A reader sent in a question about how annuity income could affect his tax on Social Security benefits: “George, I’m considering purchasing an immediate annuity. I’m 81 years old and in excellent health. The funds would come from my IRA, so I would not receive the tax break from the exclusion ratio. “I am considering this purchase because I’m currently drawing out about $1,400 a month from my IRA, or about $16,800 a year. This is affecting the tax on my Social Security income. What I don't know is if the payout from the immediate annuity would be included in the calculation of income in terms of calculating my Social Security tax? “I am aware that I’d have to pay ordinary income on the funds received. The payout on the annuity is $517 per month for life, so it reduces my income by about $10,000 a year. The question is: Will I have to include the annuity income in my Social Security calculations. “Thanks so much for any thoughts you have on this matter.” My answer: “You are correct in saying that the annuity would not qualify for the exclusion ratio since the money is coming from your IRA. And since all of the annuity’s income is taxable, it must be included in the calculation to determine how much of your Social Security benefits are taxable.” Many boomers entering retirement are not aware that their Social Security benefits could be taxable. This can apply if you are single and earning at least $25,000 a year or married and earning $32,000 or more. Earnings include one-half of your benefits and all other income, including tax-exempt interest. So before you make the decision to start taking Social Security, make sure you understand how much of those benefits will be taxable. For information, go to IRS Publication 915. Best wishes, George P.S. I’m now on Twitter. Follow me at http://twitter.com/efinancialwrite for frequent updates, personal insights and observations on how to have a healthy retirement.
Thursday, July 22, 2010
Do you keep up-to-date with your retirement plan? I’m speaking of plans like your 401(k) and IRA. Hopefully you’re on top of the investments in the accounts and not just tossing unopened, quarterly statements in a dresser drawer. There is, however, an aspect of these plans that even many savvy investors completely ignore after the accounts are opened. And that is: What happens to the money when they die. Will yours go to your spouse … an ex-spouse … your children? And if no one is named, it could end up in your estate. Then the state will hand it out as they see fit. That’s why the account beneficiary form is one of the most important forms you should review regularly. Particularly, if there has been a big change in your life. And the best part is that unless you need special legal advice, it doesn’t cost you a single penny to make changes. For instance, have you recently divorced, gotten married or both? Imagine the turmoil if your ex-spouse inherited your IRA instead of your new bride? I saw that happen to a friend on mine ... He went through a long and tumultuous divorce. Then got remarried. He changed his will and trust documents, but didn’t bother with his IRA, which was in the seven figure range. Apparently he though it was covered through the will or trust. Poor guy died. Guess who ended up with the IRA? His ex-wife and her children from a prior marriage! His new wife took the issue to court … and lost. What about children or grandchildren, any new ones? Or have any become compulsive shoppers and now have bill collectors hounding them day and night? You might have to set up special provisions for them, such as a spendthrift trust, so creditors can’t get at any of their inheritance. Have any of your beneficiaries died? If so, you should name replacements. Maybe now you have a favorite charity you’d like to help out. Updating your IRA beneficiary form to leaving it a piece of your IRA is a simple way to accomplish that. Do you have minor children named as beneficiaries? Who will receive the money on their behalf? Is that person still available? And suppose one of your adult children dies before you. Does your beneficiary form use the “per stirpes” language, which passes the deceased child’s portion to his or her children? Or will it be divided among your other children? You might want to double-check the documents. What about estate and income taxes. IRA and other retirement plan assets will be included in your taxable estate. And estate taxes are due nine months after you die. Have you discussed with your beneficiaries how to come up with the cash to pay those taxes? Income taxes can often be spread out over the beneficiary’s life expectancy. However, your beneficiaries must know how to take advantage of this provision. Otherwise, they could face a huge tax bill. Finally, does anyone know where you keep important papers, like your will and deed for your home? If so, you better put a copy of the beneficiary form there, too. Nothing is static in today’s world. Not the tax laws, not the investments inside your retirement accounts and certainly not your personal situation. So for your love ones’ sake, be sure to keep on top of your beneficiary designations. Best wishes, George
Monday, July 5, 2010
There’s a good chance you’ve been given a pitch to convert. No, not to some off-the-wall religion or cult, but by your financial advisor, insurance agent or broker to move your traditional IRA to a Roth IRA. And this can be a good thing ... After all, once your money hits the Roth you and your heirs will never have to worry about paying income taxes on it again. Plus unlike a traditional IRA, you won’t have to hassle with required minimum distributions beginning at 70½. So what’s not to like! One obstacle is that you’ll have to pay income tax on the amount you convert. That means, for example, coming up with $25,000 on a $100,000 conversion assuming you’re in the 25% tax bracket. But if you think you’ll be in a higher bracket when you retire or rates will go up in the future, paying the tax now could be a good choice. Think about your kids, too. Will they be in a higher bracket years down the road? Also, where will you get the money to pay the tax if you do convert? Your IRA custodian will ask if you want tax withheld from the distribution. This is generally a bad idea because you’ll end up paying taxes on those dollars, too. Moreover, it reduces the amount available to grow tax-free inside your Roth. A much better idea is to use money from outside your traditional IRA, such as from a money market or savings account. The second obstacle is dealing with the unknown ... How much do you trust Congress? Do you think they’ll revoke the tax-free status of Roths after they pocket the tax dollars you’ll fork over when you convert? The $1.4 trillion deficit they’ve rung up for 2010, plus $109 trillion Washington has promised to pay in Social Security and Medicare benefits, should be a clear warning that higher taxes are ahead. Already, House Majority Leader Steny Hoyer (D-MD) told reporters that raising taxes on middle class families will be necessary to tackle the debt. So where does this leave you if you’re thinking about converting? Consider these five points … 1. Do you have non-IRA money available to pay the taxes for the conversion?
2. Will your tax bracket be higher when you retire?
3. Is your beneficiaries’ tax bracket higher than yours?
4. Do you think Congress will raise income taxes in the future? What about your state taxes?
5. Do you think Congress will double-cross voters and tax Roths? If you answer “yes” for the first four questions, you’re probably a good candidate for a Roth conversion. It could pay off big time for you and your love ones. And if you answer “yes” for #5, then a Roth and any other tax-favored investment might be off the table for you. Best wishes, George