Lynn Brenner's Family Finance

After I Inherit a Roth IRA, Will I Owe Income Taxes on Its Future Earnings?

Q: If I inherit a Roth IRA from someone I'm not married to, will that IRA's future investment gains be tax-free -- that is, if I leave the money in the account? --MA via email

A: The Roth IRA's investment earnings will continue to be tax-free. But you won't be able to leave all the money in the account.

This is the main difference between being the owner of a Roth IRA and being the account's beneficiary. An owner never has to take any distributions from a Roth IRA, regardless of his age. A non-spouse beneficiary must take minimum annual distributions based on his or her life expectancy. (Someone who inherits a spouse's Roth IRA can become its owner, by transferring the inherited account into a new Roth IRA in his or her own name. )

The annual distributions you must take from the Roth IRA are tax-free -- but don't underestimate their importance! 

The penalty for failing to take them is 50% of the amount you should have withdrawn, but didn't.

If your minimum annual distribution was $2,000, for example, but you took nothing out of the account, the penalty would be $1,000.

The good news is that because the balance in the account keeps growing untaxed, an inherited Roth IRA can grow into a much bigger nest egg if you can afford to take no more than the minimum required distributions while you're still working.

If you inherit a $150,000 Roth IRA at age 45, for example, your first required annual distribution will be $3,866 ($150,000 divided by your 38.8 year life expectancy). If you take only minimum distributions and earn an average 7% annual return, the account will have doubled in size by the time you're 65.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

If I Stop Working at 63, Does It Still Make Sense to Postpone Taking Social Security Until I'm 66?

Q: This will sound pretty basic, but I can't get a confirming answer from the Social Security Administration.

I plan to retire at 63, but I don't intend to draw Social Security until I hit the full retirement age (FRA) of 66. According to my annual Social Security statement, my FRA benefits are based on the assumption that I'll continue working until 66.

In much of the reading I do, I'm led to believe that if I delay taking any Social Security benefit until I'm 66, it will allow my monthly payment to grow to the full FRA amount.

Which statement is correct? Will my benefit amount continue to grow until I reach FRA at 66 as long as I don't touch it, even though I'll no longer be working? --RS via email

A: You'll have to do some numbers-crunching to figure out whether it makes sense for you to postpone drawing a benefit until you're 66.

You're right that if you stop working at 63, the amount you're entitled to receive at FRA is going to be smaller than what's listed on your annual statement. But even so, your benefit will be bigger if you wait until FRA to take it -- because if you take it earlier, it's subject to a discount.

Let's start with getting a better fix on the benefit you can expect at FRA.

As you say, the amount listed on your annual statement is based on the assumption that you'll work until 66, and that you'll earn what you do now. 

Anyone who plans to stop working before FRA, or who expects to earn a lot less in the next few years -- perhaps because of a switch from full-time to part-time work, for example -- can check how that change will affect his Social Security benefit by using the agency's Retirement Estimator calculator.
 
The calculator lets you create 'what if' scenarios, based on your own retirement plans and earnings expectations. It's linked to your actual Social Security earnings record, so you don't have to enter all your years of earnings information. (You do, however, have to enter information like your Social Security number, date of birth, and mother's maiden name.)

Put in new assumptions, and you'll get a new number for the amount you'd be entitled to receive at FRA. You'll also see the discounted amount that you'd receive if you started taking that benefit at 63.

It's a trade-off.

Of course, applying at 63 will give you three years worth of checks you wouldn't otherwise receive. And if you have a spouse and minor children, you should consider any benefit they may be eligible to collect once you've applied for Social Security.

But if you apply at 63, the amount you get will be discounted for age -- and even though your benefit will receive annual inflation adjustments, it will always be smaller amount than if you'd waited until age 66 to apply for it. If you don't apply for Social Security until you're 66, you'll get the full benefit you're entitled to at FRA, without any discount for age.

If you live an average or longer than average life, this difference in monthly benefit can become substantial. (See my earlier post, Does It Really Pay to Postpone Taking Social Security?) Before making a decision, you might want to check out this calculator which helps you estimate how long you'll live, based on your lifestyle and family history.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

How Soon Should a Widow Transfer Her Late Husband's IRA into Her Own Name?

Q: I am a Certified Financial Planner in the Midwest. One of my clients has inherited her late husband's IRA. A certain large mutual fund company has told her to move her deceased husband's IRA into an inherited/beneficiary IRA. She's been told that later on, if she wants to, she can later move it into an IRA in her own name.  He was 62 when he died. She is 57 years old, and has more than enough money to carry her to age 59 1/2. 

But the real question is, can you move an inherited/beneficiary IRA from your spouse into an IRA in your own name down the road -- or is the decision to keep it as a beneficiary IRA irrevocable? -- MA via email

A: Some IRA decisions are indeed irrevocable, but not this one. Your client won't lose her option to transfer her late husband's account into a new IRA in her own name at a future date.

For readers who don't know, when you inherit an IRA from your husband or wife, you have a choice: You can keep the IRA in its original owner's name, and continue to be the beneficiary. Or you can transfer it into a new IRA in your own name, and become the new owner.

What if Mary decides to keep the IRA in John's name? Then as the beneficiary, she must start taking distributions from the account by December 31 of the year John would have turned 70 and a half, or by December 31 of the year after his death, whichever comes later.

If she transfers it into an IRA in her own name instead, she won't have to take distributions until after she herself turns 70 and a half. But if she does take a distribution before she turns 59 and a half, she'll owe a 10% early withdrawal penalty on the amount she withdraws.

In your client's case, if  she keeps the IRA as a beneficiary account, she doesn't have to take any distributions for another eight years, since her husband was 62 when he died. But if she does take one -- she has plenty of money, but who knows what unexpected need might arise -- she won't owe an early withdrawal penalty on it. There are no early withdrawal penalties on a beneficiary IRA.

Your client will be able to move the beneficiary IRA into an IRA in her own name later on, says Barry C. Picker, a Brooklyn, N.Y tax accountant and IRA expert.  Indded, she should do that before the eight years are up, or she'll have to take annual distributions whether or not she needs them.

But in the meantime, he adds, she must be sure to name a successor beneficiary on her beneficiary account. Let's say her son -- we'll call him Kevin -- is the successor. If Mary is hit by a truck at age 63, her successor Kevin will be able to empty the IRA over his own life expectancy. **

If she doesn't named a successor beneficiary, and dies before she transfers the beneficiary IRA into an IRA in her own name, the account will have to be paid out within five years of her death, says Picker.

**An earlier version of this post incorrectly said Kevin would have to empty the IRA over Mary's remaining life expectancy. If you want to know the details, please email me. If not, be thankful that you don't need to know anything more about these arcane rules!

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

Working in Retirement: I'm Collecting Social Security Already -- So Why Are Social Security Taxes Still Being Taken From My Paycheck?

Q: I've been collecting Social Security for a year, since I turned 62. I've also just started back to work. I won't be earning over the $14,000 annual limit that would reduce my benefit. Can you tell me why my employer is taking Social Security tax out of my pay check? Will I get this money back? Should I be paying at all? And if not, how do I go about seeing to it that this deduction isn't taken out of my pay? -- JV via email

A: There's bad news and good news. Your employer's not making a mistake; but you may get some of this money back.

We all tend to think of the money we pay to Social Security as contributions to fund our retirement -- not unlike a 401(k) contribution. But in reality of course, it's a tax. Whenever you work in a job that is covered by Social Security, your employer must deduct Social Security and Medicare taxes from your salary. He must also pay the employer's share of those taxes.

There's no exemption for people who are already receiving Social Security benefits. Your earnings are reported to the Social Security Administration every year, just like any other worker's earnings.

There's no exemption for self-employment earnings above $400, either. If you're self-employed and net more than $400, you must report those earnings, and pay Social Security and Medicare taxes on them, when you file your annual income tax return.

Okay, what about the good news?

Working after you've started collecting Social Security can boost your benefit. The reason: That benefit is based on your earnings during the 35 years in which you earned the most.

"Each year, we review the records for all Social Security recipients who work," says Jane Zanca, an agency spokeswoman in New York City. "If your latest year of earnings turns out to be one of your 35 highest years, we recalculate your benefit and pay you any increase due."

If you're making less than $14,000 a year, you're not earning a big salary by today's standards. But even after adjusting for changes in average compensation over the years, you may be earning more than you did 34 years ago. If so, your current earnings can increase your monthly benefit by replacing that earlier, lower-paid year in the Social Security Administration's calculation.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved