For many folks, starting to receive Social Security as early as possible is important – even if they’re still actively working and earning a living.

Something happens when you do this though: depending on how much you’re earning, you will be giving up a portion of the Social Security benefit that you would otherwise receive.  Up to the year that you will reach Full Retirement Age, for every two dollars that you earn over the annual limit ($14,640 for 2012, or $1,220 per month), your Social Security benefit will be reduced by one dollar.

Then in the year you will reach Full Retirement Age (FRA) there is a different income limit – actually $3,240 per month.  For every three dollars over that limit, your Social Security benefit will be reduced by one dollar – up until the month that you actually reach FRA.  Once you’ve reached FRA, there is no income limit, and you can earn as much as you want, without any of the reductions that are applied to earnings prior to FRA.

These reductions aren’t  lost – you’ll actually get credit for them later on at FRA.  So if you’re earning enough (for example) to reduce your benefit down to a point where your benefit is eliminated, you’ll get credit for that “lost” month once you reach FRA.

As you most likely already know, your Social Security benefit is reduced based upon the number of months prior to FRA that you’ve applied for and begin receiving benefits.  For every month that your benefit is eliminated (or reduced and withheld by SSA) prior to FRA, these months will be credited back to your account, reducing the number of months that were originally used to calculate your reduced early retirement benefit.

As with all of these explanations, an example is in order.  Dick, age 62, has a Primary Insurance Amount of $2,000.  When he files for benefits at age 62 his benefit is reduced by 25%, to $1,500.  Dick is still working, and his job pays him $60,000 per year ($5,000 per month).  With that income, Dick’s Social Security benefit will be reduced by $2 for each dollar over $1,220 that he earns.  So $5,000 minus $1,220 equals $3,780, so his benefit will be reduced by $1,890 – more than his benefit.  This means his benefit will be completely withheld.

When Dick reaches FRA, assuming he’s continued earning at that same pace up to that point, he will begin receiving his benefit at the same amount as if he had waited until FRA to apply for the benefit.  This is because he’s gotten credit back for all of those months that he had his benefit withheld.

Why would Dick do this, you might ask?  One reason might be if he had dependents, such as his wife and/or children, that could receive benefits based on his record if he’s actively filed.  Even though his benefit is being withheld, the dependents’ benefits can continue – these benefits are limited by the income of the individual receiving them.  So if his wife was receiving Spousal Benefits based on his record, she would have the same earnings limits as listed above, and the same goes for the children.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Did you know that there is a specific order for distributions from your Roth IRA? The Internal Revenue Service has set up a group of rules to determine the order of money, by source, as it is distributed from your account.  This holds for any distribution from a Roth account.

Ordering rules

First, over-contributions or return of your annual contribution for the tax year.  This means that if you’ve made a contribution to the Roth IRA in the tax year, the first money that you withdraw from the account will be the money that you contributed that year.  If you over-contributed to your account a prior year. Growth on this over-contribution or annual contribution needs to be removed at this time as well, with tax and penalty paid as required.

Second, regular annual contributions to the account.  The next money that comes out is the total of all of the money you’ve contributed to the Roth IRA over the years. Of course, this is reduced by all previous distributions from the account.  This amount would include rolled over contribution amounts from other Roth IRA or Roth 401(k) accounts. Growth (interest, capital gains, or dividends) on these contributions comes out later.

Third, tax-free converted amounts from IRAs or 401(k) accounts would be distributed.  Only the amount of the conversion is counted at this point.  As with the contributions, the growth or earnings within the account comes out last.

Fourth, conversion amounts that were taxed at the time of the conversion are distributed.

Fifth and last, earnings, capital gains, and growth on your contributions will be distributed.  This is everything left in the account after the other categories of funds have been removed.

Here’s an example: Jane, age 50, has a Roth IRA with a balance of $50,000.  She has made annual contributions to the account over the years in the amount of $25,000 – part of which was a contribution this tax year of $5,000.  She also made a conversion into this account with $10,000, all taxed, from an IRA a couple of years ago.

When Jane takes money out of the account, she can remove this year’s contribution of $5,000 first of all – no tax on that distribution.  After that, the remaining $20,000 of contributions to the account would come out, also tax free.  This money is followed by her conversion of $10,000.  If it’s been less than five years since the conversion, there will be a 10% penalty on the conversion since she’s under age 59½.  Any withdrawal above and beyond $35,000 would represent growth and earnings on the account, which would also be subject to the penalty since she’s under age 59½.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

The IRS recently produced Tax Tip 2012-08, which talks about scams you need to be aware of, really heinous contacts where the scammers pretend to be the  IRS.  But here’s the key: the IRS doesn’t use email as the regular communication to deliver notices of deficiency, requests for additional information, and the like.  The IRS is big about the paper notice – you’ll recognize it immediately, with the official IRS seal and all.

The information that the IRS presents is good to know, you should be familiar with what they have to say.

Here is the text of the tax tip:

Don’t be Scammed by Cyber Criminals

The Internal Revenue Service receives thousands of reports each year from taxpayers who receive suspicious emails, phone calls, faxes or notices claiming to be from the IRS.  Many of these scams fraudulently use the IRS name or logo as a lure to make the communication appear more authentic and enticing.  The goal of these scams – known as phishing – is to trick you into revealing your personal and financial information.  The scammers can then use your information – like your Social Security number, bank account or credit card numbers – to commit identity theft or steal your money.

Here are five things the IRS wants you to know about phishing scams.

1. The IRS never asks for detailed information like PIN numbers, passwords or similar secret access information for credit card, bank or other financial information.
2. The IRS does not initiate contact with taxpayers by email to request personal or financial information.  If you receive an email from someon claiming to be the IRS or directing you to an IRS site:

• Do not reply to the message.
• Do not open any attachments.  Attachments may contain malicious code that will infect your computer.
• Do not click on any links.  If you clicked on links in a suspicious email or phishing website and entered confidential information, visit the IRS website and enter the search term ‘identity theft’ for more information and resources to help.

3. The address of the official IRS website is www.irs.gov.  Do not be confused or misled by sites claiming to be the IRS but ending with .com, .net, .org, or other designations instead of .gov.  If you discover a website that claims to be the IRS but you suspect it is bogus, do not provide any personal information on the suspicious site and report it to the IRS.
4. If you receive a phone call, fax, or letter in the mail from an individual claiming to be from the IRS but you suspect they are not an IRS employee, contact the IRS at 1-800-829-1040 to determine if the IRS has a legitimate need to contact you.  Report any bogus correspondence.  You can forward a suspicious email to phishing@irs.gov.
5. You can help shut down these schemes and prevent others from being victimized.  Details on how to report specific types of scams and what to do if you’ve been victimized are available at www.irs.gov. Click on “phishing” on the home page.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

In case you don’t know what a 72t distribution is, this is shorthand for the Internal Revenue Code Section 72 part t, and the most popular provision of this code section is known as a Series of Substantially Equal  Periodic Payments – SOSEPP for short.

Enough about the code section already.  What is this thing?  A SOSEPP is a method by which you can access your IRA funds prior to age 59½.  In order to take advantage of this rule, you determine the amount of the annual distribution from your IRA (this is done in a prescribed manner, more on this in a bit) and then begin taking the distributions.  Once you start the SOSEPP, you have to keep it going for the longer of five years or until you reach age 59½.

Methods of Distribution

There are three ways that you can determine the amount of the distribution from your IRA, and all are based upon the balance of the IRA account and your age.  The first method is the simplest, known as the Required Minimum Distribution method.

The Required Minimum Distribution method for calculating your Series of Substantially Equal Periodic Payments (under IRC §72(t)(2)(A)(iv)) calculates the specific amount that you must withdraw from your IRA (or other retirement plan) each year, based upon your account balance at the end of the previous year, divided by the life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year. This annual amount will be different each year.

The second method is called the Fixed Amortization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account, from which you then create an amortization schedule over a specified number of years equal to your life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

The third method is similar to the second, but it is called the Fixed Annuitization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account and an annuity factor, which is found in Appendix B of Rev. Ruling 2002-62 using the age you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you’ve calculated your annual payment under one of the two fixed methods, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

An Important Note

It’s important to know that the amounts you’ve calculated are and will be the exact figures for your payments from the account, no more, no less.  It’s not allowable to simply name your own amount and take that each year – you have to use the prescribed amount from one of the methods.

The way to impact the amount of the payment is to adjust the balance in the IRA.  If you have more than one IRA available, you can rollover funds into one account and therefore increase or decrease your payment.  This has to be done prior to establishing the SOSEPP though – it’s not allowed to deposit money into or remove funds from your IRA while the SOSEPP is in place (well, other than the required payments from the account each year).

Any deviation from the prescribed payments will cause the SOSEPP to be “busted”, which can result in some not-so-nice consequences – which you can read more about here.  For more about the SOSEPP, see the IRA Owner’s Manual.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

I’ve received a lot of questions about this. Apparently as folks file their returns for the year, they are finding a difference in the amount of refund that they are due to receive this year versus last year.  And as they look for answers, they often focus on the Earned Income Credit (EIC) and wonder if something changed.

The answer is – very little changed.  Certainly nothing that would have a significant impact on your income tax refund.  There was one significant change, in that beginning in 2011 there was no advance payment of the EIC – in years past it was an option available for the taxpayer to receive his or her EIC in advance payments throughout the year rather than waiting until the tax return has been filed.  Beginning with 2011, you have to wait to receive the EIC payment.

Other than that, the credit tables changed slightly, but this would likely increase your EIC rather than decrease it.

Nothing else changed about the EIC in 2011.  You need to look elsewhere for whatever is different about your return.

Nothing is changing for 2012 either.  Beginning with 2013 (under current law) the additional EIC available for the third child will no longer be available, and we’ll revert back to the way the old rules worked.  But let’s wait until next year to worry about that one.

Hope this helps.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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All future Social Security recipients face this question at some point:  When should I file for benefits?

As you are likely aware, age 62 is the earliest that you can file for benefits.  By filing at this age, you will begin receiving your benefit at a reduced amount – perhaps as much as 30% reduced.

Waiting to file until your Full Retirement Age (FRA) will allow you to receive the full benefit amount, without reductions.  You could also wait until age 70 to file for benefits, which would result in an overall increase to your monthly benefit amount, by as much as 32% in some cases.  Granted, you will have foregone several years’ worth of payments if you wait to file at some age later than 62, but on average, it all works out about the same (with a few exceptions).

The way that these reductions and increases are designed is to ensure that, on average, all Social Security recipients, regardless of the age that they begin receiving benefits, ultimately receive roughly the same amount of benefits during their lifetimes.  This is all calculated by actuaries, and it involves the population’s average lifespan.

So if you start receiving your benefit earlier, even though it’s reduced you’re receiving it for a longer period of time than waiting until later.  On the other hand, if you delay filing until FRA or age 70, your benefit is greater each month, but you’ll be receiving it for a shorter period of time.  Eventually these strategies “cross over” – that is, one method begins to work more in your favor than another – at around age 82.

What I mean by that is that, filing earlier at the reduced rate will pay you more in overall benefits up to age 82, at which point the later filing ages will begin paying you more over your lifetime.  If you take into account the annual cost-of-living adjustments (COLAs), the break-even point is actually quite a bit lower, possibly as early as age 76.  This is due to the fact that the COLA is a percentage applied to your monthly benefit – and if your monthly benefit is reduced by filing early, your COLA adjustments will be smaller as well, and vice versa when you file later.

So if you plan to live past age 76, it most likely is in your best interest to wait until the latest point to file for your benefit.  And if you need more reasons to consider delayed application, read on.

Survivor Benefits

One additional reason that you might want to delay applying for your benefit is if you have family members that will depend upon your benefit upon your passing.  This is due to the fact that your survivors’ benefits are based upon the actual benefit that you were receiving at your death.  So, if you delayed filing for benefits and therefore received a higher benefit amount, your surviving spouse (and other family members, if eligible) will receive a higher benefit amount for the remainder of his or her life, assuming that the Survivor Benefit is greater.

This gives you another reason that delaying benefits could be the better option.  Otherwise, if your benefit is the same as or smaller than your spouse’s benefit, or if you don’t have a spouse, then it’s up to you: if you think you’ll outlive the average, it’s better to wait.  If you don’t think you’ll live that long, then start as early as you like.

* The above review doesn’t take into account a situation where you may still be working while receiving Social Security retirement benefits.  I’ll cover that in another article.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Financial planning often requires us to face our own certain demise – something that we often don’t want to do, but still a certainty that we all must face.

Among the things that we want to do when planning for the inevitable would be to make certain that our surviving loved ones have access to adequate monetary resources to support themselves, in the most cost-effective manner.  Another thing that we hope to accomplish is to make the transition as easy as possible for our loved ones.  One way to do this is to convert a good portion of your IRA or other tax-deferred funds to a Roth IRA account.  Here’s why:

By converting to a Roth account, you will make the funds in that account available to your heirs totally tax free.

Granted, your estate will also be smaller by the amount of tax that you paid on the conversion.  At the same time, your heirs will also not have to go through the rather painstaking process of managing the IRD deduction, if the estate is of a size that requires estate tax to be paid.  This will simplify the overall process dramatically, and depending upon the size of your overall estate this could be a significant.

On the downside of this, it’s likely that if you convert your account in a single year the tax paid on the conversion would be much, much higher than if your heirs paid tax on the ordinary required distributions if the account is left as a traditional IRA.

However, if you converted your account over several years in smaller amounts using a strategy like filling up the brackets, the overall tax cost of the conversion will be less, maybe even less than the cost that your heirs would experience otherwise.

You can always use recharacterization strategies to make sure that the whole process is as tax-efficient as possible. And in today’s tax climate (and market volatility) there are literally very few reasons not to go ahead with a Roth conversion strategy.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

When filling out your tax return this year, you may have questions about dependents – such as who can be claimed on your return.  Claiming a dependent can have a significant impact on your return, including increasing exemptions and possibly increasing certain credits like the Earned Income Credit and various others.

The IRS recently published Tax Tip 2012-07, which lists six facts about dependents and exemptions.  Below is the list of facts:

1. Exemptions reduce your taxable income. There are two types of exemptions: personal exemptions and exemptions for dependents.  For each exemption you can deduct $3,700 on your 2011 tax return.

2. Your spouse is never considered your dependent.  On a joint return, you may claim one exemption for yourself and one for your spouse.  If you’re filing a separate return, you may claim the exemption for your spouse only if they had no gross income, are not filing a joint return, and were not the dependent of another taxpayer.

3. Exemptions for dependents. You generally can take an exemption for each of your dependents.  A dependent is your qualifying child or qualifying relative. You must list the Social Security number of any dependent for whom you claim an exemption.

4. If someone else claims you as a dependent, you may still be required to file your own tax return.  Whether you must file a return depends on several factors including the amount of your unearned, earned or gross income, your marital status, and any special taxes you might owe.

5. If you are a dependent, you may not claim an exemption. If someone else – such as your parent – claims you as a depndent, you may not claim your personal exemption on your own tax return.

6. Some People cannot be claimed as your dependent. Generally, you may not claim a married person as a dependent if they file a joint return with their spouse. Also, to claim someone as a dependent, that person must be a US citizen, US resident alien, US national or resident of Canada or Mexico for some part of the year.  There is an exception to this rule for certain adopted children.  See IRS Publication 501, Exemptions, Standard Deduction, and Filing Information for additional tests to determine who can be claimed as a dependent.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Note: you can find the first part of this discussion of Social Security Survivor Benefits at the link.  Part 1 covered the basics of Survivor Benefits, and this article covers other considerations with the Survivor Benefit, including non-spouse survivor’s benefits and coordinating the Survivor Benefit with your own benefit.  As mentioned in the prior articles, don’t expect to fully understand these calculations and definitions in the first run-through. Check over the other articles (Part 1 here, Spouse Benefits here and especially the further explanation of Spouse Benefits here) for more information, and post questions in the comment section if they come up.

Coordinating the Survivor Benefit With Your Own Benefit

The Survivor Benefit is exclusive of the surviving spouse’s own retirement benefit.  If the surviving spouse is eligible for a retirement benefit that is greater than the Survivor Benefit, only the greater of the two will be payable.

Technically the surviving spouse can choose between the two benefits, if he or she is eligible for both at the same time.  This can work to the surviving spouse’s advantage if the Survivor Benefit was taken early. By starting the Survivor Benefit early, the Surviving Spouse could wait to take his or her retirement benefit, allowing this retirement benefit to earn the delayed retirement credits up to age 70. This generally amounts to an increase in the retirement benefit of 8% for each year delayed beyond Full Retirement Age.

Here’s an example – Dick and Jane, both age 62 with retirement benefits available when they reach Full Retirement Age of $2,000 and $1,300, respectively.  Neither of them has filed for Social Security retirement or Spousal Benefits.  Dick has recently passed away.

If we run the calculation, we find that Dick’s current-age benefit would have been 75% of his Full Retirement Age benefit of $2,000 since he would be 62 at this date.  (You can take my word for this reduction, or you could look it up on the table in the earlier article.)  Then, if Jane was to apply for Survivor Benefits at this age, her benefit would be further reduced by the early filing, a 19% reduction from the table above.

So here’s the calculation for the Survivor Benefit:  Dick’s Full Retirement Age Benefit is $2,000, reduced to 75%, or $1,500.  That amount is then reduced by the 19% reduction factor, since Jane is filing early for Survivor Benefits, to total $1,215.

Notice that Jane’s own benefit at Full Retirement Age would be greater than this reduced Survivor Benefit – but at this point, her own benefit would be 75% of $1,300, or $975.  So Jane could start taking the reduced Survivor Benefit now, and then later at Full Retirement Age she could switch over to her own retirement benefit, which would be the full $1,300 (plus Cost-of-Living Adjustments), or even later to age 70 when the delayed retirement credits would apply, making her own benefit even greater.

Non-Spouse Dependents

Survivor Benefits aren’t only for spouses.  Other dependents can be eligible for Survivor Benefits as well.  These dependents include children, grandchildren, and even parents, if they qualify.  Just like leaving a sinking boat, children first.

Children

The children of a deceased Social Security participant can be eligible for a Survivor Benefit of 75% of the participant’s Primary Insurance Amount or PIA (effectively the amount of benefit that the participant would receive at Full Retirement Age) if the child is under age 18.  As long as the child was the dependent of the deceased participant, whether his or her own son or daughter, step-child, or grandchild, and the deceased participant provided at least half of the support for the child, this Survivor Benefit is available.  The child didn’t have to live with the late parent to be eligible.

In addition, the surviving mother or father of the dependent child described above is also eligible for a Survivor Benefit at any age, equal to 75% of the Primary Insurance Amount of the deceased participant.  This benefit is available until the child or children are age 16 (no age limit if the child is disabled and entitled to benefits).  The only remaining qualification is that the surviving spouse and the deceased participant must have been married for at least 9 months (less if the death is accidental).  A divorced spouse can receive this benefit if he or she was married to the decedent for at least 10 years.

Parents

The parents of a deceased participant may be eligible for Survivor Benefits as well, if they were considered dependents of the deceased.  If the parents were receiving more than half of their support from the deceased participant and they are over age 62, they can be eligible for this benefit.

If there is only one parent surviving the participant, the Survivor Benefit is equal to 82.5% of the Primary Insurance Amount of the deceased participant.  If there are two surviving parents and both are eligible, each would receive a benefit of 75% of the Primary Insurance Amount.

This benefit is exclusive to any retirement benefit that the parents may have available to them.  If the parent is eligible for a retirement benefit that is greater than the Survivor Benefit, he or she (or both of them) may receive the Survivor benefit at age 62 (with no reduction) and then later switch over to the retirement benefit at Full Retirement Age or later.

Maximum Family Benefit

Each of these Survivor’s Benefits could be limited by a Maximum Family Benefit that each family unit must adhere to.  Essentially there is a limit prescribed by the Social Security Administration on the amount of benefits, based upon the deceased participant’s Primary Insurance Amount (a good explanation of the Primary Insurance Amount and Full Retirement Age can be found by clicking this link).  The Maximum Family Benefit ranges between 150% and 180% of the Primary Insurance Amount.  Once total benefits exceed the limit, each recipient’s benefit is reduced by the same ratio down to the limit.  For a detailed explanation of the Maximum Family Benefit, click the link.

So that completes our discussion of Survivor Benefits.  For more information on any of these factors, click the links within the text above – and you can also find all of this information in the book A Social Security Owner’s Manual.  If you have comments and questions, I invite you to leave post them below and we’ll try to work out answers for you.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

When you have a 401(k) plan that contains stock in your company, there is a special provision in the tax law that may be beneficial to you. This special provision is called Net Unrealized Appreciation, or NUA, treatment. It allows you to take advantage of potentially lower tax rates on the growth, or unrealized appreciation, of the stock in your company.

When your company stock is withdrawn from the account, you pay ordinary income tax only on the original cost of the stock. Then later when you sell the appreciated stock at a gain, you pay capital gains tax (at a lower rate) on the growth in the value of the stock.

The Way It Works

The distribution from your 401(k) must be a total Lump Sum Distribution in a single calendar year.  This means that your entire 401(k) balance, including not only the stock, but also any other funds in the 401(k) plan, must be withdrawn in one year.

Commonly the funds that are not company stock will be rolled over into an IRA or another 401(k) plan.  Only company stock (and only your company) can be treated with the NUA provision.

The company stock is moved into a taxable investment account – in kind.  This means that you move the actual stock rather than selling the stock and moving the money.  If you sell the stock before you move it, you won’t have NUA treatment available to you.

When you move the stock over from your 401(k) into a taxable account, you will have to pay ordinary income tax on the original cost of the stock.  This means that you need to know what is the basis (the amount you originally paid) for the stock.  Your company or 401(k) administrator will have this information for you.

Although the entire account has to be withdrawn in a single year, you don’t have to elect NUA treatment for the entire holding of company stock.  You could move only a portion of the stock if you choose to, and rollover the remaining stock to an IRA.  You may choose to do this because the amount of company stock is more than you care to pay ordinary income tax on during that tax year.  More on this a bit later.

An Example

For example, let’s say you have a 401(k) with a $500,000 balance.  $200,000 is invested in the stock of your company, and the basis is $100,000.  You can move the company stock into a taxable investment account, and pay ordinary income tax on $100,000.  If you’re in the 25% bracket, this would amount to $25,000.

The remaining $300,000 is rolled over to an IRA.  When you take money out of the IRA, as with any IRA, you’ll pay ordinary income tax on the money that you withdraw from the IRA.

At any point later you can sell the stock in the taxable account and pay tax at the capital gains rate, which is 15% these days, much lower than the ordinary tax rate. (That 15% rate is for long-term capital gains, and any stock that you elect NUA treatment for is taxed at that rate. This rate could be as low as 0% if you are otherwise in the 10% or 15% income tax bracket.)

Since paying tax on the entire $100,000 basis in your company stock would require a significant tax payment ($25,000 in our example), you might wish to work this out in a different fashion, reducing the tax.  Here’s where a twist to the tax code could REALLY be helpful – possibly eliminating taxation.

Basis Allocation Twist

When you move only a portion of the company stock, you need to allocate the basis between the NUA stock and that which was rolled over.  Since, in our example, the basis was $100,000 and the total company stock was worth $200,000, you could elect to rollover $100,000 worth of the stock to your IRA (along with the other $300,000 of funds), allocating the basis of $100,000 to the rolled over stock.  Then, when the remaining $100,000 of stock is moved from the 401(k) to the taxable account, there is no basis to be taxed at ordinary income tax rates.  The entire transaction has occurred without tax – and when you sell the stock, the entire value is taxed at capital gains rates.

This move is allowed because the tax law states that when there is a partial rollover of an account into an IRA, the rolled portion is “treated as consisting first of the portion that is includible in gross income” – meaning the basis in the stock, plus the other funds in the account.

So there you have it – Net Unrealized Appreciation in a nutshell.  If you need more details, you can check out the IRA Owner’s Manual for additional information.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

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