IRA

How can I Avoid Taxes on Social Security Income?

You may be aware that if you work while collecting benefits prior to hitting your full retirement age, it can mean you’ll get a reduced benefit. However, if you earn too much money, just by making withdrawals from some types of retirement plans, you also can also wind up owing income taxes on your Social Security benefits.

Avoid taxes on Social Security
Earning too much money while receiving social security may result in owed taxes.

Money Talk News’s article from last December entitled “5 Ways to Avoid Taxes on Social Security Income,” reported that according to the Social Security Administration (SSA):

“Some of you have to pay federal income taxes on your Social Security benefits. This usually happens only if you have other substantial income in addition to your benefits (such as wages, self-employment, interest, dividends and other taxable income that must be reported on your tax return).”

Whether you owe taxes on these benefits depends on your “combined income.” The SSA defines this as the sum of your:

  • Adjusted gross income
  • Non-taxable interest; and
  • Half of your Social Security benefits.

If you file an individual tax return and your income is between $25,000 and $34,000, you may owe income taxes on up to 50% of your Social Security benefits. If you make more, up to 85% of your benefits could be subject to taxes. If you file a joint return, and your combined income is between $32,000 and $44,000, you may owe taxes on up to 50% of your benefits. Go over, and up to 85% could be taxable. However, there are ways to reduce your income and lower — or even avoid paying — taxes owed on your Social Security benefits:

  1. Delay collecting benefits. If you wait to collect your Social Security benefits until your full retirement age (or beyond), it may be the simplest way to avoid paying taxes on your Social Security benefits—at least for a while. Waiting to file for benefits also means you will get a larger check each month once you finally do start receiving benefits.
  2. Don’t work or work less in retirement. Every dollar you earn doing part-time work can inch you a bit closer to owing taxes on your Social Security benefits. Don’t quit a job you enjoy or need, just to cut your tax bill. However, if it’s a low-paying job that’s no fun, you might be better off quittin,g so you can reduce your income in exchange for lowering or eliminating taxes on your Social Security benefits.
  3. Avoid municipal bonds. Many people buy municipal bonds to lower their tax bill because the interest earned from these types of bonds typically isn’t taxable. However, municipal bond interest is included in the formula that determines whether you pay taxes on your Social Security benefits.
  4. Withdraw money from a Roth. If you’ve saved money in a traditional IRA or 401(k), the IRS will want some of that during your retirement. After years of deferring taxes on those contributions, the bill is due when you start making withdrawals. The withdrawals will increase your combined income, which could make the difference in whether or to what extent your benefits are taxed. To avoid taxes, withdraw only as much money as the government requires you to take each year (the required minimum distribution or RMD) and take any additional cash that you need from a Roth IRA or Roth 401(k), if you have one. No taxes are due on Roth distributions, and these withdrawals won’t affect your combined income. Keep in mind that RMDs don’t apply to Roth IRAs.
  5. Distribute your RMD to a charity. Giving money to charity can lower the chances that your Social Security benefit will be taxed. If you’re at least 70½, you can take up to $100,000 of your annual RMD, give it to a charity and avoid income taxes on the money. It’s called a qualified charitable distribution. Because this money isn’t taxed, it won’t boost your adjusted gross income. However, you must direct the money to a qualified 501(c)(3) organization, and you can’t use funds from a 401(k) or other employer-sponsored plan to make this type of distribution. There are workarounds but speak with an attorney.

Reference: Money Talk News (Dec. 22, 2019) “5 Ways to Avoid Taxes on Social Security Income”

Is an Ex-Wife Entitled to an Inheritance from Her Former Husband?

Nj.com’s recent article entitled “My brother died of COVID-19. Should his ex-wife get an inheritance?” says that it’s unlikely that an ex-wife is entitled to an inheritance from her former husband’s estate.  However, the answer is highly dependent on state law.

There are three main ways property can transfer at death. They each have different rules.

ex-wife entitled to inheritance from her husband
It is not likely that an ex-wife is entitled to an inheritance from her former husband’s estate.

Joint assets. When property is held as Joint Tenants with Rights of Survivorship (JTWROS), the surviving joint owner automatically becomes the sole owner of the property. Usually, jointly owned property is retitled into individually owned property after the divorce. If this was never done, some states automatically change JTWROS property to a different form of joint ownership, called Tenancy In Common when a divorce is finalized. As a result, with tenants in common property, when one owner dies, his or her 50% ownership interest becomes a probate asset and passes pursuant to his or her will (or the state’s intestacy laws, if they didn’t have a will).

This means that even if the husband in this scenario still owned JTWROS property with his ex-wife when he passed away, she wouldn’t automatically inherit his share. She still has her own 50% share that she owned all along.

Beneficiary designations.  Property can also pass by beneficiary designation, like with life insurance or retirement accounts.

Beneficiary designations are typically updated after a divorce. However, again, ask an experienced estate planning attorney about your state laws. For example, some state’s laws revoke a divorced spouse as beneficiary, even if the beneficiary designation was never updated.

In this situation, even if the husband named his wife as a beneficiary on an insurance policy or retirement accounts and never changed it, she wouldn’t be able to collect.

Probate.  Finally, the third way that property can pass, is through the probate process. This means there’s a will.  If there was no will, it would be pursuant to the state’s intestacy laws.

An ex-spouse is never entitled to inherit property under state intestate statutes.

There’s an important caveats for these rules. They can be superseded by a divorce decree. Therefore, review the divorce decree to see whether it has any relevant language.

Reference: nj.com (Aug. 4, 2020) “My brother died of COVID-19. Should his ex-wife get an inheritance?”

How the CARES Act has Changed RMDs for 2020

Before the CARES Act, most retirees had to take withdrawals from their IRAs and other retirement accounts every year after age 72. However, the Coronavirus Aid, Relief and Economic Security Act, known as the CARES Act, has made some big changes that help retirees. Whether you have a 401(k), IRA, 403(b), 457(b) or inherited IRA, the rules have changed for 2020. A recent article in U.S. News & World Report, “How to Skip Your Required Minimum Distribution in 2020,” explains how it works.

For starters, remember that taking money out of any kind of account that has been hit hard by a market downturn, locks in investment losses. This is especially a hard hit for people who are not working and won’t be able to put the money back. Therefore, if you don’t have to take the money, it’s best to leave it in the retirement account until markets recover.

RMDs are based on the year-end value of the previous year, so the RMD for 2020 is based on the value of the account as of December 31, 2019, when values were higher.

Remember that distributions from traditional 401(k)s and IRAs are taxed as ordinary income. A retiree in the 24% bracket who takes $5,000 from their IRA is going to need to pay $1,200 in federal income tax on the distribution. By postponing the withdrawal, you can continue to defer taxes on retirement savings.

Beneficiaries who have inherited IRAs are usually required to take distributions every year, but they too are eligible to defer taking distributions in 2020. Experts recommend that if at all possible, these distributions should be delayed until 2021.

Automatic withdrawals are how many retirees receive their RMDs. That makes it easier for retirees to avoid having to pay a huge 50% penalty on the amount that should have been withdrawn, in addition to the income tax that is due on the distribution. However, if you are planning to skip that withdrawal, make sure to turn off the automated withdrawal for 2020.

If you have already taken the distribution before the law was passed (in March 2020), you might be able to roll the money over to an IRA or workplace retirement account, but only within 60 days of the distribution. You can also only do that once within a 12-month period. If the deadline for a rollover contribution falls between April 1 and July 14, you have up to July 15 to put the funds into a retirement account.

For those who have contracted COVID-19 or suffered financial hardship as a result of the pandemic, the distribution might qualify as a coronavirus hardship distribution. Talk with your accountant about classifying the distribution as a COVID-19 related distribution. This will give you an option of spreading the taxes over a three-year period or putting the money back over a three-year period.

Reference: U.S. News & World Report (May 4, 2020) “How to Skip Your Required Minimum Distribution in 2020

What Should I Know about Beneficiary Designations?

A designated beneficiary is named on a life insurance policy or some type of investment account as the designated recipient of those assets, in the event of the account holder’s death. The beneficiary designation doesn’t replace a signed will but takes precedence over any instructions about these accounts in a will. If the decedent doesn’t have a will, the beneficiary may see a long delay in the probate court.

If you’ve done your estate planning, most likely you’ve spent a fair amount of time on the creation of your will. You’ve discussed the terms with an established estate planning attorney and reviewed the document before signing it.

FEDweek’s recent article entitled “Customizing Your Beneficiary Designations” points out, however, that with your IRA, you probably spent far less time planning for its ultimate disposition.

The bank, brokerage firm, or mutual fund company that acts as custodian undoubtedly has a standard beneficiary designation form. It is likely that you took only a moment or two to write in the name of your spouse or the names of your children.

A beneficiary designation on account, like an IRA, gives instructions on how your assets will be distributed upon your death.

If you have only a tiny sum in your IRA, a cursory treatment might make sense. Therefore, you could consider preparing the customized beneficiary designation form from the bank or company.

You can address various possibilities with this form, such as the scenario where your beneficiary predeceases you, or she becomes incompetent. Another circumstance to address, is if you and your beneficiary die in the same accident.

These situations aren’t fun to think about but they’re the issues usually covered in a will. Therefore, they should be addressed, if a sizeable IRA is at stake.

After this form has been drafted to your liking, deliver at least two copies to your custodian. Request that one be signed and dated by an official at the firm and returned to you. The other copy can be kept by the custodian.

Reference: FEDweek (Dec. 26, 2019) “Customizing Your Beneficiary Designations”

How Does the SECURE Act Change Your Estate Plan?

The SECURE Act has made big changes to how IRA distributions occur after death. Anyone who owns an IRA, regardless of its size, needs to examine their retirement savings plan and their estate plan to see how these changes will have an impact. The article “SECURE Act New IRA Rules: Change Your Estate Plan” from Forbes explains what the changes are and the steps that need be taken.

Some of the changes include revising wills and trusts which include provisions creating conduit trusts that had been created to hold IRAs and preserve the stretch IRA benefit, while the IRA plan owner was still alive.

Existing conduit trusts may need to be modified before the owner’s death to address how the SECURE Act might undermine the intent of the trust.

Rethinking and possibly completely restructuring the planning for the IRA account may need to occur. This may mean making a charity the beneficiary of the account, and possibly using life insurance or other planning strategies to create a replacement for the value of the charitable donation.

Another alternative may be to pay the IRA balance to a Charitable Remainder Trust (CRT) on death that will stretch out the distributions to the beneficiary of the CRT over that beneficiary’s lifetime under the CRT rules. Paired with a life insurance trust, this might replace the assets that will ultimately pass to the charity under the CRT rules.

The biggest change in the SECURE Act being examined by estate planning and tax planning attorneys is the loss of the “stretch” IRA for beneficiaries inheriting IRAs after 2019. Most beneficiaries who inherit an IRA after 2019 will be required to completely withdraw all plan assets within ten years of the date of death.

One result of the change of this law will be to generate tax revenues. In the past, the ability to stretch an IRA out over many years, even decades, allowed families to pass wealth across generations with minimal taxes, while the IRAs continued to grow tax tree.

Another interesting change: No withdrawals need be made during that ten-year period, if that is the beneficiary’s wish. However, at the ten-year mark, ALL assets must be withdrawn, and taxes paid.

Under the prior law, the period in which the IRA assets needed to be distributed was based on whether the plan owner died before or after the RMD and the age of the beneficiary.

The deferral of withdrawals and income tax benefits encouraged many IRA owners to bequeath a large IRA balance completely to their heirs. Others, with larger IRAs, used a conduit trust to flow the RMDs to the beneficiary and protect the balance of the plan.

There are exceptions to the 10-year SECURE Act payout rule. Certain “eligible designated beneficiaries” are not required to follow the ten-year rule. They include the surviving spouse, chronically ill heirs and disabled heirs. Minor children are also considered eligible beneficiaries, but when they become legal adults, the ten year distribution rule applies to them. Therefore, by age 28 (ten years after attaining legal majority), they must take all assets from the IRA and pay the taxes as applicable.

The new law and its ramifications are under intense scrutiny by members of the estate planning and elder law bar because of these and other changes. Speak with your estate planning attorney to review your estate plan to ensure that your goals will be achieved in light of these changes.

Reference: Forbes (Dec. 25, 2019) “SECURE Act New IRA Rules: Change Your Estate Plan”

What has the Average American Saved for Retirement?

It’s the question we all wonder about, but not very many of us will come out and ask. A 2019 analysis of more than 30 million retirement accounts by Fidelity Investments found that the average balance in corporate sponsored 401(k) plans at the end of 2018 was $95,600. When it came to traditional, Roth and rollover IRAs, the number was $98,400, reports Investopedia in a recent article titled “What Is the Size of the Average Retirement Nest Egg?” A look at 403(b) and other defined contribution retirement plans in the non-profit sector found that it was $78,7000. These numbers were down between 7.8%-8% from the same quarter of the prior year. Blame the stock market for that.

Averages like this only indicate a few things. Younger workers, for example, tend to have less in their retirement accounts than older workers. Their salaries are smaller, and they haven’t had decades to accumulate tax deferred income in their accounts. However, that gap is wide.

A June 2018 report from the Transamerica Center for Retirement Studies looked at a nationally representative sample of more than 6,000 workers and broke out retirement savings by generation. The boomer members had estimated median retirement savings of $164,000 in 2017, while Gen Xers had $72,000 and millennials had $37,000.

Aside from age, the big factors in retirement savings success seem to be education and income. People with higher income put more money into their retirement accounts. The Transamerica study shows that households with incomes of under $50,000 had estimated median retirement savings of $11,000. Households with incomes between $50,000 and $99,999 had median savings of $61,000 and those with incomes of $100,000 or more had $215,000.

The higher the level of education, the more money people have set aside for retirement.

Therefore, if you’re wondering how your nest egg compares to the average nest egg, the first thing you’ll want to do is decide to whom you want to compare yourself and your nest egg. You can compare yourself to the U.S. population in general, or to people who are more like you in education, age and income.

Here’s an unnerving thought: no matter if your nest egg is way above your peer group, that doesn’t mean it will be enough when retirement rolls around. Everyone’s situation is different, and life hands us unexpected surprises.

One way to prepare is to have an estate plan. If you don’t already have an estate plan, which includes a will, power of attorney, health care power of attorney, possibly trusts and other strategic tools for tax planning and wealth transfer, make an appointment with an estate planning attorney.

Reference: Investopedia (Sep. 24, 2019) “What Is the Size of the Average Retirement Nest Egg?”

What Should I Keep in Mind in Estate Planning as a Single Parent?

Most estate planning conversation eventually come to center upon the children, regardless of whether they’re still young or adults.  So what should you keep in mind in estate planning as a single parent?

Talk to a qualified estate planning attorney and let him or her know your overall perspective about your children, and what you see as their capabilities and limitations. This information can frequently determine whether you restrict their access to funds and how long those limitations should be in place, in the event you’re no longer around.

Kiplinger’s recent article, “Estate Planning for Single Parents” explains that when one parent dies, the children typically don’t have to leave their home, school and community. However, when a single parent passes, a child may be required to move from that location to live with a relative or ex-spouse.

After looking at your children’s situation with your estate planning attorney to understand your approach to those relationships, you should then discuss your support network to see if there’s anyone who could serve in a formal capacity, if necessary. A big factor in planning decisions is the parent’s relationship with their ex. Most people think that their child’s other parent is the best person to take over full custody, in the event of incapacity or death. For others, this isn’t the case. As a result, their estate plan must be designed with great care. These parents should have a supportive network ready to advocate for the child.

Your estate planning attorney may suggest a trust with a trustee. This fund can accept funds from your estate, a retirement plan, IRA and life insurance settlement. This trust should be set up, so that any court that may be involved will have sound instructions to determine your wishes and expectations for your kids. The trust tells the court who you want to carry out your wishes and who should continue to be an advocate and influence in your child’s life.

Your will should also designate the child’s intended guardian, as well as an alternate, in case the surviving parent can’t serve for some reason. The trust should detail how funds should be spent, as well as the amount of discretion the child may be given and when, and who should be involved in the child’s life.

A trust can be drafted in many ways, but a single parent should discuss all of their questions with an estate planning attorney.

Reference: Kiplinger (May 20, 2019) “Estate Planning for Single Parents”

Your Will Isn’t the End of Your Estate Planning

Even if your financial life is pretty simple, you should have a will. And once you have a will, that’s not the end of your estate planning.  There’s still some work to be done to make sure your family isn’t left with an expensive mess to clean up.  Assets must be properly titled, so that assets are distributed as intended upon death.

Your Will is only one piece of your estate planning.

Forbes’ recent article, “For Estate Plan To Work As Intended, Assets Must Be Properly Titled” notes that with the exception of the choice of potential guardians for children, the most important function of a will is to make certain that the transfer of assets to beneficiaries is the way you intended.

However, not all assets are disposed of by a will—they pass to beneficiaries regardless of the intentions stated in the will. Your will only controls the disposition of assets that fall within your probated estate.

An example of when a designated beneficiary controls the disposition of a financial asset is life insurance. Other examples are retirement accounts, such as a 401(k) or an IRA. When there’s a named beneficiary, assets will be distributed accordingly, which may be different than the intentions stated in a will.

The title of real estate controls its disposition. When property is jointly owned, how it is titled determines if the decedent’s interest in the property passes to the surviving partner, becomes part of the decedent’s estate, or passes to a third party. Titling of jointly owned property can be complicated in community property states.

In the same light, a revocable trust is an inter vivos or living trust that’s created during the grantor’s life, as part of an estate plan.

Such a trust can be used to ensure privacy, avoid the expenses and delays in the probate process and provide for continuity of asset management. A critical part of the planning is that the grantor must transfer (or retitle) assets to the trust.

Wills are very important in estate planning. To ensure that your estate plan fulfills your intentions, talk to an estate planning attorney about the proper titling of your assets.

Reference: Forbes (May 20, 2019) “For Estate Plan To Work As Intended, Assets Must Be Properly Titled”

Common Mistakes with Beneficiary Designations

Questions about beneficiary designations are among the most common we hear from new clients in our law practice.  This is a topic that should be among those discussed by an estate planning attorney during your first meeting.

Many people don’t understand that their will doesn’t control who inherits all of their assets when they pass away. Some of a person’s assets pass by beneficiary designation. That’s accomplished by completing a form with the company that holds the asset and naming who will inherit the asset, upon your death.

Estate Planning Attorney
Assets with a beneficiary designation will not be distributed according to your will.

Kiplinger’s recent article, “Beneficiary Designations: 5 Critical Mistakes to Avoid,” explains that assets including life insurance, annuities and retirement accounts (think 401(k)s, IRAs, 403bs and similar accounts) all pass by beneficiary designation. Many financial companies also let you name beneficiaries on non-retirement accounts, known as TOD (transfer on death) or POD (pay on death) accounts.

Naming a beneficiary can be a good way to make certain your family will get assets directly. However, these beneficiary designations can also cause a host of problems. Make sure that your beneficiary designations are properly completed and given to the financial company, because mistakes can be costly. The article looks at five critical mistakes to avoid when dealing with your beneficiary designations:

  1. Failing to name a beneficiary. Many people never name a beneficiary for their retirement accounts. If you don’t name a beneficiary for retirement accounts, the financial company has it owns rules about where the assets will go after you die. For retirement benefits, if you’re married, your spouse will most likely get the assets. If you’re single, the retirement account will likely be paid to your estate, which has negative tax ramifications and may need to be handled through the costly and time-consuming probate courts. When an estate is the beneficiary of a retirement account, the assets must be paid out of the retirement account within five years of death. This means an acceleration of the deferred income tax—which must be paid earlier, than would have otherwise been necessary.
  2. Failing to consider special circumstances. Not every person should receive an asset directly. These are people like minors, those with specials needs, or people who can’t manage assets or who have creditor issues. Minor children aren’t legally competent, so they can’t claim the assets. A court-appointed conservator will claim and manage the money, until the minor turns 18. Those with special needs who get assets directly, will lose government benefits because once they receive the inheritance directly, they’ll own too many assets to qualify. People with financial issues or creditor problems can lose the asset through mismanagement or debts. Ask your estate planning attorney about creating a trust to be named as the beneficiary.
  3. Designating the wrong beneficiary. Sometimes a person will complete beneficiary designation forms incorrectly. For example, there can be multiple people in a family with similar names, and the beneficiary designation form may not be specific. People also change their names in marriage or divorce. Assets owners can also assume a person’s legal name that can later be incorrect. These mistakes can result in delays in payouts, and in a worst-case scenario of two people with similar names, can mean litigation.
  4. Failing to update your beneficiaries. Since there are life changes (like marriage and divorce for example), make sure your beneficiary designations are updated on a regular basis.
  5. Failing to review beneficiary designations with your estate planning attorney. Beneficiary designations are part of your overall financial and estate plan. Speak with your estate planning attorney to determine the best approach for your specific situation.

Beneficiary designations are designed to make certain that you have the final say over who will get your assets when you die. Take the time to carefully and correctly choose your beneficiaries and periodically review those choices and make the necessary updates to stay in control of your money.

Reference: Kiplinger (April 5, 2019) “Beneficiary Designations: 5 Critical Mistakes to Avoid”

How Will My IRA Be Taxed?

The most common of IRA tax traps results in tax bills through Unrelated Business Taxable Income (UBTI). The sources of business income from stocks, bonds, and funds like interest income, capital gains, and dividends are exempt from UBTI and the corresponding tax.

Careful consideration of your IRA’s tax treatment is necessary to avoid high taxes.

Fox Business’s recent article, “Your IRA and taxes: Don’t get a surprise tax bill” explains that IRAs that operate a business, have certain types of rental income, or receive income through certain partnerships will be taxed, when the total UBTI exceeds $1,000. This is to prevent tax-exempt entities from gaining an unfair advantage on regularly taxed business entities.

UBIT can take a chunk from an IRA, and the Tax Cuts and Jobs Act of 2017 replaced the tiered corporate tax structure with a flat 21% tax rate. That begins in tax year 2018 (this tax season). These tax bills often have penalties, because IRA owners aren’t even aware that the bill exists.

Master Limited Partnerships (MLPs) held within IRAs are a good example of how UBTI can catch investors by surprise. MLPs are fairly popular investments, but when they’re held within an IRA, they’re subject to UBIT. When the tax is due, the IRA custodian must get a special tax ID number and file Form 990-T to report the income to the IRS. That owner must pay the tax, and is typically unaware of the bill, until it arrives as a completed form to be submitted to the IRS (completed and signed on behalf of the owner). In some instances, the owner may have to pay estimated taxes throughout the year. This can mean a significant underpayment penalty.

Working with prohibited investments will also result in a tax bill. Self-directed IRAs can violate the rules. Alternative investments such as artwork, antiques, and precious metals (with some exceptions) are generally considered as distributions and are subject to taxes.

Prohibited transactions are a step above prohibited investments and can result in the loss of tax-deferred status for the entire IRA. This includes using an IRA as security to obtain a loan, using IRA funds to purchase personal property, or paying yourself an unreasonable compensation for managing your own self-directed IRA. Executing a prohibited transaction can result in the entire IRA being treated as a taxable distribution to you.

Therefore, like fund holdings, and other investments, it’s critical to understand exactly what you own and how to deal with the tax liabilities.

Reference: Fox Business (March 6, 2019) “Your IRA and taxes: Don’t get a surprise tax bill”

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