In the movies, getting an inheritance always seems like a straightforward affair. There’s a knock at the door and a lawyer wearing a flashy suit hands the stunned recipient the keys to an estate or a check for millions. But the fact is that if you were to receive an inheritance these days, it would likely be in the form of an IRA, which makes the process anything but simple. 

What Happens First?

Note: For the bulk of this article, we’re going to assume the IRA you’ve inherited is from anyone other than a spouse, as different rules apply to spousal inheritances (see below). 

Prior to receiving the IRA funds, you should work with a financial advisor to ensure all paperwork is done correctly. The first step is retitling the account which should be named as: “John Doe, Deceased (date of death) IRA F/B/O Your Name, Beneficiary.” (F/B/O stands means “for benefit of.”) Second, it’s important that the funds from the inherited IRA be kept in a separate account and that even different types of inherited IRAs remain separate. For example, you can’t combine an inherited IRA with an inherited Roth IRA. Finally, you need to make sure the funds from the inherited IRA go directly into the new account because—unlike regular IRAs where you can take out funds tax-free as long as they’re returned within 60 days—the minute you take funds from an inherited IRA, they are taxed.

What Can I Do With The Funds?

You basically have three options when you inherit an IRA: you can cash it out and take the money as a lump sum, you can disclaim it, or you can “stretch” the IRA and take regular annual payments over the course of your lifetime.

Cashing out. This is the simplest option of all, but might not be the smartest. That’s because when you take the cash, it is immediately added to your income and taxed accordingly. Depending on your earning situation, this means you could be catapulted into a higher tax bracket and pay heavy income tax on the liquidated IRA money. On the other hand, cashing out an inherited IRA does not subject the money to the 10 percent early-distribution penalty assessed to regular IRAs taken before the age of 59 1/2. Be sure to report the funds on IRS Form 1099-R as “death distributions” and use code 4 in Box 7.

Disclaiming. Taking this action means that you tun down the IRA entirely. Why on earth would anyone choose to decline free cash? Depending on the size of the IRA and your earnings, you might find that the tax levied on the distributions outweigh the benefit of receiving them. You might also be in a situation where creditors could be entitled to the distributions. But the most likely situation in which you would disclaim an IRA inheritance would be to pass it along to your children, who could enjoy the tax-deferred growth of the money for many years. If you choose to disclaim an inherited IRA, you must do so within nine months of the benefactor’s death.

Stretching the IRA. This means leaving the money in the newly created IRA and only taking small required distributions every year. To determine the amount of the annual distribution you are required to take, divide the account balance by your life expectancy figure provided by the IRS in publication 590. The benefit here is that the money will continue to grow tax deferred for as long as wish, yet you can always decide if and when you’d like to take more in any given year. It gives you the flexibility to take more cash in a low-earning year or during your own retirement to keep your tax liability low. An important thing to note here is that in order to exercise this option, the IRA must have been set up correctly in the first place: to a custodian or trust that allows stretching. If it wasn’t set up that way, you must first move the funds to an account that allows stretching by using a trustee-to-trustee transfer. Also, should you go this route, you must begin taking your annual distributions by December 31 in the year following the original owner’s death or you can be slapped with a 50 percent IRS penalty on the shortfall.

Anything Else I Should Know?

Estate Tax. Be sure that you are aware of the federal estate tax implications for the IRA you inherit. In 2013, any estates over $1 million will be subject to estate tax unless congress votes to keep the level where it is—estates over $5.12 million. However, what’s important to note here is that if an IRA is split between multiple recipients, as long as one of them pays the required estate tax, all recipients can apply the deduction against their inheritance through something known as “income in respect of a decedent.”

Year-of-death distribution. If the original owner of the IRA passed away after she was 70 1/2, you must take her required minimum (RMD) distribution in the year of death. Otherwise, the 50 percent IRS penalty will apply.

Roth IRAs. If the money you inherit comes in full or in part as a Roth IRA, check with your accountant to understand the potential tax benefits you can enjoy if the account is handled property. The rules are slightly different for these types of accounts as the cash originally deposited in them was done so on a post-tax basis.

Spousal inheritance. If you are a spouse who has received an inherited IRA you may also choose to take a lump-sum payout or open an inherited IRA, but you have the additional option of transferring the funds to your own IRA. If you choose to open an inherited IRA, you must start taking the account holder’s RMD if he was under age 70 1/2 at time of death. If the account holder was over 70 1/2, your RMDs follow the same rule as all inherited IRAs.

Useless Triva. IRA stands for Individual Retirement Arrangement, not Individual Retirement Account as often believed.

You’ve Inherited an IRA: Now What? is a post from: Lifed

I was reading an article about Social Security on a major news website, and I noticed some questions in the comments that the author of the article didn’t address. These questions made me realize there is a lot that we don’t understand about Social Security, even though it’s something that will affect all of us. Those without a large nest egg will be affected the most. Even if you’re saving for retirement with a 401K or Roth IRA (or better–both), you’re probably going to rely on Social Security for some of your income after retirement. There’s one problem with that: Social Security can be rather confusing. If you’re like many Americans, you’re probably wondering the answers to many of the following questions.

How is my Social Security benefit calculated?

Your benefit is calculated as a percentage of your income during your working years. Just like with taxes, the percentage changes based on how much you earn. According to the Social Security Administration’s website, the average worker can expect to receive about 40% of his or her lifetime earnings. If you’re 25 or over, you should receive your Social Security Statement yearly, which will show you an estimate of your retirement benefits.

Is Social Security even going to be around when I retire?

With Baby Boomers beginning to retire, and a lower ratio of working Americans paying in versus the number receiving benefits compared to previous decades, many are worried about the future of Social Security. There is cause to be worried, since the already taxed federal government will have a hard time affording the care they have promised. There’s no reason to think that it will implode in the near future, however.

It probably won’t go away completely, but there will be some changes in coming years. The full retirement age has already been pushed back from 65 to 67 for those born after 1960, and will likely be postponed until even later in life for those just starting out their careers, due to the large influx of retirees and longer life expectancies. Benefits may shrink to a smaller percentage of the amount paid in, too, or rules may get stricter. This will cause the need for retirement plans outside of Social Security to grow.

When can I start collecting?

You can start collecting Social Security at the age of 62, but you won’t receive the same benefits as if you wait until your full retirement age. Your full retirement age is from 65-67, depending on your birth year, and can be found in this chart. For those who are currently under 50, that age is 67.

If you start collecting at 62, you won’t receive the full benefit when you reach 67; you still receive the reduced amount. The reduced amount is calculated based on the average life expectancy, so the government ends up paying out about the same over your lifetime whether you start collecting at 62 or 67.

If I wait until 70 to collect Social Security, will I get more per month?

There is a slight benefit to waiting until after your retirement age, since you receive extra “credits.” This benefit ends at age 69, though, and may not be worth it to most people. There is a definite benefit in waiting until 67, though–if you can afford it. What this means is, you will receive more per month if you wait until 67 (or whatever the full retirement age is for you), but waiting until 70 or later is just wasting money. Once you start collecting, the government will pay you up to your last 6 months of benefits, but any benefits before that are lost.

Will my benefits be reduced if I keep working?

If you start collecting your benefits at 62, yes. Your benefits will be reduced by 1 dollar for every 2 dollars you make. If you make $10,000 working part time that year, then you will receive $5,000 less from Social Security that year. Once you reach 67, however, you can work as much as you want, and you won’t be penalized. This is good news for those retirees that like to stay busy, or those that just didn’t manage to save enough for retirement.

I was a stay at home mom/dad for most of my life. Do I still qualify for Social Security benefits?

If you worked for fewer than 10 years of your life, you will not qualify for benefits of your own accord. The good news is, you can qualify for benefits based on your spouse’s earnings. If you are married to someone who is receiving benefits, you can receive one half of your spouse’s benefits (provided you wait until your full retirement age, discussed above). If you are a widow or widower, you can receive benefits, too. You will receive the full amount that your spouse would have received when you reach the proper retirement age. Remarriage before age 60 will affect your eligibility, although you may be able to receive benefits based on your new spouse’s Social Security credits.

I hope I addressed some of your biggest Social Security concerns. I know there are a lot more questions out there, but if you’re still young, you shouldn’t worry about it too much yet. There will likely be a lot of changes before you’re old enough to start receiving benefits, and there’s no need to get bogged down with the details now. A better goal right now is to start contributing to your 401K or IRA. On the other hand, if you’re a bit older, this article should just be the beginning. It’s good to start learning about your options. Educate yourself as much as you can, and consult a financial advisor if you’re confused. You can also visit www.ssa.gov for more information.

Your Social Security Questions Answered is a post from: Lifed

Have you decided you need to start saving for retirement, but don’t know where to start? You’ve come to the right place. This article will give you an overview of the benefits and drawbacks of three major types of retirement plans, and who might benefit from each type of plan. If you want to know more, keep reading.

Roth IRAs

Pros:

The money you put into a Roth IRA is taxed now, so you don’t have to worry about paying taxes when you take it out. This means that your investment can grow tax-free. This is good if you’re in a fairly low tax bracket right now compared to when you retire.

Another benefit of Roth IRAs is that you can withdraw your contributions at any time without penalty, no matter what your age. You can’t withdraw the interest you’ve earned, but you can withdraw what you have contributed.

Cons:

Having the money you put into your Roth IRA taxed now means you pay more in taxes now than you would have with a Traditional IRA. Besides that, you can only contribute to a Roth if you make under a certain amount. For 2011, that amount is $107,000 if you’re single, and $169,000 if you’re married.

There’s also a limit to how much you can contribute. For those under 50 years old, that limit is $5,000; for those over 50, it’s $6,000.

Traditional IRAs

Pros:

The money you contribute is tax deductible now, so you can get a tax break by depositing money. This may be good if you’re tight on money now but expect to have more later in life.

There’s no income limit for contributing to a Traditional IRA, so this is a good option for those who make over $107,000/$169,000 per year and don’t qualify for a Roth IRA.

Cons:

The money is taxed when you take it out, which means that you pay taxes on the earnings as well as the initial amount you put in. You generally end up paying more to the IRS this way.

Unlike a Roth IRA, you can’t withdraw your money before you’re 59 ½ years old without a penalty. If you try, you’ll have to pay taxes on the amount you withdraw (which you would have to do at retirement, anyway), plus a 10% penalty. This could negate most of the interest you’ve earned by putting your money in an IRA. There are certain circumstances in which you can avoid paying a penalty, such as if you are disabled or are using the money to pay medical expenses that are more than 7.5% of your adjusted gross income.

On the other hand, like Roth IRAs, contribution limits are fairly low compared to 401Ks. You can only contribute $5,000 per year if you’re under 50, and $6,000 if you’re over 50.

401Ks

Pros:

Your employer probably matches your contribution up to a certain point. That’s free money, and is sort of like earning 100% interest on your money (or 50%, depending on the rules of your particular company’s 401K). You’re not going to get that kind of interest with an IRA.

You can contribute up to $16,500 if you’re under 50, and up to $22,000 if you’re 50 or older. Plus, there’s no income limit, although if you make over $110,000, it may affect your contribution limit. Talk to your employer for details.

Cons:

You can’t take out that money before age 59 ½ except in certain circumstances, and you’ll incur a 10% penalty, plus any taxes. This could place you in a higher tax bracket, making you have to pay even more in taxes.

Besides that, 401K plans aren’t the same across the board. The rules of your particular company’s 401K will be different from another’s. This can make 401Ks very confusing. Most of the time, you will have fewer investment options with a 401K.

So which is the best?

Most financial experts recommend investing in a 401K up to your employer’s match, then investing anything above that in a Roth IRA. Traditional IRAs may be good if your current tax bracket is significantly higher than you expect your tax bracket to be at retirement, but for most people a Roth IRA is better.

When you decide to set up a retirement plan, it’s a good idea to consult a financial advisor to help you decide which assets to invest in inside your retirement plan and to explain all of the applicable laws to you. This article will hopefully give you somewhere to start, though, when considering what type (or types—you don’t have to pick just one) of retirement plan may be best for you.

The Difference Between Roth IRAs, Traditional IRAs, and 401Ks is a post from: Lifed