Rethinking Your Retirement During COVID-19

I have several acquaintances who are retiring early because of the pandemic. You probably do, too. Retirement plans are just one more thing that have been thrown into flux due to COVID-19.

Some employers are offering early retirement incentives. Many Iowans are considering early retirement due to job challenges, health concerns, or other reasons. On top of that, temporary policy changes have made it easier for people to withdraw from their retirement accounts during 2020. You may have questions as you sort through your options.

A new 45-minute on-line workshop “Rethinking Your Retirement During COVID-19” from Iowa State University Extension and Outreach is designed to equip you to make informed retirement decisions during this turbulent time.  

The free workshop is available at noon or 5 p.m. on both Tuesday September 29 and Thursday October 1, with more dates likely through the fall. Pre-registration is required. You’ll find the registration links at ISU Extension’s retirement resource page — scroll under the “Upcoming Events” section to find the session you wish to attend!

Barb Wollan

Barb Wollan

Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.

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Financial Cause and Effect

As a site coordinator and quality reviewer at a local Volunteer Tax Assistance site, I am able to see hundreds of real-life examples of “cause and effect”. 

  • What EFFECT will cashing out my 401k have on my taxable income? It may CAUSE a portion of your Social Security taxable.
  • What EFFECT will $24,000 of income (with no withholdings) have on a 19 year-old full-time student living at home? The EFFECT will be felt by the student who will owe taxes and by the parents who will not be able to claim the child as a dependent.

The most recent unpleasant EFFECT was CAUSED by gambling winnings.  A very lucky woman in her 70’s received a W-G from a local casino, indicating she won $20,800 worth of winnings with NO taxes withheld. The fact that no taxes were withheld did not bother her because she also had documentation showing her losses, which far exceeded her winnings. She knew that her losses could be deducted from her winnings. What she did not understand was…

  • She could only write-off the losses that were equal to her winnings…meaning…of the 25,000 of losses she had incurred trying to win the $20,800, she could only write off 20,800.
  • What she also did not know was…The losses are reported on a schedule A, while the winnings are counted as income. Once the winnings were added to her pension income and the $26,418 of social security income, she discovered that, not only had the winnings pushed her into a higher tax bracket, her income now was high enough that $13,661 of her Social Security was now taxable. Last year, with no gambling winnings, none of her Social Security was taxed.
  • It was only after her total income was calculated that she could subtract her itemized deductions (which included her gambling losses). 

The combination of increased income (due to gambling winnings), plus the increased tax bracket, plus the increase in the taxable portion of her social security, and the fact that there were no tax withholding on the gambling winnings; this woman owed more than $2000 for her federal tax return…something she had not anticipated.

Before doing anything different with your money, it is important to stop and consider what effect it will have on your tax return.

Brenda Schmitt

Brenda Schmitt

A Iowa State University Extension and Outreach Family Finance Field Specialist helping North Central Iowans make the most of their money.

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Income Taxes in Retirement

United States tax forms

As a volunteer tax preparer with VITA (Volunteer Income Tax Assistance), I frequently wish people understood taxes better. In recent weeks I’ve done three tax returns for people who, in their first year of retirement, cashed out their entire IRA or 401(k) account (ranging from $15,000 to $60,000).

In most cases, these new retirees used the funds for their long-term benefit – major home improvements and other purchases that will help them in the long run. I think they probably thought about the fact that spending the money now means they’ll live on more limited income for the rest of their lives, and they decided that was okay with them.

But I do NOT think they understood the tax implications of their decision, and I found myself wishing I would’ve had the chance to explain it all before they decided to withdraw the whole amount at once. Here are some things retirees should know:

  1. Withdrawals from “traditional” IRA, 401(k), and similar retirement plans will generally be included in your taxable income. Large withdrawals can easily move you into a higher tax bracket, meaning that you pay a higher tax rate on some of that income. For a single person, income above about $53,000 is typically subject to a 22% tax rate, rather than the lower 10% or 12% rate.
  2. The first year of retirement is especially tricky for income tax purposes, because usually the person also had employment income for part of the year, which may contribute to bumping them into a higher tax bracket.
  3. Social Security income is only partly taxable (at most 85% of it is subject to tax). How much is taxable depends on how much other income you have that year. When a person has very low income, none of their Social Security income will be taxable; as their income increases, the portion of Social Security subject to tax also increases. That means that large withdrawals from retirement accounts can create a double-whammy by increasing the taxable amount of Social Security as well has increasing total income.

I know that some of the clients I served paid at least $5,000 more in income tax than they would have if they had spread their retirement plan withdrawals over five years, or even over two or three years. I’m also pretty confident that they did not really understand the tax impact when they made the decision to withdraw it all at once.

Bottom line? Before making decisions about withdrawing from retirement plans, consider various options and get information from someone who is knowledgeable about taxes. If you don’t have a tax expert to ask, try using IRS form 1040-ES (estimated taxes) OR the IRS online withholding estimator to compare different options. Note: remember to consider state income taxes, as well.

Barb Wollan

Barb Wollan

Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.

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Secure Act: Part 1

The Secure Act was originally written to make changes to retirement laws. The act passed through the House last May and was held by the Senate until November when it was added to the Appropriations Bill and signed into law in December.

The law change catching attention is the starting age for required minimum distributions (RMDs). If you are retired and reached 70 1/2 before the end of 2019 you are required to take distributions. Everyone else can wait until the year they reach age 72. The annual RMD amount continues to be based on life expectancy tables published by the IRS.

The other change attracting attention relates to distribution rules for inherited retirement accounts. These accounts, including IRAs, 401(k)s and other similar qualified accounts, generally have named beneficiaries. When there is just one beneficiary and it is the spouse, then the withdrawal rules are the same as if the account originally belonged to the spouse. The SECURE Act did not change this.

However, when the account beneficiary is not the spouse, the rules for taking distributions have changed. In general, the beneficiary must take distributions on a schedule that will liquidate the account within ten years. Stretch IRAs, which set up for distributions over the beneficiary’s life expectancy, are no longer an option. Beneficiaries will want to plan for the tax implications of those distributions.

Exceptions to the ten year distribution schedule include: disabled beneficiary, chronically ill beneficiary, beneficiaries not more than ten years younger than the deceased, and children that have not reached the age of majority. Separate rules apply to these individuals, and also to situations where multiple beneficiaries are named, so professional guidance is recommended.

More about the Secure Act will follow in subsequent posts……

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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Secure Act : Part II

Welcome to part two of our review of the the Secure Act! We’ll introduce you to some of the other retirement plan changes employees can expect to hear about as new rules and options are added to their plans.

A part-time employee who has worked a minimum of 500 hours each year for three continuous years can now begin making retirement savings contributions to an employer’s retirement plan. This change expands eligibility beyond the old rules that allowed an employer to use a 1,000-hours-worked rule before full time employees are allowed to participate in a retirement plan.

New tax credits are available for small business owners who start a retirement plan for their employees. Additional credit is given if the plan uses an automatic enrollment structure. The additional business tax credit is also available if an existing plan is converted to automatic enrollment. The business tax credits range from $500 to $5000 and can be claimed for three years. Small employers can also participate in multiple-employer plans that allow many unrelated businesses to join together to share costs of plan administration.

Old rules allowed employers to include annuity options in their 401K plans, but if the insurance company selling the annuity contract failed, the employer was required to guarantee the continuation of the contract payments. The Secure Act removed the employer’s responsibility to protect retirees. The inclusion of annuities in retirement plan menus is expected to increase.

The cap for auto enrollment contributions to an employer’s retirement plan was 10% of employee pay; the amount has been raised to 15%. Employers must continue to give employees the option, once a year, to change their contribution.

The Secure Act also removes the restriction that prohibited individuals age 70 1/2 or older, who are still working, from making contributions to an IRA.

In our next post we will visit some of the non-retirement changes included in the new Secure Act.

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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Secure Act: Part III

Eligibility for participation in retirement savings plans, incentives for small businesses to establish retirement plans, and rules for contributions and distributions are the main focus of the Secure Act, but there are other changes worth understanding in the new law.

  • Loans allowed by an employer from retirement funds can no longer be distributed through a credit card account or similar arrangements. If received through a credit card, the funds must be claimed as income and are subject to taxes and penalties.
  • Withdrawals from retirement accounts can now be made for the birth or adoption of a child within one year of the event. The limit is $5000 per account owner and it has to be claimed as income, but there will be no penalty tax added.
  • At least once a year, your retirement account report must include a statement of monthly benefits the owner can expect in retirement. The amount will be based on a single lifetime or joint lifetime annuity.
  • 403B and 457 plans have new rules for transferring account funds to a new employer’s plan or to a qualified plan distribution annuity.

And in areas unrelated to retirement accounts:

  • 529 plans can now be used to cover the costs of registered apprenticeships, homeschooling costs, private elementary, secondary and religious schooling. Up to $10,000 can be used to repay student loan debt. (State alignment is necessary so check your state rules.)
  • The Kiddie Tax on unearned income is being reset to rules in place before the 2017 TCJA law. Under TCJA, unearned income was subject to the Estate or Trust tax rates. Amended returns can be filed for 2018.
  • The penalty for failing to file a tax return is a maximum of $400 or 100% of the tax due.

Rules and implementation guidelines will further define these changes, so check with financial professionals and your employer’s HR departments for more details.

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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Social Security Myth

Dollars becoming Euros

The government has been robbing the Social Security Trust! Most of us have heard this version of Social Security history.  Is it true?  Myth is a more correct answer.

Social Security’s history includes details of social movements taking place long before the Act became law in the 1930’s. The movements focused on providing some level of income security for individuals who aged out of the workforce.

Two decisions – both made at the time the bill was written – explain part of how the Social Security Trust Fund was diminished:

  • Benefits were earned when a worker had made three years of contributions prior to reaching the age of 65. BUT – to be fair to workers who would not be able to make three full years of contributions prior to their 65th birthday, the legislation granted them annual payments as well.  In the period 1937 to 1939, this annual payment resulted in a payout of $25,562,000. The actual amount paid out is larger as the payments would have continued until death.  
  • Social Security was also set up as a “pay as you go” program.  What came into the fund was paid out. Ida Mae Fuller is the first person to apply for and receive a monthly benefit. She contributed a total of $24.75 in the three years prior to reaching her 65th birthday. Her first benefit check was $22.54.  Because she lived many years past age 65, Ms. Fuller’s $24.75 investment yielded a total retirement benefit of $22,888.92.  Part of her payment would have come from new contributions and part from income earned from the excess deposits.

Social Security never achieved the trust fund it needed to give it stability. Benefits paid to American retirees in the early days of the program were far in excess of the contributions.  Legislative changes expanding benefits and building in cost of living adjustments have continued to keep the fund from building a sufficient cash reserve that would generate earnings to sustain long term benefits. 

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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Your Biggest Financial Decision

What’s the biggest financial decision you’ll ever make? Going to college? Buying a house? Maybe, but it may also be true that the biggest financial decision is the decision about when to claim Social Security. And that is a decision where you’ll hear people give opposite advice – some will recommend claiming early, and others encourage you to wait.

Because it’s a big decision, it’s worth exploring your options carefully using readily available online tools. Tool #1 is well-known, but read on to tool #2, as well, because it offers a bonus.

Tool #1: Set up your account at www.socialsecurity.gov and check out your options. Notice how your monthly Social Security income changes depending on your age at claim. You’ll notice that it’s not just what year, but also what month, that matters. For example, if you turn 67 in November, but really don’t have any plans until summer, working an extra 5 or 6 months will give you a higher monthly income.

Tool #2: Check out the Social Security Estimator from the Consumer Financial Protection Bureau (CFPB).  Although this tool is not personalized to your individual history of work and earnings, it does something the Social Security tool does not. It shows the cumulative impact of your decision about when to claim. 

Here’s how the CFPB tool works: You enter your birthdate, and type in how much has been your highest annual earned income in your career. Based on that, it estimates what your social security retirement benefit would be at your full retirement age, and at other ages between 62 and 70. When you select an age, it shows what your monthly income will be, AND (in the left margin) it shows the total amount you will receive from Social Security if you live to the average life expectancy of 85.

graphic depiction of output described.
Combined graphic showing calculator results at ages 62 and 70

I ran an example for a person born in 1960 whose highest earning level was $50,000/year. If they claimed at age 62 and lived till age 85, they would receive a monthly benefit of $1,112 and would have received a total of $305,800 from Social Security during their life. By contrast, if they claimed at age 70 and lived to age 85, their monthly benefit would be $1,958 and their total by age 85 would be $352,440. Note: all these figures would actually be higher, because of adjustments for inflation.

There is no “right” age to claim Social Security; your choice depends on your situation – your needs, other sources of income, health situation, and more. But using available tools, including the CFPB calculator which enables you to easily see the total impact of your decision at age 85, will help you make a well-informed decision. Find more retirement planning information our retirement resource page.

Barb Wollan

Barb Wollan

Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.

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Unretirement

Questions are part of our Writing Your Retirement Paycheck program. The more common questions are about finances, but every now and then, someone will ask, “How am I going to know when to retire and will I like it?” The question of when is sometimes tied to finances, which is fairly straightforward to discuss, but helping someone like retirement is a challenge.   

A number of individuals in the United States practice unretirement. A word being used to describe reentry into the workforce after a formal retirement. In an article published by the National Institute of Health, 80% of near-retirement individuals expect to return to the world of work in some capacity.  After 2 years, 25% are working full time.  Returning to work is less likely to occur if an individual experiences health issues. Interestingly, financial need does not appear to be a common reason for reentry into the workforce.

Retirement plans are highly individual; one size does not fit all. The successful transitions all have individual differences, but three elements are frequently mentioned.

  • A planned trip or activity to create a bridge between the everyday routine of going to work and the freedom of setting your own daily schedule. It creates a distraction and gives a chance for individuals to refocus on a new lifestyle.
  • Setting goals to complete in the early years of retirement. If chosen wisely, these goals help with time management, simulate thinking, and can result in enjoyment of new accomplishments.
  • Developing new relationships with individuals and groups outside of the workplace prior to retirement. New associations can help replace the psychological value individuals gained from their roles in the workplace. 

Planning for the transition to retirement is financial, but also includes mental preparation for a new lifestyle. Without that step, we might find ourselves part of the “unretirement” movement.  

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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Capital Gains Taxes

United States tax documents with cash and the American flag

My husband is retired, so he has more opportunities to spend time in the repair shop waiting for tires to be patched or equipment to be repaired, all the while chatting with his peers. Those conversations result in questions for me when there has been a discussion about finances. The topics of inquiry are usually related to estate planning. The average age of farmers is 57.5 years, so it stands to reason it wouldn’t be about student loans, and he doesn’t need answers when the topic is commodities, livestock or equipment sales.

The most recent ask was the result of a statement concerning a tax liability of 38% if farm ground was sold. “That’s probably wrong” I said, and here is why:

  • Only property owned for less than a year is subject to regular income tax rates.
  • The 2019 tax rates on regular income is 10%, 12%, 22%, 24%, 32%, 35%, and 37%
  • The owner would be able to subtract costs and would only pay taxes on the profit. Farm ground has actually gone down in price or stayed stable during the past year.
  • Income taxes are graduated and rise as your income increases. All single taxpayers pay 10% on the first $9,700 of taxable income. The 37% income tax is calculated on income greater than $510,301.

If the farm ground was owned for more than a year then profits from sales would be subject to long term capital gains taxes.

  • Long term capital gains taxes are 0%, 15%, and 20%.
  • The tax rate would be determined by income. A single taxpayer with income of $39,375 or less pays 0%, 20% is the capital gains rate when a single taxpayer has income greater than $434,551.

If the farm ground had a house on it and the owner lived in it for two of the five years before the sale, then up to $250,000 of profit resulting from the home sale would be exempt from taxes.

There could be an extra tax as a result of the Affordable Care Act. A 3.8% investment tax is collected when a single taxpayer’s investment income exceeds $200,000.

With plenty of tax laws to consider and individual circumstances that vary, it wouldn’t be wise to suggest taxes on the sale of farm ground would be 38%.

Joyce Lash

Joyce Lash

Joyce Lash is a Human Sciences Specialist in Family Finance who wants to keep you ahead of the curve on financial information.

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