Lynn Brenner's Family Finance

'Sweet Spot': The Key 11 Years of Retirement Planning

If you're nearing age 59 or you haven't yet reached age 70, listen up.

You're standing in a window of opportunity -- the 'sweet spot' of retirement planning. Now's the time to take steps to protect your future retirement income from the ravages of annual taxes and market volatility.  For more, see my recent Reuters article "Six Ways to Maximize Retirement 'Sweet Spot' Years".

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

 

When is the Best Time For a Roth Conversion?

Q: I'll be retiring sometime in 2012. I'd like to take all or a part of my 401(k) and roll it into a Roth IRA. What would I have to pay in taxes to begin with? Could I remove a portion of the Roth IRA tax-free in an emergency? I'll be 64 in 2012. --DH via email

 

A: The amount you transfer from your 401(k) to a Roth IRA is added to your taxable income for the year in which you do the conversion. If you rolled $100,000 into a Roth in 2011, for example, your 2011 taxable income would shoot up by $100,000.

Financial planners say it's often less expensive to do a Roth conversion the year after you retire than while you're still employed.

Your taxable income will be smaller because you'll no longer be earning a salary. What's more, you may be able to claim high deductions from the previous year. (The 2010 state and local income taxes that you paid in 2011 are deductible on your 2011 federal return, for example.) If your deductions exceed your income, you may not even owe any taxes in your first year of retirement, says Robert Schmansky, a Pittsburgh financial adviser. As a result, you might be able to withdraw money from a tax-deferred account like a traditional IRA or a 401(k) plan -- whether you need it to live on or want to roll it into a Roth IRA -- without triggering a tax bill.  

Make an appointment with a tax accountant who can crunch your numbers and advise you on the best way to time your Roth conversion. (One question to discuss with him or her is whether it makes sense for you to do a single conversion, or a series of small annual conversions. Depending on your tax situation, several small conversions may be less expensive.)

As for your second question, yes, the money in the Roth IRA will be accessible tax-free in an emergency. In fact, you'll be able to take a tax-free distribution of the entire amount you rolled into the Roth IRA after you do the conversion.

This important point is often misunderstood. 

The rule is that you can withdraw Roth IRA earnings tax-free after you are 59 and a half years old and have owned the account for five years. What people usually don't understand is that in an ordinary Roth IRA (not a converted IRA) your principal -- i.e., the amount you contributed -- is not subject to that requirement. You can withdraw principal at any time, regardless of your age, without incurring a tax.

The reason is very simple: You've already paid taxes on that money.

In a converted Roth IRA, there is a penalty on funds withdrawn within five years of the conversion -- but only if you're under 59 1/2 years old. In your case, it wouldn't apply, says Barry C. Picker, a Brooklyn tax accountant.

Here's an example. You roll $100,000 from your 401(k) plan into a Roth IRA. Let's say you're in the 15% tax bracket when you do the transfer, so it costs you $15,000 in taxes. We'll also say you can pay that bill from another account, so you're able to deposit the entire $100,000 in the Roth IRA. (If not, you'd only be able to roll $85,000 into the Roth account.)

The very next day, you could take your entire $100,000 deposit out of the Roth IRA tax-free.

But of course you hope you won't have to do that ... because the Roth conversion only makes financial sense if your earnings in the account ultimately exceed the $15,000 tax you paid to do the transfer. That's very unlikely to happen if you must start emptying the Roth account right away. 

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.

 

 

Are Mom's Assisted Living Expenses Tax Deductible?

Q: My mother lives in a assisted living facility, where she gets 24/7 care. My brother, my sister and I each pay about $1,800 a month towards her upkeep. Are we entitled to any tax deduction? JJ via email

 

A: Maybe.

If your mother's 2011 income (not including her Social Security benefit) is under $3,700, another taxpayer who pays more than half of her total living expenses can claim her as a dependent and take an itemized deduction for her medical expenses.

You’re splitting those expenses among the three of you; so no one is paying more than 50% of her support. But each of you is paying more than 10%. If you file a Multiple Support Declaration with the Internal Revenue Service,  you can take turns claiming her as a dependent.

A couple of caveats:

You’ll have to ask the assisted living facility how much of your mother’s monthly bill qualifies as a medical expense. (The entire cost is only deductible if her doctor certifies that she must live there because she can't perform “activities of daily living” – like washing or getting dressed – without help.)

And bear in mind that medical expenses are deductible only to the extent that they are a) unreimbursed;  and b) exceed 7.5% of your income.

For example, let’s say it’s Joe’s turn to claim Mom as a dependent this year, and he writes a $5,400 monthly check to the nursing home. If his two sisters reimburse him for their respective $1,800 shares, Joe can only claim a medical deduction for his own $1,800 share. And he can’t actually take the deduction unless his total unreimbursed medical expenses exceed 7.5% of his income.

For more information about potential tax breaks for adult children who are giving financial help to their parents, see my Reuters article, 'Caring for Mom and Dad Can Activate Tax Breaks'.

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.

There Are Only Three Reasons to Own Life Insurance

Q: Does it make sense for me to keep paying for a life insurance policy now that I'm 67 years old, my kids are grown and my mortgage is paid off? --OR, via email

A: Maybe not. At the very least, it's sensible to reassess your insurance needs at this stage of life, especially if you own a permanent policy -- a combination of a death benefit and a tax-deferred investment.

There are three basic reasons to own life insurance:

A) To replace your salary for your dependents when you die.

This is crucial when you're a breadwinner with a young family. If this is your reason to own life insurance, your best purchase is a term policy -- insurance with no investment component -- because it provides the biggest death benefit at the smallest cost. Permanent policies are much more expensive. The cost of term insurance rises as you age, but even in your 50s it's often the cheapest coverage available.

B) To make sure your heirs have cash to pay your estate taxes. 

Few people have to worry about how their survivors will pay estate taxes, because most people don't leave taxable estates. There is no estate tax on the assets you leave to your spouse. And under current law, what you leave to everyone else isn't subject to federal estate tax unless its value exceeds $5 million. True, the current law expires in 2013. And some states impose a tax on smaller estates. New York's estate tax law applies to estates worth more than $1 million, for example.

But even if your estate is taxable, buying life insurance to pay the taxes isn't a no-brainer. If the estate includes liquid assets, you might decide to let your heirs pay the taxes out of their inheritance. On the other hand, you may want to consider a life insurance policy if your survivors would be unable to pay the estate taxes without selling your business or taking taxable withdrawals from your IRA. 

(One caveat: If you want life insurance to pay your estate taxes, you must not own the policy yourself. A policy intended to pay your estate taxes should be transferred to another person or to an irrevocable life insurance trust -- after you've consulted a tax professional to make sure the transfer won't inadvertently trigger gift or income taxes.)

C) To invest on a tax-deferred basis.

If your kids are grown and your other assets are sufficient to provide for your surviving spouse, this is the main reason for still owning life insurance. 

So how good an investment is it?

That depends on your policy, says Richard Freeman, a fee-only financial planner at Round Table Services in Westport, Connecticut.

When you bought it, you saw a policy illustration showing how your investment (or cash value) would grow. But the illustration was a marketing tool, not a guarantee. Here's Freeman's explanation of how permanent insurance works:

Your premiums go into an investment box, from which the cost of insurance and expenses is deducted every month.

If things go worse than expected -- if the cost of insurance and expenses rises more than anticipated, for example, or if the investments underperform because, say, the financial markets crashed -- one of three things will happen: You'll have to pay higher premiums, or take a lower death benefit, or you won't be able to pull as much cash out of the policy as you expected.

If things go better than expected, you'll have the option to pay smaller premiums, or to increase your death benefit, or you'll have more cash to tap.

To find out how your policy is performing as an investment, you need an objective appraisal by someone who understands insurance but isn't paid to sell it -- i.e., not an agent. If your policy represents a substantial investment, it's worth paying a fee-only adviser like Richard Freeman or Glenn Daily for an in-depth analysis and assessment of your options. (One choice that sometimes makes sense, for example, is to exchange your life insurance policy for an annuity.) Fee-only advisers typically charge $200 to $300 per hour. If your policy isn't big enough to justify that expense, a much simpler but equally objective assessment from the Consumer Federation of America (CFA) will cost you only $85.  

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