Your Life Expectancy After You're Dead? September Edition of Financial Strategies

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Greetings!

Are You Ready for Some Football? As I'm writing this College Football has started and by the time you read this the NFL regular season will have started. My second favorite team (The USAFA Fightin' Falcons) put one in the win column on Saturday. I'm looking for my favorite team, the Green Bay Packers, to do the same this weekend. I figure they beat the Super Bowl Champs last year. This year they just have to do it in the actual Super Bowl.

This month's Financial Strategies has a college focus. It is that time of the year. Either College Bills are coming in, or you're starting to plan seriously for future years.

But...my lead article doesn't talk about college. It instead talks about your life expectancy after you are dead. It's true, when it comes to the IRS and your IRA or Qualified Accounts, you have a life expectancy after you die. It kind of makes my head explode, but it is important to understand when dealing with your own and inherited IRAs.

The second article returns to the theme and tests your understanding of 529 plans, financial aid and how they affect each other. See how you do.

The Around the Horn section starts with my quick comment which reminds you about the State Income Tax advantages in State sponsored 529 plans. The first article from the financial presses is about 401(k) fees. You should check and see if your employer is meeting his or fiduciary duties in regards to your 401(k). And, if your employer needs a fiduciary advisor to help him/her meet his/her obligations, I'm available to help. Finally, it is back to college as the last article reviews college tax benefits available to you.

Have a great September and good luck to your team (except when they're playing mine)!

Curt

Curtis L. Sheldon, CFP®, EA, AIF®

C.L. Sheldon & Company, LLC

www.CLSheldon.com

(703)542-4000 or (800) 928-1820

Featured Article

Your Life Expectancy After You're Dead? Yes...the IRS Says You Have One. IRA RMDs...

One of the great advantages of Qualified Plans and Traditional IRAs is that you get to deduct your contributions today and the earnings on your account accrue tax deferred. But, the IRS wants to get that tax money...and the sooner the better. You must take Required Minimum Distributions (RMDs) by your Required Beginning Date (RBD). (By the way, I like this article...I've already worked in two acronyms in the first paragraph!) For most, the RBD is 1 April of the year after you turn 70 1/2. Most of us know that. But most of us don't know how much we have to take out. The amount you have to take out is based upon your life expectancy. But you say, "I don't know how long I'll live!" Not to worry, the IRS knows how long you will live. They know everything...

Your Own IRA

In most cases, calculating RMDs for your IRA is relatively simple. The IRS has a uniform life expectancy tables that will tell you how long you will live. For example, at age 70 the life expectancy of an IRA owner is 27.4 years. What is interesting is that if your spouse is more than 10 years younger than you, your life expectancy increases (I'll leave that to the IRS to explain). For example, if you're aged 70 and your spouse is age 50 your life expectancy is 35.1 years. Once you determine your life expectancy you simply divide your account balance on 31 Dec of the prior year by your life expectancy to determine your RMD.

On a related note, according to the IRS if you make it to 115 you may never die as the life expectancy for those age 115 and older is 1.9 year. So, at each birthday after age 115 you've still got 1.9 years to live. Again, I'll leave it to the IRS to explain.

Inherited IRAs

This is where things get a little bit more complicated. The most complicated part is calculating the life expectancy for the deceased IRA owner...and the answer isn't what you think. Rules are different for spouses and other beneficiaries.

Spouses. First of all, spouses have the option to roll over an inherited IRA into their own IRA. If they do, the rules above apply. But rolling the inherited IRA in, may not be a good idea as it limits the ability to take distributions prior to age 59 1/2 without paying a penalty. If the IRA is maintained as an inherited IRA then the following rules apply:

If the original owner dies before the RBD the distributions must begin on or before the later of

The end of the calendar year immediately following the calendar year in which the owner died, and

The end of the calendar year in which the owner would have attained age 70 1/2.

The RMD each year will be calculated using the life expectancy of the surviving spouse. Again, in only logic the IRS can defend, the surviving spouse uses a different life expectancy table and at age 70 has a life expectancy of 17 years.

If the original owner dies after the RBD.

First of all, the IRA owner (deceased) must take a RMD in the year of death based on the deceased owner's life expectancy that year (yes...you read that right) or a modified amount based on joint life expectancy.

Spousal owners of inherited IRAs must begin taking distributions by 31 Dec of the year after death.

The RMD will be based on the age of the surviving spouse, unless the surviving is older than the deceased owner then the deceased owner's life expectancy can be used (I know...I know).

Non-Spouses. Non-spouse beneficiaries can't roll inherited IRA funds into their own IRAs. The inherited IRA will maintain it's characteristics as an inherited IRA.

It the original owner dies prior to RBD.

The beneficiary must begin distributions prior to 31 Dec of the year after the IRA owner's death.

The RMDs will be generally be calculated based on the designated beneficiary's single life expectancy (different table than the owner's table).

However, if the designated beneficiary is older than the deceased owner, then the beneficiary may continue to use the deceased owner's life expectancy (Yup...again) to calculate minimum distributions.

If the original owner dies after beginning RMDs

Like in the case of a spouse, the deceased owner must take a distribution in the year of death...based (again) on the deceased owner's life expectancy

The RMD will be calculated based on the longer of:

The designated beneficiary's remaining life expectancy determined using the beneficiary's age as of his or her birthday in the year following the year of the owner's death, reduced by one for each subsequent year or

The deceased owner's life expectancy (one last time...) determined using his or her birthday in the year of death reduced by one for each subsequent year.

Non-Person Beneficiary. If a non-person, such as an estate inherits the IRA it must be paid out in 5 years. Many times if a trust inherits an IRA it also will have to pay out the balance in 5 years. But, if the trust is structured properly the IRA can be distributed in accordance with the rules above.

I've pretty much decided that IRA rules are the most complicated part of the Tax Code and the IRS is not forgiving. Like many of you have heard me say, "Don't do Estate Planning without a net." I would echo that when it comes to IRAs. "Don't try to manage IRA payouts (inherited or otherwise) without a safety net too." Give us a call if you need some help with this complicated area.

Second Thoughts

Making the Grade: Test Your Knowledge of Key College Planning Facts

The latest report on college costs published by the College Board brought some good news: The increase in tuition and fees for the 2014-2015 academic year were lower than the average annual increases in the past 30 years across all sectors included in the study.

Yet even though college price increases are not accelerating, the report's authors affirmed that, in real terms, college costs have been rising for decades. For instance, the report, "Trends in College Pricing 2014," revealed that the inflation-adjusted average published price for in-state students at public four-year universities is 42% higher than it was 10 years ago and more than twice as high as it was 20 years ago. In the private nonprofit four-year sector, the increases were 24% over 10 years and 66% over 20 years.

Given this reality, it is easy to see why devising a plan to pay for college is a major stressor for many American families. Underlying that anxiety are numerous misconceptions about the financial aid process and how a family's savings might affect a student's eligibility to receive aid.

Further, there also seems to be a general lack of knowledge about college savings vehicles, specifically 529 college savings plans -- how they work, and the many benefits they have to offer families struggling to juggle multiple financial goals.(1)

529 plans have altered education planning in much the same way that the 401(k) altered retirement planning. A unique combination of features -- high contribution limits, professional asset management, account holder control of assets, flexibility in transferring the money, and perhaps most important, generous tax advantages -- have solidified the 529 plan's position as a leader in the education planning world.

Test Your Knowledge

Here's your chance to test your knowledge about college planning and 529 plans. We hope that the information shared here will shed new light on some of the details of the process.

1. What form do all colleges require of students applying for financial aid?

_____ CSS Financial Aid PROFILE

_____ FAFSA

_____ EFC

Answer: FAFSA. Any college or university that awards federal student aid requires the Free Application for Federal Student Aid (FAFSA). For the majority of colleges this is the only aid application required. The CSS Financial Aid PROFILE is required by some private colleges for assessing eligibility for the specific college's institutional aid dollars. The Expected Family Contribution (EFC) is a number calculated by the financial aid forms.

2. Saving for college in a 529 college savings plan negatively impacts eligibility for financial aid.

_____ True

_____ Maybe, but often the effect is minimal in the financial needs-analysis process

_____ False

Answer: Maybe, but often not enough to worry about. The value of a 529 savings plan account set up by a parent or legal guardian is reported as a parental asset on the FAFSA and only increases the EFC by a maximum of 5.64% of the total account value. 529 plans and Coverdell Education Savings Accounts tend to be two of the better options for saving for college without jeopardizing financial aid. Income is generally more of a determinant of need-based financial aid eligibility or lack thereof.

3. Assets held in a 529 college savings plan can be used to pay for what type of school?

_____ Four-year college or university

_____ Two-year community college

_____ Qualified trade school

_____ All of the above

Answer: All of the above. With a 529 savings program, you can use your account at any accredited college or university in the country (and some outside of the country).

4. What happens to the 529 college savings funds if the student does not go to college?

_____ The money can be used by another family member to pay for qualified expenses

_____ The federal government will seize the account

_____ Nothing

_____ The plan will be declared void, and the money returned to the plan owner

Answer: You may generally change the beneficiary. That money can be used by a sibling, cousin, or other family member for qualified higher education expenses, without penalty.

5. 529 assets held in the grandparent's name are shielded from the needs-analysis process.

_____ True

_____ False

Answer: True. Assets saved in the name of a grandparent are not reported on the FAFSA and do not typically count toward the EFC.

Caution: Distributions from a grandparent-owned 529 plan used to pay for a student's college expenses generally weigh heavily in the federal needs-analysis process and are typically counted as student income on the following year's FAFSA form, with an assessment rate of 50%.(2)

6. 529 plan distributions from a parent-owned 529 account do not increase the family's EFC.

_____ True

_____ False

Answer: True. Unlike distributions from a grandparent-owned account, distributions from a parent-owned 529 plan that are used to pay for a dependent student's college expenses are not reported on the FAFSA and do not typically count as income in the federal needs-analysis process.(2)

7. What is assessed most heavily in the federal financial aid formula for dependent students?

_____ Student's income

_____ Parent's income

_____ Student's assets

_____ Parent's assets

Answer: Student's income is generally assessed at the highest rate. The federal formula considers up to 50% of a dependent student's income as being available to pay for college. Here are the approximate rates for the primary financial resource categories that are assessed in computing an EFC:

Student's income up to 50%
Parent's income 22% to 47%
Student's assets 20%
Parent's assets 2.06% to 5.64%

8. Federal loans tend to be the most common type of financial aid used for the education of dependent undergraduates.

_____ True

_____ False

Answer: True. For many families, the lion's share of financial aid is in the form of federal loans often supplemented by private loans, particularly when incomes are above a certain level and many need-based grants have been ruled out.

Important caveat: If you combine all grant/scholarship aid dollars from all sources for all undergraduates, the amount would exceed the total federal loan dollars. Federal loans constituted 34% of total undergraduate student aid in 2013-14, according to the College Board.

How did you do? Hopefully this information has helped you to better understand the financial aspects of college planning -- in particular the powerful but somewhat complex 529 college savings plan. To learn more about 529 plans and selecting the right plan for your situation, give us a call.

For more on the financial aid process, the following organizations offer ample, free information:

The College Board: Call your regional office or visit collegeboard.org
FinAid: Visit finaid.org
U.S. Department of Education, Federal Student Aid Information Center: Call (800) 433-3243 or visit fafsa.ed.gov

Source/Disclaimer

(1) Investing in 529 plans involves risk, including loss of principal. Before you invest in a 529 plan, request the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state's plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.

(2) Note that some private colleges may treat the needs-analysis process a little differently from what is reported here, and generally the comments in this document apply to the federal needs-analysis process. Individual situations will vary.

Sources:

The College Board, "Trends in College Pricing 2014," November 13, 2014.

Wealth Management Systems Inc., "Increasing 529 Sales & Savings Rates: The Role of Personalized Planning Tools and Education: Part 2," June 2015.

The College Board, "Trends in Student Aid 2014," November 13, 2014.

Forbes, "How Much Do You Know About a 529 Savings Plan? [Quiz]," June 23, 2015.

Required Attribution

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.

Around the Horn


Curt's Quick Comment Remember, after you retire from the military and establish residency in a State that has State Income Tax you may gain tax deductions for contributions to the State's 529 Plan. Here are some examples. VA: $4,000 per year MD: $2,500 per year CO: Up to CO Income CA: None So, don't miss the opportunity to trim your State Income Tax and fund your Child's (or Grandchild's) education. Give us a call if you need some help.	Top Court Mandates 401(k) Fee Duty Are you being charged more than you should be for management fees in your 401(k) account? The U.S. Supreme Court thinks you might be. In a landmark ruling, the nation's top court says employers have a continuing duty to monitor the fees paid by participants in 401(k) plans (Tibble v. Edison International, S. Ct. No. 13-550, 5/21/15). And whereas the court often is divided along political lines, in this instance it came to a unanimous conclusion. More Here...	Education Tax Breaks It takes a lot of scrimping and saving to put a child through college. However, you may be able to salvage some relief on your federal tax return, although some upper-income parents are locked out. Specifically, you may qualify for one or more of three main tax breaks-but you can choose only one each year. Read More Here...

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