Q&A: IRMAA is not your friend

Dear Liz: My wife and I retired in 2019 and ran into IRMAA — Medicare’s income-related monthly adjustment amount, which increased our monthly premiums. I thought I’d done such a good job budgeting for retirement but missed this. A lot of couples have their best income years at the end of their career and then get blindsided by the cost of Medicare and the adjustment based on their previous income. I will say that the folks at the local Social Security office were very helpful, and they supplied us with forms for an exception based on our new income.

Answer: IRMAA can boost premiums substantially for singles with yearly income above $87,000 and married couples with incomes above $174,000. The increases for Medicare Part B, which covers doctor’s visits, range from $57.80 to $347 a person per month. The surcharges for Part D, which pays for prescription drugs, start at $12.20 and top out at $76.40 a person per month.

The adjustments are based on your income two years prior (so 2018 income determines 2020 premiums). You can appeal the increase if you’ve experienced a life-changing event. Retirement with a subsequent drop in income can be one such event. So can other work stoppages or reductions, marriage or divorce, the death of a spouse, loss of income-producing property or loss of pension income.

Even without IRMAA, healthcare costs can catch many newly retired people by surprise, especially if they previously had generous employer-subsidized coverage. Medicare doesn’t cover everything; it has deductibles and co-pays in addition to premiums, and excludes most vision, hearing and dental expenses.

How much you pay out of pocket depends on your health, where you live and what supplemental coverage you buy. A study by Vanguard and Mercer Health and Benefits estimated that a typical 65-year-old woman in 2018 could expect to pay $5,200, but her costs could range from $3,000 to $26,200. (The researchers say a 65-year-old man’s costs are typically about 3% lower.)

Q&A: Tax tips for hybrid owners

Dear Liz: Not a question, but a tip for your readers. I bought a plug-in hybrid in 2018. I couldn’t take advantage of the $7,500 federal tax credit because my income was too low to pay much in federal taxes. So I converted $30,000 of my IRA to a Roth IRA, which added that money to my income for 2018, allowing me to take full advantage of the credit. Hey, I even got some money back. I can’t touch that Roth account for five years, or else the income it generates won’t be tax-free, but when the time comes for my mandatory withdrawals, I’ll tap into the remainder of my regular IRA. This might be of help to some of your readers.

Answer: Normally conversions from a regular IRA to a Roth trigger a hefty tax bill, but your credit allowed you to convert tax-free. Leasing is another option to consider with hybrids and other cars that offer a federal tax credit. The value of the credit typically is built into the deal, so you benefit even if you don’t have a federal tax bill to offset.

Q&A: Here’s what early retirees need to know about Roth IRA and 401(k) taxes and penalties

Dear Liz: I have been contributing to a Roth 401(k) and a Roth IRA for several years. I plan to retire early. Am I able to withdraw any of my Roth contributions without penalty before I reach age 60?

Answer: Your contributions to a Roth IRA can always be withdrawn tax free, at any time and at any age, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Once you’ve withdrawn an amount equal to your contributions, though, the rest of your money — your earnings — may be subject to taxes and penalties. To avoid those, you generally must be at least 59½ and the account must be at least five years old.

The rules are somewhat different for Roth 401(k)s. Early withdrawals from these accounts are considered a mix of contributions and earnings, so any distributions before age 59½ typically incur taxes and penalties. Even after 59½, the withdrawals could be taxed and penalized if you haven’t been contributing to the account for at least five years.

Roth 401(k)s are also subject to rules that require minimum distributions to start at age 72. Many people who retire with Roth 401(k)s roll the money into Roth IRAs to avoid these restrictions.

Q&A: New rules for required distributions

Dear Liz: I cannot find when the SECURE Act takes effect. My wife, who turns 69 this summer, has a traditional Roth IRA worth about $150,000, all in a single large-company growth mutual fund. Obviously we don’t want to see it depreciate during a certain-to-come down market and then have to begin withdrawals before the market recovers. Would it be wise to move from the mutual fund into certificates of deposit or bonds, within the same IRA?

Answer: There’s really no such thing as a “traditional Roth IRA.” Since you’re asking about the Setting Every Community Up for Retirement Enhancement Act, which pushed back the age at which required minimum distributions have to begin from 70½ to 72, we’ll assume she has a traditional IRA subject to those RMD rules. (Roth IRAs are not subject to required minimum distributions.)

According to the IRS, people who reached 70½ in 2019 are subject to the prior rule and must take their first RMD by April 1 of this year. Those who reach 70½ this year or later must take their first RMD by April 1 of the year they turn 72.

That means your wife has some time to find an asset allocation that protects her somewhat from market drops while still allowing some growth. A fee-only financial planner could help her customize a portfolio, or she could consider a target date retirement fund (with a target date of 2015 or 2020, to benefit from a more conservative asset allocation). Moving everything to CDs or bonds would be trying to time the market, which rarely works, but having at least a portion of her money in safer investments could be smart.

Q&A: Storing documents in emergency kits

Dear Liz: I have appreciated your advice over the years, but I strongly disagree with your information about relying on electronic media during a disaster. If a really big disaster happens in this country, there will be no internet or Wi-Fi available. When the Loma Prieta earthquake hit in 1989, everything was offline for days, including gas pumps, banks and grocery stores.

Answer: Natural disasters are obviously quite disruptive, which is why it’s important to keep cash on hand, your gas tank at least half full and a couple weeks’ worth of meals in the pantry. But it’s important to note that quite a few things have changed since 1989, including the prevalence of identity theft.

The original question was specifically about storing copies of driver’s licenses, credit cards and financial records, including bank and brokerage documents, in a disaster kit. A copy of a driver’s license does little to help you prove your identity, since copies can be counterfeited, but it could provide an identity thief with enough valuable information to successfully impersonate you. The same is true of hard copies of credit cards and financial records — the benefit of having them in the kit is outweighed by the risks.

Instead, security expert Avivah Litan suggests storing only the account numbers in the kit, and keeping your driver’s license or other original identifying document with you at all times. She also recommended scanning important documents and storing them in a secure online account.

The providers of these accounts typically have backup systems and alternate power supplies to keep them up and running. The same is true of your financial institutions, which also store electronic records of your accounts. Chances are those servers and backup servers also are located far from where you live, so they probably would not be affected by any disaster that hits you.

Should we have a disaster big enough to knock everyone offline permanently, then all the documents in the world are unlikely to be of much use.

Q&A: Required distributions and charity

Dear Liz: In a recent column, you mentioned that after age 70½, one can donate up to $100,000 to a charity directly from an IRA. Can one still take that as a charitable donation on income tax forms? If I have a required minimum distribution of $10,000, but make a $10,000 donation to a charity, does that take care of the required minimum distribution for that year?

Answer: The $10,000 charitable contribution would count as your required minimum distribution for the year and the money would not be included in your income, but you can’t also deduct the contribution. That would be double dipping.

As a refresher: Money doesn’t get to stay in retirement accounts forever. At some point, withdrawals must begin and those withdrawals are typically taxed as income. Congress recently changed the rules so that required minimum distributions now start at age 72 (they used to start at age 70½). But so-called qualified charitable distributions — donations made directly from a retirement account to charity — can still begin at 70½.

Before you make a qualified charitable distribution or any other withdrawal from a retirement account, consult with a tax pro to make sure you understand the rules that apply to your situation. Penalties for mistakes can be high, so it pays to get expert help.

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.

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.

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.

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.