Q&A: Finding a fiduciary advisor

Dear Liz: I am having difficulty finding a fiduciary, fee-only financial advisor. I have inherited considerable investments from my parents’ trust and now that their house is sold, there will be a payout in excess of $1 million. I believe that my parents’ money manager has done an excellent job of investing and managing their money, so I want to stay with him. My IRA is with another money manager. Without any personal recommendations, I do not know how to go about selecting a financial advisor from a list of advisors on the internet. Interviewing and selecting one based on likability makes me uneasy.

Answer: If anything makes you uneasy, it should be that an advisor isn’t required to look after your best interests.

A fiduciary is someone who is committed to putting their clients’ interests ahead of their own. Most financial professionals are not fiduciaries and are typically held to a lower “suitability” standard. That means they’re allowed to recommend investments that are more expensive or that perform worse than available alternatives, simply because the recommended investments pay the advisor more.

You can start your search for fiduciary, fee-only advisors by getting referrals from the National Assn. of Personal Financial Advisors, the Alliance of Comprehensive Planners, the XY Planning Network or the Garrett Planning NetworkLetsMakeAPlan.org has a list of questions to ask.

Q&A: How to reduce the tax penalty from an IRA distribution goof

Dear Liz: I have missed three years of required minimum distributions from one of my IRAs although I have not heard from the IRS about this. What do you advise me to do now?

Answer: Did you include this account when calculating your required minimum distribution each year? If so, you won’t owe a penalty. You’re supposed to calculate RMDs for each of your IRAs, but you don’t have to withdraw money from each account. Instead, you can take the year total from any of your IRA accounts.

If you forgot to include this account in your calculations, however, then you would typically owe a penalty.

In the past, people who failed to take their RMDs faced a 50% penalty on the amount they should have withdrawn but didn’t. Starting in 2023, the penalty has been reduced to 25%, or 10% if the oversight is corrected within two years of the RMD’s due date, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

You can request a complete waiver of the penalty if you can show the failure was due to reasonable cause and that you are taking steps to correct the oversight, Luscombe said. You’ll need to file Form 5329 and attach a letter explaining why you failed to withdraw the proper amount.

Q&A: Asset allocation requires pro advice

Dear Liz: I need guidance on asset allocation in retirement. I will retire in June at 65. I’m in good health, so I am planning for 30 more years of life, understanding that it could easily be fewer and might be more. I have a robust government pension and a good chunk of retirement savings. Targeting a 4% withdrawal rate from retirement savings, my post-retirement income will be about the same as my current income, less current savings contributions. The pension will make up about 75% of that income and the savings, about 25%. I could live on the pension alone if it came down to it. At age 70, I’ll get a bump of about 15% of that total income when I start taking Social Security, after accounting for the windfall elimination provision.

My analysis is that I essentially have 75% of my retirement assets allocated to very safe investments, i.e., my pension and future Social Security. I think I should allocate my 401(k) and 457(b) more aggressively than the usual guidance calls for. I’m considering selecting a 2050 or 2055 target date fund.

Am I looking at this correctly?

Answer: You do need guidance, and it should come from a fee-only, fiduciary financial planner hired to provide you with individualized advice. This is, after all, the first and probably only time you’ll retire, while a good advisor has guided many people through this process. The advisor will know the questions to ask and the traps to avoid far better than any novice could.

The advisor may concur that you can take more risk with your investments, given your substantial amount of guaranteed income. A lot will depend on your risk tolerance, of course, but the planner will consider other factors, such as your family situation and your plans for covering long-term care costs.

If you don’t have long-term care insurance, for example, you may want to stockpile more cash or identify assets you could sell to pay for care. If you’re married and your pension would end or diminish at your death, you may want to take less risk with your investments so they can better support your survivor.

There’s no substitute for having another set of expert eyes looking at your plan. So many retirement decisions are irreversible, and you’ll want to get this right.

Q&A: How to roll over your 401(k) into an IRA

Dear Liz: My question relates to 401(k) rollovers. Are there different tax implications when it comes to rolling the money into a traditional IRA versus a traditional IRA brokerage fund? I’ve always associated the word “brokerage” with after-tax dollars.

Answer: Financial terms can get confusing, so let’s start with the basics. Both 401(k)s and IRAs are tax-advantaged accounts that allow you to save for retirement. Employers offer 401(k)s, but you can open an IRA at a brokerage, bank, credit union, mutual fund company or robo advisor, among other providers. Some people liken 401(k)s and IRAs to buckets that receive your retirement funds, while the providers are where you store the bucket.

If you leave the employer that offers your 401(k), you have the option to roll your account into an IRA so your money can continue to grow tax-deferred. (You often have other options, such as leaving the money in your former employer’s plan or rolling it into a new employer’s plan.)

When you arrange a direct rollover, the money goes straight from the 401(k) to the IRA provider and no taxes will be withheld or charged. By contrast, if you opt to have a check sent to you rather than the IRA provider — something known as an indirect rollover — 20% of your funds will be withheld for federal taxes.

If you want to avoid those taxes and have your money continue to grow tax deferred, you’d have to deposit the check into the IRA within 60 days and come up with that 20% out of your own pocket. You’d get the money back in the form of a tax credit once you file the tax return for that year, but clearly the simpler, better way is to make the rollover a direct one.

Q&A: Distributing funds from inherited IRAs

Dear Liz: You have referenced the relatively new 10-year rule that sets a deadline for distributing money out of an inherited IRA. You mentioned that surviving spouses are one exception to that rule. Aren’t there others?

Answer: Yes. The 10-year rule applies to IRAs of those who die after Dec. 31, 2019. Most non-spouse inheritors must empty an inherited IRA by the tenth year after the year the original owner died. If the original owners had reached the age where they were expected to make required minimum distributions, the inheritor also must take yearly distributions.

“Eligible designated beneficiaries,” however, have the option of taking distributions more slowly, typically over their own life expectancy. Eligible designated beneficiaries include the original owner’s spouse or minor children, people who are chronically ill or permanently disabled, or inheritors who are not more than 10 years younger than the original account holder. Minor children will be subject to the 10-year rule once they reach the age of majority, which is 18 in most states.

Q&A: Explaining required minimum distributions

Dear Liz: When my wife reached age 59½, we initiated required minimum distributions for all of her retirement funds. During the process, the investment company representative stated that as long as she was still working and contributing to her 401(k) and 403(b) at work, she was not required to take RMDs for those accounts. With all the changes lately in those types of accounts, is that still the case, or has the law changed?

Answer: Minimum distributions have never been required at age 59½ from any retirement fund. That’s the age at which people no longer have to pay penalties for accessing their retirement funds, not the age at which they must start taking money out.

The current age at which retired minimum distributions must begin is 73, and it rises to 75 for people born in 1960 and later. If your wife is still working at that point, she can put off RMDs from the retirement plans sponsored by her current employer. RMDs will still be required on other retirement accounts, such as IRAs and 401(k)s or 403(b)s from a previous employer. The other RMD exception is for Roth accounts, which don’t have RMDs for the account owner.

Generally you want money to stay in tax-deferred retirement accounts as long as possible. Unnecessary distributions just increase your tax bill and can reduce the amount you have to live on later in life.

If your wife has already taken a distribution, she has 60 days to roll it over into an IRA and avoid taxation.

Tax law can be confusing and mistakes can be expensive. Please use this experience as a reason to hire a good tax pro who can answer your questions and ensure you don’t make another potentially expensive misstep.

Q&A: Roth IRAs and taxes

Dear Liz: I sold some stocks from a Roth IRA to pay for some bad debts. Is this going to count as taxable income for this year?

Answer: You can always withdraw the amount you contributed to a Roth IRA without owing income taxes or penalties. For example, if you withdrew $10,000 but your contributions over the years totaled $10,000 or more, then you didn’t incur taxes or penalties.

You also won’t have tax issues if you withdrew more than your contributions but are 59½ and have had the account for at least five years. If you’re old enough but haven’t had the account long enough, you’ll pay income taxes but not penalties on the part of the withdrawal that exceeded your contributions — in other words, on the earnings.

If you’re under 59½, you could be subject to taxes and penalties on any earnings you withdrew. Please consult a tax pro for details.

Q&A: IRA investments and minimum distributions

Dear Liz: I have an IRA invested in stocks, bonds and Treasury bonds. I’m 60 now and am hoping to retire in a few years. When I stop work and start pulling money from my IRA, can I withdraw a security or Treasury bond? Or must I first sell the security or Treasury bond, and then withdraw cash? I ask because I’ve recently purchased 30-year Treasury bonds (as well as Treasury Inflation-Protected Securities, or TIPS). Once required minimum distributions kick in, I’d prefer not to sell a Treasury bond or TIP, if I don’t have to.

Answer: First, you should know that you have several years before your first required minimum distributions will be due. Because you were born after 1959, the age at which you’re required to start taking minimum distributions from most retirement accounts is 75. (The RMD age used to be 72, but it’s currently 73 for those born between 1951 and 1959 and 75 for those born in 1960 and later.) You can take penalty-free distributions from retirement accounts as early as age 59½, but the increase in RMD age can be advantageous for good savers who don’t need the money and want to allow their tax-deferred retirement funds to continue growing.

Most people take their required distributions in cash, but you’re allowed to take them “in kind” — in other words, you can transfer your stocks and other investments from your retirement account to a taxable brokerage account.

There’s no tax advantage to in-kind transfers and they can be tricky because the value of investments can change day to day, unlike cash, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. If the investments’ value on the day of distribution is less than your RMD, you’ll need to make up the difference in cash to avoid penalties.

Q&A: Don’t try evading Roth IRA requirements

Dear Liz: My son is a student. He would like to maximize his Roth IRA at the annual $7,000 limit and has the money in savings to do so. However, his income from odd jobs, paid in cash, will probably be less than the $7,000 required to make this maximum contribution. Can he report additional income on his income tax beyond what he earned, pay the associated additional income taxes and thus meet the $7,000 income requirement?

Answer: Your son’s enthusiasm for retirement savings is commendable, but filing fraudulent tax returns is not. He can’t contribute more than he legitimately earns.

Q&A: You might have unclaimed retirement benefits. How to find them

Dear Liz: My wife recently received from the Social Security Administration a notice of “Potential Private Retirement Benefit Information.” It cites a 401(k) account with a previous employer with a relatively small balance and states the “year reported” as 1992. My wife does not have any recollection of ever cashing out this account. Should the account still be accessible or are 401(k) accounts subject to abandoned property laws?

Answer: Keep in mind that many small accounts in that era were simply cashed out. The company sent the departing worker a check with a certain amount withheld for taxes, and that was that.

Still, even a small account could have grown substantially in the meantime, so it’s worth trying to find out if it might still exist somewhere. A couple of places to check first would be the National Registry of Unclaimed Retirement Benefits, which allows you to search using your Social Security number. Another site to check for missing money of all sorts is the National Assn. of Unclaimed Property Administrators.

If nothing turns up, your wife should try to find the plan’s administrator. If she has any old statements or paperwork from the plan, the administrator or plan provider would be listed. If not, and her former employer is still in business, she can call the human resources department to find out what company administered the plan.

If that doesn’t work, her next stop would be the Department of Labor’s efast system to look for the plan’s Form 5500. Employee benefit plans have to file these annual reports and include contact information. FreeErisa is another site to check for Forms 5500.