Lynn Brenner's Family Finance

Don't Make Your Estate Your IRA Beneficiary

Q: My mother had an IRA and the IRA beneficiary is her estate.  However, her will leaves everything, including the IRA, equally divided between my sister and me.  Since we were not the actual beneficiaries on the IRA, what is our best course of action to reduce tax exposure?  I’ve seen a lot of documentation on how to handle an IRA if you are the beneficiary, but since the estate is the beneficiary, the attorney handling her will says it makes a difference to us. -- CS via email


A:   Your lawyer is right. The rules are different when the estate is the IRA beneficiary.

In fact, there are three sets of rules for inherited IRAs. The first applies only to beneficiaries who are surviving spouses. The second applies to all non-spouse human beneficiaries -- i.e., children, siblings, friends. And the third applies to non-human beneficiaries like estates and charitable organizations.

A surviving spouse can transfer an inherited IRA into an IRA in his or her own name, and thus postpone taking taxable distributions from the account until after turning 70 and a half.

But no other heir can transfer your IRA into a new account in his or her own name. They must start taking distributions after your death. The big question is, how fast must they empty the account? A lot of money rides on the answer, since the longer they can postpone taking money out of the IRA, the longer it can keep growing untaxed.

If the designated IRA beneficiaries are human beings, they can take minimum annual distributions based on their own life expectancies. But in your case, the IRA beneficiary is your mother's estate -- and it has no life expectancy. The result: 

If your mother was under 70 and a half when she died, her IRA must be emptied within five years of her death. If she was older -- and therefore already taking mandatory IRA distributions -- you and your sister can empty the account over her remaining life expectancy, as defined on the Internal Revenue Service 'Single Life' actuarial table for IRA owners. You'll find that table in the index of IRS Publication 590, which you can download at www.irs.gov.

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

    

Roth IRA Conversions and Buyer's Remorse: How Often Can I Change My Mind About A Conversion?

Q: I am in the process of converting a traditional IRA to a Roth IRA. If I later find it desirable to recharacterize, is there any waiting period before I can re-convert the account into a Roth? -- LW, via email

A: Yes, there is.

But let's start by filling in the background for everybody else.

When you convert a traditional IRA into a Roth IRA, you must pay income taxes on the amount you convert. (In a special one-time deal, if you do a conversion in 2010, you have the option of either declaring the conversion in your 2010 income tax return, or dividing it between your 2011 and 2012 returns.)

Why would you want to do a conversion? Because your earnings and withdrawals in the traditional IRA are only tax-deferred. You'll pay taxes on them when you start tapping the account. By contrast, your future earnings in the new Roth IRA will be tax-free; and so will your withdrawals from the Roth IRA, after you're 59 and a half years old and have owned the account for five years.

(Even so, Roth conversions aren't a no-brainer. In a future post, I'll discuss their pros and cons. For now, let's stick with your question.)

Let's say you're converting a $100,000 IRA -- and let's keep it simple by assuming that you plan to include that $100,000 in your 2010 taxable income rather than spread it over future tax years. We'll assume the tax on the $100,000 conversion is $28,000. You'll pay it when you file your 2010 return in April 2011.

Then after doing the conversion, you decide it was a bad idea. Maybe the market has tanked and by September, your $100,000 account is worth only $80,000. With a sinking heart, you realize that makes no never mind to the Internal Revenue Service: Come April 2011, you'll still owe the $28,000 tax on a $100,000 conversion.

Can you avoid that tax?

Yes. You can wipe the slate clean by turning your new Roth IRA back into a regular IRA. This is called a `recharacterization.'

You're allowed to recharacterize a 2010 Roth conversion right up until the final due date of your 2010 income tax return. With extensions, that means you have until October 15, 2011 to recharacterize a 2010 Roth conversion. (If you don't decide to recharacterize the account until after you're paid your 2010 taxes, you can file an amended 2010 return and get a refund for the $28,000 tax you paid on the conversion.)

Your question is, what if you change your mind again? How soon can you turn that account back into a Roth IRA?

Not until the year following the original conversion, or the 31^st day after the recharacterization, whichever comes later, says Barry C. Picker, a Brooklyn, New York tax accountant and IRA expert.  

In other words, if you do the conversion this month, and then recharacterize your Roth IRA in November 2010, you'll be able to reconvert it as early as January 2011. If you don't recharacterize your 2010 conversion until, say, May 1, 2011, you'll be able to reconvert thirty days later -- on June 1, 2011.

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

A Double Double Dip: Can a Married Couple Both Collect Social Security Based on Each Other's Earnings at The Same Time?

Q: Thanks to your AARP Magazine article and to this blog, I learned about Social Security spousal benefits. But there is one question I haven't seen addressed here. Can both spouses receive spousal benefits at the same time, while they both postpone taking their own benefits?

 
My wife and I both have earned benefits of our own. She reached her full retirement age (FRA) in October, and I reached mine in December. We both want to defer taking our benefits until age 70. I know that I can apply for Social Security at my FRA, so my wife can apply for a spousal benefit based on my earnings record. And I can then suspend my application, so that my benefit will keep growing until I'm 70. Is there any way I could then apply for a spousal benefit based on my wife's earnings record? - GS via email

 

A:  In a nutshell, no.

Several people have written me to ask the same question, which is really only of interest to people who a) are married and b) can afford to postpone taking Social Security. The first group is huge, of course; the second ... not so big.

First, let's recap the relevant rules:

1. Anyone who is married can claim a Social Security benefit based on his/her spouse's earnings. Your maximum spousal benefit is 50% of what your mate is entitled to receive.

2. You can never collect both your own benefit -- the one based on your own work record -- and your spousal benefit at the same time. 

3. You can't apply for a spousal benefit based on your husband or wife's earnings until he/she has actually applied for Social Security.

4. After you've reached FRA, you have the option of applying for Social Security and then suspending your application. You can't do that when you're younger.

5. After you've reached FRA, you can choose to apply for a spousal benefit ONLY, letting your own benefit continue to grow. You can't do that when you're younger. (People who apply for Social Security while under their FRA are automatically considered to be applying for both benefits, and receive an amount equal to the larger of the two.)

Clear so far? Okay. Here's an example of how the strategy works:

Bob and Nancy have reached their FRA. They're both 66 years old. He has earned a $2,000 monthly benefit and she has earned an $800 monthly benefit. They both want to postpone taking their benefits until they're 70 years old in order to earn extra credits.  (When you wait until after your FRA to apply for Social Security, your benefit gains extra 8% for each year of delay until you're 70.)

But Nancy doesn't have to wait to collect a spousal benefit based on Bob's work record. He can file now for his benefit. That green-lights her application for her spousal benefit. (See rule #5). She gets $1,000 a month - 50% of his benefit amount. Bob can then suspend his application so his benefit keeps growing. (See rule #4).

The result: Bob and Nancy are both delaying their applications for their own benefits, and meantime she is collecting a $1,000 spousal benefit based on his record.

Your question is, Can Bob now also get a spousal benefit based on Nancy's work record?    

No. Nancy hasn't yet filed for her own benefit. (See rule #3, above). She must do that before Bob can collect anything based on her record.  And remember, Nancy wants to delay her application for her benefit until she's 70.

What happens if Nancy applies for her own benefit and then suspends her application?

As soon as Nancy applies for her own benefit, she'll only be eligible for a spousal benefit to the extent that it exceeds her own, says Linda Lauria, a Social Security Administration spokesman in New York City. (This is true even if Nancy later voluntarily suspends her application for her own benefit.)

In this case, her spousal benefit is $1,000 and her own benefit is $800. Lauria says she'd therefore only receive the difference between the two -- $200 a month.

As for Bob, who already applied for and suspended his own benefit, he can only get a spousal benefit to the extent that it exceeds his own. His own benefit is $2,000 a month, and his spousal benefit is $400. So he collects nothing.

The result: Bob and Nancy have both postponed their own benefits. Meantime, she is collecting $200 a month because that's the amount by which her spousal benefit exceeds her own.

And in case you're wondering, this doesn't play out any better with different numbers. Here's an example:

Again, Bob and Nancy are both 66.  But this time, both have earned a $2,000 FRA benefit.

Bob files for his benefit and and then voluntarily suspend the application. Then Nancy files for a spousal benefit and restricts her application to exclude her own retirement benefit. (See rule #5).  She gets $1,000 on Bob's record as his spouse.   

  But  what happens if Nancy files for her benefit so Bob can collect as her spouse, and then suspends her application? Her spousal benefit would stop, because her own retirement benefit is higher. "Once she files an application for her own benefit, even if she later suspends it, she is only entitled to receive a wife's benefit if it exceeds her own,"   says Lauria.  "In this case, her own benefit is $2,000 and the spousal benefit is just $1,000."
 
So she'd get nothing while her own (suspended) benefit kept growing. 

 And since Bob has already filed (and suspended) his application for his own benefit, he too only qualifies for a spousal benefit if it's bigger than his own. His spousal benefit is $1,000 and his own benefit is $2,000. So he wouldn't collect anything while his own benefit grows, either.

The result: Both of them have postponed their own benefits, and neither is collecting a spousal benefit.

The bottom line: This strategy works only for one spouse.

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

 

Can My Unemployment Insurance Benefit Be Cut If I Collect Social Security?

Q: I'm a resident of Virginia, and I've been receiving full unemployment benefits for about two months now. I recently received a letter saying the state would have to start paying me only 50% of what I was getting because they believe I may be receiving Social Security benefits.

The fact is, in 2006 I lost my wife, so my two sons are collecting survivor benefits. I know that's probably what they're talking about. The check comes to me because they are minors, but it is for them. So my question is, does the fact that my kids receive survivor benefits affect how much unemployment insurance I receive? --JD, via email

A: No. Social Security survivors' benefits should not have any impact on your unemployment insurance.

You're almost certainly right about what prompted the letter. Virginia does reduce your unemployment benefit by 50% of your weekly Social Security retirement benefit. It's one of only five states in the nation that still has a law off-setting unemployment insurance for Social Security benefits. But there's no offset for your sons' survivor benefit.

For other readers who don't know, surviving children who are under age 16  -- and disabled children of any age -- are eligible for a Social Security survivor benefit based on their deceased parent's work record. A widower who has minor or disabled children in his care is also eligible for a survivor's benefit as the adult who is responsible for them. (The same is true for a widow.)

The Social Security payment you get as a widower with minor children will end when they're no longer minors. In any event, it is not a retirement benefit and therefore should have no effect on your unemployment benefits.

The five states that still have Social Security off-set laws for unemployment insurance are Illinois, Louisiana, South Dakota, Utah, and Virginia. ***

In the past, I've written that only four states still have these offset laws. I was wrong not to include Virginia and South Dakota.

Virginia's original 100% offset -- which subtracted your entire Social Security retirement benefit from your unemployment insurance benefit -- was changed to a 50% offset in 2003, and eliminated in 2005. But Virginia reinstated the 50% offset last summer. In many cases, of course, that reduction effectively eliminates unemployment benefits.

South Dakota repealed its offset law in 2006 -- but that repeal was only to become effective when the state's unemployment trust fund reached a balance of $30 million. That never happened. South Dakota still reduces a claimant's unemployment benefit by 50 cents for every dollar of Social Security he or she receive, says Rick McHugh, a staff attorney at the National Employment Law Project.

***The original post incorrectly included Colorado among the states that still have a Social Security offset law. Colorado repealed its law late last year.

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