Should I Use My 401(k) Now in the Pandemic?

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Many Americans are struggling with what to do with their retirement savings, as we endure the COVID-19 pandemic. Many don’t know if they should stand pat or cash in their savings.

The new CARES Act makes it easier for us to tap our 401(k) and retirement accounts. However, there may be significant long-term effects for your financial security.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by Congress signed into law by President Trump on March 27. The law provides more than $2 trillion in economic relief to protect the American people from the public health and economic impacts of COVID-19. The Act provides fast and direct economic assistance for American workers, families, and small businesses, as well as preserving jobs for American industries.

CNBC’s recent article entitled “Tapping Your 401(k): Is now the right time to do it?” says that if you need emergency cash, and your 401(k) is your only source of funds in this pandemic, taking a short-term loan from your retirement account as a “last resort” may be a wise option.

While you will be repaying yourself rather than paying 11% interest on average on a personal loan, know that you’re borrowing from your financial future and possibly risking your financial security in retirement.

The CARES Act lets you borrow up to $100,000 (double the previous loan limit of $50,000) from your 401(k) and delay repayment for up to a year. After you borrow, you’ll typically have to repay the loan within five years, depending on the terms of your 401(k) plan. Under the CARES Act, loan payments due in 2020 can be delayed for up to a year from the time you take out the loan. However, if you can’t pay back the loan within the time frame designated by your plan, your outstanding balance will be taxed like a withdrawal. That means you’ll also pay a 10% early withdrawal penalty.

If you leave your job — regardless of whether by choice — there’s a good chance your plan will require you to repay the money back quickly. If you don’t, your account balance will be decreased by the amount owed and considered a taxable distribution. This choice must factor in the length of time before you need your money, your ability to save, and your comfort level with risk.

You can also take a penalty-free distribution from your IRA or 401(k) of up to 100% of your balance or $100,000, whichever is less. You aren’t required to pay the 10% early withdrawal penalty, if you’re under age 59½ and you can pay taxes on the money you take out over a period of three years or pay no tax, if you pay it all back. However, your employer must agree to adopt these new rules for your existing 401(k) plan.

Reference: CNBC (April 20, 2020) “Tapping Your 401(k): Is now the right time to do it?”

Some Estate Planning Actions for 2020

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Many of us set New Year’s resolutions to improve our quality of life. While it’s often a goal to exercise more or eat more healthily, you can also resolve to improve your financial well-being. It’s a great time to review your estate plan to make sure your legacy is protected, especially if you are home and have some time to think about your finances and your family.

The Tennessean’s recent article entitled “Five estate-planning steps to take in the new year” gives us some common updates for your estate planning.

Schedule a meeting with your estate planning attorney to discuss your situation and to help the attorney create your estate plan.

You should also regularly review and update all your estate planning documents.

Goals and priorities change, so review your estate documents annually to make sure that your plan continues to reflect your present circumstances and intent. You may have changes to family or friendship dynamics or a change in assets that may impact your estate plan. It could be a divorce or remarriage; a family member or a loved one with a disability diagnosis, mental illness, or addiction; a move to a new state; or a change in a family business. If there’s a change in your circumstances, get in touch with your estate planning attorney to update your documents as soon as possible.

Federal and state tax and estate laws change, so ask your attorney to look at your estate planning documents every few years in light of any new legislation.

Review retirement, investment, and trust accounts to make sure that they achieve your long-term financial goals.

A frequent estate planning error is forgetting to update the beneficiary designations on your retirement and investment accounts. Thoroughly review your accounts every year to ensure everything is up to snuff in your estate plan.

Communicate your intent to your heirs, who may include family, friends, and charities. It is important to engage in a frank discussion with your heirs about your legacy and estate plan. Because this can be an emotional conversation, begin with the basics.

Having this type of conversation now can prevent conflict and hard feelings later.

Reference: Tennessean (Jan. 3, 2020) “Five estate-planning steps to take in the new year.”

What Should I Know about Beneficiary Designations?

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A designated beneficiary is named on a life insurance policy or some type of investment account as the individual(s) who will receive those assets upon the account holder’s death. The beneficiary designation doesn’t replace a signed will but instead takes precedence over any instructions about these accounts in a will. If the decedent doesn’t have a will, and there is no beneficiary designation, the heirs 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, despite the fact that it probably houses a significant portion of your assets.

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.

For more customization, you can have a form prepared by an estate planning attorney familiar with retirement plans.

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 Will the New SECURE Act Impact My IRAs and 401(k)?

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The SECURE Act is the most substantial change to our retirement savings system in over a decade, says Covering Katy (TX) News’ recent article entitled “Laws Change for IRA and 401K Retirement Savings Plans.” The new law, called the Setting Every Community Up for Retirement Enhancement (SECURE) Act, includes several important changes. Let’s take a look at them.

Increased RMD Age. There is now a higher age for RMDs. The old law said that you must start taking withdrawals or required minimum distributions from your traditional IRA and 401(k) or similar employer-sponsored plan when you turn 70½. The new law delays this to age 72, so you can hold on to your retirement savings a while longer.

No age limit for contributions to traditional IRAs. Before the new law, you could only contribute to your traditional IRA until you were 70½. Under the new SECURE Act, you can now fund your traditional IRA for as long as you have taxable earned income.

Stretch IRA Limitations. Previously, beneficiaries could stretch taxable distributions from an inherited retirement account over his or her lifetime. Under the SECURE Act, spouse beneficiaries can still take advantage of this “stretch” distribution, but most non-spouse beneficiaries will have to take out the entire balance of the IRA by the end of the 10th year after the account owner dies. Therefore, non-spouse beneficiaries who inherit an IRA or other retirement plans could have significant income tax consequences due to the larger distributions that must be received within a shorter amount of time.

Exception to early withdrawal penalty for a new child. As a general rule, a plan participant must pay a 10% penalty when funds are withdrawn from IRA or 401(k) accounts prior to 59½. However, the new legislation allows you take out up to $5,000 from your retirement plan without paying the early withdrawal penalty if it is taken out for the costs of a new child, and the money is taken out within a year of a child being born or if an adoption becomes final.

There are provisions of the SECURE Act that primarily impact business owners, which include the following:

New multi-employer retirement plans. The new law allows unrelated companies to coordinate to offer employees a 401(k) plan with less administrative work, lower costs and fewer fiduciary responsibilities than individual employers used to have when offering their own retirement plans.

Tax credit for automatic enrollment. There’s now a tax credit of $500 for some small businesses that create automatic enrollment in their retirement plans. A tax credit for establishing a retirement plan has also been increased from $500 to $5,000.

Annuities in 401(k) plans. The Act makes it easier for employers to add annuities as an investment option within 401(k) plans. Before the SECURE Act, businesses avoided annuities in these plans because of the liability related to the annuity provider. However, the new rules should help decrease any concerns.

Talk to an experienced estate planning attorney to examine the potential impact on your investment strategies and determine any possible tax and estate planning implications of the SECURE Act.

Reference: Covering Katy (TX) News “Laws Change for IRA and 401K Retirement Savings Plans”

SECURE Act Means It’s Time for an Estate Plan Review

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The most significant legislation affecting retirement was signed into law on Friday, Dec. 20, 2019. After stalling for months, Congress suddenly passed several bills, as attachments to budget appropriations, as reported by Advisor News’ article “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans.”

Here are some of the key points that retirees and those planning their retirements need to know:

Changes to Age Limits for IRA and 401(k) Accounts. The age for taking Required Minimum Distributions (RMDs) has increased from 70½ to 72 years. Adding a year and a half for investors to continue deferred growth for retirement gives a little more time to prepare for longer lifespans. The change recognizes the prior limits were arbitrary, and that Americans need to save more.

New Restrictions for Inheriting IRAs. The SECURE Act also enacted strict limitations on the usage of the “stretch” IRA. With few exceptions, Americans who inherit an IRA must now withdraw the money within 10 years of the account owner’s death, along with paying taxes. Some of the exceptions include surviving spouses and minor children. These exempt heirs can still spend down inherited IRA accounts over their lifetime, otherwise known as “stretching” the IRA.

Small Business 401(k)s. The SECURE Act expands access to Multiple Employer Plans, known as MEPs, so that employers with only a few employees can pool resources and share the costs of retirement plans for employees. This will cut administration and management costs, which will ideally allow more small businesses to offer higher-quality retirement plans to their employees.

The law also enhances automatic enrollment and auto-escalation, letting companies automatically enroll employees into a retirement plan at a rate of 6%, instead of 3%. Employers can now raise employee contributions to a maximum of 15% of their annual pay, although workers can opt out of these plans at any time.

Annuities Options. The SECURE Act now allows 401(k) plans to offer annuities as a retirement plan option. Experts have mixed opinions on this. Annuities are a type of life insurance that convert retirement savings into lifetime income. However, fees are often high, and if the insurance company closes its doors, those lifetime income payments may vanish. Under the new law, employers also have what’s called a “safe harbor” from being sued in the event that annuity providers go out of business or stop making payments to annuity purchasers. Being freed from liability may make employers more likely to offer annuities, but that may put 401(k) investors at more risk, say consumer advocates.

529 Plans and Saving for Children. The new law expands 529 accounts to cover many more types of education, such as registered apprenticeships, homeschooling, private elementary, secondary or religious schools. Up to $10,000 can be used for qualified student loan repayments, including for siblings.

Reference: Advisor News (December 23, 2019) “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans”

What Will New Acts of Congress Mean for Stretch IRAs?

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The SECURE and RESA acts are currently being considered in Congress. These acts may impact stretch IRAs. A stretch IRA is an estate planning strategy that extends the tax-deferred condition of an inherited IRA when it is passed to a non-spouse beneficiary. This strategy lets the account continue its tax-deferred growth over a long period of time.

Congress is considering legislation with the SECURE and RESA Acts, that would eliminate the ability of children to create a stretch IRA, one that would let them to stretch distributions from the inherited IRA over their lifetimes. The proposed SECURE and RESA Acts under consideration state that the maximum deferral period will be 10 years. If the beneficiary is a minor, the period would be 10 years or age 21.

If Congress does pass the SECURE and RESA acts, people will need to change the way they financially plan for their retirement accounts. If a parent doesn’t need to spend any of her Required Minimum Distributions, does it make sense to do a gradual Roth IRA conversion and use the RMDs to pay taxes on the conversion? Or should the parent invest the RMDs in a brokerage account?

There are several options in this situation, according to nj.com’s recent article, “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

As with many things related to financial and estate planning, the best planning strategy for a parent would depend on her overall finances and what she wants for her children’s inheritance.

The conversion to a Roth may be a good planning move if the parent’s tax bracket makes the income tax rate reasonable. Putting the money in a brokerage account is also an option.

A parent may also want to think about using the RMD proceeds to purchase a life insurance policy held by an irrevocable trust for the benefit of her children.

It’s best to contact an experienced estate planning attorney, so he or she can review the details of the parent’s finances and help her choose the best options for her situation.

Reference: nj.com (October 15, 2019) “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

The Biggest Estate Planning Errors

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The Biggest Estate Planning Errors
Young woman making a mistake on a pink background

Nobody likes to plan for events like aging, incapacity, or death. However, failing to do so can cause families burdens and grief, thousands of dollars and hundreds of hours. Fox Business’ recent article, “Here are the top estate planning mistakes to avoid,” says that planning for life’s unexpected events is critical. However, it can often be a hard process to navigate. Let’s look at the top estate planning mistakes to avoid, according to industry experts:

1. Failing to have a will (or one that can be located). The biggest mistake is simply not having a will. Many people wait for “a more appropriate time” to put a will together. The truth is, we all need estate planning, no matter the amount of assets a person may have. In addition to having a will prepared and executed, it needs to be findable. The Wall Street Journal says that the biggest estate planning error is simply losing a will. Make sure your family has access to any estate planning documents you create.

2. Failing to name and update beneficiaries. An asset with a beneficiary designation supersedes any terms in a will. Review your 401(k), IRA, life insurance, and any other accounts with beneficiaries after any significant life event. If you don’t have the proper beneficiary designations, income tax on retirement accounts may have to be paid sooner and your heirs will have to pay a lump sum tax immediately. Without a life insurance policy, the proceeds will have to go through probate, which means they are subject to creditors’ claims.

Another mistake that impacts people with minor children is naming a guardian for minor children and then naming the guardian as the outright beneficiary of their life insurance. If money is left to the guardian, then the proceeds are now considered the assets of the guardian and do not transfer to the minors. The cash also now faces exposure to the creditors and spouse of the guardian named as a beneficiary Instead, parents should leave the money to a trust for the children and name the guardian, or another trusted and responsible person, as the trustee of the trust.

3. Failing to consider powers of attorney for adult children. When your children reach age 18, they’re adults in the eyes of the law. If something unfortunate happens to them, you may be left without any say in their treatment or even access to their medical records. In the event that an 18-year-old becomes ill or has an accident, a hospital won’t consult with their parents if a power of attorney for health care isn’t in place. Further, without a financial power of attorney, a parent may not be able to take care of bills, make investment decisions or pay taxes without the child’s signature. This could create an issue when your child is in college—especially if he or she is attending school abroad. It is very important that when your child turns 18 that you have powers of attorney put into place.

Reference: Fox Business (October 15, 2019) “Here are the top estate planning mistakes to avoid”

Another Good Reason to Update Your Estate Plan: Taxes

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Gift, estate and generation-skipping transfer tax (GST) exemptions have doubled as a result of the Federal Tax Cut and Jobs Act, raising them to historic highs. The exemptions, which are all linked in a unified estate and gift tax, had been scheduled to increase to $5.6 million per person in 2018, but they were modified to reach the current level of $11.2 million per person, or $22.4 million per couple. The inflation-adjusted exemption for 2019 is $11.4 million per person or $22.8 million per couple.

In the article “Updating estate plan could save heirs in taxes,” the Atlanta Business Chronicle asks why this matters to an individual or couple whose net worth is nowhere near these levels.

When the most that could be transferred to heirs was under a million dollars, everyone worried about the estate tax. Since the estate tax was so much higher than the capital gains tax, it was never considered a big deal if a person paid the capital gains tax on selling, because it was less costly than paying the estate tax.

Now with the new exemption, trying to move assets out of estates and into trusts may not be the best solution to preserve wealth and minimize taxation.

In the past, a trust would be created, and the maximum amount of funds placed into the trust for use when the grantor (the person who created the trust) died. The goal was to provide income for the spouse until the spouse’s death, at which point the money bypassed the estate and went directly to the beneficiaries, who would pay income tax on the funds.

If a person owned $10,000 worth of stock at their death and the trust required it to be placed into a bypass trust instead of transferring it to the spouse, the heirs would pay taxes on gains upon the sale of stock. In a case where the stock held in the bypass trust increased to $100,000, then $90,000 of that would be considered taxable gain. If, instead, the stock was transferred to the surviving spouse and it was sold upon the spouse’s death, that stock would receive a stepped-up basis of $100,000 and there would be no income tax on the sale of the stock.

Note that the law creating the present $11.4 million limit is currently set to end at the end of 2025 when the tax exemption will return to $5 million (adjusted for inflation).

Another aspect of estate tax planning relates to the source and account types of the inheritance. For instance, heirs who receive money from Individual Retirement Accounts (IRAs) have to pay taxes when they withdraw funds from the account. IRA money is not taxed when it goes into the account, but the growth is taxed when the money is taken out.

As an alternative, IRAs could be converted to Roth IRAs, although they would be taxed immediately on conversion. If the Roth IRA is held for five years, funds withdrawn are tax-free and can be taken out whenever the owner wishes.

However, because current exemption amounts may not be available after 2025, or if further changes to tax laws are made, another strategy for individuals who wish to make significant lifetime gifts is to make those gifts with the current high levels. Because of the way the transfer tax systems interact, those lifetime gifts will not be taxed at death if the total of taxable gifts is less than the exemption amount in the year the gift is made.

Some experts advise that wealth be distributed between tax-deferred accounts, like 401(k)s, after-tax money, like the Roth IRA and taxable accounts, which include brokerage accounts. The goal is to be able to respond when changes are made to the tax code.

Reference: Atlanta Business Chronicle (May 31, 2019) “Updating estate plan could save heirs in taxes”

Are Inheritances Taxable?

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Inheritances come in all sizes and shapes. People inherit financial accounts, real estate, jewelry, and personal items. Whatever kind of inheritance you have, you’ll want to understand exactly what, if any, taxes might be due, advises the article “Will I Pay Taxes on My Inheritance” from Orange Town News. An inheritance might have an impact on Medicare premiums or financial aid eligibility for a college-age child. This post looks at some different assets and how they may impact a family’s tax liability.

Bank Savings Accounts or CDs. As long as the cash inherited is not from a retirement account, there are no federal taxes due. The IRS does not impose a federal inheritance tax. However, there are some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania, that do have an inheritance tax. Speak with an estate planning attorney about this tax.

Primary Residence or Other Real Estate. Inheriting a home is not a taxable event. However, once you take ownership and sell the home or other property, there will be taxes due on any gains. The value of the home or property is established on the day of death. If you inherit a home valued at death at $250,000 and you sell it a year later for $275,000, you’ll have to declare a long-term capital gain and pay taxes on the $25,000 gain. The cost-basis is determined when you take ownership.

Life Insurance Proceeds. Life insurance proceeds are not taxable, nor are they reported as income by the beneficiaries. There are exceptions: if interest is earned, which can happen when receipt of the proceeds is delayed, that must be reported as income. The beneficiary will receive a Form 1099-INT and that interest is taxable by the state and federal tax agencies. If the proceeds from the life insurance policy are transferred to an individual as part of an arrangement before the insured’s death, they are also fully taxable.

Retirement Accounts: 401(k) and IRA. Distributions from an inherited traditional IRA are taxable, just as they are for non-inherited IRAs. Distributions from an inherited Roth IRA are not taxable unless the Roth was established within the five years prior to inheritance.

There are some changes coming to retirement accounts because of pending legislation, so it will be important to check on this with your estate planning attorney. Inherited 401(k) plans are or eventually will be taxable, but the tax rate depends upon the rules of the 401(k) plan. Many 401(k) plans require a lump-sum distribution upon the death of the owner. The surviving spouse is permitted to roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they may have to take the lump-sum payment and pay the resulting taxes.

Stocks. Generally, when stocks or funds are sold, capital gains taxes are paid on any gains that occurred during the period of ownership. When stock is inherited, the cost basis is based on the fair market value of the stock or fund at the date of death.

Artwork and Jewelry. Collectibles, artwork, or jewelry that is inherited and then sold will incur a tax on the net gain of the sale. There is a 28% capital gains tax rate, compared to a 15% to 20% capital gains tax rate that applies to most capital assets. The value is based on the value at the date of death or the alternate valuation date. This asset class includes anything that is considered an item worth collecting: rare stamps, books, fine art, antiques and coin collections fall into this category.

Speak with an estate planning attorney before signing and accepting an inheritance, so you’ll know what kind of tax liability comes with the inheritance. Take your time. Most people are advised to wait about a year before making any big financial decisions after a loss.

Reference: Orange Town News (May 29, 2019) “Will I Pay Taxes on My Inheritance”

A Lesson in Retirement from Pro Athletes

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Preparing for retirement and avoiding the stress of strained budgets is something that everyone can relate to. Most people who are 65 and older rely on Social Security as their primary source of income, as reported in Money’s article “What Former Pro Athletes Can Teach Us About Preparing for Retirement.”

Staying financially healthy as you get older comes from following some core principles that apply whether you are running defense for the National Football League or working your way up the corporate ladder.

Here are a few good lessons from professional athletes that can help you to prepare for your own retirement:

Live Below Your Means. With an average salary of $1.9 million, it sounds like athletes have lots of spending cash. However, remember that they have a payroll of their own: an agent, a financial advisor and maybe personal trainers and nutritionists. They also have to pay substantial taxes on their income. Smart players, like Cincinnati Bengal’s Andrew Hawkins, waited to buy a luxury car until he had a nest egg secured.

The NFL has one of the best 401(k) programs around, with a two-to-one match. Hawkins makes sure to max that out and told his fellow players to do the same. Not taking advantage of any type of matching program is just like leaving money on the table. Investing in a retirement account is something we should all do, but particularly if your employer offers a matching program.

Contributing to 401(k) and IRAs may not be as sexy as driving a Lamborghini or investing in an IPO, but they offer a great deal more security.

Retired hockey player and assistant coach for the Tampa Bay Lightning, Jeff Halpern, said that when players go out to dinner with each other, they spend like crazy, picking up bar tabs, and paying for everyone’s meal. The tendency is to spend more when you earn more—it even has a name: “lifestyle inflation.” Steer clear, and you’ll save more.

Don’t Bank on Future Income. One of the biggest mistakes that athletes make is to spend the income they don’t have. They spend every dime of their first big contract and say they’ll save when they get a second contract. However, injuries are common, and if the second contract never comes, they’re left with nothing.

For the average worker, salary growth works differently. Average workers with college degrees peak around 40 for women, and 49 for men. The average NFL player? Age 21.

Although later than an athlete’s peak earnings, the average worker’s peak salary occurs earlier than people think. The years before retirement are the years when you should be saving most aggressively for retirement. However, many don’t have that option. More than half of all workers are laid off when they are 50 and older, or they leave jobs under financially difficult circumstances, according to an analysis by ProPublica and the Urban Institute.

If you wait until your 50s to start seriously saving for retirement, it may be too late.

Plan in Advance for Transitions. Not all NFL players are able to move to the broadcast booth with smooth success. Smart professional athletes start thinking about their second careers, while they are still playing.  This lets them take advantage of their name recognition and get meetings with people who might not otherwise know who they are.

Networking while successful is good for everyone, for both athletes and “regular” people. Most Americans hold an average of 12 jobs in their lifetime. Lay the groundwork for your next job, while you are well employed at your current job. Testing the waters is easier when you have the security of a regular paycheck.

Saving for retirement never really ends, up until the date that you stop working. You can never be too early, noted Hawkins, but you can definitely be too late.

Reference: Money (Feb. 17, 2019) “What Former Pro Athletes Can Teach Us About Preparing for Retirement”