Lynn Brenner's Family Finance

An Expensive Mistake: Waiting Until Cobra Expires to Enroll in Medicare

Q: I am currently employed and have health benefits. As of December 31, I’ll longer be employed, and my company has offered to pay my Cobra benefits for 8 months.  Do I have to sign up for Medicare on January 1 and have Medicare as my primary coverage? Or can I wait without penalty and sign up for Medicare when my Cobra is over? 

Also, I understand that the fee for Medicare is based on your salary two years earlier. Will my Medicare premium be adjusted downwards in two years, after my salary is no longer substantial? --CD, via email

 

A:  Depending on when you turn 65, it can indeed be a costly mistake to postpone your Medicare application until your Cobra coverage expires.

To explain why, let's start with the general Medicare enrollment rule for people who are employed:

If you're covered for health insurance through a company with 20 or more workers for whom you or your spouse is actively working [my emphasis added], that group coverage is primary even after you turn 65. But you must sign up for Medicare not later than eight months after the termination of your employer-sponsored coverage or your job, whichever comes first.

People often assume that this means after they leave a job, they can stay on Cobra for at least eight months before applying for Medicare. It’s an easy mistake to make – but it is a mistake!

The key words in the rule are 'actively working'. True, with Cobra you're still insured in your former employer's group plan -- but you're no longer actively working. The result is that as soon as you turn 65, your Cobra coverage becomes secondary to Medicare.

Anyone who will turn 65 while on Cobra should enroll in Medicare the month before his or her birthday. Medicare coverage begins the month after you enroll. By signing up the month before your birthday, you avoid any gap in coverage.

Three bad things can happen if you postpone your Medicare enrollment while you're on Cobra:  

The first is that after you turn 65, you'll be without primary health insurance. People usually learn this in a very unpleasant way: Their Cobra policy suddenly rejects their medical claims on the grounds that Medicare should be their primary coverage.

The second is that it may not be possible to sign up for Medicare as soon as you get this bad news. If you didn't enroll in Medicare within the three months before or the three months after your 65th birthday, your next opportunity is general enrollment, which takes place between January 1 and March 31, for coverage that starts July 1. In other words, depending on the timing, you could face up to 15 months without health insurance.

The third is that you pay more for Medicare when you enroll late. Your Medicare Part B premium is permanently 10% higher for each 12 months that have elapsed since your original enrollment deadline. If you enroll two years late, you'll always pay 20% more for Part B coverage.

The Part B monthly premium is currently $110.50 for individuals with income up to $85,000 and married couples with income up to $170,000. As you say, more affluent taxpayers pay more. (You'll find the details here.) The highest monthly premium is $353.60, currently paid by individuals and married couples whose respective income is $214,000 and $428,000.

The Social Security Administration uses the income reported on your tax return two years earlier to determine your premium -- so your 2013 premium will be based on your 2011 income.

One suggestion: It sounds as if your employer has offered to pay for eight months of Cobra coverage as part of your severance. If it would be more helpful to you, why not ask if the company will instead pay the same amount towards your Medicare Part B premiums?

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

What Happens if You Inherit an IRA from a Trust and the Previous Owner Didn't Take His Last Annual Distribution?

Q: My father passed away in July, leaving an IRA in trust that is to be divided amongst the three children.  We intend to divide the inherited IRA (carefully), and we know we will have to take mandatory distributions starting on December 31, 2011.

My father was over the age of 71 when he died, and had not yet taken his mandatory distribution for this year (2010).  My question is:  Do we need to take a mandatory distribution from the undivided IRA this year in the amount my father would have had to take? Or do we ignore the distribution this year and start our mandatory distributions individually next year? --SK via email

A: It's never a good idea to ignore a required IRA distribution!

After you turn 70 and a half, you must take a yearly minimum distribution from your IRA, and the year of your death is no exception. If you die before taking your required minimum distribution, your heirs must take it for you.

You say your father was over 71 when he died. Assuming he turned 70 and a half in 2009, he did indeed have to take a minimum 2010 IRA distribution.

Your deadline for taking his 2010 distribution for him is this December 31. To calculate the correct amount for that distribution, use the Uniform Table for Determining Lifetime Distributions. It's at the back of IRS Publication 529, which you can download here.

That actuarial table is only for IRA owners. To calculate your own required distributions, you and your siblings should use the Single Life Expectancy Table For Inherited IRAs, which you'll find in the same publication. As you say, your deadline for taking your distributions is December 31, 2011 -- the end of the year after your father's death.

Your father left the IRA to a trust to be divided between his three children. Assuming the wording of the trust allows it, each of you can take his or her share as an Inherited IRA -- but all three of you must use the life expectancy of the oldest to determine your required distributions, says Barry C. Picker, a Brooklyn tax accountant and IRA expert. (Other IRA owners, take note: That's one of the drawbacks of leaving an IRA to a trust for several beneficiaries. They can't each base required distributions on their own life expectancies.)

To determine the correct amount, divide your share on December 31 of the previous year -- i.e., 2010 -- by the life expectancy factor on the IRS table.

If the oldest will be 49 in 2011, for example, his life expectancy factor is 35.1. 

If your share of the IRA is $25,000 on December 31 2010, your minimum annual withdrawal in 2011  would be $712.25 -- $25,000 divided by 35.1. Every year, your withdrawal will be based on the account balance at the end of the previous year; and every year, you'll reduce the original life expectancy factor by 1. (In 2012, your life expectancy factor will be 34.1; in 2013, it will be 33.1, etc.)

Of course, you can always take out more than the minimum. And as an IRA beneficiary, you don't own an early withdrawal penalty on distributions regardless of your age.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

Social Security: Postponing Your Benefit Helps Your Surviving Spouse

Q: My wife and I used the strategy of her taking early Social Security benefits when she turned 64 based on her own earnings record, while I completely deferred my benefit from my own earnings record, which is significantly higher than my wife's benefit. I'm four years older than she is, so I was over 66 when she applied for her benefit and able to apply for 50% of her benefit as her spouse. This strategy has been recommended by several financial planners.

Now that I'm turning 70, I've applied for my own benefit. The Social Security Administration is telling us that although I will benefit from the deferral, my wife will not. It seems her benefit as my spouse is 50% of the amount I would receive at age 66, but only about 35% of my benefit at 70.  Is that correct? --WG via email

 

A: Yes. Nevertheless, your wife definitely stands to gain as a result of your strategy -- and not just because it has boosted your household income.

It's true that your bigger benefit won't increase her spousal benefit during your lifetime. Your benefit gains 8% a year for each of the four years you postpone taking it between the time you turn 66 and the time you turn 70 -- but her maximum spousal benefit is 50% of what you would have received at your full retirement age of 66.

However, she will certainly benefit if she survives you: her maximum widow's benefit is 100% of what you were entitled to when you died. That will be a much larger amount as a result of your deferral.

People who are contemplating the strategy you've used sometimes ask me if it isn't a gamble. 'What if I decide to postpone my Social Security application at 66, and then die before I turn 70?'' they ask. 'Won't it all have been for nothing?'

From your viewpoint, perhaps, since you personally will never reap the extra benefit. But it will make a big difference to your surviving spouse. He or she will receive 100% of the amount you were entitled to get at the time you died, regardless of whether you had actually applied for it. An example: Your benefit at 66 is $2,000 a month; but you defer your application. Unhappily, you die at 68. Your survivor will receive $2,320 a month -- 16% more than if you had taken Social Security at age 66. 

And of course, annual inflation adjustments in that survivor's benefit will be based on a bigger initial amount. Over time, that too will make a substantial difference in his or her monthly income.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

At What Age Can I Move My IRA Penalty-Free From One Bank to Another?

Q: I have traditional and Roth IRAs of my own, and I have also inherited some traditional IRAs. I am currently taking annual distributions from the inherited IRAs based upon my own life expectancy. Here are my questions: 

When I reach age 59 1/2, I understand that I can "move around" all IRAs (traditional, Roth, and Inherited) without any penalty. Is that correct? Is there any special treatment for moving Inherited IRAs from one bank to another? Now that bank interest rates are slowly creeping up, after I turn 59 and a half I'd like to move some IRAs that are invested in CDs currently earning low interest rates. Are there any tax consequences if I do this? Will I have to file anything with the IRS when I move an IRA from one bank to another?

If I have four IRAs in four different banks, is there any rule against moving all of them in the same year?  Is there a limit on the number of times I can move each IRA in one calendar year?

Are there any penalties in "breaking" any of the IRA CDs before their maturity dates?

At what age can I take out some of my own IRA money without penalty? I know that any money I take from the traditional IRAs have to be reported on my tax returns. But am I right that I don't have to report my withdrawals from the Roth IRAs? --DM, via email

A: You don’t have to wait until you’re 59 and a half years old to move the IRAs you own from one provider to another without triggering any taxes or any tax penalty. An IRA owner can do that at any age.

It's not always possible for a beneficiary to move Inherited IRAs, however, as I’ll explain in a moment.

But even though there is no tax penalty, you may trigger a provider's early withdrawal penalty depending on how your IRA is invested.  A prime example is moving a CD before its maturity date. The only time banks waive this penalty -- and not all of them do -- is if you must ‘break’ a CD before maturity in order to take a required distribution from an IRA after you turn 70 and a half years old. 

You don’t have to file anything with the IRS when you transfer an IRA between providers. And there’s no limit to how many times you can move each IRA in a single calendar year – although moving four IRAs several times a year would require a high tolerance for filling out financial services providers’ paperwork.

The best way to move an IRA from one provider to another is in a trustee-to-trustee transfer: You want to move an IRA from Bank A to Bank B. You open a new IRA at Bank B, and then Bank B asks Bank A to transfer your IRA money into the new account.

Alternatively, you can take a check from Bank A and deposit it in a new IRA in Bank B. But in that case, to avoid taxes you must deposit the entire amount in a new IRA within 60 days. (This is called the 60-day rule.)

You can start withdrawing money from your own traditional IRAs without incurring a 10% early withdrawal tax penalty as soon as you turn 59 and a half. But the amount you withdraw is taxable income. (The IRA custodian reports IRA withdrawals to the IRS – so don’t omit it from your tax return in the hope that you can avoid paying taxes on it.)

Your Roth IRA withdrawals are all tax free after you turn 59 and a half and have owned the account for five years. You don't have to report them to the IRS.

Okay, so what about moving an Inherited IRA from one bank to another?

The IRS has no objection to your doing this, as long as you put the new Inherited IRA account in its original owner's name, listing yourself as the beneficiary. But occasionally, the bank’s rules don’t allow IRA beneficiaries to do a trustee-to-trustee transfer; this doesn't happen often, but it does happen. Unlike an IRA owner, an IRA beneficiary cannot use the 60-day rule to avoid taxes on a transfer. In other words, by refusing to allow trustee-to-trustee transfers, a bank with this rule makes it impossible for a beneficiary to move an Inherited IRA without triggering taxes.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved