Financial Ducks In A Row is Independent financial advicor of IRA, Social Security, income tax, and all things financial. It's all about providing you with valuable advice specific to your situation. I specialize in retirement and college planning, and my extensive tax background provides a very good foundation for navigating all of the complexities that go along with your financial life.
Don’t let the alphabet soup in the title put you off. If you’ve never come face-to-face with a QDRO you might not need to know this – but then again, the basic underlying premises are good information to understand…
First some definitions, just so we know what we’re talking about:
QDRO: Qualified Domestic Relations Order – this is a method for permitting distributions from a qualified retirement plan (not an IRA) in the event of a divorce. How a QDRO works is that, upon the decreed division of assets, if a retirement plan (such as a 401(k) or 403(b)) of one spouse is chosen as an asset to be divided and a portion given to the other spouse, a QDRO is issued. The QDRO allows the division to occur without penalty… otherwise, making a distribution from a qualified plan before age 59½ would result in penalty and possible taxation, as we all know. The QDRO provides a way (allowed by the IRS) for the receiving spouse to rollover the funds into an IRA of his or her own, without tax or penalty to either spouse.
NUA: Net Unrealized Appreciation – this is a special provision from qualified retirement plans that allows the employee to elect to treat company stock differently from all other assets in the plan when making a distribution from the plan. Essentially, you pay ordinary income tax on the basis, original cost, of the stock in your employer’s (actually former employer’s) company, and then place the stock in a taxable brokerage account. At this point, any gains on the stock are subject only to capital gains tax (rather than ordinary income tax, which is a much higher rate). The trick is that you can only do this maneuver one time, and the distribution must be in a lump sum of all your 401(k) account holdings. Everything in the account that is not company stock can be rolled over into an IRA and maintain tax deferral as usual. It’s critical to note that this can be the only distribution of funds from the account. If you were to distribute any amount, even a small amount from the employer plan in a previous year, you are no longer eligible to use the NUA provision on this employer account.
QDRO and NUA
So the question comes up – if a QDRO distribution occurs for your account, and that distribution includes company stock: does this “bust” the original employee’s ability to later have the company stock treated with the NUA privilege, since the rule states that the distribution must be a one-time single lump-sum distribution?
(drum roll…) The answer is NO. A QDRO is a division of the account, and though technically a distribution has occurred, this distribution does not impact the remaining account’s ability to take advantage of the NUA provision. The employee can go ahead and, upon separation from service, perform the lump-sum distribution of the stock and rollover the remainder into an IRA and get the NUA treatment for the stock.
Now, if you’re really astute, the last paragraph made you think of another question (it’s okay to admit it if you aren’t tax-geeky enough to have thought of this question): Can the ex-spouse (the one receiving a split of the employee’s plan) elect NUA treatment of any stock that was included in his portion of the account?
(drum roll…) The answer is a qualified YES. The qualification is this: As long as the rest of the account is eligible to be distributed (to include NUA treatment), the QDRO’d portion of the account can also take advantage of this provision.
In other words, although the ex-spouse of the employee could rollover the QDRO’d qualified retirement plan into an IRA at any time, if the account contains appreciated employer stock (stock of the former spouse’s employer) – it may be in the best interest of the receiving spouse to wait until the employee reaches age 59½ or leaves employment (termination or retirement), so that she can take advantage of the NUA provision. Otherwise, any rollover will squash this option forever.
Here’s a quick example to illustrate: Dick and Jane are divorcing. Dick has a 401(k) plan with his employer, including some stock in his employer. Part of the divorce includes a QDRO to give Jane half of the 401(k) plan.
Once the QDRO is completed, Dick still has his original 401(k) account (albeit diminished by half), and Jane has an account in the plan of equal size. Jane can rollover those funds into an IRA at any time, if she chooses, without penalty. However, since the account holds highly appreciated company stock, in order to qualify for NUA treatment, she must maintain the account in the 401(k) plan until Dick terminates employment, retires, or reaches age 59½. At that time, she can pull the lump-sum distribution for NUA treatment and rollover the rest into an IRA. Dick can elect NUA treatment for his account when he terminates employment or retires.
Now you may be wondering about that picture… the button is the prize that a person gets when in a seminar with Natalie Choate, the renowned IRA expert – if you happen to ask a question that she is unable to answer. I asked the above questions of Mrs. Choate recently and received the button. No disrespect for her whatsoever – as an admirer of her work, I am proud of the button and wanted to share it here.
With a headline like that I bet you’re thinking this is one of those wild & crazy get rich schemes. However, it’s really just a hypothetical illustration of the great benefits of three factors that can work in your favor in building a legacy:
What follows is an example of how you can make those three factors work together to create this $33 million legacy.
How It All Started…
Once upon a time, there was this guy named Joe. Joe is 20 years old, working part-time making decent money, finishing up college, just generally living large (by a 20-year-old’s definition). On the advice of his father (yes, some 20-year-olds do listen to their fathers!), he opened up a Roth IRA, funding it with $5,000. The account was invested in a fixed 5% yield instrument of some sort (not important what the investment is, just assume a 5% annual yield).
Using the Roth IRA is advantageous to Joe because his tax rate is very low at this stage of his life. And presumably tax rates will be increasing for him in the future. Any growth within this account is tax-deferred and most likely tax-free, as long as any future distributions are for qualified purposes.
Each year thereafter, Joe contributes an additional $5,000 to the Roth account. After he completes college, Joe starts working at an entry-level job. Not long after, he marries his high school sweetheart Jane, and Joe & Jane settle into their newlywed life. As life goes, they soon have children in their household, and even though money is tight, Joe continues to contribute the $5,000 each year into his Roth IRA. Life goes on like this for a while.
And then… 20 years pass
At age 40, Joe launches his own business. During this time in his life, tax deductibility becomes more important to him since he’s making a lot more money and is in a higher tax bracket. With this change to his tax circumstances, he stops contributing to the Roth IRA and starts investing in tax deductible retirement accounts.
All this time, his investments in the Roth account have been steadily growing at that fixed 5% rate. Now after 20 years the balance of Joe’s Roth IRA is now up to $165,329. Joe’s 20 years’ worth of $5,000 investments, makes a total of $100,000 contributed. Pretty nice, right?
Joe just sets the Roth IRA aside at this point, forgetting about it altogether for quite a while (other than those pesky quarterly statements). Not much of note happens in our story for a long, long time, other than compounding interest, time passing, and continued tax deferral.
… and another 50 years pass
Joe is now 90 years old. His business has flourished through the years, and his children are reaping the benefits of having worked there, and the children are now retiring. His grandchildren have taken over the business, and he and Jane are enjoying their great-grandchildren. A couple of years later, little Jolene is born, and this first great-granddaughter quickly becomes the apple of Joe’s eye.
It is along this time that Joe remembers that long lost Roth IRA account. To this point the Roth IRA has grown to over $2 million – from that original series of $5,000 contributions that amounted to a total of $100,000. Pretty amazing what can happen with compounding interest and time. Now, while doing his estate planning, Joe has plenty of other assets that he intends to eventually bequeath to his children: the business, other retirement and investment accounts, etc.. This Roth IRA though, he’s decided he’d like to really make a legacy out of it. So Joe decides to name his great-granddaughter Jolene, a newborn, the primary beneficiary of the Roth IRA account.
… and then, a couple of years later…
At age 95, with his family surrounding him, our protaganist Joe passes away.
Little Jolene is now two years old, and as primary beneficiary of the Roth IRA (now worth over $2.4 million), Jolene must begin taking Required Minimum Distributions from the account, based on her age. Jolene’s Table I factor is 80.6, and so her first distribution is for just over $30,000. Her parents file the necessary paperwork and then they put this money away for Jolene’s college education fund.
And so on it goes, the account continuing to compound at 5% each year, Jolene receiving her RMD each year, and her parents putting that money away for college.
Fast forward some more…
Jolene has graduated from high school, and she’s planning to go off to college. Over the past 16 years since her beloved great-grandpa Joe passed away, she has received a total of over $650,000 in distributions from the Roth IRA that he left for her. This has made for a nice start on her college costs. (We won’t get into it now, but if we projected college costs out this far into the future, a year of college might cost more than $6 million at the 7% rate of increases we’ve seen recently.)
So Jolene finishes college, and she continues to receive the RMD payments from the wonderful gift from great-grandpa Joe throughout her life. She lives a long, full life, with a loving family and great success. At age 82, according to the original Table I factor, she has depleted the inherited Roth IRA. The total of all of the RMD distributions she received over those 80 years amounts to $33,069,557. Not too shabby for Joe’s $5,000-a-year commitment over 20 years.
Note: other than acknowledging the factors, income taxes, inflation, and other factors have not been calculated into this example. The example is only intended to illustrate the value of long-term investing, compounding of interest, and tax-deferral benefits of Roth IRAs, plus the stretch provisions. This example is not intended to represent real life situations, although it is certainly feasible. Bear in mind that this entire example’s activity takes place over the span of approximately 155 years.
If you happen to be in one of those jobs (there can only be a handful left at this point, right?) that has a traditional pension plan, you may be faced with an important decision. When you’re ready to retire (did I just hear angels singing?) – you have to decide if you’ll take annuitized payments, or if you cash out the plan and roll it over to an IRA.
These “traditional” pension plans are referred to as defined benefit (or DB) plans – meaning that your benefit is defined as a determined amount. This benefit is usually based on a combination of your longevity in the job, plus your ending salary. You’re probably familiar with these computations: an example is a pension that is 2% per year of employment, multiplied by the average of your final five years of salary. So if you worked at a job for 25 years and your final five years’ salary average was $80,000, your annuity would equal $40,000 – which is $80,000 times 2% times 25 years. Often the calculations are more complicated, but that’s the gist of how they work.
In addition, your plan may also offer a cost of living adjustment, or COLA. With a COLA, each year the amount of your annuity payment is increased according to an inflation index such as the CPI, or a fixed rate such as 3%.
There are often other options to choose, such as the pension payout period. It might be for your lifetime (a “life annuity”), for you and your spouse’s lifetimes (a “joint and survivor annuity”), or over a set period of time, like 10 or 20 years (a “period certain annuity”). Quite often, unless there is a survivor option (such as a joint and survivor annuity) or a set period of time (like the period certain annuity), upon your death there will be no residual benefit from the plan. It is because of this that many folks look with favor upon the final option: the cash-out and rollover.
Cash Out and Rollover
Most often these DB plans also offer an option to receive a cash value settlement for the plan. The amount of the settlement is a discounted value of the future cash flows (the pension payments) that you could expect to receive. For example, the pension mentioned above (the $40,000 per year payment, with no COLA) for a 62 year old retiree might have a cash-out value of $400,000. This may seem like a pretty nice amount of cash. However, this is where some folks act too quickly. (Actuaries, if you’re out there, I just picked some numbers out of the air. I don’t know if they’re realistic or not. Forgive me!)
I get it – $400,000 in hand seems like it would be worth more than a future promise to pay $40,000 a year. Because, what happens if you die two years into the plan? As mentioned before, unless you have a survivor element in the pension plan, there will be nothing left for your heirs. There’s a lot more to consider than just the amount of the payout and your lifespan.
Things to Consider
It’s important to look at the provisions of the plan and all of the available options in order to determine what’s the best route to take. Each of the various payout options (life annuity, joint and survivor, period certain, etc.) needs to be examined to understand how the cash-out payment is calculated. (This is where it pays to know and work with a financial advisor.)
As you look at the various pension alternatives, consider them in comparison to one another. Sometimes the company subsidizes the survivor benefit to a degree, making a joint and survivor annuity more beneficial than either the single life or the cash-out option. In addition, sometimes for an early retirement option, the pension itself (over all payout options) is subsidized by the company, or “sweetened” to make retirement more attractive to the potential retiree.
As mentioned before, your health and the health of your spouse (as it impacts your lifespan), plus your other financial resources and lifestyle goals need to be considered as you look at the plan options. You also want to consider the financial strength of the company whose pension you’re considering, as well.
Going back to our example: the cash-out payment of $400,000 should be considered against the other pension payout options. The single-life payout was calculated at $40,000 per year for your life. What if the joint and survivor pension payout option was calculated at $36,000, and your spouse is also age 62? This means that you would instead receive $36,000 over your life and the life of your spouse if you predecease him or her. First of all, which option is a better deal? And secondly, is one or the other better than the lump sum cash payout?
We have to make some assumptions when calculating the values of these options. According to actuarial tables, using a joint and survivor option will statistically result in more years of payments, even if the two lives are the same age. Therefore, when comparing a single life annuity to a joint and survivor annuity, we assume that the joint and survivor annuity will be paid out for a longer period of time.
Using a 5% discount rate, the value of the joint and survivor payout is worth approximately 10.8% more (in present value) than the single life annuity. In other words, if you bypass the joint and survivor option, you’re giving up that potential 10.8% of extra value. Another way to look at it is that you’re giving your company a gift of the extra value by not choosing the J&S option.
Either of the pension options are also better than the cash payout – from a strictly financial standpoint, as long as you live to whatever the projected mortality age is for your plan (I used 82 for the example). This is because the rate used to discount the present value of your future cash flows was 5%. This means that you’d need to get a return of something more than 5% from your lump-sum cash payout during that time frame in order to break even. Keep in mind that this 5% is a guaranteed rate – as long as you live long enough.
Of course, if your health is poor (or you have a family history of life-shortening health problems), you may benefit by taking the lump sum, for the “bird in the hand” benefit. However, if you happen to live longer than the actuarial tables project, you might be in the unenviable position of outliving your funds.
These are some of the issues you need to consider. This has been a very rough example but it should help you to understand the importance of looking before you leap.
It’s often very attractive to choose the cash-payout option since there are many inherent problems with the defined benefit pension plans. But you shouldn’t make the decision willy-nilly. It pays to examine the numbers closely, and if necessary hire someone to look at the numbers with you. You should know what you’re possibly giving up with each choice versus the alternatives.
(In case you are confused by the headline: a principle is a rule, and pollex is an obscure term for thumb. Therefore, we’re talking about Rules of Thumb.)
I like rules of thumb, as a rule of thumb… I think we all generally want difficult issues in our lives to be boiled down to a simple, easy-to-understand statement. These rules of thumb are everywhere, all around us. Heck, there’s even a whole website dedicated to rules of thumb, where you can find rules on all kinds of subjects, as diverse as how to outrun a crocodile to changing your answers on a test.
Save 10% of Your Income
Let’s start with one of the basics you might hear regularly: Save 10% of your income. Like most all rules of thumb, this one is very general in nature, but it provides a good starting point.
This starting point is best for someone starting the savings process at an early age – perhaps in your twenties or thirties. If you started to save 10% of your income at an early age and kept up the habit over your lifetime, you’d be bound to have a significant sum of money put aside when retirement comes. (You might be interested to note that this particular rule of thumb is one of the base recommendations in the book “The Richest Man in Babylon” which I wrote a summary of some time ago.)
The problem is that many folks don’t start early in life, and by the time they get around to saving in earnest (maybe in their forties), 10% savings will likely be woefully inadequate – 25% to 30% may be more appropriate.
The other, likely bigger problem with the 10% rule is that it doesn’t account for your timeline or the purpose or goal for the savings. The assumption of the rule of thumb is that you have a long timeline, meaning 30 or more years, and that your goal is retirement at some poorly-defined rate of income, such as 80% of pre-retirement income (see below). These two assumptions don’t fit everyone – although they could fit some people in general, your mileage may vary, quite a bit. If your timeline is shorter (say 10 to 15 years or less) or your goal is for a higher retirement income your percentage of savings should be higher, possibly much higher. If your goal is something altogether different, like a downpayment on a home (in a short timeline but of a specific, small-ish amount), 10% would be too much – although you will likely benefit on other goals by saving at least 10% starting at any time.
So, for a starting point, for someone with a relatively long timeline and a vague goal to aim for, 10% isn’t a bad place to start. Start with 10% (or however much you can afford) and adjust upward over time. It’s better than no rule at all, in my opinion.
In this blog many times we’ve covered how beneficial it can be to delay receiving Social Security benefits as long as you can. An example of this discussion is in the article Ah, Sweet Procrastination – it makes good financial sense to delay receiving your benefit to age 70 in many cases, but of course not all.
The reason delayed filing can be such a great benefit is that this government-backed income stream is pretty much as good as you can get, in terms of longevity insurance. When you start receiving the benefit, you’ll continue to receive it through your entire life. When you start receiving your benefit impacts the amount that you will receive for your life. Plus, depending upon the amount of your spouse’s benefit, it will impact the amount that your spouse would receive as a Survivor’s Benefit as well.
But there are times when it may make more sense to begin receiving your benefit earlier…
Circumstances require it. If you’re in ill health, have a shortened life expectancy, or have very limited other resources, it may be necessary to start taking your Social Security benefit early. The financial calculations that we do that explain how delaying receipt of benefits is the better choice, always assume that the recipient will live to at least age 80 or beyond and can get along using other resources until filing at age 70. If one or the other (or both) of these circumstances is not the case for you, it likely makes more sense to begin taking your benefit earlier.
Spouse with a relatively small benefit. If the spouse with the lower wage base has earned a relatively small benefit and intends to switch over to a Spousal Benefit as soon as it makes financial sense, it might make more sense to start taking the smaller benefit early, even though it is reduced. In this case the financial impact of starting to take the benefit early doesn’t amount to a significant reduction in real dollars, so taking the benefit for several years is just extra “gravy on your french fries”, in a manner of speaking.
Social Security doesn’t matter to you. If you have more funds than you really need and the Social Security benefit is of very little real benefit to you – or if you consider the Social Security system a “safety net” for needy folks, you might want to start early. Or you may choose to not take the benefit at all.
Psychological impact. If you simply cannot stand the thought of leaving your Social Security benefit in the government’s hands any longer than necessary and you feel it’s to your best interest to start early (even in the face of facts to the contrary), then by all means start taking benefits early. If that’s what it takes to ease your mind, you should do it. Life’s too short to be wrought up over such matters.
As stated before, in many cases it makes the most financial sense for the spouse with the higher earned benefit to delay benefits to age 70, but not in all cases. In order to really get a good handle on how these calculations would work for you, it may help to hire a professional advisor to run through the numbers with you.
Statistics tell us that approximately 25% of us will need some sort of extended long-term nursing care during our lives – and as our life spans increase with improvements in medical care, this number is likely to increase.
Most of us have experienced family or friends needing this type of long-term nursing care. Since Medicare doesn’t provide much in the way of long-term care benefits, the individual is left with three possible sources to pay for long-term care:
private payments from your savings and other sources
long-term care insurance coverage (LTCI)
Given the tremendous costs for long-term care, many individuals are faced with the distinct possibility that any savings that they have amassed over their lifetimes (and that they hoped to pass along to their heirs) could be quickly wiped out or drastically reduced with a stint in a skilled-care facility. Then who will take care of the sheep?
Briefly, Medicaid was originally introduced in 1965 (alongside Medicare) as a “safety net” for healthcare, primarily to help the poverty-stricken. Along in the late ’80’s, it became clear that this safety net could be beneficial to people of modest means as well. So the laws were adjusted to allow for additional beneficiaries of the program through some simple planning. Later during the early ’90’s, the eligibility requirements were tightened up a bit, but with planning, certain beneficiaries can still receive Medicaid benefits.
Eligibility for Medicaid is based upon the assets available to the individual – only about $2,000 is allowed to remain in savings vehicles. Community (joint, owned by both members of a married couple) accounts are subject to special rules, and depending upon how your state chooses to administer the program, half of these jointly-held accounts could be considered eligible assets. Other assets, including primary residences, annuities, and life estates, receive special treatment under Medicaid eligibility rules as well.
Retirement Accounts and Medicaid Eligibility
How are your IRA, 401(k), and other accounts viewed with regard to Medicaid eligibility? As a general rule, retirement accounts are included as available assets. Even if the individual is under age 59½ and otherwise ineligible for distributions without penalty. The retirement accounts must be liquidated before the individual can be eligible for Medicaid coverage.
One way to protect assets from liquidation is if the account is in periodic payment status. This might mean the account is subject to Required Minimum Distribution (RMD) either due to age 70½ requirement or if the IRA is inherited and subject to inherited RMD. In some states, an account in periodic payment status is considered an income source rather than an asset. The circumstances might help to protect the account’s assets from being included in total for Medicaid eligibility.
For example, if an individual was in RMD status due to being over age 70½, his account would be considered in payment status. If the account was worth $200,000, this amount would not be counted against him for Medicaid eligility, but the periodic income stream would be. If he is age 72, his annual required payment from the account would be roughly $7,812, which would be considered for his income budget, approximately $651 per month. If this was his only income, that amount would be paid to the nursing home – with the balance of the cost of the nursing care paid by Medicaid.
If the individual is married and the other spouse is not applying for Medicaid, there are allowances made for monthly minimum maintenance (of the non-Medicaid spouse) as well. In 2019, the maximum monthly maintenance needs allowance is $3,160.50. This is the most in monthly income that a community spouse is allowed to have if her own income is not enough to live on and she must take some or all of the institutionalized spouse’s income. The minimum monthly maintenance needs allowance for the lower 48 states remains $2,057.50 ($2,572.50 for Alaska and $2,366.25 for Hawaii) until July 1, 2019.
Not all states utilize a minimum and maximum income allowance. Some states use just one figure that falls somewhere between the federally set minimum and maximum figures. For example, as of 2019, New York, Texas, and California all use a standard monthly figure of $3,160.50 (the maximum), and Illinois uses a standard monthly figure of $2,739.
What About a Roth IRA?
So, if you’re thinking ahead you’re wondering how this impacts a Roth IRA… since a Roth IRA is not subject to minimum distribution rules. Rightly so – the Roth IRA is never in a payment status as long as the original owner is living. As such, your own Roth IRA assets are counted toward Medicaid eligibility status. These assets would have to be spent down before the individual could become eligible for Medicaid.
So the bottom line is that you need to consider lots of things as you think about Medicaid eligibility. If you have significant assets available, you could be better off to consider a Long-Term Care Insurance (LTCI) strategy, as otherwise your assets might have to be spent down and quite possibly depleted. Unfortunately there isn’t a “rule of thumb” to use in determining whether LTCI makes sense. Each individual’s situation will be a little different, taking into account medical history, family medical history, asset base, age, etc.. This is the sort of analysis that you need to do as you near retirement age in order to consider whether or not LTCI or Medicaid could be a part of your future healthcare plans.
After beneficiaries are named and you understand how assets
are distributed at death, we need to discuss the tax implications of gifted and
inherited assets. The following is a description of the tax implications of non-qualified
assets (those not in 401(k)s or IRAs) received by beneficiaries if gifted
during lifetime or inherited after death.
Our example will use stocks in a brokerage account as the
assets demonstrating the tax implications of assets gifted during lifetime or
inherited at death.
Let’s assume that an individual has a brokerage account and
they initially purchased $250,000 worth of stock in the account. Several years
have gone by and the account as grown to $500,000. For tax purposes the basis
in the account is $250,000. The individual is contemplating gifting the account
to their beneficiary.
If the individual decides to gift the account during their
lifetime to their beneficiary, the beneficiary receives the assets and acquires
the same tax basis as the original account owner. This transfer of basis,
called carryover basis, means that if the beneficiary then sells any or all the
stocks in the account, the beneficiary’s tax basis is $250,000. So, if the
beneficiary sold the entire account for its current value of $500,000, the
taxable gain would be $250,000 – the difference between the carryover basis of
$250,000 and the sales price of $500,000.
On the other hand, if the original account owner decides not
to gift the account during their lifetime and instead waits until dying for the
beneficiary to inherit the account, the beneficiary receives the assets and a
new basis is established. This new basis, called a step-up (or step-to) in
basis, means that the beneficiary’s tax basis is the fair market value of the
account assets on the account owner’s date of death.
In this example, if the fair market value of the stocks is
$500,000 when the account owner dies, the beneficiary’s new tax basis is
$500,000. Thus, if the beneficiary sold the account for $500,000, the tax
liability to the beneficiary would be zero. Any gains or losses on the
inherited $500,000 would be subject to short- or long-term gains and losses,
depending on the beneficiary’s holding period after inheriting the assets.
This same tax basis situation would apply to mutual funds,
ETFs, real estate, and other non-qualified assets. Of course, the intentions of
the individual gifting or leaving the assets after their death is entirely
their prerogative – which may supersede regardless of the tax implications to
When you die, the way in which your property is handled will
depend on the type of documents (or lack thereof) you’ve set up before your
death. The following is a summary of the ways your property transfers to heirs
when you pass away.
Life Insurance. At death, life insurance proceeds are passed
to your beneficiaries (and in most cases, tax free). For example, if you have a
life insurance policy with a face amount of $500,000, when you die, your
beneficiaries receive the $500,000 face amount tax free.
When you purchase life insurance, you name your beneficiary
or beneficiaries – those who receive the death benefit when you die. Most
married couples will name each other as beneficiaries on their respective
polices, some will name charities, and other will name other relatives,
individuals, or trusts. Life insurance contracts generally avoid probate (the
legal process of validating a will and division of property), unless you name
your estate beneficiary (a bad idea) or fail to name a beneficiary (also a bad idea).
Annuities. At death annuities operate the same way as life
insurance regarding beneficiaries. A big difference however, is the tax
treatment. Even though an annuity may pay a death benefit, in most cases it is
taxable to the beneficiary. This is different from life insurance death
benefits that are received tax free. Any taxable annuity death benefits are
taxed as ordinary income.
Trusts. Trusts can be established either during your
lifetime or at your death. They may also be revocable (changeable) or
irrevocable (not changeable). Trusts are set up by a grantor (the person
wanting the trust) and assets are placed in the trust, managed by a trustee,
for the benefit of the trust beneficiary. When you die, the assets in the trust
are still managed by the trustee for the benefit of the beneficiary. Like
annuities and life insurance, trusts avoid probate.
Brokerage Accounts. When you have a brokerage account where
you hold stocks, bonds, mutual funds, or ETFs it’s called a non-qualified
brokerage account. The non-qualified means that it’s not a 401(k) or IRA. When
you open this type of account, you are given the option to name a beneficiary
on the account should you die. At death, the property passes to the
beneficiary. The beneficiary also receives special tax treatment on the account.
Brokerage accounts also avoid probate.
Retirement plans. When you have retirement plans such as
401(k)s and IRAs you also name beneficiaries who get the account assets when
you die. The tax treatment of the assets will depend on the account (Roth or
not), and what the beneficiary chooses to do with the assets (sell them all or
take minimum distributions). Brokerage accounts avoid probate.
Wills. A will is a written legal document that directs how
and to whom your assets are dispersed after your death. Wills also name a
guardian(s) for minor children should both parents die. Wills also name an
executor for your estate that helps direct where assets go, what assets to
sell, and filing the final tax return for the deceased and or the estate.
As mentioned before, probate is the process of validating a
will. Thus, it’s a public process, and often long and expensive. Additionally,
the documents mentioned above supersede the language in a will. In other words,
if your will states that your kids get your IRA assets at your death, but your
IRA beneficiary is another person or entity, the IRA overrides the language in
Dying without a will means dying intestate. Dying intestate
means that the state determines how your assets are divided, who gets them, and
if you have minor children, who becomes their guardian. Different states have
different laws, but be assured, the laws may differ from what your intentions
are or who you think should get your assets or be guardians. Don’t risk it. If
you don’t have a will, or your beneficiaries named, consider taking care of
An extremely important point not to be overlooked is the
need to update your beneficiaries or documents whenever you have a life changing
event. Life changes mean births, deaths, divorces, job changes, etc. For
example, if you get divorced and remarry, and forget to change your beneficiary
from your ex-spouse to your new spouse – and you die – your ex-spouse is still
the beneficiary and gets the property. It is paramount to update your accounts,
estate documents, insurance policies, and retirement plans to reflect any life
On this date fifteen years ago, April 19, 2004, this blog was officially launched. The article below was the first post ever, and I’ve reposted it here in celebration of the 15 year anniversary of Financial Ducks In A Row.
I have not edited the content below, it’s exactly the same as it was originally posted back in 2004.
A lot has changed over the years, and I continue to enjoy sharing sound financial principles, information and advice through this medium, and I hope to keep it up for a long time into the future.
Nine Essential Tips for a Bright Financial Future
1. See a lawyer and make a Will. If you have a Will make sure it is current and valid in your home state. Make sure that you and your spouse have reviewed each other’s Will – ensuring that both of your wishes will be carried out. Provide for guardianship of minor children, and education and maintenance trusts. 2. Pay off your credit cards. Forty percent of Americans carry an account balance – not good. Create a systematic plan to pay down balances. Don’t fall into the “0% balance transfer game” as it will hurt your FICO score. Credit scores matter not only to credit card companies but to insurance companies as well; you can avoid an unpleasant increase in your insurance rates by managing your credit wisely. 3. Buy term life insurance equal to 6-8 times your annual income. Most consumers don’t need a permanent policy (such as whole life or universal life). Also consider purchasing disability insurance; think of it as “paycheck insurance.” Stay-at-home spouses need life insurance, too! Note: Each family’s needs are different. Some families have a need for other kinds of life insurance, so you should review your situation carefully with an insurance professional or two before making decisions in this area. 4. Build a 3 to 6 month emergency fund. Establish a home equity line of credit before you need it – this can take the place of part of your emergency fund. 5. Don’t count on social security! Fund your IRA each and every year. If you don’t fund it annually, you lose the opportunity. Fund a Roth IRA over a traditional IRA if you qualify. 6. If offered, contribute to your 401(k), 403(b) or other employer-sponsored saving plan. Use your company’s flex spending plan to leverage tax advantages. If you don’t use your flex plan or fund your retirement plan annually, you lose the opportunity – and the tax advantages – for that year. 7. Buy a home if you can afford it. Maintain it properly. Build equity in your property. You’ll have much more to show for your money spent than a box full of rental receipts! 8. Use broad market stock index funds and direct purchase government bonds to reduce risk, minimize costs and diversify your portfolio. If you have limited options, for example in your 401(k) plan, make sure that you diversify across a broad spectrum of options. Don’t over-weight in any one security, especially your employer’s stock – remember ENRON?
If you are unsure about your financial affairs or you have financial goals such as retirement planning, college funding, business succession or estate planning that you’d like help achieving, call Blankenship Financial Planning at 217/488-6473 to schedule a no-cost, no-obligation “Get Acquainted” meeting to discuss your situation.
Back in the olden days, you used to receive an annual statement from the Social Security Administration detailing your benefits projected to your potential retirement age(s). Nowadays you can go online (www.SocialSecurity.gov) and request a current statement at any time. If you haven’t gone online for your statement, you should receive a mailed copy of the statement every five years.
While the statement is designed to be pretty well self-explanatory, I thought it might be beneficial to review the statement so that you know what the statement is telling you.
This page is your basic SSA boilerplate, explaining to you some of the current details of the Social Security system, including the services and tools that they have available to you.
In addition, SSA points out that Social Security benefits should be only a part of the overall retirement resources picture. On average, Social Security will replace about 40% of your annual pre-retirement earnings.
Now we’re into the meat of the report. At the top of the page is the detail of your Estimated Benefits. These estimates assume that your current earnings rates continue until the projected ages. First are your Retirement Benefits – at Full Retirement Age (your FRA will be listed), at age 70, and at your early retirement age of 62 (if you’re not over this age already). These figures are helpful when planning retirement income, assuming that you expect to continue earning at your current income level until the projected age(s). You also must assume that the Social Security system will continue to pay out at the current rates to folks at your particular level of income in the future (but that’s a discussion for another time).
Next comes the section on Disability Benefits for you. This shows the amount of Social Security Disability Benefit that you are currently eligible to receive. (If you’re looking for a rough estimate of your current Primary Insurance Amount or PIA, this figure is a good estimate to use.)
The next section is for Family and Survivor’s Benefits – indicating the amount of benefit that your Child, your Surviving Spouse caring for your child under age 16 or who has reached Full Retirement Age would receive upon your death. In addition, your Family Maximum Benefit will be listed here as well.
Lastly in this top section, the statement provides you with information about whether you have earned enough credits to qualify for Medicare at age 65, followed by your birthdate and the income estimate that Social Security is basing their projected estimates of your benefit upon.
The bottom portion of the second page details how the benefits are estimated. The explanation includes information which may change your benefit amounts (versus the projections), such as changes in earnings levels, receipt of Railroad Retirement benefits, and potential changes to the laws governing benefit amounts. Also included here is information about the WEP and GPO calculations, where they might apply to potentially reduce benefits.
The Third Page of the statement lists out the details of your Earnings Record at the top. This section is important to review carefully… you should review the earnings listed for each year against your tax records or W2 statements, to make sure that the information the SSA has is correct. In addition to reviewing for correctness, you should look over your record and note the “zero” earnings years, as well as years that you earned considerably less than what you earned (or are earning) in later years.
As we’ve discussed in the past, your benefits are based upon your 35 highest earning years. If you have had some “zero” years in the past or some very low earnings years, you can expect for your estimated benefit to reflect any increases that the current year’s income represents over your earlier low earnings or zero years. This only becomes significant once you have a full 35 year record in the system.
Another key here is that your projected benefits listed on page 2 are based upon your earnings remaining the same until your projected retirement age(s). If you choose, for example, to retire at age 55 and have no earnings subject to Social Security withholding, your projected benefit will be reduced since those years projected at your current earning level will actually be “zero” years or much lower if you have a lower salaried job during that period. This reduction is in addition to any actuarial reductions that you would experience if you choose to take retirement benefits before FRA.
In addition, if you have gaps showing in your earnings history, you may have had a job that was not covered by Social Security, so you will be interested in knowing how the Windfall Elimination Provision (WEP) affects you, and how the Government Pension Offset (GPO) may affect your family or benefits that you may be eligible from your spouse.
The middle portion of the Third Page shows how much you have paid in to the system over the years – both the Social Security system and Medicare system. This can be an eye-opener… quite often we don’t realize how the money we’ve paid in can stack up!
Lastly on the Third Page, there are details on how to report any inaccuracies that you might find on your statement. It’s much easier to resolve things earlier in the process rather than later – when you’re possibly under the gun about applying for your benefits.
The Back Page
The Back Page of the statement is full of additional information about the Social Security system, benefit calculations, and other fun facts about your benefits. There is also a lot of information about how to find more information about your benefits as well.