Retirement benefits: a steady stream of lifetime income

While Social Security retirement benefits are important for everyone, they are especially important for women. Because women generally live longer and tend to have lower lifetime earnings than men, they may be more dependent on Social Security benefits in retirement.*

Fortunately, you can count on two features of Social Security to help you provide for a long retirement. First, benefits last as long as you live; although you may exhaust other sources of retirement income, it’s impossible to outlive your Social Security retirement income. Second, Social Security benefits are subject to automatic cost-of-living adjustments that increase benefits when prices increase, an especially valuable feature when you have to rely on a fixed income for many years.
When you work and pay Social Security taxes, you earn credits that enable you to qualify for Social Security benefits.

You can earn up to 4 credits per year, depending on the amount of income that you earn, and you’ll generally need 40 credits (10 years of work) to be insured for retirement benefits. Your monthly retirement benefit will be based on your lifetime earnings. However, if you don’t work outside the home or haven’t worked long enough to qualify for Social Security based on your own record (or have much lower earnings than your spouse), you may still be eligible based on your spouse’s record.

Disability benefits: help when you’re ill or injured

During your working years, you may suffer a serious illness or injury that prevents you from earning a living, potentially putting yourself and your family at financial risk. But if you’re insured under Social Security, you may be able to get disability benefits if you have worked long enough in recent years, your disability is expected to last at least a year or result in death, and you meet other requirements.

More women than ever are now insured for Social Security disability benefits. According to the Social Security Administration (SSA), in 1970, only 41% of women were insured; today, approximately 74% of women are insured.** In general, to be insured for disability benefits, you must have earned at least 20 work credits during the last 40 calendar quarters (10 years). If you qualify for benefits, certain family members (such as your dependent children) may also be able to collect benefits based on your work record.

Because eligibility requirements are strict, Social Security is not a substitute for other types of disability insurance, but it can provide basic income protection for working women and their family members.

Survivor’s benefits: financial protection for your family

You probably know the value of having life insurance to protect your family, but did you know that Social Security offers valuable income protection as well? If you are insured under Social Security at your death, your surviving spouse (or ex-spouse), your children, or dependent parents may be eligible for benefits based on your earnings record.

You also have survivor protection if you’re married and your insured spouse dies. If you’re caring for a child who is younger than age 16 or disabled and who is entitled to benefits, you may be entitled to widow’s benefits. You may also be entitled to benefits if you are age 60 or older (age 50 or older if you’re disabled).

Three tips

1. Use the benefit calculators available on the Social Security website to estimate your future retirement, disability, and survivor’s benefits. Social Security was never intended to cover all of your financial needs, but understanding what benefits you might be entitled to can help you plan for the future.
2. Consider the impact on your Social Security benefits if you plan on taking time out of the workforce. Having years of no or low earnings may mean lower benefits, and can also affect your eligibility for disability coverage.
3. Check your earnings history regularly, and report any name changes right away to the SSA so that your earnings are recorded properly. If your name doesn’t match SSA records, any income tax refund can also be delayed.

Sources: *Fact Sheet: Social Security Is Important to Women, SSA Press Office; **Fast Facts & Figures About Social Security, 2011, SSA

Copyright 2012 Forefield Inc.

Rate of return on investments versus interest rate on debt

Probably the most common factor used to decide whether to pay off debt or to make investments is to consider whether you could earn a higher after-tax rate of return on the investments than the after-tax interest rate on the debt if you were to invest your money instead of using it to pay off the debt.

For example, say you have a credit card with a $10,000 balance on which you pay nondeductible interest of 18%. You would generally need to earn an after-tax rate of return greater than 18% to consider making an investment rather than paying off the debt. So, if you have $10,000 available to invest or pay off debt and the outlook for earning an after-tax rate of return greater than 18% isn’t good, it may be better to pay off the debt than to make an investment.
On the other hand, say you have a mortgage with a $10,000 balance on which you pay deductible interest of 6%.

If your income tax rate is 28%, your after-tax cost for the mortgage is only 4.32% (6% x (1 – 28%)). You would generally need to earn an after-tax rate of return greater than 4.32% to consider making an investment rather than paying off the debt. So, if you have $10,000 available to invest or pay off debt and the outlook for earning an after-tax rate of return greater than 4.32% is good, it may be better to invest the $10,000 rather than using it to pay off the debt.

Of course, it isn’t an all-or-nothing choice. It may be useful to apply a strategy of paying off debts with high interest rates first, and then investing when you have a good opportunity to make investments that may earn a higher after-tax rate of return than the after-tax interest rate on the debts remaining.

Say, for example, you have a credit card with a $10,000 balance on which you pay 18% nondeductible interest. You also have a mortgage with a $10,000 balance on which you pay deductible interest of 6%, and your tax rate is 28%. So, if you have $20,000 available to invest or pay off debt, it may make sense to pay off the credit card with $10,000 and invest the remaining $10,000.

When investing, keep in mind that, in general, the higher the rate of return, the greater the risk, which can include the loss of principal. If you make investments rather than pay off debt and your investments incur losses, you may still have debts to pay, but will you have the money needed to pay them?

Some other considerations

When deciding whether to pay down debt or to save and invest, you might also consider the following.
What are the terms of your debt? Are there any penalties for prepayment?

Do you actually have money that you could invest? Most debts have minimum payments that must be paid each month. Failure to make the minimum payment can result in penalties, increased interest rates, and default. Are your funds needed to make those payments?

How much debt do you have? Is it a problem? How do you feel about debt? Is it something you can easily live with or does it make you uncomfortable?

If you say you will save the money, will you really invest it or will you spend it? If you pay off the debt, you will have assured instant savings by eliminating the need to come up with the money needed to pay the interest on the debt.
Would you be able to borrow an additional amount, if needed, and at what interest rate, if you paid off current debt? Do you have an emergency fund, or other source of funds, that could be used if you lose your job or have a medical emergency, or would you have to borrow?

If your employer matches your contributions in a 401(k) plan, you should generally invest in the 401(k) to get the matching contribution. For example, if your employer matches 50% of your contributions up to 6% in a 401(k) plan, getting the 50% match is like getting an instant 50% return on your contribution. In addition, there are tax advantages to investing in a 401(k) plan.

Copyright 2012 Forefield Inc.

How much will you need?

How much you’ll spend generally may depend on when you retire, how long you live, your health status, and the cost of medical care in your area. But the costs can add up. You won’t have to pay for Medicare Part A hospital insurance (unless you don’t qualify and have to buy into the program), but you will likely pay either $96.40 or $110.50 each month in 2011 for Medicare Part B physician’s coverage (although you may pay higher premiums based on income and other factors), and an average of $30 per month for Medicare Part D prescription coverage. In addition, there are co-pays and deductibles to consider (e.g., after paying the first $162 in Part B expenses per year, you pay 20% of the Medicare-approved amount for services thereafter).

The cost of health care is rising. The Centers for Medicare & Medicaid Services (CMS) reports that national health expenditures grew by 4% in 2009. And the CMS Office of the Actuary estimates that out-of-pocket spending is projected to grow at an average rate of 5% from 2015 through 2020.

What can you do?

It’s clear that health care is an important factor in retirement planning. And while you may be able to buy a cheaper car, live in a smaller home, or take fewer vacations in order to stay within your retirement income budget, you can’t do without necessary medical care. So what can you do? You can better prepare for these expenses by taking the following steps:

• Acknowledge that paying for health care in retirement is an issue to consider. Don’t presume Medicare and Medigap insurance will cover all your expenses–they probably won’t. Include potential health-care costs in your retirement plan.
• Evaluate your present health and project your future medical needs. That might be easier said than done, but taking stock of your overall health now and factoring in your family’s health history may help you determine the type of care you might need in retirement. Are you currently being treated for high blood pressure or diabetes? Do you live a healthy lifestyle? Does heart disease run in your family?
• Understand what Medicare covers and what it costs. For instance, Medicare (Part A, Part B, and Part D) generally provides benefits for inpatient hospital care, medically necessary doctor’s visits, and prescriptions. But Medicare doesn’t cover everything. Examples of services generally not covered by Medicare include most chiropractic care, dental or vision care, and long-term care. You’ll also have to account for deductibles, co-insurance costs for some services, and a monthly premium for Medicare Parts B and D.
• Consider the cost of supplemental insurance. Medigap plans are standardized policies sold by private insurance companies that pay for some or all of the costs not covered by Medicare. In addition to Medigap policies, other types of supplemental insurance include long-term care insurance, dental insurance, and vision insurance. The type and amount of coverage that’s best for you depends on a number of factors, including how much premium you can afford, what benefits you need, your financial resources, your health, and your anticipated medical needs.
• Don’t forget to factor in the cost of long-term care. The National Clearinghouse for Long-Term Care Information estimates that at least 70% of people over age 65 will require some long-term care services. Medicare does not pay for custodial (nonskilled) long-term care services, and Medicaid pays only if you and your spouse meet income and asset criteria.
• Save, save, save. You may have already begun saving for your retirement, but if you fail to include the cost of health care in your plan, you’re likely leaving out a big expense. Your financial professional can help you figure out how much you may need to save and adjust your retirement planning strategies to account for potential health-care costs in retirement.

Women as caregivers

While you may think most long-term care is received in a nursing home setting, the National Clearinghouse for Long-Term Care Information (National Clearinghouse) estimates that about 80% of care is provided at home by informal (unpaid) family caregivers. Of those caregivers, about 60% are women (www.longtermcare.gov).

In many instances, the care provided for chronically disabled older adults is quite intensive and time-consuming. Women who act as family caregivers of older people with high levels of personal-care needs may face considerable financial, emotional, and physical strain. For instance, caregivers may face financial challenges due to lost wages from reduced work hours, time out of the workforce, extended family leave, or early retirement. Reduced work hours or extended time out of work may also affect the ability to contribute toward retirement savings, potentially resulting in a loss of retirement income.

Caregivers also may face emotional strains and poor health related to their caregiving responsibilities. This may be especially true for older women caregivers and younger women who may be caring for an older family member in addition to managing their own household.

Women as long-term care recipients

According to the Centers for Disease Control and Prevention (CDC), women outlive men by an average of 6 years (www.cdc.gov). Because they tend to live longer, women are at a higher risk than men of needing long-term care (source: National Clearinghouse). And the National Clearinghouse reports that women, on average, need care over a longer time than men (3.7 years vs. 2.2 years). With a longer life expectancy and a greater likelihood of needing long-term care, women often must confront their long-term care needs without the help of their spouse or other family members.

Paying for long-term care

Long-term care can be expensive. An important part of planning is deciding how to pay for these services.

Buying long-term care (LTC) insurance is an option. Many LTC insurance policies pay for the cost of care provided in a nursing home, assisted-living facility, or at home, but the premium paid generally depends on the age of the insured and the policy benefits and options purchased. And premiums can increase if the insurer raises its overall rates. Even with LTC insurance, you still may have some out-of-pocket contributions in addition to premium payments. For example:

• Not all policies provide coverage for care in your home, even though that’s where most care is provided. While the cost of in-home care may be less than the cost of care provided in a nursing home, it can still be quite expensive.
• Most policies allow for the selection of an elimination period of between 10 days and 1 year, during which time the insured is responsible for payment of care.
• The LTC insurance benefit is often paid based on a daily or monthly maximum amount, which may not be enough to cover all of the costs of care.
• While lifetime coverage may be selected, it can increase the premium cost significantly, and some policies may not offer that option. Most common LTC insurance benefit periods last from 1 year to 5 years, after which time the insurance coverage generally ends regardless of whether care is still being provided.

Government benefits provided primarily through a state’s Medicaid program may be used to pay for long-term care. To qualify for Medicaid, however, assets and income must fall below certain limits, which vary from state to state. Often, this requires spending down assets, which may mean using savings to pay for care before qualifying for Medicaid.

Women may have to confront particular challenges when planning for long-term care. A financial professional can help with some of the complex issues you may face when preparing for the possibility of long-term care, both as a caregiver and a receiver of care.

Copyright 2012 Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning Frisco Texas

529 plan

A 529 plan, sometimes called a qualified tuition program, offers federal, and often state, tax advantages if used to save for college. There are two types of 529 plans–a college savings plan, which is an individual investment-type account, and a prepaid tuition plan, which is a pooled account that typically promises it will cover a certain percentage of college costs in the future.

With either type of 529 plan, contributions accumulate tax deferred at the federal level and earnings are completely tax free if used to pay the beneficiary’s qualified education expenses. In addition, many states offer their own tax benefits, such as income tax deductions for contributions and tax-free withdrawals. If a withdrawal is used for a noneducational expense, the earnings portion of the withdrawal will be subject to federal income tax and a 10% federal penalty.

Investors should consider the investment objectives, risks, charges, expenses, and prerequisites for state tax benefits associated with each 529 plan before investing. More information is available in each 529 plan issuer’s official statement, which should be read carefully before investing.

Coverdell education savings accounts

A Coverdell education savings account (ESA) lets you contribute up to $2,000 per year per child for a child’s elementary, secondary, and/or college expenses. Like a 529 plan, contributions accumulate tax deferred at the federal level and earnings are tax free when used to pay the beneficiary’s qualified education expenses. Similar to a 529 plan, if a withdrawal is for a noneducational expense, the earnings portion of the withdrawal will be subject to federal income tax and a 10% federal penalty.

However, only married couples with a modified adjusted gross income of $190,000 or less and individuals with an income of $95,000 or less can contribute the full $2,000 per year.

The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the annual contribution limit for Coverdell ESAs to $2,000 from $500 and expanded the use of funds to K-12. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended these provisions through 2012.

U.S. savings bonds

Series EE and Series I savings bonds offer a special tax benefit for college savers–the interest earned by the bonds is exempt from federal income tax if the bonds are used to pay college expenses. However, this benefit is restricted by income level. For 2011, to exclude all of the bond interest, married couples must have a modified adjusted gross income of $106,650 or less ($109,250 or less in 2012) at the time the bonds are redeemed (cashed in) and individuals must have an income of $71,100 or less ($72,850 or less in 2012). A partial exemption of interest is allowed for people with incomes slightly above these levels. Income levels are indexed for inflation each year.

The interest earned on U.S. savings bonds is always exempt from state income tax, no matter what your income level, even if the bonds aren’t used to pay for college.

UTMA/UGMA custodial accounts

A custodial account allows you to hold assets in your child’s name without having to set up a trust; these assets must then be used for the benefit of the child. A custodial account doesn’t offer federal tax-deferred and tax-free earnings like a 529 plan or a Coverdell account, but it does provide some opportunity for tax savings due to the way earnings generated by the account are taxed.

Specifically, earnings are taxed to the child each year pursuant to the “kiddie tax” rules, and under these rules the first $950 of earnings is tax exempt and the next $950 is taxed at the child’s rate (any earnings over $1,900 are taxed at the parent’s rate). So, you’ll have an opportunity for tax savings if the earnings in the account are $1,900 or less for the year.

A word about IRAs

Money you withdraw from a traditional IRA or Roth IRA to pay your child’s qualified education expenses is not subject to the 10% premature distribution penalty tax that normally applies to taxable IRA distributions made before age 59½. However, some or all of the IRA money you withdraw may still be subject to regular federal and possibly state income tax.

Copyright 2012 Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning Frisco Texas

What are some advantages of a SEP?

• Fairly high contribution limits. For 2012, you can contribute and deduct up to 25% of each employee’s W-2 compensation (up to $250,000, $245,000 in 2011). If you’re self-employed, the contribution to your IRA can’t exceed 20% of your net earnings from self-employment. Contributions can’t exceed $50,000 per participant ($49,000 in 2011).
• You don’t have to make contributions to the SEP every year. However, if you do make a contribution, you must generally contribute a uniform percent of pay for yourself and each eligible employee.
• You have until the due date of your business’s federal income tax return (including extensions) to set up a SEP and make contributions.
• SEPs are fairly easy to set up and inexpensive to operate. You can establish a SEP by using a simple two-page IRS document (Form 5305-SEP), or by adopting a prepackaged prototype SEP from a bank, insurance company, or financial institution.
• Reporting requirements are minimal.A SEP doesn’t preclude you or your employees from establishing or contributing to a separate IRA. (However, participation in the SEP may impact whether or not annual traditional IRA contributions are deductible.)
• Employer contributions can be made after age 70½.
• Generally, you won’t have fiduciary responsibility for your employees’ investment decisions.

What are some disadvantages?

• All employees must be included in the SEP except employees who have not attained age 21, haven’t worked for you in at least three of the last five years, or earn less than $550.
• Your contributions vest immediately. This can be costly if you have high employee turnover.
• Unlike a 401(k) plan, employees can’t make pretax contributions or Roth contributions to a SEP (but a SEP can accept annual and rollover IRA contributions, like any other traditional IRA).
• Plan loans are not allowed.
• A SEP-IRA may provide less protection from creditors outside of bankruptcy than some other alternatives.

What are my options?

A number of other types of retirement plans are available to small business owners, including 401(k) plans, profit-sharing plans, defined benefit plans, and SIMPLE IRAs.

If you have no employees (other than your spouse) and don’t anticipate having any in the near future, a solo 401(k) plan may be a better choice, as it may allow a higher deductible contribution than a SEP. For example, if you’re incorporated, you can receive an employer contribution of up to 25% of your W-2 income (to $250,000 in 2012, $245,000 in 2011) (like a SEP) but in addition, you can make up to $17,000 ($16,500 in 2011) of pretax employee contributions (plus an additional $5,500 of catch-up contributions if you’re age 50 or older). Total contributions (employer and employee) are limited to $50,000 in 2012 ($49,000 in 2011), plus any catch-up contributions (or, if less, 100% of your compensation).

Unlike a SEP, a solo 401(k) can allow plan loans and Roth contributions. And because a solo 401(k) doesn’t cover any common law employees, it’s simpler to administer than a regular 401(k) plan (because the Employee Retirement Income Security Act of 1974 (ERISA) does not apply).

Copyright Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning Frisco, Texas

Why seniors?

Seniors are a popular target for scammers for a number of reasons:

Seniors are more likely to own their own homes, have a nest egg that’s liquid and easily accessible, and have excellent credit.
Today’s generation of seniors were raised to be kind, helpful, trusting, and polite–perfect qualities for a scammer to exploit, knowing that it’s hard for some seniors to simply say “no.”
Age has a tendency to affect memory, and scammers count on seniors not being able to remember important details when reporting a scam to the authorities.

What to look for

Scams targeting seniors often occur in one of three ways–through the Internet, on the telephone, or in person. And just when you think you’ve heard of all the possible scams out there, scammers will come up with another scheme intended to victimize seniors. The FBI website (www.fbi.gov) has a section dedicated to fraud targeting seniors. The site describes a number of schemes that have been discovered. It’s a good idea to check this site regularly to keep updated on new scams. Here are some of the more popular scams that have victimized seniors.

Scams related to health care

There are a number of scams that focus on the new health-care law, health insurance for seniors, and Medicare. These scams may focus on “Obamacare” benefits, claiming that there is a “limited enrollment period,” great insurance coverage including drug benefits for a low monthly cost, free medical equipment, low-cost drugs, or free medical tests given at nonmedical facilities like health clubs or shopping malls. To be on the safe side, don’t sign a blank insurance claim form, since your insurance company may be billed for items you never received; generally don’t do business over the phone or in person with a door-to-door salesman for medical services or benefits; and call your insurance carrier to be sure that what you’re supposed to be getting “free of charge” is actually covered by your insurance.

Telemarketing scams

We’ve all been subjected to telemarketing, and it isn’t always a bad thing. Some products and services are legitimate. However, telemarketing also serves as a way to scam people, especially seniors. Some warning signs that should prompt you to decline the offer include being told you “must act now or the offer won’t be good,” any offer that seems to be free (except that you have to pay for shipping and handling or administrative fees), the requirement that you provide your credit or debit card information or bank account number, and the suggestion that you “leave a check taped to your front door for a courier to pick up.” In any case, if the caller tells you it isn’t necessary to check out their company or consult family members or your lawyer, it’s probably best just to decline altogether.

Internet and e-mail scams

Seniors’ use of the Internet and e-mail is increasing daily, and so are Internet scams targeting seniors. Many such scams are based on getting credit or debit card information for services or merchandise that is never delivered. If you’re going to give out this information online, try to ensure that the site is secure and reputable. Depending on the Web browser you use, you may see a padlock icon or some other indication to symbolize that there’s a higher level of security to send important personal information, but it’s not a guarantee that the site is secure. Also, check out the source of the merchandise or service before buying. It should have a physical address and phone number(s) that actually work.

In another type of Internet scam, people send you an e-mail claiming to be in possession of large sums of money and need you to help them open a U.S. bank account. Often, they ask that you “seed” the account with your own money, and in return, they’ll pay you handsomely. Don’t believe this promise and don’t respond to the e-mail.

How loved ones can help

Here are a few things that may help you protect an elderly relative from being victimized by a scam:

• Become familiar with your loved one’s finances
• Recommend that they have any regular income directly deposited to their bank
• Suggest that they consult you or someone else they trust before buying any service or product over the phone, online, or via the mail

Bottom line

In short, as we’ve all heard before, if it sounds too good to be true, it probably is. If you fall victim to a scam, in addition to reporting it to your local police, you can report it to the FBI through their electronic tip line found at www.fbi.gov.

Copyright 2012 Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning in Frisco, Texas

Mistake 1: Jumping on the bandwagon

Are you letting economic news–good or bad–control your financial decisions? For example, are you selling gold because you’ve heard that prices are at record highs or buying real estate because you’ve heard that prices are at record lows? Have you decided to pull most of your money out of the stock market because you’ve seen headlines warning of a possible financial crisis?

Unless you’re basing your decisions on your own needs and circumstances rather than on the opinions or actions of others, you can’t be sure you’re doing what’s right for you. Instead of jumping on the bandwagon, take a proactive, rather than reactive, approach to your finances, no matter what economic news you’re hearing or what other investors are doing. Revisit your tolerance for risk and your own financial goals, and try to prepare yourself for a variety of scenarios. Avoid basing money decisions on emotion, or you may find yourself facing unanticipated consequences down the road.

Mistake 2: Only saving what’s left over

Do you continue to worry that you’re not saving enough? Do you routinely rely on credit rather than cash to pay for the things you want or need? Rather than blame your financial inertia on your income, look a bit deeper, because the real culprit may be the lack of financial priorities. If you don’t know exactly how you’re spending your money and you haven’t set financial goals, it’s unlikely that you’ll see much financial progress.

Go back to basics by preparing (or reviewing) your budget. If you tend to save only what you have left over every month, you can put yourself on a more disciplined course by having a fixed amount taken out of your paycheck automatically for retirement. Or, you can set up automatic transfers from your checking account to a savings or investment account.

Mistake 3: Not having an emergency fund

One lesson that you may have learned over the past few years is that the job market isn’t stable. That’s a major reason why one of your savings priorities should be an emergency fund. While it isn’t glamorous, this underappreciated workhorse really pulls its weight during hard times. Having cash on hand that you can use for an unexpected expense, or to pay bills if you lose your job, is vital because it can help you avoid having to rely on credit or tap your retirement savings. If you don’t have emergency savings to fall back on, a minor money shortfall can quickly turn into a major cash crisis.

Mistake 4: Not asking for help

Even if your finances are in good shape right now, you may be overdue for a checkup. Reviewing your finances is especially important during periods of volatility because it can help reveal potential strengths and weaknesses, and identify changes you might need to make to adjust to the current economic climate. And if you’re already in financial trouble, don’t let fear or shame prevent you from asking for help. Facing financial problems early may help you make a full recovery. Many creditors are willing to work with you, but this may be much easier while your credit is still good, and while you still have time to turn things around.

Copyright 2012 Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning Frisco, Texas

Transferring inherited IRA assets

If you inherit a traditional or Roth IRA from someone who isn’t your spouse, your options are fairly limited. You can’t roll the proceeds over to your own IRA, treat the IRA as your own, or make any additional contributions to the IRA. What you can do is transfer the assets to a different IRA provider, as long as the registration of the account continues to reflect that the IRA is an inherited IRA, and not your own.

If you inherit an IRA from your spouse, however, you have additional options. You can roll over all or part of the IRA proceeds to your own IRA (or to a qualified plan). If you roll the proceeds over to your own IRA (an existing one, or one you establish just for this purpose) the rules that apply to IRA owners, not beneficiaries, will apply from that point on. If you’re the sole beneficiary, you can also generally treat the inherited IRA as your own by simply retitling the IRA in your name.

But you aren’t required to assume ownership of an IRA you inherit from your spouse. You can, instead, continue to maintain the inherited IRA as a beneficiary. You might want to do this if, for example, you inherit a traditional IRA and you’ll need to use the funds before you turn 59½ (distributions from inherited IRAs aren’t subject to the 10% early distribution penalty but distributions from IRAs you own are subject to the penalty, unless an exception applies).

A spouse beneficiary can also convert all or part of an inherited traditional IRA to a Roth IRA (you’ll generally have to pay income tax on the amount converted). This option is not available to nonspouse beneficiaries.

Required minimum distributions

Nonspouse beneficiary: Federal law requires that you begin taking distributions (called required minimum distributions, or RMDs) from an inherited IRA (traditional or Roth) after the IRA owner dies.

Spouse beneficiary: If you roll the inherited IRA over to your own IRA, or treat it as your own, then the RMD rules apply to you the same way they apply to any IRA owner–you’ll generally need to begin taking RMDs from a traditional IRA after you turn 70½; no lifetime RMDs are required at all from a Roth IRA. If you don’t roll the IRA assets over or treat the IRA as your own, then the same rules described above for nonspouse beneficiaries generally apply to you, except that you can defer receiving distributions until your spouse would have turned 70½.

In both cases, if the IRA owner died after turning 70½ and didn’t take a required distribution for the year of death, you’ll need to make sure to take that distribution by December 31 of the year of death in order to avoid a 50% penalty.

Taxation of inherited Roth IRAs

Qualified distributions to a beneficiary from an inherited Roth IRA are free from federal income taxes. To be qualified, the distribution must be made after a five-year holding period. The five-year period begins on January 1 of the year the deceased IRA owner first established any Roth IRA, and ends after five full calendar years. If you take a distribution from an inherited Roth IRA before this five-year period ends, any earnings you receive will be nonqualified, and will be subject to federal income taxes (earnings generally come out last).

For example, you inherit a Roth IRA from your father on January 1, 2013. Your father established this IRA in June 2012. Your father also established a separate Roth IRA, which you did not inherit, in December 2008. Distributions you receive from the Roth IRA will be qualified, and tax free, because the five-year holding period (January 1, 2008, to December 31, 2012) has been satisfied.

If you’re a spouse beneficiary, and you roll the inherited Roth IRA over to your own Roth IRA or treat the inherited IRA as your own, then you’ll be eligible to take tax-free distributions only after you reach age 59½, become disabled, or have qualifying first-time homebuyer expenses. You’ll also need to satisfy the five-year holding period, but a special rule applies. The five-year period for all of your Roth IRAs–including the inherited IRA–will be deemed to have started on January 1 of the year either you or your spouse first established any Roth IRA.

Speak to a financial professional if …

You’re sharing the inherited IRA with other beneficiaries. This can impact when and how you must begin receiving RMDs from the IRA.
You don’t want or need the IRA funds. You may be able to disclaim the IRA and have it pass to another beneficiary. This must be done in accordance with strict IRA rules.
Any estate taxes were paid that are attributable to the inherited IRA. You may be entitled to an income tax deduction equal to the estate taxes paid.

Copyright Forefield, Inc.

Frisco Financial Planning LLC
Financial Planning Frisco, Texas

Here are some common questions and answers regarding the application process.

What documents will I need to fill out the FAFSA?

The FAFSA relies on financial information from your previous year’s federal income tax return; for example, a FAFSA completed in 2012 will rely on information contained in your 2011 return. So the papers and statements you use to file your tax return are generally the same ones you would need to fill out the FAFSA, such as Social Security numbers, W-2 information, and information on savings, investments, and business assets. Your child will also need to have this information.

But here’s a dilemma: since most parents probably won’t complete their federal income tax return in January, how can they fill out the FAFSA, which relies on figures from their tax return? There are two possible solutions. The first is to prepare your tax return earlier. The second is to prepare (or hire a tax professional to prepare) an estimated tax return, which can then be used to complete the FAFSA–a practice the federal government deems acceptable. If you use an estimated tax return, keep in mind that you will need to provide a final tax return later on.

Even if you don’t expect your child to qualify for federal aid, you should still consider filing the FAFSA because colleges often require it as a prerequisite for students to be eligible for the college’s own institutional aid.

How do I file the FAFSA?

You can complete a paper FAFSA or file it electronically. The way you submit the FAFSA does not affect your child’s eligibility for aid.

You can get a paper FAFSA at your child’s high school or your local library. Once it’s complete, you should make a copy for your records and mail it in the preaddressed envelope that comes with the form.

You can file an electronic FAFSA at www.fafsa.ed.gov. You’ll need to apply for a PIN before you can actually start filling out the online application. Electronic FAFSAs offer several advantages over paper FAFSAs: detailed online help screens, an online chat option with a customer service representative, built-in error detectors, confirmation that the application was transmitted successfully, and faster processing–one week as opposed to two to four weeks for paper FAFSAs.

If you’ve previously filled out the FAFSA4caster, the federal government’s online financial aid forecasting tool, the online FAFSA will be automatically populated with your data.

What happens after I file the FAFSA?

After your FAFSA is processed, you will receive a Student Aid Report (SAR) either in the mail or electronically (depending on how you filed the FAFSA). This document summarizes data from your FAFSA and indicates your official expected family contribution (EFC), which is the amount of money the government expects your family to contribute to college costs for the current year to be eligible for financial aid. For example, “EFC25000″ means that your expected family contribution is $25,000.

You should review the SAR carefully to make sure it contains your correct income and asset information. Any corrections should be made immediately and sent back for reprocessing. If you have questions, you can contact the Federal Student Aid Information Center at 1-800-433-3243.

If there is an asterisk (*) next to your EFC figure, you have been selected for verification. FAFSAs are selected for verification randomly, or because the FAFSA is incomplete or contains estimated tax information. If you are selected for verification, you will need to provide additional documentation that might include a final tax return, household information, or appraisals for certain assets listed on the FAFSA. Not all families selected for verification will need to submit the same documents.

The SAR is also sent to each college you listed on your FAFSA. Once the college receives your child’s SAR, the financial aid administrator at each school that has accepted your child will craft an aid package that tries to meet your child’s financial need (remember, colleges aren’t obligated to meet all of it). To determine your child’s need, the administrator subtracts your EFC from the cost of attendance at that particular college. Your child will then be notified of the college’s aid package in an award letter sent out in the spring. The package typically includes various combinations of federal and college loans, grants, scholarships, and work-study jobs.

Copyright Forefield Inc.

Frisco Financial Planning LLC
Financial Planning Frisco Texas