She’s Making Sure Her IRA Nest Egg Doesn’t Hatch Too Quickly
This is the year that Pasadena resident Marie Tashima turns 70 1/2.
Young investors might find that an odd milestone to note, but retirees understand. Turning 70 1/2 requires making some important and often irrevocable choices about tapping individual retirement accounts.
The decisions Tashima makes in the next few months will have profound effects on her lifestyle, her tax bill and the estate the single woman leaves behind.
Smart choices will allow her to afford the kind of months-long European trips she enjoyed in her 20s. She could also fulfill her goal to leave money to relatives and favorite charities. Bad choices could mean running out of money before she runs out of life.
Tashima has made some good decisions already, said Karen Goodfriend, a certified public accountant and personal financial specialist who reviewed Tashima’s finances for The Times.
Tashima has no debt, she lives within her means and she is a lifelong investor. But her long love of stocks now leaves her dangerously exposed to market downturns, Goodfriend said, and now is a good time for some diversification.
Overall, Tashima wants to arrange her finances to minimize capital gains, income and estate taxes; maintain her standard of living; handle any long-term health-care needs; and maximize what beneficiaries receive from her estate.
Tashima has been investing since her 20s, when several smart stock picks helped raise a $10,000 fund for graduate school, European travel and a supplement to her stipend as a Fulbright scholar. She spent her working life as a corporate librarian and information manager for large chemical companies in the Midwest. Those jobs offered solid pensions, as well as insight into the fields of chemicals and technology that she used to build her stock portfolio.
By the time she retired from full-time work 10 years ago, Tashima’s portfolio, both in and outside her IRA, was worth about $300,000. Today, its value has more than tripled, to $920,000.
“I buy and hold, and some [stocks] do very well,” Tashima said.
Tashima lives modestly but comfortably on $38,000 a year, money that comes from Social Security, two pensions, an annuity from stocks she donated to charity and dividends and interest from her investment portfolio. She owns outright a unit in a cooperative apartment building and so doesn’t have mortgage or rent expense.
In short, Tashima doesn’t need to take much money from her IRA, which is now worth $300,000--but she must.
Tax laws require that minimum distributions from IRAs start in the year following the year an investor turns 70 1/2 and continue annually after that until the IRA is exhausted or the IRA holder dies. Failure to take a distribution means risking a federal income tax penalty equal to 50% of the missed withdrawal.
Ways to Take IRA Distributions
Minimum distributions are calculated based on the IRA holder’s life expectancy. IRA holders can choose from two methods of calculating that amount--fixed or recalculated--and can further reduce or increase the minimum distributions to whoever inherits the IRA.
An investor can always take more than the minimum required distribution, but not less.
* The fixed method involves determining the IRA holder’s life expectancy at the time of the first withdrawal and then reducing the life expectancy one year for each subsequent withdrawal. Tashima’s first withdrawal would thus be based on a 16-year life expectancy, while her second would be based on a 15-year life expectancy, and so on.
* The recalculation method allows for smaller withdrawals over time because it takes into account that life expectancy increases as we age. Under this method, Tashima’s first withdrawal is the same as under the fixed method, but the second payment would be based on a life expectancy in 2000 of 15.3 years, not 15. Details on how to make the calculations are available from the IRS’ Publication 590, Individual Retirement Arrangements.
For retirees in Tashima’s enviable position, the goal is usually to put off paying taxes as long as possible, allowing the money in the IRA to continue growing tax-deferred, Goodfriend said. But there are other considerations. For example, if Tashima wants to leave some money to charity and some to relatives, who should get the IRA?
If Tashima named a charity as the beneficiary of her IRA, the required distributions would be based on her life expectancy alone, Goodfriend said. That would require a $19,000 withdrawal in the first year.
If Tashima named a person as her beneficiary, on the other hand, she could use that person’s life expectancy along with her own to reduce the amount of money she had to take out of her IRA each year. (There are limits on the IRS’ generosity: If the beneficiary is more than 10 years younger, the joint life expectancy is figured as if he or she were only 10 years younger.) Naming one of her nieces or her nephew would allow Tashima to withdraw about $11,500 the first year, Goodfriend said.
But naming relatives as beneficiaries has disadvantages. Tashima won’t be able to predict how much money, if any, will remain in the IRA when she dies. That could make it difficult if she wanted to give equal amounts of her estate to relatives, who would have to pay income tax on IRA funds they receive.
If Tashima instead named a charity, there would be no income tax due.
Tashima probably would prefer to bequeath shares of stock held outside her IRA to her nieces and nephew, Goodfriend said. Her heirs would pay no taxes when they received the shares. If they decided to sell the stocks, they would get a special tax break known as a “stepped-up basis.” That means they would pay tax if there were a gain compared with the stocks’ value at the time of Tashima’s death, not the value when Tashima purchased the stocks.
Say Tashima bought a stock for $20 that climbed to $100 when she died. If a niece inherited the stock and later sold it for $110, the niece would pay taxes based on the $10 difference between the selling price and its $100 stepped-up basis.
If Tashima had sold the stock, or if she gave her niece the stock before dying, the basis would be $20, and the seller would owe tax on the difference between $20 and the selling price.
Should She Delay First Check?
Tashima liked the idea of leaving the IRA to a charity and stock to her relatives. But Goodfriend urged her to review the decision with an estate-planning attorney, in part because Tashima’s estate may be subject to federal taxes. (Estates worth more than $650,000 at death are currently subject to the tax, but the limit is scheduled to rise annually and reach $1 million by 2006.)
It’s important for Tashima to make the right IRA choice upfront, Goodfriend said. If Tashima changes her mind after she starts taking distributions and names a new beneficiary, she won’t have a choice between the old and new formula--she would have to use the one that required the largest withdrawals.
Tashima is scheduled to take her first distribution on Dec. 31, although tax law allows her to delay that withdrawal until April 1, 2000. Her second distribution would have to take place the same year, before Dec. 31, 2000. Every year after that, the distribution would have to be made before Dec. 31.
Having two distributions in one year can have serious tax consequences. People can be thrown into higher tax brackets or have more of their Social Security payments taxed. For single people, some Social Security income becomes taxable when income reaches $25,000 a year; for marrieds, taxes kick in at $32,000.
As it turns out, however, Tashima will save about $1,000 in taxes by taking both her distributions next year, even though she would probably be thrown temporarily from the 28% tax bracket to the 31% bracket. That’s because of the complex ways that Social Security income is taxed.
Asset Allocation
In essence, not taking a distribution in 1999 would allow Tashima to shelter more of her Social Security income this year, more than offsetting the extra tax next year, Goodfriend said.
For Tashima, “it’s a one-time opportunity to shelter some income,” Goodfriend said, but that opportunity doesn’t apply at all income levels.
Once Tashima determines her minimum IRA distribution, she must also decide whether she wants to take out more. Early in retirement, people tend to spend more money than they expect to on travel and other hobbies and then worry about running out of money later, especially if they need a nursing home or long-term health care, Goodfriend said. But spending too little may not be sensible either, especially if the retiree later is in too poor health to enjoy the money accrued, she said. Even healthy people tend to travel much less in their 80s and 90s than they do in their 70s.
How much money Tashima can comfortably spend also depends on her mixture of stocks, bonds and cash. While stocks give her inflation-fighting growth, bonds provide a cushion of interest payments.
If Tashima takes out $19,000 from her IRA and spends both it and the $15,000 in dividends and interest she spends now, she would be tapping about 3.7% of her portfolio. Spending at that rate may be too high for a portfolio that’s currently 90% stocks. (See accompanying story.)
More important, Tashima is uncomfortable having so much in stocks. She has long wanted to move more of her money to bonds anyway, because she fears that a stock market correction could cut deeply into her net worth--and her ability to enjoy her retirement years. But she has been reluctant to sell her stocks because of the tax she would have to pay on the accumulated capital gains.
Goodfriend recommended Tashima move 40% of her portfolio to bonds. But rather than selling any of the low-basis stocks she holds directly, Tashima should reallocate most of her IRA to bonds, Goodfriend said. The transactions inside the IRA would not be subject to tax; Tashima would simply pay regular income tax on the withdrawals as she makes them.
In thinking about IRA distributions, Goodfriend cautions, retirees should not make too many assumptions. As investment companies are fond of saying, “Past performance is no guarantee of future results”; no one can predict what financial markets will do.
In general, a conservative investor, someone who retires early or someone who wants to leave a substantial sum to heirs or charity should make the smallest possible withdrawals. A more aggressive investor who isn’t fazed by stock market drops might choose a higher proportion of stocks and larger withdrawals--as would someone with a short life expectancy or someone who didn’t care about leaving an estate.
Some people prefer to match their withdrawals to the market, taking out more when stocks are doing well and tightening their belts when the market lags. Others let their health and interests dictate their spending.
Retirees must also consider the costs of long-term health care, because more than 40% of adults 65 and older spend some time in a nursing home. Many more need some kind of extended health care. Tashima has personal experience with the costs and needs of elderly people; she spent the last seven years caring for her mother, who was disabled by a stroke and died in December. Tashima wants to make sure she has enough money to provide for her own care while still being able to leave something behind for her heirs.
Statistically speaking, Tashima has enough money to pay for a nursing home or home-based health care for as long as she is likely to need it. The average nursing-home stay is less than two years. The average monthly cost for a private nursing home in 1997 was $3,460, according to the California Department of Health Services. In expensive areas, such as San Francisco and Los Angeles, a nursing home can cost anywhere from $3,600 to $6,600 a month, said Arlen Brownstein, a Palo Alto long-term-care insurance broker. Home-based health care generally starts at $1,000 a month and can easily become as costly as a nursing home, Brownstein said.
Tashima’s experience with her mother, and her own desire to leave behind an estate, mean that the extra expense of a long-term-care policy might be worthwhile, Goodfriend said. A policy that pays for five years of benefits would cost Tashima $2,700 to $3,900 a year, while one with lifetime benefits would cost $3,700 to $5,100 a year. If she decides to buy a policy, Tashima should shop carefully and compare the types of care covered and the benefits. The best coverage now covers home-based health care and assisted-living centers as well as nursing homes, Brownstein said.
“Although she has a large and supportive family to assist her, a long-term-care policy would provide for her care without burdening her family,” Goodfriend noted. “A policy could provide her with greater peace of mind.”
Tashima said she plans to investigate the costs of long-term care. In the meantime, she’s planning for her next European trip.
“After seven years of taking care of my mother, it’s nice to be on my own again,” Tashima said. “I’m ready for some leisure time.”
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When It’s Time to Spend
Tax rules and other considerations for organizing your finances in retirement can be complicated, and an estate-planning attorney or accountant can be helpful. Here are some points to start2037347698 If you don’t have much money, you don’t have to worry about protecting it from taxes orsaving it for unexpected health expenses. A majority of Americans pay no estate taxes and many rely on government assistance if they become seriously ill.
If you do have a substantial amount of money, you probably want to keep as much of your retirement nest egg as possible in tax-deferred accounts. That generally means taking only the minimum required distributions from individual retirement accounts and other retirement funds.
Except for those with particular kinds of serious, long-term illnesses, people tend to spend less as they age.
Estates worth more than $650,000 at death are currently subject to federal estate tax, but the exemption is scheduled to rise annually and reach $1 million by 2006. (Congress often 1684632419 If you give less than $10,000 per person in any year you are alive, no one pays taxes on it. People with estates worth more than the federal estate-tax exemption limit often make such annual gifts to reduce the amount of estate taxes paid after death.
If you give a stock or other property to another person while you are alive, when the beneficiary sells it he or she pays taxes on the gain (or can deduct the loss) based on the price you paid.
If you bequeath a stock or other property--in other words, if you give it away after you die as part of your estate--when the beneficiary sells it he or she pays taxes on the gain (or may deduct the loss) based on its value at your death.
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Meet the Planner
Karen R. Goodfriend is a certified public accountant and personal financial specialist with Palo Alto-based Moorman & Co. She specializes in tax planning, portfolio diversification and retirement planning. She has been one of Worth magazine’s “250 Best Financial Advisors” for the last two years.
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Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com. To be considered for a published Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. You can also e-mail to money@latimes.com, or you can save a step and print or download the questionnaire at https://www.latimes.com/HOME/BUSINESS/FINPLAN/make-over.htm.
