Using Retirement Funds in a Financial Crisis

July 2, 2020

For generations, the tax code has been a public policy tool, used to encourage people to save for retirement and what used to be called “old age.” However, the coronavirus pandemic has caused many households to begin using retirement funds in a financial crisis. Lawmakers have responded by making it easier to tap these accounts. The article “Should You Tap Retirement Funds in a Crisis? Increasingly, People Say Yes” from The Wall Street Journal asks if this is really a good idea.

This shift in thinking actually coincides with trends that began to emerge before the last recession. People were living and working longer. Unemployment and career changes later in life were becoming more commonplace, and fewer and fewer people devoted four decades to working for a single employer, before retiring with an employer-funded pension.

For those who have been affected by the economic downturns of the coronavirus, withdrawals up to $100,000 from retirement savings accounts are now allowed, with no early-withdrawal penalty. That includes IRAs (Individual Retirement Accounts) or employment-linked 401(k) plans. In addition, $100,000 may be borrowed from 401(k) plans.

Americans are not alone in this. Australia and Malaysia are also allowing citizens to take money from retirement accounts.

Lawmakers are hoping that by using retirement funds now, it may help households prevent foreclosures, evictions and bankruptcies, with less of an impact on government spending. With trillions in retirement accounts in the U.S., these accounts are where legislators frequently look when resources are threatened.

However, there’s a tradeoff. If you take out money from accounts that have lost value because of the market’s volatility, those losses are not likely to be recouped. And if money is taken out and not replaced when the world returns to work, there will be less money during retirement. Not only will you miss out on the money you took out, but on the return, it might have made through years of tax-advantaged investments.

The danger of using retirement funds in a financial crisis is that if these accounts are widely seen as accessible and necessary now, a return to saving for retirement or the possibility of putting money back into these accounts when the economy returns to normal may not happen.

IRA and 401(k) accounts began to supplant pensions in the 1970s as a way to encourage people to save for retirement, by deferring income tax on money that was saved. By the end of 2019, IRAs and 401(k) types of accounts held about $20 trillion in the US.

Boston College’s Center for Retirement Research has estimated that even before the coronavirus, early withdrawals were reducing retirement accounts by a quarter over 30 years, taking into account the lost returns on savings that were no longer in the accounts. For many people, taking retirement funds now may be their only choice, but the risk to their financial future and retirement is very real.

Reference: The Wall Street Journal (June 4, 2020) “Should You Tap Retirement Funds in a Crisis? Increasingly, People Say Yes”

What You Need to Know about Drafting Your Will

July 1, 2020

A last will and testament is just one of the legal documents that you should have in place to help your loved ones know what your wishes are, if you can’t say so yourself, advises CNBC’s recent article entitled, “Here’s what you need to know about creating a will.” In this pandemic, the coronavirus may have you thinking more about your mortality. Here’s what you need to know about drafting your will.

Despite COVID-19, it’s important to ponder what would happen to your bank accounts, your home, your belongings or even your minor children, if you’re no longer here. You should prepare a will, if you don’t already have one. It is also important to update your will, if it’s been written.

If you don’t have a valid will, your property will pass on to your heirs by law. These individuals may or may not be who you would have provided for in a will. If you pass away with no will —dying intestate — a state court decides who gets your assets and, if you have children, a judge says who will care for them. As a result, if you have an unmarried partner or a favorite charity but have no estate plan, your assets may not go to them.

The courts will typically pass on assets to your closest blood relatives, despite the fact that it wouldn’t have been your first choice.

Your will is just one part of a complete estate plan. Putting a plan in place for your assets helps ensure that at your death, your wishes will be carried out and that family fights and hurt feelings don’t make for destroyed relationships.

There are some assets that pass outside of the will, such as retirement accounts, 401(k) plans, pensions, IRAs and life insurance policies.

Therefore, the individual designated as beneficiary on those accounts will receive the money, despite any directions to the contrary in your will. If there’s no beneficiary is listed on those accounts, or the beneficiary has already passed away, the assets automatically go into probate—the process by which all of your debt is paid off and then the remaining assets are distributed to heirs.

If you own a home, be certain that you know the way in which it should be titled. This will help it end up with those you intend, since laws vary from state to state.

Ask an estate planning attorney in your area — to ensure familiarity with state laws—for help learning what you need to know about drafting your will and the rest of your estate plan.

Reference: CNBC (June 1, 2020) “Here’s what you need to know about creating a will”

How a Charitable Remainder Trust Works

June 30, 2020

The passage of the SECURE Act, effective January 1, 2020, made big changes in how we need to plan for taxes for beneficiaries. Federal estate and gift tax exemptions did not change, but anyone who inherits a retirement account is likely to find fewer options than before the SECURE Act. This is where a Charitable remainder trust works to your benefit.

The least popular beneficiary is almost always the federal government. Most people are concerned that their estate will need to pay taxes and do what they can through estate planning to keep federal estate tax liability to a minimum. However, with federal estate and gift tax exemptions at $11.58 million per person this year, and twice that when properly used with the spousal exemption, most people don’t need to worry about the federal estate tax, explains The News Enterprise in the article “New federal law resurrects Charitable Remainder Trust.”

Charitable remainder trusts have been used for many years to avoid high capital gains taxes on appreciated assets. Appreciated assets are placed into trusts and no taxes are due on the transfer. The donor also gets a charitable tax deduction. The amount in the trust grows, while paying out a small amount to beneficiaries in installment payments.

With the passage of the SECURE Act, non-spousal beneficiaries, with certain exceptions, must withdraw the entire amount of the qualified retirement account within ten years. Generally, beneficiaries may not roll the account into their own qualified account, and there are no required annual distributions. However, there’s a ten-year window to empty the account. Taxes are due on every withdrawal, whether it takes place over ten years or as a single withdrawal.

By using a CRT, the full amount of the account may be transferred into the CRT, no taxes are due, and the donor (or the donor’s estate) gets a charitable deduction.

The trust is simply an instrument created, so that a beneficiary may receive regular payments, which may include the donor, beneficiaries or multiple beneficiaries, over the span of their lives, or in a set number of years, with the remainder interest of at least ten percent of the initial contribution paid to a qualified charity at the end of the trust.

This effectively creates a stretch for the IRA, with withdrawals being taxed to the beneficiary, over a longer time span. With only ten percent being required to be donated to a charity, those who plan on making a donation to a charity anyway receive a benefit, and their beneficiaries can receive a lifetime income stream.

Speak with your estate planning attorney to learn how Charitable remainder trusts could be part of your estate plan.

Reference: The News Enterprise (June 2, 2020) “New federal law resurrects Charitable Remainder Trust”

Utilizing the SECURE and CARES Acts?

June 24, 2020

Are you utilizing the SECURE and CARES Acts in the best way possible? The SECURE Act made a number of changes to IRAs, effective January 1, 2020. It was followed by the CARES Act, effective March 27, 2020, which brought even more changes. A recent article from the Milwaukee Business Journal, titled “IRA planning tips for changes associated with the SECURE and CARES acts,” explains what account owners need to know.

Setting Every Community Up for Retirement (SECURE) Act

The age when you have to take your RMD increased from 70½ to 72, if you turned 70½ on or before December 31, 2019. Younger than 70½ before 2020? You still must take your RMDs. But, if you can, consider deferring any distributions from your RMD, until you must. This gives your IRA a chance to rebound, rather than locking in any losses from the current market.

Beneficiary rules changed. The “stretch” feature of the IRA was eliminated. Any non-spousal beneficiary of an IRA owner who dies after Dec. 31, 2019, must take the entire amount of the IRA within 10 years after the date of death. The exceptions are those who fall into the “Eligible Designated Beneficiary” category. That includes the surviving spouse, a child under age 18, a disabled or chronically ill beneficiary, or a beneficiary who is not more than ten years younger than the IRA owner. The Eligible Designated Beneficiary can take distributions over their life expectancy, starting in the year after the death of the IRA holder. If your estate plan intended any IRA to be paid to a trust, the trust may include a “conduit IRA” provision. This may not work under the new rules. Talk with your estate planning attorney.

IRA contributions can be made at any age, as long as there is earned income. If you have earned income and are 70 or 71, consider continuing to contribute to a Roth IRA. These assets grow tax free and qualified withdrawals are also tax free. If you plan on making Qualified Charitable Distributions (QCD), you’ll be able to use that contribution (up to $100,000 per year) from the IRA to offset any RMDs for the year and not be treated as a taxable distribution.

Coronavirus Aid, Relief and Economic Security (CARES) Act

The deadline for contributions for traditional or Roth IRAs this year is July 15, 2020. The 2019 limit is $6,000 if you are younger than 50 and $7,000 if you are 50 and older.

RMDs have been waived for 2020. This applies to life expectancy payments. It may be possible to “undo” an RMD, if it meets these qualifications:

The RMD must have been taken between February 1—May 15 and must be recontributed or rolled over prior to July 15.
RMDs taken in January or after May 15 are not eligible.
Only one rollover per person is permitted within the last 12 months.
Life expectancy payments may not be rolled over.

Individuals impacted by coronavirus may be permitted to take out $100,000 from an IRA with no penalties. They are eligible if they have:

Been diagnosed with SARS-Cov-2 or COVID-19
A spouse or dependent has been diagnosed
Have experienced adverse consequences as a result of being quarantined, furloughed or laid off or having work hours reduced due to the virus, are unable to work because of a lack of child care, closed or reduced hours of a business owned or operated by the individual or due to other factors, as determined by the Secretary of the Treasury.
Note that these distributions are still taxable, but the income taxes can be spread ratably over a three-year period and are not subject to the 10% early distribution penalty.

Keep careful records, as it is not yet known how any of these distributions/redistributions will be accounted for through tax reporting. All of these tips will allow you to utilize the SECURE and CARE Acts effectively.

Reference: Milwaukee Business Journal (June 1, 2020) “IRA planning tips for changes associated with the SECURE and CARES acts”

Looking at tapping an Inherited IRA?

June 17, 2020

Are you looking at tapping an inherited IRA this year? The rules about when and how you can tap the money you inherited changed with the passage of the SECURE Act at the end of December 2019. It then changed again with the passage of the CARES Act in late March, in response to the financial impact of the pandemic.

Things are different now, reports the article “Read This Before You Touch Your Inherited IRA Funds” from the News & Record, but one thing is the same: you need to know the rules.

First, if the owner had the account for fewer than five years, you may need to pay taxes on traditional IRA distributions and on Roth IRA earnings. This year, the federal government has waived mandatory distributions (required minimum distributions, or RMDs) for 2020. You may take out money if you wish, but you can also leave it in the account for a year.

Surviving spouses who don’t need the money may consider doing a spousal transfer, rolling the spouse’s IRA funds into their own. The RMD doesn’t occur until age 72. This is only available for surviving spouses, and only if the spouse is the decedent’s sole beneficiary.

The federal government has also waived the 10% early withdrawal penalty for taxpayers who are under 59½. If you are over 59½, then you can access your funds.

The five-year method of taking IRA funds from an inherited IRA is available to beneficiaries, if the owner died in 2019 or earlier. You can take as much as you wish, but by December 31 of the fifth year following the owner’s death, the entire account must be depleted. The ten-year method is similar, but only applies if the IRA’s owner died in 2020 or later. By December 31 of the tenth year following the owner’s death, the entire IRA must be depleted.

Heirs can take the entire amount in a lump sum immediately, but that may move their income into a higher tax bracket and could increase tax liability dramatically.

A big change to inherited IRAs has to do with the “life expectancy” method, which is now only available to the surviving spouse, minor children, disabled or chronically ill people and anyone not more than ten years younger than the deceased. Minor children may use the life expectancy method until they turn 18, and then they have ten years to withdraw all remaining funds.

There is no right or wrong answer, when it comes to taking distributions from inherited IRAs. However, it is best to do so, only when you fully understand how taking the withdrawals will impact your taxes and your long-term financial picture. Speak with an estate planning attorney to learn how the inherited IRA fits in with your overall estate plan.

Reference: News & Record (May 25, 2020) “Read This Before You Touch Your Inherited IRA Funds”

What Do I Do If I’m Named Financial Power of Attorney?

June 4, 2020

A financial power of attorney (POA) is a document whereby the “principal” appoints a trusted someone known as the “attorney-in-fact” or “agent” to act on behalf of the principal, especially when the principal is incapacitated. It typically permits the attorney-in-fact to pay the principal’s bills, access his accounts, pay his taxes and buy and sell investments or even real estate. In effect, the attorney-in-fact steps into the shoes of the principal and is able to act for him in all matters, as described in the POA document.

Kiplinger’s recent article entitled “What Are the Duties for Financial Powers of Attorney?” says these responsibilities may sound overwhelming, and it’s only natural to feel this way initially. Let’s look at the steps to take to do this important job:

Don’t panic but begin reading. Review the POA document and determine what the principal has given you power to do on his behalf. A POA will typically include information addressed to the agent that explains the legal duties he or she owes to the principal.
See what you have to handle for the principal. Create a list of the principal’s assets and liabilities. If the principle is organized, it’ll be easy. If not, you will need to find their brokerage and bank accounts, 401(k)s/IRAs/403(b)s, the mortgage, taxes, insurance and other bills (utilities, phone, cable and internet).
Protect the principal’s property. Be sure the principal’s home is secure and make a video inventory of the home. If it looks like your principal will be incapacitated for an extended period of time, you may cancel the phone and newspaper subscriptions. You may need to change the locks on the principal’s home. If you have control of the principal’s investments and their incapacitation may continue for a long time, review their brokerage statements for high-risk positions that you don’t understand, like options, puts and calls, or commodities. Get advice on liquidating positions you don’t have the know-how to handle.
Pay all bills, as necessary. Look at your principal’s bills and credit card statements for potential fraud. Perhaps you should suspend their credit cards that you won’t be using on the principal’s behalf. Note that they may have bills automatically paid by credit card and plan accordingly.
Pay the taxes. Many powers of attorney give the agent the power to pay the principal’s taxes. If so, you’ll be responsible for filing and paying taxes during the principal’s lifetime. If the principal passes away, the executor of the principal’s last will is responsible for preparing any final taxes.
Keep meticulous records. Track every expenditure you make and every action you take on the principal’s behalf. You’ll be asked to demonstrate that you have upheld your duties and acted in the principal’s best interests. It will also be important for you to receive reimbursement for expenses, and (if the power of attorney provides for it) the time you spent acting as agent.

Finally, you must always act in the principal’s best interest.

Reference: Kiplinger (April 22, 2020) “What Are the Duties for Financial Powers of Attorney?”

Do Beneficiaries of a Will Get Notified?

June 2, 2020

In most instances, a will is required to go through probate to prove its validity.

Investopedia’s recent article entitled “When the Beneficiaries of a Will Are Notified” explains that there are exceptions to the requirement for probate, if the assets of the diseased are below a set dollar amount. This dollar amount depends on state law.

For example, in Alabama, the threshold is $3,000, and in California, the cut-off is an estate with assets valued at less than $150,000. If the assets are valued below those limits, the family can divide any property as they want with court approval.

The beneficiaries of a will must be notified after the will is filed in the probate court, and in addition, probated wills are placed in the public record. As a result, anyone who wants to look, can find out the details. When the will is proved to be valid, anyone can look at the will at the courthouse where it was filed, including anyone who expects to be a beneficiary.

However, if the will is structured to avoid probate, there are no specific notification requirements. This is pretty uncommon.

As a reminder, probate is a legal process that establishes the validity of a will. After examining the will, the probate judge collects the decedent’s assets with the help of the executor. When all of the assets and property are inventoried, they are then distributed to the heirs, as instructed in the will.

Once the probate court declares the will to be valid, all beneficiaries are required to be notified within a certain period established by state probate law.

There are devices to avoid probate, such as setting up joint tenancy or making an asset payable upon death. In these circumstances, there are no formal notification requirements, unless specifically stated in the terms of the will.

In addition, some types of assets are not required to go through probate. These assets include accounts, such as pension assets, life insurance proceeds and individual retirement accounts (IRAs).

The county courthouse will file its probated wills in a department, often called the Register of Wills.

A will is a wise plan for everyone. Ask a qualified estate planning attorney to help you draft yours today.

Reference: Investopedia (Nov. 21, 2019) “When the Beneficiaries of a Will Are Notified”

Are My Beneficiary Designations Trouble for My Heirs?

May 27, 2020

There are many account types that are governed by beneficiary designation, such as life insurance, 401(k)s, IRAs and annuities. These are the most common investment accounts people have with contractual provisions to designate who receives the asset upon the death of the owner.

Kiplinger’s recent article entitled “Beneficiary Designations – The Overlooked Minefield of Estate Planning” provides several of the mistakes that people make with beneficiary designations and some ideas to avoid problems for you or family members.

Believing that Your Will is More Power Than It Really Is. Many people mistakenly think that their will takes precedent over any beneficiary designation form. This is not true. Your will controls the disposition of assets in your “probate” estate. However, the accounts with contractual beneficiary designations aren’t governed by your will, because they pass outside of probate. That is why you need to review your beneficiary designations, when you review your will.

Allowing Accounts to Fall Through the Cracks. Inattention is another thing that can lead to unintended outcomes. A prior employer 401(k) account can be what is known as “orphaned,” which means that the account stays with the former employer and isn’t updated to reflect the account holder’s current situation. It’s not unusual to forget about an account you started at your first job and fail to update the primary beneficiary, which is your ex-wife.

Not Having a Contingency Plan. Another thing people don’t think about, is that a beneficiary may predecease them. This can present a problem with the family, if the beneficiary form does not indicate whether it is a per stirpes or per capita election. This is the difference between a deceased beneficiary’s family getting the share or it going to the other living beneficiaries.

It’s smart to retain copies of all communications when updating beneficiary designations in hard copy or electronically. These copies of correspondence, website submissions and received confirmations from account administrators should be kept with your estate planning documents in a safe location.

Remember that you should review your estate plan and beneficiary designations every few years. Sound estate planning goes well beyond a will but requires periodic review. If this is overlooked, something as simple as a beneficiary designation could create major issues in your family after you pass away.

Reference: Kiplinger (March 4, 2020) “Beneficiary Designations – The Overlooked Minefield of Estate Planning”

Would an Early Retirement and Early Social Security Be Smart?

May 14, 2020

For older employees who are laid off as a result of the pandemic, the idea of an early retirement and taking Social Security benefits early may seem like the best or only way forward. However, cautions Forbes in the article “Should You Take Social Security Earlier Than Planned If You’re Laid Off Due to COVID-19?,” this could be a big mistake with long-term repercussions.

In the recession that began in 2008, there were very few jobs for older workers. As a result, many had no choice but to take Social Security early. The problem is that taking benefits early means a smaller benefit.

In 2009, one year after the market took a nosedive, as many as 42.4 percent of 62-year-olds signed up for Social Security benefits. By comparison, in 2008, the number of 62-year-olds who took Social Security benefits was 37.6 percent.

You can start taking Social Security early and then stop it later. However, there are other options for those who are strapped for cash.

There is a new tool from the IRS that allows taxpayers to update their direct deposit information to get their stimulus payment faster and track when to expect it. There is also a separate tool for non-tax filers.

Apply for unemployment insurance. Yes, the online system is coping with huge demand, so it is going to take more than a little effort and patience. However, unemployment insurance is there for this very same purpose. Part of the economic stimulus package extends benefits to gig workers, freelancers and the self-employed, who are not usually eligible for unemployment.

Consider asking a family member for a loan, or a gift. Any individual is allowed to give someone else up to $15,000 a year with no tax consequences. Gifts that are larger require a gift tax return, but no tax is due. The amount is simply counted against the amount that any one person can give tax free during their lifetime. That amount is now over $11 million. By law, you can accept a loan from a family member up to $10,000 with no paperwork. After that amount, you’ll need a written loan agreement that states that interest will be charged – at least the minimum AFR—Applicable Federal Rate. An estate planning attorney can help you with this.

Tap retirement accounts—gently. The stimulus package eases the rules around retirement account loans and withdrawals for people who have been impacted by the COVID-19 downturn. The 10% penalty for early withdrawals before age 59½ has been waived for 2020.

If you must take Social Security, you can do so starting at age 62. In normal times, the advice is to tap retirement accounts before taking Social Security, so that your benefits can continue to grow. The return on Social Security continues to be higher than equities, so this is still good advice.

Reference: Forbes (April 15, 2020) “Should You Take Social Security Earlier Than Planned If You’re Laid Off Due to COVID-19?”

Coronavirus Stimulus Allows Retirees to Tap Funds Early, With Little or No Penalties

May 4, 2020

For a limited time, Americans will now be able to withdraw money from tax-deferred accounts without penalties, under the Coronavirus Stimulus law. Rules on taking loans from 401(k)s will also be loosened up, and some retirees will be able to avoid Required Minimum Distributions (RMDs) that otherwise would have been costly, says the article “Coronavirus stimulus lets struggling Americans tap retirement accounts early” from the Los Angeles Times.

In some cases, these changes reflect what has been done for retirement savers in previous disasters. However, for the most part, these are more intense than in other events. The chief government affairs officer of the American Retirement Association, Will Hansen, says that we are now in uncharted territory as a result of the Covid-19 pandemic. The numbers of people filing for unemployment make it likely that many people will be tapping their retirement accounts.

One provision in the bill would allow investors of any age to take as much as $100,000 from their retirement accounts without any early withdrawal penalties. If the money is put back in the account within three years, there won’t be any taxes due. If the money is not put back, taxes can be paid over the course of three years. The law says that the money must be a “coronavirus-related distribution,” but the rules are loose.

People who test positive for the virus, along with anyone who experiences adverse financial consequences as a result of the pandemic, including being unable to find work or childcare, are permitted to make these withdrawals.

The bill also makes it easier to borrow money from 401(k) accounts, raising the limit on these loans from $50,000 to $100,000. The payment dates for any loans due in 2020 are extended for a year.

Retirees in their early 70s were previously required to start taking money out of tax-deferred accounts and start paying taxes on those distributions. The bill also waives these rules.

U.S. individual retirement accounts held nearly $20 trillion in assets at the end of 2019. While those amounts have certainly dropped due to market volatility, Americans still hold a lot of money in retirement accounts.

However, pre- and post-retirees need to think carefully about withdrawing large sums of money now. For pre-retirees, this should only be a last resort. Some professionals think the 401(k)-loan amount is too high and that people will jump to take out too much money, which will never find its way back.

According to a U.S. Government Accountability Office report from 2019, Americans ages 25-55 take approximately $69 billion a year from their retirement accounts. Once the money is gone, it’s not able to earn future tax-deferred returns.

Reference: Los Angeles Times (March 27, 2020) “Coronavirus stimulus lets struggling Americans tap retirement accounts early”

Category: Retirement Accounts