Make It Last – Ep 37 – 5 Fees You Should NEVER Pay in Retirement & Getting Tax Credit for Charitable Giving
There are 5 fees you should NEVER pay in retirement, and we cover how to get tax credit for charitable giving.
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
For more information, visit Medina Law Group or Private Client Capital Group.
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Announcer: Welcome to “Make It Last.” Helping you keep your legal ducks in a row and your nest egg secure. With your host Victor Medina, an estate planning and elder law attorney and Certified Financial Planner.
Victor J. Medina: Everybody, welcome back to Make It Last. I am your host, Victor Medina. I’m glad you could join us this Christmas week. Airing this show, it’s December 23rd. I got to be very honest. It’s Saturday the 23rd, and you’re maybe listening live on the radio. I am not in the studio right now. We’ve pre‑recorded this show.
But we do want to tell you a little bit about what’s going to be coming up because I’m excited for this show. I’m going to cover five retirement fees you should never, ever, ever, ever pay as well as your charitable giving. It’s the season. It’s the Christmas season. We think about giving, and so, I want to make sure that you understand as much as possible about how to give in a way that doesn’t run afoul of the IRS.
Many times we do this giving to make sure we get some tax benefit out of it, and the government’s helped us out with that. But we want to make sure that we would do it the right way.
One of the things we can do is think about that. There is going to be some time for you to complete some charitable giving by the end of the year if you want it to count for this tax year. If you listen to this on the 23rd or soon afterwards I’d tell you, you can take advantage of it.
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Listen, I wanted to talk to you first about five retirement fees you should never ever, ever, ever pay. Now some of these I’ve covered in the past. This is the first time I’m consolidating them here in this idea that these are ones that you can absolutely avoid.
Maybe you want to take a notepad and a pen and make sure that you write these down. Make sure that in your retirement life, you are not paying these fees.
Retirement in on itself is complicated. Not only it is easy to trigger some of these fees, but those people who are paying attention to their planning, maybe those of you who are working with a great financial advisor, you can help avoid these.
This is a list of five of them. The first one has to do with 401(k) or IRA early withdrawal penalties.
As you may know, there is a 10 percent early withdrawal penalty for IRA distributions that are made before 59‑and‑a‑half and 401(k) distributions made before age 55. That penalty is applied in addition to the income tax that you owe on taking that money out. Remember that 401(k) or IRA money is tax‑deferred, which means that eventually the tax is going to have to be paid.
There are a number of ways around the penalty even for people who need access to that money early.
In a 401(k), you can take a loan which allows eligible place take up a 50 percent of their vested value up to $50,000 without any penalties or tax consequences. You have to watch out there are some loan fees and the loan may be due if you leave your jobs, where be careful with that.
There are also exceptions to the IRA withdrawal penalty. That penalty doesn’t apply if you’re using the money for qualified purposes like a large medical expense, health insurance after a lay‑off, college costs or your first home purchase.
Another little wrinkle is for people who need income immediately. Those people who set regular annuity payments or structured payments over their life expectancy, they’re not going to get charged the 10 percent penalty. Those are a couple of ways of getting around that.
If you have a Roth, Roth accounts have a lot more flexibility for people who need that money earlier. They can take an early withdrawal without being subject to a penalty as long as they don’t withdraw more than the amount contributed to the account. You want to be careful on that as well.
The first one is the IRA and 401(k) early withdrawal fees. You want to make sure you avoid those. The second one is the penalty for skipping a required minimum distribution. I did talk a couple of shows ago about some end of the year tax‑planning tips, and one of them was to make sure that you take your withdrawals from your accounts.
As a reminder, annual withdrawals are required for people that are older than 70‑and‑a‑half. For those people that are older, the RMDs have to be taken by December 31st. You can’t take them between January and when you file your taxes. It has to be done before the end of the year. The income tax is due on each of the withdrawals.
The penalty for missing a withdrawal is 50% of the amount that should have been taken. That’s on top of the income tax that’s due.
If you think about that if you were supposed to take $2,000 out and you were in the 25 percent bracket. What ends up happening is that, if you don’t take that money out you owe thousand dollars, 50 percent as a tax, the fee for doing it. You also owe the 25 percent of the 2,000 or essentially, $500 as income taxes. That’s a lot of money that’s supposed to be eaten up. You want to make sure that you avoid that.
As a reminder, we look at these RMDs as part of our financial planning practice back in September. We want to make sure that we’re nowhere near the end of the deadline. When I go into another portion of the show, we’re going to talk a little bit about how you can take those distributions in…contribute them to a qualified charity and not have to pay income tax.
You still have to take them out before the end of the year. You just want to make sure that you’re avoiding that penalty. The third fee that you should avoid is the social security early enrollment penalty. You can start your social security as early as 62 but your payments are reduced if you sign up before your full retirement age which is typically 66 or 67. It’s been graduated up depending on your year of birth.
If you begin collecting at 62, you will get 25 percent smaller monthly payments if your full retirement age is 66. You get 30 percent smaller payments if your full retirement age is 67. You don’t want to be careful here. I hate throwing financial advisors under the bus, but many times the advice that you are receiving about taking social security early is because they want to avoid you taking money out of the account because they get paid on how much money you have invested.
That’s not really working in your best interest. In your best interest, one of the things you want to think about doing is, in fact, delaying the social security because not only will you avoid this penalty for starting early, but if you can delay it between your full retirement age and age 70, if you can allow that to accrue, you will actually increase that benefit by eight percent per year which is the best return guaranteed that you could ever get.
You want to make sure that you are taking advantage of that if your cash will permits it. That’s one of the things a planner should help you do is make sure understand that you can make withdrawals from your savings in order to allow your social security to accrue.
If you sign up for social security early and you regret it, you have a couple of options. You can change your mind within 12 months of starting the benefits and you can repay all of the money you’ve received. You withdraw your social security application and then apply for the higher payments later.
The other thing that you can do to increase it is you can continue to work in retirement. If you earn more towards the end than you did earlier, you can replace some of those lower years of earnings because the amount that you’re going to get from social security is calculated off your highest 35 years of income.
If you had some zero years of income, or if you had some income, or you’re just starting and it’s not as high as it was now, working longer can have an effect on what your benefit will be later in the future.
Those are three retirement fees that you should avoid. When we come back I’m going to cover two more and then transition into talking about some charitable giving and how you can make sure that the charitable giving that you do doesn’t run afoul of the IRS. Stick with us at Make It Last. We’ll be right back after this break.
Victor: Hey, welcome back to Make It Last. We’ve been covering five retirement fees that you should absolutely never pay in retirement, ever, ever, ever, whatever, ever. [laughs] You should avoid paying them, and you can avoid paying them with some smart planning.
We’ve covered three of them so far. We’ve talked a little bit about the penalty debts for early withdrawals for 401(k) and IRAs, since withdrawals should take out if your younger than 59‑and‑a‑half. We talked about the penalty for skipping a required minimum distribution.
These are the distributions that you have to take after 70‑and‑a‑half, and those who have a 50 percent penalty, so you would definitely want to make sure that you avoid those.
Then we talked about some social security early enrollment penalty, which is really a reduction in the amount of social security that you get for your life, 25 or 30 percent, depending on your full retirement age.
Certainly, there’s some planning situations in which taking it early makes sense, if you’ve been diagnosed with a terminal condition, if you have some illness that’s going to shortcut your ability to receive the social security benefits. You have that, it’s not an all or nothing proposition.
For most people, they’re going to live to being 80 years old or more, taking social security early is not really a good idea. Now, there’s two more, and they’re two of my favorites.
One is a little known one and the other one is one that I had been banging on the bell as hard as I can since the beginning of the show, and every meeting that I have when I meet with clients as their financial advisor and lawyer, just looking for their best interest and telling them what they should think about for retirement.
The first one, that’s a little known one, is the Medicare late enrollment penalty. We’re working longer and longer, and people are being covered by their old employer or they might have a pension benefit if they work for the state. This can get a little bit complicated.
It is important for you to sign up for Medicare when you first start eligible to do so, beginning three months before your 65th birthday, or within eight months of leaving a job with a group health coverage.
If you sign up later, the Medicare Part B premiums increase by 10 percent for every 12‑month period you delayed enrolling in Medicare after becoming eligible for benefits. It is important to make sure that the group health coverage has a substantially similar coverage to Medicare.
It’s going to be one of the tests. You have to ask your employer for their letter that says that Medicare has deemed that health insurance is substantially similar to what you would be getting in Medicare.
Once you have that letter, it’s OK to still be covered by this group policy, but when you separate from service or you lose that, within eight months of doing that, you have to sign up for Medicare part B or else incur 10 percent premium increase for every 12‑month period.
Medicare Part D penalty is a little bit different. It begins if you just go 63 days without a prescription drug coverage after becoming eligible for Medicare, and increases the longer you go without coverage. That penalty is added to the premium for any Medicare Part D you select.
Remember, you can go in to the plan finder at medicare.gov and put in your drug list, and how much you take. It will give you the least expensive option for a coverage depending on which retail pharmacy you want to go to, or if you’re going to get it for mail order.
That number does not include any penalties that you might have to pay for Part D. You want to make sure that you avoid that penalty.
Finally, related to Medicare, you only have a right to buy a Medigap policy during the six‑month period when you are 65 and older, and enrolled in a Medicare Part B. After that, the private insurance companies that offer the Medigap policies can charge you significantly higher premiums or even deny you the policy. You may not even have one available to you.
It is important to sign up for these various parts of Medicare during months around your 65th birthday. Failing to do so can increase the premiums fairly significantly.
Finally, and this is the one that I’ve been hitting on over, and over, and over. These are high expense ratios for your investments.
You can’t control at all how your investments are going to perform. No one can give you a guarantee that your mutual funds and the things that you buy are going to up or go down. No way, at all. You do have a measure of control over how much you pay in fees and other investment cost.
This is one of those things where most of the knowledge is still behind. A lot of people understand about buying in whole, they understand long term investing, that information is trickled down to them.
There was a recent survey of about 3,000 different private sector workers. It found that over third of them aren’t familiar with the fees that they’re charged in their retirement account at all. In 401(k), plan sponsors are required to provide fee information for every investment option.
If you are not in a 401(k), and you’ve rolled it over, and you’re working with another advisor, they may not be disclosing the expense ratios in there. You could take the investment portfolio, and you can look it up on Morningstar, or you can come to an advisor like me.
One of the first thing you will do is examine your expense ratio to see if whether you’re getting charged too much for your investments. The savings that you have in the expense ratios will compound over time. It’s the same amount of compounding that is available to you just for the growth of the investments, the savings get compounded.
I’m pretty famous in my talks about showing a comparison between an average mutual fund ratio of about 1.44 percent and our blended ratio of about 0.33 percent. The difference between the two is a savings of almost 20 percent or a growth of almost 20 percent. It is important to look at that.
You might even include this concept of fixed index annuities, which we used from time to time, which have no fees associated with them, or the fees that are associated or exchange for some contractual benefits. The idea is that the growth itself is going to continue to get compounded.
Again, you want to avoid these expense ratios because they can be high, and they can really impact it.
To go over the five again real quick, we have our early withdrawal penalties from 401(k), we have the late withdrawals on the RMDs, early enrollment in social security, late enrollment in Medicare, and excessive expense ratios. Those are the five retirement fees that you should absolutely avoid.
Now, I’m going to go into some discussions on charitable donation. Whether you’re giving money to a religious organization, or for medical research, or to save the elephants, you need to remember certain guidelines if you want to be able to take a tax deduction when you file your return the next year.
While you can make these donations in cash, or by check, or credit cards, or payroll deduction, or anything like that, it’s going to be important for you hold on to the proof because the IRS is not going to take it on, pardon the expression that we’re talking about, it is a Christmas thing, but on faith that you dropped $10,000 into the collection box on your way out of the door.
The burden on proof for every deduction falls on you and the taxpayer. When we come back, I’m going to give you the rules on how to give to charity in a way that is tax deductible.
In that way, you can make sure that you’re in a great position coming in at the end of this year and we can do something Christmassy, which is to think about other people and giving to them.
We’ll be right back on Make It Last just right after this break. Thanks.
Victor: Hey, welcome back to Make It Last. I’m talking to you about how to make charitable deductions in a way that is tax deductible. It is important for you to think through these issues because we want to make sure that all of your giving has the ultimate optimized benefit, which can include some tax deductions.
Surely, you can give without thinking about the tax deductions, but hey, [inaudible 19:13] financial planner. If I’m going to talk to you about this stuff, I’m going to talk to you about doing it in a way that is tax deductible.
One of the first things we want to make sure is that you’re giving to a qualified charity. A lot of times, people just think about charitable organizations without thinking about their tax qualifications. One of the things you can do is go to the IRS website.
You can go to a website called “Select Check.” In Select Check, it’s at the IRS, it’s the Charitable and Non‑Profits. One of the things you want to do is go ahead and look at making sure that they have tax exempt status. It’s the EO Select Check, which is the Exempt Organization Select Check.
It’s a search tool that allows you to search for and select exempt organizations and see what their filing status is. It will give you an opportunity to make sure that what you’re giving to is a qualified charity.
They list most organizations. If you’re giving to a religious or government organization, you’re pretty safe in taking the ride of, but you want to make sure that you have checked on their status.
A little wrinkle on the way that you can give. We’ve talked to you a little bit about you can give it in cash and check. If you made a year‑end gift on your credit card, you can take the deduction in the year that you hit the “send” button, not when you paid the bill.
It’s the same thing for checks that were mailed before the end of the year. As long as you mailed the check before the end of the year, you can take the deduction regardless of whenever the charity received or cashed the check.
For those who are always on the edge, [laughs] mailing the check in the New Year with a pre‑dated check is probably going to get you caught. If the charity receives the donation in February and processes it, it’s probably unreasonable to assume that you mailed it before the deadline.
If you’re coming up near the deadline and you want to make sure that you’re able to take the deduction which you’re concerned, if I put the check in the mail, but they’re closed for the rest of the year and they don’t cash it until the first or second week of January, can I still take the deduction?
The answer is yes. You can absolutely take that deduction, if you’ve just gone ahead and sent and mailed it beforehand, and certainly, if you’ve paid it by credit card, even if you don’t pay the credit card bill until a little bit later.
Of course, in sound financial planning, make sure you pay all of your credit card bills off in the next month. We don’t want to give credit card companies any unnecessary interest on their money.
A couple of things that we need to remember especially for those people that are a little bit higher income. The deduction for the charitable donations can only be taken on Schedule A of your 1040. If you can’t itemize your deductions, there’s no place to take the deductions on the rest of the tax return.
Another way to think about it is this, if you take the standard deduction, for people who can’t itemize, it’s assumed that you’re taking a standard amount of charitable donations. Again, if you can’t itemize, you can’t take advantage of any further charitable deductions.
There are special rules when it comes to donations of property including things like your clothes or household items. The IRS website provides details for taxpayers, who give old clothes, sofas, cars, boats, other things.
You have to keep a receipt from the charity that they received it, the date of the contributions, and the detailed list of the items donated and what is the fair market value. It’s not uncommon for taxpayers to get creative with the value of their 30‑year‑old [laughs] Gucci leather belt.
If you’re assessment crosses that threshold of reasonableness, you can expect to get called out on that for how much you are claiming. If it’s something like your boat or car, the deduction is usually limited to the gross proceeds of the sale of the asset.
You might have an absolute clunker that might have a book value of $2,500, but if it only brings $500 in in the sales of the charity, you can only take the $500 deduction. Again, written documentation is important. Those are the couple of rules on how you can make gifts of your items.
When you start thinking about gifting to charities appreciated stocks, the rules can get complicated. This is a point where we’re going to recommend that you talk to a financial planner and/or a lawyer about it.
There are ways of getting deductions off of that and even exempting the total gain off of it while still receiving some money back. That concept is called charitable remainder trust.
Essentially, the way that it works is you can take your highly‑appreciated stock, let’s say that you got stock years and years ago for a very low amount, low bases and it’s appreciated a lot. Normally, when you sell all of that, you would contribute it inside of…You’d have to pay capital gains on all of the growth.
But if you’ve contributed to a qualified charitable remainder trust, what you can do is you contribute the shares. You sell the shares. The shares don’t pay any capital gains tax. You’re allowed to take what we can call an annuity payment. It’s an annuity in like the small a‑version.
It’s just a structured payment overtime. What you’re doing is you’re taking an amount, let’s say, five percent out annually for a period. At the end of it, whatever is left over, whether it’s 10 percent or a lot more of the original value, all of that goes to charity.
If you’re already charitably inclined, you can use this structure to not only exempt the sale from any income taxes, specifically capital gains taxes, but you can also get an annuity payment out of that and get a structured payment to come out of it, which you can use and spend.
It’s a great powerful planning tool because, there are some rules, you have to make sure that a minimum of 10 percent goes to the charity of whatever is left over, and if you don’t, if that doesn’t happen, you can have a problem. You want to make sure that you don’t deplete the entire value.
It’s a really interesting way for you to exempt the sale of taxes. Usually, it’s worth paying a planner and an attorney to get that done because the amount that you can save on taxes is pretty powerful.
That’s a little primer on charitable deductions. There are some rules about the number of the years that you can take a deduction and depreciate over five years and there’s a percentage of your income. That gets a little complicated, a little too much for a 30‑minute radio show.
I do want to let you know that you always have the opportunity to counsel with somebody who knows about this, a CPA, a tax‑planning attorney, or a financial planner that can help you understand how to make sure that your charitable deductions are things that you can take full advantage of, not only helping other people, but also paying less in taxes, which allows you to have more money to help more people.
Helping others is always a good thing [laughs] the feeling you get from providing aid to great causes touches our soul and getting a deduction for your generosity is just that little sweetener that comes back. You just have to make sure that you follow the rules on it. That winds up today’s show. This is our Christmas episode.
I really hope for all you, if you celebrate Christmas, you’re doing it with your family. If you don’t celebrate Christmas, you have had an opportunity over the course of this holiday season to be with family and understand those things we cherish most is the opportunity to interact with others, see what we’re grateful for, help other people when we can, those are really the things that make for a great life.
I’ll leave you with this quick story. I recently went to go with a coaching program for other attorneys that are looking to make their practices better. It was a summit of all of these attorneys that came together. They have these different programs that once a year, they bring everybody together.
There’s a room full of probably 80 or so lawyers, which is pretty big. What was unique about this gathering is that everybody there really was focused on making great lives for themselves ‑‑ I don’t mean financial, I mean in the way that they help people ‑‑ making great lives for their teams, people that they work with, making great lives for their clients, and also making great lives for each other.
It’s rare to be in that group. I just stepped back, especially seeing people that I know, people that work on my team, help other people and participate in this. It was really nice to take a step back and marvel at the wonder of the goodness of humanity. I had all these people here, that was their focus. I decided that those are the people I want to be around. I want that for you as well.
I want you to really have an opportunity to share in that with other people. That’s the little Christmas message that I’m leaving you with. When we come back, we’re going to have one more show before the end of the year. We will celebrate year‑end together.
As always, we’re here 7:30 in the morning on WCTC 1450 AM. We are simulcast as a podcast. You can see that on iTunes, Android, and now, you can see it on Spotify. If you just search for Make It Last on Spotify, our little blue box logo is right there at the bottom.
If you like the show, what I can ask you to do, please, on behalf of us, just share it widely. Our listenership is growing and growing and growing. We watch the numbers and the number of downloads on podcast. We want to help spread this information, something we do for free.
We give this information freely to anybody that wants to listen. We think it’s great information for other people to know. We want you to share that with somebody. That’s it for this show. I want to thank you for joining us.
Victor: This has been Make it Last, where we help you keep your legal ducks in a row and your financial nest egg secure. We will catch you next Saturday. Bye‑bye.
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