Month: April 2014

My prior four posts have discussed how to withdraw money from your IRA (or 401K, or 403B, or MyRA, when it arrives, or any other tax-deferred account.)  See “IRAs and 401Ks are not for tax avoidance. They are for tax timing” from March 20, 2014, “IRAs and 401Ks – Withdrawing Money Too Slowly” from March 27, 2014, IRAs and 401Ks – Withdrawing Money Too Quickly from April 4, 2014, and IRA and 401k Withdrawal Strategy – Don’t be Stupid about It from April 11, 2014.  (As I’ve done before, to protect my poor tired typing fingers, I will call them all IRAs, but the discussion will apply to 401Ks, 403Bs, and even MyRAs (assuming that they act like IRAs when the rules eventually get written,) and other tax deferred accounts, except perhaps Roth IRAs.)  This week, I want to discuss why I, an elder law attorney, not a financial advisor, write (and worry) so much about IRAs.

LONG TERM CARE (the usual focus of elder law practice) is why I worry about IRAs.

As an elder law attorney, I help seniors (and sometimes non-seniors who have a disability) get long term care without losing their entire life savings.  I sometimes describe my job as helping people avoid a complete “financial bleed out” from the costs of long term care.  While I am preventing a financial bleed out, I also want to minimize losses of money to other expenses.  I often call these other expenses “financial leaks.”

One big financial leak is a big income tax payment triggered by a sudden withdrawal from an IRA.  That big tax leak is why I’ve spent the last several weeks writing about IRAs.

When someone needs long term care, their cost of living shoots through the roof.  In northeast Ohio where I live, the room and board cost (just the room and board) for a nursing home is usually between $6,500 and $9,500 per month.  That’s not counting prescriptions, doctor visits, incontinence supplies, and other non-room and board costs.  Costs for in-home care or for assisted living are not as high as for a nursing home, but in-home care and assisted living costs are still usually much higher than the patient’s/resident’s monthly income.  These long term care costs eat away (in small bites or in big mouthfuls) at a senior’s savings.

Many people use Medicaid (which has a different name in some states, like Medi-Cal or MaineCare) or VA Pension (more commonly known as Aid and Attendance) to help pay for long term care.  Both of these programs are available only to people with few assets.  (For Medicaid, it’s almost no assets.)  In most states, an IRA is counted as part of the assets.  (I understand that Florida and California do not include IRAs in the asset count.  I suspect that a few other states also exempt IRAs and other retirement savings accounts.  Ohio, where I work, counts IRAs as assets.)

When the IRA is counted as an asset, it must be depleted or reduced to help the senior qualify for Medicaid or VA Pension.  (An elder law attorney can help many seniors protect some of their assets, including contents of the IRA, but rarely can the money stay in the IRA and be protected.  It must usually come out.)  So, either with a spend-down to pay for long term care or an elder law attorney’s asset protection plan to shield some of the senior’s money, the IRA must usually be depleted or reduced quickly.  That means a big tax hit in one year (similar to what I describe in IRAs and 401Ks – Withdrawing Money Too Quickly from April 4.)  That’s a big financial leak that I try to help clients avoid.

And don’t try to be too smart about it.  Don’t expect that you can manage the IRA withdrawals to spread out the taxes over several years.  You won’t be able to get Medicaid.  The contents of the IRA will make you too “rich” to get Medicaid.

(Spreading out withdrawals over years might work for VA Pension because the asset amount that VA applicants can keep is much higher than Medicaid allows.  VA Pension rarely provides enough money for a nursing home stay, though.  It’s great for assisted living and for in-home care, but you’ll probably want Medicaid for a nursing home.)

You also probably won’t want to turn the IRA contents into an annuity and take it as income over a long period of time (unless you’ve got significant assets outside the IRA that you are trying to protect.)  In most states (including Ohio,) your income must be paid toward your care before Medicaid will cover you.  So, that monthly annuity payment that you set up inside the IRA to avoid paying taxes will be lost to your long term care costs.  You’re paying the nursing home rather than the tax man, but you’re still losing the money.  It’s usually better to take the tax hit in year one and let an elder law attorney help you shelter what’s left after taxes.

In short, money in an IRA is a ticking time bomb as you get older past retirement.  The costs of long term care are bad enough.  If, because of poor planning or bad luck, you still have an IRA when you need long term care, the tax payments will make the financial loss that much bigger.

For more information visit www.ProtectingSeniors.com

Jim Koewler’s mission is
Protecting a Senior’s Life Savings™
from the costs of long term care

For help with long term care costs or special needs planning,
call Jim or contact him through his website.

© 2014 The Koewler Law Firm.  All rights reserved.

My prior three posts have discussed how to withdraw money from your IRA (or 401K, or 403B, or MyRA, when it arrives, or any other tax-deferred account.)  See “IRAs and 401Ks are not for tax avoidance. They are for tax timing.” from March 20, 2014, “IRAs and 401Ks – Withdrawing Money Too Slowly” from March 27, 2014, and IRAs and 401Ks – Withdrawing Money Too Quickly from April 4, 2014.  (As I’ve done before, to preserve what little sanity I have, I will call them all IRAs, but the discussion will apply to 401Ks, 403Bs, and even MyRAs (assuming that they act like IRAs when the rules eventually get written,) and other tax deferred accounts, except perhaps Roth IRAs.)  (As before, I will ignore state and local taxes because there is so much variation among them.)  This week, I want to discuss some special circumstances that might require an adjustment of my earlier advice for particular situations and also to discuss what to do with the money after you withdraw it from the tax-deferred account.

First, why be so systematic about withdrawals?  Steady withdrawals from an IRA that are measured by tax brackets are like investing in the market with a dollar cost averaging approach.  With dollar cost averaging, you invest the same amount of money every month or every quarter.  By investing the same amount of money each time, you get more shares when share prices are low and fewer shares when share prices are high.  Over time, you build up a significant position in the market with a lower-than-average cost per share.  Applying the same theory to IRA withdrawals, you can withdraw a significant amount of previously-untaxed money and pay lower-than-average taxes on the withdrawals by stretching them out over time and watching the tax brackets (and watching your other income as well.)  You aren’t necessarily trying to withdraw the same exact amount each year.  Instead, you are trying to have your money in the same tax brackets each year.

Second, aim for the 15% tax bracket as much as possible.  The next tax bracket is 25%.  That 10% jump will be a big bite out of your savings.  No other tax bracket is more than 5% above the bracket below.  (If your IRA is less than $100,000 and you’re still a young retiree, then aim for the 10% bracket.)  If you’ve got more than $400,000 in your IRA you’re probably going to have to pay 25% on some of your withdrawals, or you can stretch it out farther than 10 years, but your risk of needing long term care (and having to do something drastic with your IRA) goes up significantly as you get older.  If you’ve got millions of dollars in the IRA, you’re going to take a bigger tax hit, but you knew that.  (You’ll still have millions of dollars though, just not as many millions.)  If you’re Jack Dorsey, Warren Buffett, or Bill Gates, you’ve got plenty of advice from others (and, because you’re not in Ohio, you weren’t going to be my clients anyway.)

Third, you can make much larger withdrawals as a married couple (twice as large in the 10% and 15% brackets.)  Don’t wait until your spouse has passed away to start IRA withdrawals.

Fourth, if an IRA investment has a penalty attached to it for early surrender (other than the taxes on the withdrawal,) wait until the penalty is gone (or at least is low.)  For example, if you’ve invested in an annuity inside the IRA, and the annuity has a 12% surrender charge, don’t surrender the annuity (unless you have other reasons to make the IRA withdrawal.)  KEEP IN MIND, though, that many annuities that have surrender charges still allow a withdrawal of a certain percentage (10% is what I hear most often.) of the principal each year without penalty.  If your annuity has that option, use it.

Fifth, don’t let small transaction costs freeze you into inaction.  You’ll probably have some transaction costs.  They go with investing.  They are small, though, compared to the tax hit you or your family will take if you handle IRA withdrawals unwisely.  (If you’ve got big transaction costs, please consider my discussion above about surrender charges.  Also, if you have big transaction costs, I sure hope that investment is giving you a big return.)

Sixth, now that you’ve made a withdrawal, what do you do with the money?  Use what you need for your expenses, and invest the rest.  Yes, I know it was invested before the withdrawal, and it seems illogical to move the money and then simply reinvest it.  Still, reinvesting (even in the same investment as you had inside the IRA, if you like that investment) is not as illogical as you might think (even with transaction costs.)  You’re making the withdrawals for a combination of good tax planning and an effort to get the withdrawals completed before the risk of long term care gets high.  You still have a long life ahead and will need most or all of that money to support yourself.  Now, though, each dollar you’ve got invested is worth a dollar.  In the IRA, each dollar was only worth 90¢ or 85¢ or 75¢, or even less.  It still needs to be invested and grow.  Now, though, only the growth will be taxed, not the principal.

Overall, try to be smart about implementing my suggested strategy of withdrawing over 3 to 10 years.  Don’t be “penny wise and pound foolish.”

For more information visit www.ProtectingSeniors.com

Jim Koewler’s mission is
Protecting a Senior’s Life Savings™
from the costs of long term care

For help with long term care costs, call Jim
or contact him through his website.

© 2014 The Koewler Law Firm.  All rights reserved.

My prior two posts have discussed how to withdraw money from your IRA (or 401K, or 403B, or MyRA, when it arrives, or any other tax-deferred account.  )  See “IRAs and 401Ks are not for tax avoidance. They are for tax timing.” from March 20, 2014 and “IRAs and 401Ks – Withdrawing Money Too Slowly” from March 27, 2014.  (As I’ve done before, to preserve what little sanity I have, I will call them all IRAs, but the discussion will apply to 401Ks, 403Bs, MyRAs (I assume, subject to seeing the rules when they get written,) and other tax deferred accounts, except perhaps Roth IRAs.)  This week, I want to continue the discussion to consider the consequences of withdrawing money from an IRA too quickly.

It’s simple.  Too quick an IRA withdrawal will cost you more in taxes.  In a sort-of mirror image of too slow a withdrawal, in which your family will pay more in taxes, too fast a withdrawal will cost YOU more in taxes.

Your guide to how quickly (and, at the same time, how slowly) to withdraw from your IRA is the federal system of tax brackets.  (I’m ignoring state taxes in this discussions because there are too many variations among the states.)

The tax brackets are the guide because they are graduated.  For 2014,  the tax brackets look like this:

(From http://taxfoundation.org/article/2014-tax-brackets)

So, any single person making more than $406,751 is in the 39.6% tax bracket.  Remember, though, that the taxpayer is NOT paying 39.6% of all of his or her income.  He or she pays 10% on the first $9,075 of income, 15% on the income between $9,076 and $36,900, 25% on the income between $36,901 and $89,350, etc.

So, if your income is $50,000 (after deductions, etc.,) you’ll pay $907.50 (for the first $9,075 of income) plus $4,173.75 (on the income between $9,075 and $36,900) plus $3,275 (on the income between $36,900 and $50,000,) for a total of $8,356.25.  Jack Dorsey (the founder of Twitter and Square) pays the same taxes on the first $50,000 of his income.  He just has additional income above that first $50,000, some of which is taxed at 25%, some taxed at 28%, some taxed at 33%, etc.  Although a sizable amount of Mr. Dorsey’s income is taxed at 39.6 percent, some of it is not.  (I’d have used the more recognizable (to me, anyway) billionaires Warren Buffett or Bill Gates, but they’re both married and, therefore, in a different set of brackets than our hypothetical taxpayer who is single.)

So, how does this graduated tax system help you choose how much to withdraw from your IRA?  The key is to stay close to a bracket cut-off amount.  (It’s okay to be a little over or a little under, but try to stay close.)

So, let’s say you have a $300,000 IRA at the time you retire.  You can withdraw $30,000 a year for 10 years and (depending on your other income) stay in the 15% tax bracket the whole time.  (You may have to adjust your annual withdrawals now and then to account for growth inside your IRA and income outside the IRA as more assets are held outside.)  Ignoring revisions in the tax brackets (because I don’t want to get that fancy, nor do I want to make economic projections on inflation, etc.,) a 10-year withdrawal would cost $31,397.25 in taxes.

Because you can take an IRA withdrawal late in the year, you can know what your other income is for the year, and take enough out of your IRA to get right up to the $36,900 bracket cut-off and give yourself a buffer in later years for income growth.

If you took that same $300,000 out of the IRA in 3 years, that would mean $100,000 withdrawn each year, resulting in taxes of $67,606.62 because lots of the money is in higher tax brackets.  If you did the withdrawal in one year, the taxes would be $82,858.25.  (Boy, I hope I did the math correctly on all of those.)

The key is to find the balance of haste (to avoid tax losses to your heirs) and patience (to minimize your own tax losses) on your IRA withdrawals by considering the size of your IRA, your other (non-IRA) income, your age at the time you start systematic withdrawals, and then stay close to the tax bracket cut-off that makes the most sense.

For more information visit www.ProtectingSeniors.com

Jim Koewler’s mission is
Protecting a Senior’s Life Savings™
from the costs of long term care

For help with long term care costs, call Jim
or contact him through his website.

© 2014 The Koewler Law Firm.  All rights reserved.