Five Things to Consider Before Retiring Early

January 13, 2018

fee only financial advisor kansas cityThe magic number for most people to retire is age 65.  However, some people will retire before then, whether by choice or by chance.

If you will be retiring before “normal retirement age”, you may face many challenges, such as how to tap into your assets, the high cost of health care before Medicare age, and how to stretch your assets out for a longer retirement period.

If you are considering retiring early, here are five things to consider before turning in your pink slip.

1. The IRS doesn’t want you to touch your retirement accounts before your sixties. To enforce this, it assesses a 10% early withdrawal penalty if you tap into your IRA before age 59 ½.  There are a few ways to get around this rule.

One way to avoid the 10% penalty is by taking 72(t) distributions. Under a provision in the Internal Revenue Code, you can withdraw funds from a traditional IRA prior to age 59½ in the form of substantially equal periodic payments (SEPPs) over the course of your lifetime. The schedule of payments must last for at least five years or until you reach age 59½, whichever period is longer. Once the schedule of periodic payments is established, it cannot be revised – if the payments are not taken according to schedule, you will be hit with the 10% early withdrawal penalty on all the payments taken. Distributions under a 72(t) plan are taxable income.

Or, you can choose to leave your 401K with your employer when you retire. 401K plans have different age requirements than IRAs. Unlike an IRA, if you separate from service (retire or otherwise lose your job) at age 55 or later, and you leave your funds in your employer’s retirement plan, you can take distributions without penalty.  If you retire or lose your job before reaching age 55, this exception does not apply.

If you have a Roth IRA or Roth employer-sponsored retirement account, things get easier. You can withdraw your contributions to these accounts at any time without incurring taxes or penalties. At age 59½ or older, both account contributions and account earnings can be distributed tax free and penalty free if you have held the account for at least five years.

2. The cost of healthcare for retirees can be very high; some early retirees even get a part-time job just to pay for health insurance! If you retire early, you could have several years before you are eligible for Medicare. Some companies offer retiree health coverage, but this is rare. COBRA is available for 18 months after you retire, but if you are still under Medicare age when COBRA ends you will need to purchase your own insurance.  Health insurance for early retirees can be very high (the average monthly premiums for people age 55-64 were $580 according to eHealth’s Health Insurance Price Index Report for 2016), so you will need to plan for this if you are retiring early.

A health savings account can help bridge the high health coverage cost for early retirees. Contributions to HSAs are tax deductible, and the assets within them grow tax-free. HSAs can help with health care costs until you reach Medicare age; in addition, they are also sometimes called “backdoor IRAs” because you can use the money within them for any reason without penalty once you turn 65, not just for qualified health care expenses.

3. Your assets will need to last longer when you retire early. With the average life expectancy in the mid-80s and many people living into their 90s, your assets may need to last for 30-50 years! To avoid outliving your money, you will either need to save more, work part-time during retirement, or reduce your withdrawal rate.  Most people have heard of the 4% withdrawal rate as a baseline to keep from running out of money during your lifetime. However, this may be too optimistic if you are retiring early; 3% or 3.5% may be more realistic if you will be retired for 30 years or longer.

4. You can’t tap into Social Security until age 62, and even then, you may not want to. If you retire before age 62, you won’t have access to Social Security, a main income source for retirees in the United States.  The full retirement age for people retiring today is age 66, so if you start collecting benefits at age 62 you will be penalized.  Many early retirees plan on starting Social Security at age 62, but that may not be your best strategy. The trade-off for collecting benefits early is that you will receive proportionately smaller monthly benefits over the rest of your life compared to the larger monthly benefits you could receive by claiming at your full retirement age or later. With inflation and the related cost of living adjustment that Social Security beneficiaries receive, delaying benefits can make a big difference in your later years.

5. Retiring early can mean tax challenges, and tax planning opportunities. As mentioned earlier in the article, tapping into your retirement accounts when you retire early can be challenging. However, retiring early can also present tax planning opportunities, such as doing Roth IRA conversions or selling appreciated assets at the lower long-term capital gain tax rate while you are in a lower tax bracket.

As you can see, retiring early has many financial challenges. You should consult your financial or tax advisor before making any early retirement decisions. This is a critical financial juncture in your life, and whether you find yourself retiring early by choice or by chance, the decisions you make could have lifelong impact.

This material was prepared in part by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate.

Kristine McKinley is a fee only financial advisor in Kansas City, Missouri. Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis. To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Congress Extends Tax Breaks for 2015 and Beyond

December 29, 2015

tax_refund_336x280In what has become an annual ritual, Congress recently passed a last minute bill to extend tax laws that expired at the end of 2014. The good news is that some of these extenders are now permanent, which will eliminate the need to extend them in future years. Other provisions were extended just through 2016 and others were extended through 2019.

The Protecting American from Tax Hikes (PATH) Act of 2015 was signed into law on December 18. Here is a summary of the most popular provisions that were extended or made permanent.

Extenders that are now permanent include:

Tax free distributions from IRAs to charities: The PATH Act permanently extends the provisions allowing tax-free distributions by individuals age 70½ or older directly from their IRAs to qualified charities. The annual limit is $100,000 per taxpayer.

American Opportunity Tax Credit: The PATH Act makes permanent an enhanced AOTC, with a maximum deduction of $2,500 and phaseout thresholds of $80,000 for single filers and $160,000 for joint filers. 

Deduction for state and local sales taxes: Taxpayers may elect to deduct state and local sales taxes in lieu of deducting state and local income taxes. This optional deduction, which is especially valuable to residents of states without a state income tax and purchasers of certain big-ticket items, is now permanent.

Child Tax Credit: The enhanced child credit, which allows for a refundable portion with a reduced income threshold, is made permanent. This provision was scheduled to expire after 2017.

Earned Income Credit: The PATH Act makes permanent certain enhancements in the EITC for lower-income taxpayers. Previously, the enhancements were only available though 2017.

Deductions for teacher’s expenses: The deduction for up to $250 of out-of-pocket eligible educator expenses is now permanent. It will be indexed for inflation beginning with 2016 tax returns. You claim this deduction “above the line,” meaning it’s available even if you don’t itemize. If you do itemize, you can also generally claim qualified expenses above $250 as a deduction subject to a 2% of adjusted gross income limit.

Section 529 plans: The PATH Act permanently extends the rule allowing computers and related equipment to be treated as qualified expenses.

Section 179 expensing: The PATH ACT permanently restores the maximum expensing deduction of $500,000 for qualified business property with a phaseout threshold of $2 million. (It was scheduled to drop to $25,000 with a $200,000 phaseout threshold.) It will be indexed for inflation for 2016 and thereafter.

The following provisions were extended through 2016

Tuition and fees deduction: If you or a family member is an eligible student, you may be able to claim a tuition and fees above-the-line deduction for qualified higher education expenses for 2015 and 2016. For 2015 tax returns, the maximum deduction is $4,000 when your adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers). The maximum deduction is $2,000 when your AGI is less than $80,000 ($160,000 for joint filers).

Residential energy credit: The latest version of the residential energy credit, which provides a lifetime credit of up to $500 for 10% of qualified expenses, is extended through 2016.

Mortgage debt exclusion: The tax exclusion for mortgage forgiveness on up to $2 million of debt on a principal residence is extended, with certain modifications through 2016.

Deductibility of mortgage insurance premiums: This provision allows taxpayers to deduct mortgage insurance premiums subject to a phaseout beginning at $100,000 of AGI. The deduction is extended through 2016.

50% bonus depreciation (extended through 2019): Although 50% bonus depreciation for qualified business property is retroactively extended to 2015, it will be reduced to 40% for 2018 and then 30% for 2019. Bonus depreciation will completely expire after 2019 unless it is extended again.

These are just a few of the tax extenders included in the 231 page PATH Act passed last week.  For a more detailed list of the tax provisions that were extended please see  “SECTION-BY-SECTION SUMMARY OF THE PROPOSED PROTECTING AMERICANS FROM TAX HIKES ACT OF 2015”

Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Budget Deal Eliminates Important Social Security Filing Strategies

November 5, 2015

social security strategies eliminated Earlier this week President Obama signed the 2016 budget deal which included several surprise provisions for Social Security.

The two biggest changes will be to the “file and suspend” strategy and the ability to file a “restricted application”. The loss of these two strategies will affect many Americans’ retirement plans as they were relying on these strategies to boost their retirement income. People who were relying on the additional income from these strategies will need to re-evaluate their retirement plan to determine if they can still retire at their goal date or if they will have to work longer to replace the lost income.

File and Suspend

The biggest change is to the “file and suspend” strategy.

First a little background on the strategy… In order for spouses to collect the spousal benefit, the other spouse must have already filed for benefits. Often times the higher earning spouse is not yet ready to receive benefits though, so in the past he got around this by filing for benefits and then immediately suspending them. This allowed his spouse to start receiving spousal benefits while he delayed his own benefit (usually to age 70). The benefit of this strategy was that the higher earner could continue to earn accrued benefits (at a rate of 8% per year) on his own benefit while allowing his spouse to start receiving a spousal benefit on his earnings record.

Under the new law, spousal benefits are no longer payable while the other spouse’s benefits are under suspension. In other words, spousal benefits can only be collected if the other spouse is actually receiving his benefits. The husband can no longer file and suspend his benefits; he must actually be receiving them for his spouse to collect spousal benefits.

In previous versions of the budget deal, anyone receiving spousal benefits based on a suspended benefit would have had their benefits terminated within six months if the other spouse didn’t reinstate his benefits. Thankfully the bill was changed so that people already receiving spousal benefits on a suspended benefit will not lose their benefits; however, this strategy will not be available going forward.

Another benefit of suspending benefits was the ability to request a retroactive lump sum for the amount that the person would have received if he/she had not suspended her benefits. This benefit has also been eliminated under the new budget deal.

In effect, the only reason to do a voluntary suspension under the new law is if you take Social Security benefits early and you later decide that you made a mistake and want to delay your benefits. In that case, you will still be able to suspend your benefits, but only after you have reached your full retirement age, and your spouse and other dependents will not be able to claim benefits while your benefit is under suspension.

Restricted Application

The other strategy that has been eliminated is the ability to file a restricted application for spousal benefits only.

Under the old law a spouse who was eligible for both a spousal benefit and her own benefit could choose to receive the spousal benefit only (at her full retirement age) and delay her own benefit to age 70. This was the best of both worlds as it allowed her to delay her own benefit to the maximum amount while still collecting a benefit at her full retirement age (the spousal benefit, which is half of her spouse’s primary insurance amount). This strategy was called the restricted application.

Unfortunately, under the new law this will no longer be allowed. If you apply for benefits you will be considered to have “deemed” to have filed for your own benefits. The only way you would receive the spousal benefit instead of your own is if the spousal benefit is higher than the benefit you would receive based on your own earnings record.

The impact of this change is that spouses will either have to start claiming their own benefits early or they will delay to age 70 but they won’t be able to receive a spousal benefit between full retirement age and age 70.

Widow’s Benefits

The changes above apply to retirement and spousal benefits only, they do not apply to survivor benefits. Widows who choose to receive survivor benefits can still elect to delay their own benefits to full retirement age or later to receive the delayed credits.

Time-Line: When Will the Changes Take Place

File and Suspend:

The key date for the file and suspend strategy is May 1, 2016.

If you have already filed and suspended, this bill will not affect you. Your spouse can still collect spousal benefits even though your own benefits are suspended.

If you have not yet filed and suspended benefits (but are eligible to do so), you can still file and suspend before May 1, 2016 and your spouse will still be able to collect spousal benefits.

If you turn age 66 within six months after the law is enacted (the law was officially signed on Monday 11/2/15 so you must reach age 66 by May 1, 2016), you can still file and suspend benefits allowing your spouse and dependents to receive benefits on your earnings record.

After May 1, 2016 no one will be able to collect benefits on another person’s earnings record unless they are actually receiving benefits. If someone has filed and suspended their benefits, then no other benefits will be paid on that account.

The only reason someone will want to file and suspend benefits after May 1, 2016 is to correct a mistake. For example, if you retired at 64 and immediately started receiving Social Security but then decided that may not have been the best idea, you can still suspend your benefits once you reach your full retirement age. However, no one will be able to receive benefits on your earnings record while your own benefits are suspended.

Restricted Application:

The key age/date for the restricted application is people who will be age 62 or older by the end of 2015. Basically, people born before January 1, 1954 will be grandfathered in for the restricted application strategy.

Here is the time-line for the restricted application elimination: If you are already receiving spousal benefits then you can continue to receive those benefits, they will not be taken away from you.

If you will be age 62 by the end of 2015, then you may still file a restricted application to claim spousal benefits only when you reach age 66. However, the person who’s earnings you are claiming benefits on must either be collecting benefits when you apply or they must have filed and suspended their benefits within the time-line above. Divorced spouses who are age 62 by the end of 2015 can collect spousal benefits at age 66 even if their ex-spouse is not yet claiming benefits (as long as they are at least age 62).

Anyone younger than age 62 at the end of 2015 will not be allowed to claim spousal benefits only going forward. This will primarily affect people who have benefits based on their own earnings record that are higher than the spousal benefit would be. In the past, you could elect to take the spousal benefit only, even if it was lower than your own benefit, and delay your own benefit until age 70. Now when you apply for benefits, you will only be awarded the spousal benefit if the amount is greater than your own benefit would be.

Conclusion and What to Do Now

The purpose of the changes above was to “close several loopholes in Social Security’s rules about deemed filing, dual entitlement and benefit suspension in order to prevent individuals from obtaining larger benefits than Congress intended.”

Unfortunately this reform will affect more than the top 1% that Congress was supposedly targeting. Millions of middle income Americans use these strategies to improve their qualify of life during retirement, including divorced women who will likely be hit the hardest.

Reform measures of this magnitude usually take years to happen. These changes took place over just a few days and will be implemented quickly, leaving very little planning time for the people who will be impacted.

If you are already retired or are close to retirement and were planning on taking advantage of the file and suspend or restricted application strategies, please contact me for a review.  We will need to re-evaluate when you will start receiving Social Security as well as how that will impact your overall plan.

Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Yes You CAN Donate Your 2010 RMD to Charity!

December 20, 2010

Good news for charitable IRA owners over age 70 ½… the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, signed last week by President Obama, extends the ability to give up to $100,000 directly from your IRA to a charitable institution, tax-free.  Furthermore, because this bill was passed so late in the year, you get an extra month to complete the transfer and have it count for your 2010 taxes (transfers made in January 2011 will count as if they were made in 2010).

If you’re not familiar with charitable IRA donations, for the past few years taxpayers age 70 ½ or older have been able to make direct transfers of up to $100,000 per year from their IRA to a charity.  By giving the money directly to charity (rather than receiving the distribution then later cutting a check to your favorite charity), taxpayers were able to exclude the IRA distribution from their income.

This was a great strategy for IRA owners who didn’t need the money from the required minimum distribution as they won’t have to pay a large tax bill for IRA withdrawals that they wouldn’t otherwise have taken (if not required to by the RMD rules).

The direct transfer strategy not only reduced their taxable income, but it also reduced their adjusted gross income, which resulted in many taxpayers having less of their Social Security income taxed; it also allowed taxpayers to qualify for credits and deductions that they would not have qualified for otherwise because their income was too high.

This IRA donation strategy was introduced in the Pension Protection Act of 2006 and was originally only intended to apply to the 2007 tax year.  It was later extended to include 2008 and 2009.  IRA owners who have taken advantage of this strategy were hoping that it would be extended for 2010, but for a while it didn’t look like it would happen.  Thankfully, Congress included a provision in the tax bill passed last week to extend the ability to donate IRAs directly to charity for not only 2010, but 2011 as well.

Since this bill was passed so late in the year, you may have already taken your 2010 RMD and written a check to your favorite charity.  You can still deduct your donation on Schedule A: Itemized Deductions (if you itemize your deductions).  However, please note that you can’t do both.  If you do a direct transfer to a charity from your IRA you will exclude the distribution from your income; if you write a check to a charity you will deduct it on Schedule A.

Thanks to Kay Bell at Bankrate.com for the update on RMD charitable donations in “How the New Tax Law Affects Your 2010 Taxes”.

Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Should You Move to “Safer” Investments?

January 17, 2009

After watching their 401K balances shrink up to 40% in 2008, many people are wondering if they should change their allocation to include more “safe” investments, or if they should move completely to “safe” investments then move back into the market later.

Here’s what Walter Updegrave with Money Magazine has to say about this:

But as understandable as the urge may be to transfer all your money into the investments that seem safest – stable value funds, capital preservation funds, money market funds and the like – that would be a mistake.

Read more

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About Us

Kristine McKinley, CFP®, CPA, is the founding principal of Beacon Financial Advisors, LLC, an independent, fee-only financial planning firm located in Lee’s Summit, Missouri and serving the greater Kansas City area.

Kristine focuses on providing fee-only financial planning, investment advice, and tax preparation to individuals and families from all income levels.  About Us

In the News

Investment News – Kristine McKinley discusses the 0% Social Security COLA (for 2016) in No Social Security cost-of-living adjustment in 2016.

Kiplinger Magazine/NAPFA – Kristine McKinley answered reader’s tax questions during the 2013 Jump Start Your Retirement Plan Days sponsored by Kiplinger magazine and the NAPFA Consumer Education Foundation.