You’ve inherited an IRA- so what happens next?
Before we start, we need to understand some key terms:
Required Minimum Distribution (RMD):
The dollar amount the IRS requires one to distribute from IRAs and defined contribution plans like 401(k)s and 403(b)s. This amount is distributed from your IRA and taxed as normal income unless that distribution comes from your basis or from a Roth IRA.
This dollar amount is determined by the IRS’ Single Life Expectancy Table. You can always distribute more than the Required Minimum Distribution, but never any less. Failure to distribute the required amounts results in a sever 50% penalty. If your RMD was $10,000 and you took nothing, the IRS would penalize you $5,000!
IRS’ Single Life Expectancy Table
The table is created by the IRS to calculate how much of your IRA balance needs to be distributed each year. The table can be seen here. There are rules that govern which life expectancy age an owner or beneficiary must use in this calculation, which we will discuss.
Starting The Process
When it’s time to start the transfer process, you’ll first setup a Beneficiary IRA to hold the inherited assets. This Beneficiary IRA cannot be co-mingled with any other IRA, retirement plan, brokerage account, etc. Remember, understanding the IRS will require you to distribute some of your inheritance and knowing how that distribution is calculated is crucial in determining how to structure your Beneficiary IRA.
With your Beneficiary IRA established the IRS gives you a few options on how you can distribute the assets:
Cash Out Everything
You can take the money- but don’t run. The lump sum distribution will be taxable income and may bump you into a higher tax bracket. When April rolls around you can expect a higher tax bill from the large distribution.
Distribute Everything in 5 Years
You can take withdrawals as you please, so long as the entire IRA balance has been distributed by December 31st of the 5th year after the original IRA owner’s death. Each distribution will be taxed as normal income, so again- tax planning is crucial.
Take RMDs Based on Your Life Expectancy
If the IRA owner has not started taking RMDs or your life expectancy is longer than the IRA owner’s, use your age in the year following the year the original IRA owner died (i.e. owner dies in 2018, you would use your age in 2019 to determine the RMDs for 2019). This is especially useful for heirs who are much younger than the original IRA owner, keeping more tax deferred income and growth in the Beneficiary IRA for a longer time.
Take RMDs Based on IRA Owner’s Life Expectancy
This only applies when your life expectancy is less than that of the IRA owner’s. You use the life expectancy table based on the deceased’s age rather than your own. All distributions are taxed as normal income.
Take RMDs Based on the Oldest Beneficiary’s Life Expectancy
Only applicable with more than one beneficiary and only if no separate Beneficiary IRA accounts are setup for said beneficiaries by December 31st of the year following the IRA owner’s death. Using the oldest beneficiary’s RMD schedule for all other beneficiaries. This could be a major negative for a younger heir. Again, all distributions are taxed as normal income.
What’s Best for You?
The best thing any IRA beneficiary can do is talk with a fee-only financial adviser who will look at their entire financial picture to determine a customized strategy. Often there are further financial and tax-related issues that should be addressed when considering how to move forward with an Inherited IRA so attention to detail is of the upmost importance.
If you’re not sure what to do with an inherited IRA give us call (843.901.7778 / 843.946-9868) or shoot us an e-mail and we’ll reach out to help you navigate your Beneficiary IRA strategy.
If you're age 70 ½ or older you probably know you must begin taking distributions from your IRA -whether you want to or not. The IRS life expectancy tables determine your required minimum distribution (RMD) based on the previous years ending balance for your IRA and your attained age for the tax year.
The qualified charitable distribution rules provide those subject to RMDs an option that can help them reduce their income tax liability by having certain charitable contributions made directly to a qualified charity. Given the changes to itemized deductions and the standard deduction in the 2017 tax law update, the qualified charitable distribution rules for your IRA account becomes even more important.
If you make charitable contributions throughout the year, it would be wise to consider making those contributions directly from your IRA. Up to $100,000 of charitable distributions from each IRA owner's accounts can be excluded from your taxable income each year.
Say you plan to give $10,000 to your church or another qualified charity and you are receiving taxable distributions from your IRA. If you make the contribution to the charity directly from your IRA, your $10.000 gift will not be reported as income on your income tax return.
If you instead receive these funds as income from your IRA distribution and then send the same $10,000 to the charity it is included in your taxable income and could result in higher Medicare premiums and a higher percentage of your social security income being taxable. If you do not have itemized deductions that exceed the new $24,000 per couple or $12,000 per individual standard deduction, you could lose all the tax benefits of your generosity.
By having the distributions sent directly to the qualified charity from your IRA, you will exclude the amount from your taxable income, potentially lowering your Medicare premiums, the taxable portion of your social security benefits, and your overall income tax rate at both the federal and state level.
If you follow this strategy, be sure to let your income tax preparer know. There is no indicator on the 1099R you receive at the end of the year that shows that part of your distribution is non-taxable, so there is a chance many people using this strategy are over-paying their income taxes each year.
There’s been a lot of writing about the new Trump Tariffs so I’m not going to delve into any figures, charts, numbers etc. (I started to, but it’s a long way down that rabbit hole). So here’s what you need to know in short form.
How this affects US producers of raw materials
How this affects US manufacturers
How this affects you
There, that wasn’t so bad was it?
The Department of Labor’s fiduciary rule has died in the courtroom. The Insured Retirement Institute and the Securities Industry and Financial Markets Association along with the Chamber of Commerce brought suit to protect the financial service companies who would prefer not to act as your fiduciary partner. After a three-judge panel ruled the DOL had exceeded their authority the DOL chose not to appeal the ruling. Despite 17 states and the AARP’s pleas to be allowed to continue the case the 5th circuit court denied their request, leaving investors once again on their own to determine who they can trust with their life savings.
To make matters worse, the SEC has proposed new rules that provides cover to those not willing to act as a fiduciary. They call it the “Regulation” Best Interest rule. Best interest sounds much like fiduciary to most folks, but as with many things written by attorneys it might not mean what you think it means.
While the Regulation Best Interest is an improvement over the suitability standard, the name alone is deceptive. Unlike the fiduciary standard that has a long history of common law and case law definition, ‘best interest’ is undefined and subject to future court rulings to grow the teeth needed to provide needed protections.
The SEC proposal also requires both brokers and advisors to provide a four-page disclosure document to help define how they will behave in the client relationship. It seems to me a simple check a box form would be clearer and simpler for all parties. One box would say, “yes, I will always act as a fiduciary in our relationship” and the other would simply say “No, I will not act as a fiduciary at all times”.
A rose is a rose is a rose, unless we are talking about your retirement nest egg, then it’s more “buyer beware”.
Life insurance can be a confusing topic. There are many different flavors and choosing the right coverage for your needs and budget can be difficult. Throw in the fact that life insurance agents goal of collecting a commission check may be at odds with your goal of obtaining the best protection for the lowest price and you have a recipe for disaster.
Let’s start by getting to know some of the basic flavors of life insurance available to you. While this is not a complete guide to all the life insurance options available nor does this explain all the nuances of each policy type, it is useful as a primer to get you started.
Term Life Insurance
Term insurance is the most basic and the least expensive type of life insurance policy available. Term insurance is pure protection. You give the insurance company a premium and the commit to paying your beneficiaries a death benefit if you die during the policy’s term. Once the term has expired you no longer have life insurance protection and the insurance company no longer has an obligation to pay.
One-year non-renewable term insurance is the absolute cheapest type of policy you can buy, but that is rarely the type of policy you will need.
Usually you need protection for longer than a year, so insurance companies came up with multi year guaranteed renewable term policies to meet that need. You can often find 5 year to 20 year guaranteed renewable coverage that can be used to customize coverage for just about any situation. Because the policies cover multiple years and have guaranteed renewability, premiums are a bit higher. You can also add level premium guarantees to the coverage, so you know what your premiums will be for the entire term of the contract. Level premiums mean there is a bit more risk for the insurance company which gets passed along to you the consumer in the form of higher premiums.
Many young families can use term insurance to protect against premature death and until they have accumulated enough capital to no longer need as much protection. For instance, new parents might purchase enough coverage to protect against the loss of wages if one spouse dies and provide funds for childcare and education until their children graduate from college with a fifteen or twenty-year level premium term policy. After that term expires their need for insurance may well be much lower and they can follow it up with a ten-year level premium policy to provide protection until retirement when they will likely not need any life insurance coverage.
Whole Life Insurance
Whole life coverage as the name implies will last your entire life. The insurance company issues you a policy with a premium based on your age when the policy is issued. The premium you pay is calculated to cover the cost of term coverage for you, pay the agent, and have some money left over to go into a savings account inside the policy. Usually there is a stated interest rate that your excess premiums earn inside the insurance policy. As you continue to make premium payments, you gradually build up enough money inside the policy to either increase the policy’s death benefit or to stop making premium payments altogether.
Whole life coverage is usually the most expensive flavor of life insurance you can buy. There was an old adage that said buy term and invest the savings yourself for a better long-term outcome but having worked with many clients who are terrible savers, I do recognize the place for whole life insurance policies in many family’s insurance portfolio. Perhaps it is used as a foundation that you build term coverage on to meet all your needs for all your life.
Universal Life Insurance
Universal insurance works like whole life but rather than earning a guaranteed rate, the excess premiums are credited with an interest rate that floats with market rates. These policies were popular when interest rates were high. As interest rates came down over the past two decades many of these policies collapsed as the interest rate assumptions made when they were issued failed to materialize leaving the owners with much higher than anticipated premiums or reduced or even eliminated death benefits.
Variable Universal Life
Okay, take a universal insurance policy and make the savings account inside the policy a high priced mutual fund and what you end up with is variable universal life. If the mutual funds you own inside the policy earn enough net of fees, your premiums vanish or your death benefit increases. If you can find a variable universal policy with low expenses this is a good idea, but determining all the fees being charges to your account can be very challenging.
In the end life insurance is often a must for building a solid foundation for your family's financial plan. Life insurance is the one product that can create wealth where none existed before. Life insurance provides the cash your family will need to replace the earnings or human capital of a loved one. Life insurance is a valuable tool for providing protection for your family, but it is almost never a good tool for investing. If your agent talks about the investment properties of a life insurance product you should see this as a red flag and seek out a second opinion.
“Sell in May, then Go Away” used to be a common theme in the investment world.
This referred to the idea that traders would be occupied during summer months vacationing and enjoying the warm weather and are not as easily available to watch markets and make educated trades. This would in turn reduce liquidity in the markets and exacerbate any volatility which caused a lot of stress on traders during the summer months.
Today, that explanation just doesn’t add up with access to markets, data, and trades quite literally at the palm of our hands. You will find it very hard to really “Go Away”.
Whether you go away or not the ”Sell in May” strategy actually works, and they have data to back it up. It seems that seasonality is a real thing, and something to be looked at. If you’re a DIYer this may be something to look in to- it shows a strong success rate and you even get to take the summer off!
Spring is the time of year when all the potholes created by the freeze/thaw cycles of winter become all too obvious. You can damage your car, your tires, and your rims if you are not careful. We all have to slowdown to avoid these cavernous craters on our roadways and we complain to our local officials about fixing them on the roads we travel the most often.
Your investment portfolio can be like that also. Stocks fall in value creating imbalances or potholes in our holdings. Not all stocks rise at the same rate, so you could have some underperformers that you should be adding to or selling. Or maybe you sold something at a profit, but you haven’t reinvested the proceeds. Maybe you sold something that wasn’t working in your portfolio or even worse, maybe you need to sell something in your portfolio that isn’t working.
Maybe your pothole isn’t an investment at all. Maybe your pothole is a lack of a long-term plan or the need for a consistent strategy. Your pothole could be that life insurance you have been meaning to buy since your second child was born, or the debt you have let accumulate on a credit card since the holidays. Maybe your pothole is the will or power of attorney you have been meaning to establish for the past four years.
Whatever the case you need to periodically look at filling in the potholes in your financial life. The work crews you pass everyday on your way to the office can serve as a reminder that your financial life needs maintenance and care if it is to provide you a smooth and comfortable ride on your journey. Patch your potholes – today is as good a time as any.
The popular press is fond of pointing out how old the bull market for stocks is. After bottoming in 2009 we have seen stocks march upward for for nearly a decade. Many of today’s younger investors, say those in their thirties, have seen the stock market fall, but never felt the pain in their own portfolio.
Yet for another class of investor, those who have invested in bonds, the bull market run has been even longer. Going back to the days of President Jimmy Carter in 1981, bond yields have fallen, year after year. Because bond prices move inversely to interest rates, bond prices have been rising for the last 36 years. That means someone who entered the workforce in the early eighties, bond prices have always gone up.
For some perspective the Certified Financial Planner Board of Standards was formed in 1985. As a group, CFP® practitioners have never experienced a true bear market in fixed income securities. Although the credit freeze that coincided with the great recession bear market for stocks, had a short, sharp panic in the fixed income markets; a long drawn out bear market for fixed income has been an experience the profession will for the most part find alien.
The closest thing to the pain of a bear market in bonds experienced by this group was the 2004 to 2006 Chinese water torture of the Greenspan/Bernanke Fed. During the thirteen months that spanned June of 2005 to July of 2006, the Federal Reserve raised rates 25 basis points every time they met. Although the aggregate bond index only fell in price by about 5%, the constant barrage of interest rate increases was hard to live through.
That pain was nothing compared to the Burns/Miller/Volker era where we saw the Fed raise rates from 4.75% in November of 1976 to the 20% Fed Funds rate of May 1981. That was the last true bear market for fixed income products in the United States. Although your grandfather might wistfully talk about getting 18% on his CDs, the path that led to those astronomical rates was littered with bond investors who saw the value of longer term bonds fall by 50% or more.
When I hear today’s press ask what will happen if the 10-year Treasury bond breaches 4% I am astonished. It is not a question of if, but a question of when.
If we can avoid creating a trade war with the rest of the world, there are some very expansive monetary policies recently enacted by congress and the Trump administration investors can benefit from. The tax overhaul will provide a good measure of impetus to the economy, and the budget bill recently signed into law gets us away from the restrictive spending of the sequestration agreement and into a more expansive government spending era.
Yet, the Federal Reserve must walk a fine line between economic growth and containing inflation. GDP growth has entered a more normal territory.
Inflation, while still subdued, has shown signs of rebounding. The uptick in inflation is related to a small increase in wage growth, which is in turn related to the continued implosion of our unemployment rate. You also will note a similar uptick in mortgage rates.
As investors search for yield in a low rate world, we have seen a compression in the interest rate spreads between high quality bonds and low quality (junk) bonds. With rates as low as they are today and with the economy growing it is inevitable that interest rates will rise. The end of the 36-year bond bull market is likely upon us.
A flattish yield curve where the difference in a two-year treasury and a ten-year treasury is a mere 52 basis points, puts bond investors in a peculiar spot where an interest rate increase of just 1% could potentially wipe out three to five years of interest income.
The take away from all this is bonds are a minefield for investors today. A small misstep can be very costly and the rewards for investment are very small. Many advisors are ill-prepared for a world of falling bond prices.
Unless you or your advisor are true experts with fixed income investments, your best option in today's environment is to keep your maturities very short. That means you should be selling any bonds or bond mutual funds that have long durations. You should direct those allocations to short term treasuries, certificates of deposit, and bonds in the 1 to 3 year maturity range. Hopefully you will ladder those investments so you have new money available to invest at progressively higher rates throughout this interest rate cycle.
For those of you who need to squeeze every last drop of return out of your fixed income investments, I recommend you read an article I had selected for publication in the "Journal of Financial Planning" in July of 2011. In this article I explain how thinking about the life of a bond as it moves toward maturity can produce positive returns even when interest rates are moving up.
The recent income tax revamp has made income tax planning early in the year a must for many self-employed professionals. The ability to take a 20% deduction of business income, available for single filers with income below $157,500 and married filers with income below $315,000, is too good to pass up. Filers with taxable income at these levels will be in the 24% marginal tax bracket, so being able to qualify for the business income deduction is worth thousands, particularly when proper tax planning can prevent many from reaching the next 32% bracket. There are a number of ways to game your reported income, allowing many filers with reportable income well above these limits to qualify for the 20% exclusion.
First, the exclusion counts toward reducing your income below the phaseout thresholds. A married couple with employment income of $175,000 and a like amount received as business income would see their total income of $350,000 reduced by 20% of the business income or $35,000 allowing them to remain within the proscribed income limits.
Contributions made to an Health Savings Accounts will also reduce your taxable income. For 2018 single filers can deduct up to $3,450 and couples up to $6,900.
A real biggie for high earners looking to qualify for the 20% exclusion is retirement plan contributions. Money contributed to your qualified retirement plans can make a huge difference. For 2018 those under age 50 can contribute $18,500 to a 401k and those 50 and above can contribute up to $24,500. Presumably as a business owner you can also be sure to offer a generous match. Matching contributions are a deductible business expense that benefits you the owner directly yet reduces your reported profits and thus your total income for purposes of qualifying for the 20% deduction. And for very high earners, adding a defined benefit plan to your existing defined contribution plan might be a smart move, depending on the demographics and size of your workforce.
Don’t overlook simple things like using tax free municipal bonds for your savings versus taxable bonds and CDs.
Going beyond the basics, some business owners could benefit from reimagining their business ownership. Suppose you are a professional who owns your place of business. Setting up a separate company to own the real estate could be a smart move. You lease the building back from the owner at a fair market rate creating business income that is not subject to the target income limits.
Busy professionals have little time to devote to income tax planning and their CPAs are busy during tax season, but the difference between qualifying for the deduction and not qualifying could hinge on how soon you begin a given strategy.
It has been a long time since we have seen the stock market exhibit this much volatility. Corrections are a normal and healthy part of investing. Corrections weed out the speculators and hot money. For a clearer view of what is happening, we offer a few charts with longer term views.