Hi everyone. Below is a quick summary of the COVID-19 legislation that affects retirees. Before jumping into that, a quick apology. Sorry I haven’t written much lately. January and February are normally very busy months for me as I meet with clients for annual reviews. Just as that was wrapping up, the world (and markets) went haywire with the pandemic and I’m just now coming up for air.
New Rules That Affect Retirees
The coronavirus stimulus packages contain something for (almost) everyone: businesses, individuals, students and yes, retirees. I won’t bore you with a comprehensive list, but I’ll give you a quick overview of the elements that impact retirees.
Changes to Required Minimum Distribution (RMD) rules: The CARES Act allows you to suspend RMDs for 2020 from 401(k)s, 403(b)s and IRAs. If your IRA took a hit and you don’t need the money, it’s probably a good idea to skip your 2020 RMD. That will hopefully give your account time to recover from the recent downturn. If you have your RMD set to happen automatically each year, you’ll want to call your adviser or IRA custodian to stop it. If you’ve already taken it for the year, there is a provision that allows you to put it back. Certain restrictions apply, so check with your IRA custodian for details. Also keep in mind that Congress made another change to RMDs at the beginning of the year that pushed the required age from 70 ½ to 72.
Penalty waived for early retirement withdrawals: Normally, you have to pay a 10% penalty if you take a distribution from your IRA prior to age 59 ½. That penalty is waived for 2020 on amounts up to $100,000 for anyone affected by COVID-19 (e.g. sickness, job loss, reduced hours, etc.). You’ll still owe taxes on the distribution, but you can spread the taxes out over three years. And if you end up not needing some or all of the money, you can put it back into your IRA within three years and that contribution won’t count toward your annual contribution limit.
Stimulus checks: Even if you’re retired and not working, you may still be eligible for a stimulus check. The CARES act provides one-time payments of $1,200 for individuals and $2,400 for couples. The benefit begins to phase out at adjusted gross income of $75,000 for single filers and $150,000 for those married filing jointly. They phase out completely at $99,000 for singles and $198,000 for married filing jointly. Initially, people were required to file a 2018 or 2019 tax return in order to receive the benefit, but many retirees are not required to file a tax return, so the government now says it will look at SSA-1099 benefit statements. If you are receiving Social Security and are eligible for the benefit, the government will send out your stimulus check automatically in the same manner that you receive your regular benefits (likely via direct deposit).
Expanded loans from qualified plans: If you have a 401(k) or other qualified plan, you can now borrow 100% of your vested account balance, up to a maximum of $100,000. The deadline to initiate the loan is September 23, 2020. If you already have a loan outstanding, you can delay repayments for up to one year.
Delayed tax filing deadline: The due date for filing federal income tax returns (and paying any balance due) has been moved from April 15, 2020 to July 15, 2020. This extension applies automatically to all taxpayers and you don’t need to file any additional forms to qualify. The delay applies to 2019 returns as well as estimated tax payments for Q1 of 2020 that would otherwise have been due on April 15. If you’re still unable to file by July 15, you can file for a normal extension using Form 4868. Keep in mind that the regular rules still apply to that second extension (i.e. it extends the due date of your filing, but not the due date of any taxes due). Not all states extended their filing deadline, so be sure to check your state’s deadline to make sure you file on time.
Delayed mortgage payments: The CARES Act allows certain borrowers to delay their mortgage payments for up to a year. Be careful with this provision, however, because depending on who owns your mortgage (your bank or another servicer), you may be allowed to tack the payments onto the end of the loan or you may be required to pay all of your back payments in a lump sum at the end of the forbearance period. Check with your mortgage provider for details.
Medicare and COVID-19: Under earlier legislation (the Families First Coronavirus Response Act), health plans are required to cover COVID-19 testing at no cost to the patient. If you’re already on Medicare, it provides coverage as well. Medicare will cover COVID-19 testing and also covers hospitalization and treatment. In addition to these benefits, Medicare has expanded its coverage of telehealth benefits. For more information on all these things, visit https://www.medicare.gov/medicare-coronavirus.
These are definitely unprecedented times. Stay safe and touch base if you have any questions or if there’s anything I can do to help you.
Qualified Charitable Distributions
Once you reach age 70 ½ you need to start taking required minimum distributions (RMDs) from your IRA each year. There’s a simple formula to determine how much you need to take. Then you just withdraw the money and—here’s the important part—pay the taxes. Until recently, there was no way around those taxes. Then Congress changed the rules to allow people to make tax free charitable donations directly from their IRAs and count those donations toward their RMDs. These are called Qualified Charitable Distributions (QCDs). Here’s how they work.
If you have an RMD due, rather than having the money distributed to you, instruct the IRA trustee to send the money directly to a qualified charity. The distribution will count toward your RMD and the IRS will exclude it from your taxable income. You can exclude up to $100,000 per year. If married and you file a joint return, your spouse can exclude an additional $100,000.
These distributions are particularly appealing after the recent tax law changes. The standard deduction was raised considerably, which means many people will no longer itemize and deduct their giving. The QCD allows you to still get a tax benefit for your charitable giving even if you don’t itemize.
A few things to keep in mind:
- You must be at least 70 ½ to make a QCD.
- The QCD must be a distribution that would have otherwise been taxable.
- The distribution must go directly to the charity. If you distribute it to yourself and then give it to the charity, it counts toward your RMD, but it does not count as a QCD.
- QCDs are excluded from your taxable income, so you can’t double dip and also claim them as a charitable contribution on your tax return.
- You can make a QCD for up to $100,000 even if your RMD is less than that.
- A QCD cannot go to a private foundation or donor-advised fund.
There is a lot of uncertainty with healthcare lately, but two trends will likely continue: It will continue to get more expensive and you will continue to be responsible for more and more of the costs. Even with Medicare, it is estimated that the typical retiree will need between $200,000 and $400,000 to pay for health expenses during retirement. With that in mind you should seriously consider using a Health Savings Account (HSA) to help fund your retirement health expenses. You might be using one now, but if you’re like most, you’re not using it to its full potential. Let’s change that.
What is an HSA?
An HSA is a tax advantaged medical savings account available to people enrolled in high deductible health plans. Think of it as an IRA for your medical expenses. Unlike IRAs, however, HSA money is triple tax free: going in, as it grows and coming out. That is a huge advantage. The only caveat is that you need to spend the money on qualified health expenses or you’ll pay taxes and a penalty. The list of qualified expenses is rather long and even includes things like long-term care insurance premiums. Here are a few quick facts on HSAs:
- Contributions are tax deductible.
- The assets in the account grow tax free.
- Withdrawals for qualified medical expenses are tax free.
- If you take the money out for non-qualified expenses, you will pay taxes and a 20% penalty.
- Unlike FSAs, HSA dollars are not “use it or lose it.”
- Contributions can be made by either you or your employer.
- 2017 annual contribution limits are $3,400 for an individual and $6,750 for a family.
- Those over age 55 can make an additional $1,000 catch-up contribution each year.
- Money in the HSA can be invested in stocks, bonds and mutual funds.
A few things change at age 65…
- Distributions after age 65 are never subject to a penalty, even if not spent on qualified medical expenses. For non-qualified expenses just pay the taxes and use the money for whatever you want.
- At 65 you can pay for all Medicare premiums except Medigap with tax free HSA distributions.
- Once you enroll in Medicare, you can no longer make contributions to an HSA, but you can continue to use the existing money in your HSA.
Your best strategy
HSAs are growing in popularity, but they are not being used to their full potential. Because of the HSA triple tax advantage (in, out and during), the money should be invested for growth and allowed to compound as long as possible. Instead, here’s how most people use their HSA: 1) Add some money, 2) Leave the money in a no risk/no return money market, 3) Use the money as soon as they incur a medical expense.
Here’s how you should use your HSA: 1) Contribute the maximum amount allowed each year, 2) Invest the money in stocks, bonds and/or mutual funds, 3) If possible, pay for your current medical expenses out of pocket and allow your HSA money to grow until you retire. By doing that you are getting the most bang for your buck and creating a pot of money for retirement that can be used tax free for medical expenses or for anything else as long as you pay the tax.
Your tax bill will vary in retirement depending on which state you call home. Some states are tax-friendly to retirees and their income. Others, not so much. Once you no longer have a job anchoring you in place, you have more freedom to evaluate your options. To help do that, here are three questions to ask.
1) What are my sources of retirement income? The typical retiree gets his or her income from a variety of sources. Some of the more common sources include a pension, Social Security, part-time work, IRA distributions and dividend income. Different states tax those income sources differently. States like Alaska, Florida, Texas, South Dakota, Nevada, Washington and Wyoming have no personal income tax at all. More than half of the states exempt Social Security benefits from tax. States like Illinois and Mississippi exclude income from retirement plan distributions. Nearly two dozen states exempt military and government pensions. As you mull over where you want to retire, think about your income sources and then work with your financial and tax advisers to determine your potential tax burden in the states you’re considering.
2) How will I spend my retirement income? Just because a state has low or no income tax doesn’t mean that your tax bill will be low. Some states, like Alaska, have a genuinely low tax burden. Other states, like Arizona, have low income taxes, but high sales taxes. Depending on how you spend money during retirement, a high sales tax (or a high property tax) can be just as much of a burden as a high income tax. In short, beware the tax “shell game” that some states play. Rather than genuinely trying to reduce the tax burden, they simply change which pocket they take it from.
3) What other factors should I be considering? When deciding where to retire, taxes are an important piece of the decision, but they aren’t the only piece. Don’t get so hung up on your tax bill that you forget to consider things like proximity to family and friends, climate, cost of living, quality of medical facilities, entertainment options and outdoor activities (e.g. mountains, oceans, etc.). Make your decision based on all those factors and you’ll not only have a fun, meaningful retirement, but you might even have a little extra money in your pocket to pay for it.
Well, another year is in the history books. Where does the time go? It seems like just yesterday that I was singing along to Prince’s “Party Like It’s 1999” and worrying that my coffee machine was going to be a victim of Y2K and here we are a “Baker’s Decade” into the new millennium.
As the years go by, I, along with millions of others, find the idea of retirement morphing from a vague concept to an impending reality. The signs are subtle at first. An AARP magazine in the mailbox. A “take this job and shove it” daydream at work. A lingering glance at the orange and red sections of the USA Today weather map. If retirement looms large on your horizon, then there’s no time to waste. Below are 7 resolutions for the New Year to make sure that your planning is on track.
Recalibrate after the “Fiscal Cliff.” As the dust settles in Washington, there are several variables in your retirement plan that you may want to review. In particular, any changes in your tax bill can affect everything from your planned retirement date to your distribution strategy. Entitlement reform was delayed (color me surprised!), but any eventual changes to Medicare and Social Security will also affect your retirement. Schedule a meeting with your adviser to factor in these new variables and make sure that your plans are still realistic.
Increase your contributions. Are you getting a raise in 2013? Sure you could use that to upgrade your iPad or buy tickets to the soon to be announced Rolling Stones tour, but a third option would be to route that extra cash into your retirement accounts. Contribution limits for 2013 are increasing to $5,500 (plus an additional $1,000 for those over 50) for IRAs and $17,500 (plus an additional $5,500 for those over 50) for 401(k)s.
Create a debt payoff plan. If you subscribe to the 4 percent withdrawal rule, then for every $1,000 in income you need to generate during retirement, you’ll need $25,000 in assets. Doing some simple arithmetic, it’s easy to see that retiring with a mortgage, car payment or other debts can add hundreds of thousands of dollars to your “Number.” Reduce that burden by committing to a plan to retire debt free.
Get on the same page with your spouse. Try this experiment. At the dinner table tonight say “I can’t wait to retire in 2016 so we can move to San Carlos, Uruguay and I can realize my dream of becoming a real life gaucho.” The response that you get will show you how important it is to be on the same page with your spouse when it comes to your retirement planning. Now that the conversation is going, spend some time talking through your hopes, dreams and plans so that you can iron out any differences and compromise on a plan.
Take a mini-retirement. You wouldn’t want to get all the way to Uruguay only to second guess the whole gaucho thing. As you get closer to retirement, you should start using whatever vacation and sick time you have to test drive your plans. A mini-retirement is a great way to learn more about a place or to experiment with your retirement budget. Use what you learn to refine and improve your plans.
Set aside your first year of expenses. In case you hadn’t noticed, the financial markets have been a bit—what’s the word?—schizophrenic the past decade or so. If retirement is just around the corner, you run the risk of having to withdraw money from your nest egg at a time when your investments are performing poorly. Experts refer to this as sequence risk. To avoid that problem, set aside one year of your retirement expenses in cash. If the markets are doing well, you can draw income from your investments. If markets are doing poorly, you can draw from your cash and give your investments a chance to recover.
Update your estate plan. Estate and gift taxes were scheduled to change drastically in 2013, but got a last minute reprieve with the deal in Congress. The estate tax rate increased to 40 percent from 35 percent, but other than that, most existing estate tax rules were made permanent. Work closely with your attorney and financial adviser to make sure that your plan is up to date and designed to minimize taxes. Also be sure to have a strategy in place to cover any potential liability (e.g. life insurance) and make sure that your beneficiary designations and powers of attorney are up-to-date and reflect your wishes.
That list of resolutions makes me long for the days of simpler goals like “join a gym” or “quit smoking.” But hey, no one said retirement was going to be easy. If it was, the world would have more gauchos.
I originally published this article at www.marketwatch.com. Photo by Sacha Fernandez. Used under Creative Commons License.
Do you keep hearing the phrase “Fiscal Cliff,” but don’t know exactly what it means? Well, get ready to impress your friends at the next cocktail party, because here’s a short cheat sheet on what it is as well as a few thoughts on how it might affect retirees.
The Fiscal Cliff is a combination of tax increases and spending cuts that will automatically occur on December 31 unless Congress and the White House come to some sort of compromise.
The tax increases include:
- An increase in Federal income taxes. We will go from six brackets to five, and the rates will go from 10%, 15%, 25%, 28%, 33% and 35% to 15%, 28%, 31%, 36% and 39.6%.
- The maximum long-term capital gains tax rate will go from 15% to 20%.
- Dividends will go from being the same as long-term gains (usually 15%) to being taxed as ordinary income (up to 39.6%)
- The temporary 2% reduction in the FICA payroll tax will go away.
- Itemized deductions and dependency deductions will be phased out for high wage earners.
- The earned income tax credit, child tax credit and Hope tax credit will revert to their old (and less generous) limits.
- People with student loans will no longer be able to deduct loan interest beyond the first 60 months of repayment.
- Estate and gift tax provisions will change drastically. The amount that can be excluded from an estate will drop from $5.12 million to $1 million and the top tax rate will increase from 35% to 55%.
- The alternative minimum tax (AMT) exemption amounts will fall significantly, subjecting many more people to this tax.
- In addition to the above, high wage earners will see a 0.9% increase in the Medicare portion of their payroll tax as well as a new 3.8% tax on some or all of their net investment income.
The spending cuts include:
- The failure of the “Super Committee” to reach a deal to cut spending in 2011 means across the board cuts will happen automatically in 2013. The cuts will total about $1.2 trillion ($109 billion of that in 2013) and will be spread evenly between defense and non-defense spending.
What this means for you:
There’s good news and bad news if all of these things are allowed to happen. The good news is that, according to the Congressional Budget Office, the deficit will be significantly reduced (i.e. We will go into debt more slowly). The bad news is that the country will likely go back into recession.
I’m assuming that Congress and the White House will come to some sort of agreement to avoid at least some of the things outlined above. That will grab the headlines and cause the markets to rally, but don’t let that obscure the larger point.
Our country has promised and spent far beyond its means for many decades. That cannot go on forever. If you filter out the “noise,” the major themes of the next decade or two will likely be higher taxes, more reserved spending and less generous benefits (think Medicare, Social Security, etc.). That’s not doom and gloom, it’s just reality. Keep that in mind as you plan for retirement and do your best to build a margin of safety into your planning.
Photo by Victoria. Used under Creative Commons License.