules, making it even more important to have a tax pro who can assist you.

Filed Under: Q&A, Real Estate, Taxes Tagged With: , , ,
January 13, 2020 By

Q&A: Planning philanthropy

Dear Liz: You recently explained to a reader why it was better to make one donation of $1,000 rather than 10 donations of $100. I understand why you gave the response you did and you made some good points, especially about the importance of researching charities before you give. You also mentioned the costs each organization would incur in processing the smaller donations. As a longtime nonprofit executive, I think the social capital enjoyed by those organizations outweighs the costs. It often is helpful to the organization to be able to count that donor among their ranks to demonstrate that they have widespread support, for example, or to include that donor in future efforts to serve the community. My experience is that it’s not always just about the dollars and cents.

Answer: Thanks for adding your perspective. It’s understandable that a charity would prefer a small donation to no donation. The charity still gets some money, even after processing fees, and the opportunity to add another donor to their mailing lists.

Savvy givers, however, want as much of their money to benefit their favorite causes as possible. Giving larger donations to fewer charities is a good way to do that, since that approach minimizes processing costs as well as the volume of appeals for more donations. Also, adequately researching and monitoring 10 different charities is a tall order for most busy people. Winnowing the choices can help ensure we’re rewarding the best-run charities, rather than those that spend the bulk of their donations on fundraising and overhead.

Filed Under: Estate planning, Q&A Tagged With: ,
January 13, 2020 By

Q&A: Your retirement plans require lots of decisions. Get help

Dear Liz: We are a working couple in our late 50s. We live a comfortable lifestyle, have no mortgage, no debt, and we enjoy our careers. Through luck and diligence we have built a sizable net worth of $4.5 million (37% equity in our primary residence, 37% IRAs, 25% taxable equities). The investments are being managed by a family member. We plan to wait as long as possible before taking Social Security but would like to quit working within the next five years. As we look to retirement, we are undecided about where we’d like to live. We could stay in our current large house in Los Angeles, or we could move to a just-as-expensive nearby beach town and opt for a much smaller condominium.

I’d like to purchase the condo before retirement (paying cash, as we are debt-averse at this stage of our lives). This plan could improve our current lifestyle by providing a weekend retreat. Once retired, we might then have the luxury of deciding which home to keep and which to sell.

However, my partner is rightfully concerned about having too much exposure to real estate and missing out on the portfolio growth we’ve enjoyed by staying in the stock market as long as we have. What should we do?

Answer: It’s not a bad idea to test drive your planned retirement community before you give up your current home. But your partner is right to be concerned about having too much money tied up in real estate. Most people need to keep a substantial portion of their portfolios in stocks even in retirement. Plus, any money you pull from your investments could incur a rather substantial tax bill.

One solution could be to purchase the condo using a mortgage. Interest rates are quite low, and it sounds like your finances are in good-enough shape to pass the extra scrutiny lenders often give second-home purchases. If you eventually decide to sell your current home, the proceeds could be used to pay off the loan.

This would be a good time to hire a comprehensive financial planner who can help you figure out how this next phase of your life will work. The planner also could help you with all the other retirement issues you’ll face, such as picking a Medicare supplement plan, managing required minimum distributions and paying for long-term care.

You can get referrals to fee-only planners from a number of organizations, including the National Assn. of Personal Financial Advisors, the Garrett Planning Network, the XY Planning Network and the Alliance of Comprehensive Planners.

Filed Under: Q&A, Retirement Tagged With: , ,
January 6, 2020 By

Q&A: This retiree got a big surprise: taxes

Dear Liz: I’m 76 and retired. During the decades I worked, I contributed to my IRA yearly using my tax refund or having money deducted from my paycheck. No one told me I would have to pay taxes on this when I turned 70. For the past six years, I have been required to withdraw a certain percentage of this IRA money and pay taxes on it. Is there ever going to be an end to this? Do I have to keep paying taxes on the same money every year? And what about when I pass away, do my children have to keep paying?

Answer: Ever heard the expression, “There’s no such thing as a free lunch”?

You got tax deductions on the money you contributed to your IRA over the years, and the earnings were allowed to grow tax deferred. Those tax breaks are designed to encourage people to save, but eventually Uncle Sam wants his cut.

Also, you aren’t “paying taxes on the same money every year,” because the money you withdraw has never been taxed. Plus, you’re required to take out only a small portion of your IRA each year starting at 70½. The required minimum distribution starts at 3.65% and creeps up a bit every year, but even at age 100 it’s only 15.87% of the total. You can leave the bulk of your IRA alone so it can continue to grow and bequeath the balance to your children.

Your heirs won’t get the money tax free. They typically will be required to make withdrawals to empty the account within 10 years and pay income taxes on those withdrawals. Previously, they were allowed to spread required minimum distributions over their own lifetimes. Congress recently changed that to require faster payouts because the intent of IRA deductions was to encourage saving for retirement, not transfer large sums to heirs.

The Roth IRA is an exception to the above rules. There’s no tax deduction when you contribute the money, but the money can be withdrawn tax-free in retirement or left alone — there are no required minimum distributions. Your children would be required to start distributions, but wouldn’t owe taxes on those withdrawals.

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