Lynn Brenner's Family Finance

How To Tap A Nest Egg For Annual Income In Retirement

Q: Do you have any advice on how to withdraw retirement income from a portfolio that combines a total bond fund, a total stock market fund, and a money market fund? – DA via email

 

A: There are no easy answers to this question unless you have so much money that you don't need to ask it. But there are sensible ways to approach the problem, which I'll discuss in the next several posts.

Let’s address it as three related questions: What’s the best way to invest your portfolio in retirement? What’s a practical method for taking annual withdrawals? And how much can you withdraw every year without running out of money?

You’re definitely on the right track with a portfolio that combines stocks, bonds, and cash; and I applaud what sounds like a decision to use index mutual funds. It's smart to invest as simply and as inexpensively as you can; and there's nothing simpler or less costly than index funds.

But I think you need more than three funds. In a very basic retirement portfolio, I'd consider owning three bond funds (one very short-term fund, one intermediate-term fund, and one Treasury Inflation-Protected bond fund), and at least two stock funds (one for U.S. stocks and one for international stocks.)

The ideal retirement portfolio, which I described in a recent article for AARP Bulletin, contains about five years’ worth of living expenses in cash and very short-term bonds, with the balance divided between stocks and longer term bonds.

"Five years is roughly the length of an economic cycle," explains Harold Evensky, a Coral Gables Florida financial planner. With five years worth of living expenses in liquid investments, you minimize the risk of having to sell stocks in the middle of a bear market. Selling at a loss is a calamity for retirees, who no longer have the time or the earnings to replenish their savings. To be sure, leaving your stocks untouched for five years doesn’t guarantee that you won’t lose money – but if you do, says Evensky, it’s unlikely to be a very big loss.  

Like all good rules of thumb, however, this one comes with a big caveat – a caveat that unfortunately applies to virtually every rule about investing: It doesn't work well if you don't have enough money.

Your cash and short-term bond investments shouldn’t exceed 50% of your total portfolio, says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. The reason: At least 50% of your savings have to be invested in stocks and longer-term bonds to ensure your portfolio will last as long as you do. 

If five years of your living expenses equals 80% your portfolio, Blayney says, your savings alone are insufficient to cover those living expenses throughout your retirement. You’ll therefore need to supplement your annual withdrawals with income from other sources, like a part-time job, the equity in your house, and Social Security. And that, of course, is the situation in which most of us can expect to find ourselves.

In my next post, I’ll describe the best practical method I know for taking annual withdrawals from your investment portfolio.

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 Are the Financial Pros and Cons of Marriage?

Q: My partner and I are in our late 50s, and have been together for 4 years. We plan to be together for the rest of our lives, but we're wondering what the ramifications of marriage would be on finances.

I'm especially concerned about my home, which is solely in my name and will be paid off in a few years. If we were married and my husband needed long-term nursing home care, would my home be an asset that might be lost? I seem to remember when my grandmother went into a nursing home in her final years, they required that her home be surrendered as payment. We have agreed that my home will eventually go to my children. I don't want to risk losing it.

Are there any other financial pros or cons we should be aware of when considering whether or not to legally tie the knot? -- CB via email

 

A:  I can give you some pointers, but you and your partner should to consult a lawyer about the specifics of your situation. Look for an estate lawyer who knows elder law, and is therefore familiar with your state's rules about nursing home care.

Here's my earlier post about how to find an estate lawyer.

You don't just need legal advice on how to protect your house in the event that either of you needs long-term care. You also need to put your agreement that your kids will ultimately inherit the house in writing -- not because you distrust your partner, but because state law will supercede your agreement unless it's in a legal contract.

Your marriage is a unique relationship that you create together. But it's also a legal partnership with rights and obligations regulated by the government.

By federal law, your spouse is legally entitled to be the beneficiary of your employer-sponsored retirement plans, for example. State laws require that you leave a certain percentage of your assets – typically at least one-third – to your spouse. As a married couple, you also have the option to file a joint income tax return, which may substantially reduce your total tax bill. You’re automatically entitled to be each other’s dependents for health insurance and other employee benefits. And you’re automatically entitled to Medicare, and to Social Security spousal and survivor benefits based on each other’s work records. These marital rights can all add up to a very pretty penny!

But of course the one-size-fits-all marital inheritance rights don't fit every family -- and you don't have to accept them. You can sign a prenuptial or postnuptial agreement -- a contract in which both of you agree to waive your legal entitlements, and create a plan that’s more appropriate to your situation.

Naturally, prenuptial contracts are particularly important for people who want to safeguard some of their assets for their children by a previous marriage.

A good prenuptial or postnuptial agreement protects your spouse as well as your kids. In your case, for example, your agreement could say that your children will inherit your house when you die, but that your husband will have the right to continue living there for his lifetime if he survives you. (If so, the agreement should also spell out who will be responsible for the cost of maintenance and capital improvements to the house while your surviving spouse lives there.)

A prenuptial and/or postnuptial agreement allows both of you to leave your solely-owned assets to anyone you wish. But it won't protect those assets from legitimate third party claims -- and these include claims from your spouse's medical providers. By state law, spouses are responsible for paying for each other's food, clothing, shelter and medical care.

An attorney familiar with your state's laws can tell you if there are legal steps you can take to protect your house from potential future claims. (One way might be to put your children on the deed now, for example.)  

From what you say about your grandmother, it sounds as if Medicaid paid for her nursing home care. Medicaid is a joint federal and state program that provides medical and long-term care based on financial need. (Don’t confuse it with Medicare. Medicare is a federal program whose benefits are not based on financial need; it provides medical coverage, but doesn’t cover long-term care.)

Although Medicaid rules are state-specific, in general you must spend most of your assets before you can qualify for nursing home benefits. Your house is an exception, however. Even if you are receiving Medicaid nursing home benefits, in most states your house cannot be sold to pay for your care as long as you affirm your intention to return there. And even after your death, Medicaid cannot enforce a lien against your house to recoup benefits that it paid for your care as long as your spouse still lives there.

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

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