transcript
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Episode #482 - Listener Questions: “How Do I Report A QCD On My Income Tax Return?”
"When one door closes, another opens, but we often look so regretfully upon the closed door that we don't see the one that has opened for us."
-Alexander Graham Bell.
INTRODUCTION
Well, hey there.
Welcome to the Retirement Answer Man Show. My name is Roger Whitney. I am your host, and this is the show dedicated to not just surviving retirement but having the confidence because you're doing the work intentionally to lean in and really rock retirement.
I love that quote from Alexander Graham Bell.
I was thinking about last week's discussion on triage for getting laid off. When a door closes sometimes rather abruptly, that really rocks your world. Every time a door closes, another opens, and it's so easy to look back regretfully at what you lost, rather than look forward and say, okay, let's bring it on, what can we create here?
They have shown that we value things that we possess much more than they're really worth in a lot of ways. We overvalue things that we possess, and we attach more value to them. That's true with work. When we lose something, we look back regretfully as it is with material things.
I'm in this season where I'm decluttering material possessions. As an example, I recently purchased seven shirts that are identical. Same exact shirt. I changed some of the colors up, and I am throwing away, or giving away perfectly good clothes that were part of my wardrobe that I've collected over the years, some of them not that long ago.
I'm trying to get very simple in what I wear every day. It helps simplify decisions for sure, but I want to not worry as much about my clothing options and my possessions, in this domain clothes. It is hard to throw away perfectly good clothes that are very nice. Because there's always a reason. I own them. I put a value on them a little bit more than I should, and this is part of what I'm working against.
I wear pretty much the same thing every day and just take that out of the equation of my possessions, but also out of my mindset so I can focus on you and on creating and then creating a great life. That's where it's at.
Just some thoughts for the day, Roger's thoughts for the day.
ANNOUNCEMENTS
A couple of announcements. We have the Rock Retirement Club opening up on May 11th. You can go to livewithroger.com. We're going to have a couple of open houses for you to join in, and I'll explain what the club can help you accomplish and let you ask your questions.
It's really just going to be a time to come on in and have a chat about it and see if it's a good fit for you in order for you to rock retirement. So, we're excited about that.
Today we're going to continue to focus on you and your retirement questions. So why don't we go do that?
LISTENER QUESTIONS
I got some great questions lined up for today. If you have a question for the show, you can go to rogerwhitney.com/askroger, and you can type in your question or you can leave an audio question if you desire, and we'll try to get it on the show and focus on you and the issue that you're dealing with.
QUESTION ONE
So, our first question comes from Jim in regard to where to store his safe bucket,
Jim says,
"Hey, Roger, great show. Listen to all the episodes. I have a simple question. I just retired and have about three years’ worth of expenses and some fun money that are in money markets and credit union savings. I'd like to bridge about three years before I reach full retirement age for social security, and this money will cover that. I'd like to keep these three years of funding in fairly safe liquid assets, i e cash or CDs, and then maybe three more years in a reasonably safe investment. However, with CD rates where they are now, or even short-term treasuries, I can lock in pretty good returns and keep my money safe.
I hear a lot of advice about utilizing bond funds for two to six years. So, two years of cash, say three to four years in bond funds. I'm not sure I see the advantage to this approach. Bond funds have all taken a beating here in the last 18 months. As interest rates increase, I can lock in over 4% safely for those years and not have to think about it anymore. What are your thoughts regarding using bond funds, even short-term bond funds with durations of three years or less. Is that better than instead of cash? What would be the advantage?"
That's a great question, Jim. So, let's break this down and give you a way of thinking about this.
So, it's already a given that you're going to keep three years in "liquid" assets, CDs, treasuries, or money market and savings. You're asking about the next three years, years four through six. What do you do with those monies if you want to have essentially a six-year income floor?
As you noted, we've been in this shifting environment in terms of interest rates. A little over a year ago, interest rates were zero, CD rates and bond fund rates were not that attractive, and everybody was searching just to try to get some kind of yield, and bond funds even short-term bond funds was a place where a lot of people were looking.
Now, fast forward the 18 months that you talk about, and interest rates have come up significantly, which has changed the game for everything and those short term bond funds, even the ones with a duration of three years or less have actually lost money over the last 12 to 18 months because the value of the funds has gone down because interest rates are higher and bond prices move inversely to interest rates.
Now this term you use "duration", Jim, just so everybody understands, what that means is essentially the average weight of the maturity within the portfolio.
So as an example, a bond fund with a duration of three means that the average maturity, even including the interest payments, is about three years. The reason that number is important when you're gauging potential risks with a bond fund, mutual fund, in this sense, the rule of thumb is that for every 1% movement in interest rates, the value of the bond mutual fund will move up and down inversely related to interest rates. So as an example, if interest rates go up by 1%, The rule of thumb is that a bond fund with a duration of three years would go down by 3%.
Just like if interest rates went down right now by 1%. Mutual funds with a duration of three years would move up by 3%. So, it's a gauge of the volatility of a bond fund. What you decide to do, CDs, treasuries, money markets, has a little bit to do with your opinion on where interest rates are going to go from here.
If you believe that interest rates will go higher, then purchasing money markets or short-term treasuries would make sense because that money would come due in a shorter period of time, and then you could reinvest at the higher rates. Conversely, if you thought interest rates were going to go down from here, then you would want to lock in maturity a little bit longer.
You'd want to lock in year four, year five in, say, a CD or even a bond fund because you think interest rates are going to go down. Whatever you think is going to happen is probably going to be different than what really happens.
My rule of thumb with this, Jim, is not to use bond funds for the income floor between five to six years, even out to seven or eight years.
The return of your money, even in year four, five, and six, is more important than the return on your money. Ergo, I would not recommend that you look at trying to perhaps capture a higher yield in an even short-term bond fund. I would look at how can I get a reasonable return on my money, whether that's a 3, 4, 5, 6-year treasury or a corporate bond or CDs, and just lock in the return that you're going to get in the terms of the interest rate. Have guarantee and clarity that you will get your dollars back upon maturity, and then not make it any more complicated.
When you're looking at monies that you're investing longer than this income floor, Jim, then you can look at bond funds because really, you're trying to get an aggregate asset allocation. The timeframe is such, in theory that, whatever cycles we're in, whether it's interest rates, bear market or bull market, statistically you're setting yourself up for success. So, I'm not a big fan of reaching for yield in using short-term bond funds, if it's money that you're going to need, even if it's four or five or six years.
QUESTION TWO
Our next question comes from MC related to QCD, so I'll read the question and we'll talk about what it is.
"Recently discovered your podcast. My question is regarding QCDs. Have the rules for QCDs changed for 2022 in 2023? Both Schwab and Vanguard have issued 1099s showing QCDs as taxable income."
When asked about the change vs the 1099s in 2021, The answer seems to be a version of, well, that's how we do it now, and it's your responsibility to provide documentation to your CPA®, blah, blah, blah. You need to document that the checks were actually sent to a charity rather than to me, and they're not really taxable income.
This system discourages donations, and I understand exactly what you mean, MC. So, let's talk about what MCs are talking about.
If you are 70 and a half or older, you can make a qualified charitable distribution from your IRAs or your 401k in the form of a charitable contribution, and the check is written directly from your tax-deferred account to the charity in question.
You can actually do multiple distributions as charitable gift from your IRA. You can do up to $100,000 per year if you're over 70 and a half and any QCD qualified charitable distribution you make going directly to a 501c3, a qualified charity, counts towards your required minimum distribution. There's been a lot of changes to your required minimum distributions, your RMD here in the last few years. First it went to 72, now it's 73 or 75 depending on the year that you are turning or the year that you were born. But the rule for qualified charitable distributions has not changed. It's still 70 and a half. In fact, I'm doing one for a client that's 70 and a half right now.
The process for doing a qualified charitable distribution is you're working with your custodian. In this case, MC is talking about Schwab and Vanguard, but any custodian financial firm, you don't just take a distribution and then give the money to charity. There's a process for this that you have to follow, and each of these financial firms will have their own form.
You give them the information for the charity, and they send the amount that you want to give to the charity from your IRA directly to that charitable institution, so it never goes into your hands. That qualifies you for covering your required minimum distributions, and it's not a taxable event because it's going directly to a charity. So, it's a good way to give, but also to not have to pay taxes on income as a result of RMDs.
So what MC is talking about is every year when you take distributions from an IRA, you receive. A 1099-R, showing the distributions from your IRA, and this is where it can get confusing. It's not just simply with QCDs, it can be with a Roth conversion. It will show things in weird ways that can be confusing. In this case, what MCs saying is that he received a 1099-R and it showed the amount of the qualified charitable distribution as a taxable distribution on that tax form.
In your mind, you're like hey, wait a second. This isn't taxable because it was a QCD, you made me fill out a special form. These custodians have their standard operating procedures and just how they report things, and it can be annoying at times. So, what do you do with that?
What you can do is, rather than argue with a big organization that's not going to change their policies for you, is document the fact that you gave this as a QCD to the charity at hand.
So, you want to make sure you get an acknowledgement in writing that shows how much the charitable contribution was, whether you received any goods or services in exchange, and it should show the date of the contribution. You want to have all of this in writing, acknowledging the charitable contribution that they received, and you have the statements, and then when you go to do your taxes, in the 1040 you're going to identify a portion or all of that distribution from the 1099-R that you received from the financial firm as a qualified charitable distribution. That's where you're going to have the offset so you're not actually paying taxes on the distribution that went to the charity.
Yes, it could be easier, but we're dealing with huge bureaucracies, not just the IRS, but individual large financial firms, in MCs case multiple financial firms, and they all make their decisions of how they do things for reasons that you and I just don't understand at times.
So, just make sure you get written acknowledgement showing those items. And then when you're doing your taxes, make sure you inform your CPA® that hey, yeah, I got the 1099 that shows this, but here's the documentation that this went to a charity via the process, so you can have that offset.
QUESTION THREE
So, our next question comes from Mary in regard to Roth IRAs.
Mary asks,
"Does the iris define 1099 wages as earned income?"
Specifically, Mary wants to know if a taxpayer only has 1099 wages in a year, no w2. Can the taxpayer contribute to a Roth IRA?
It's a great question, Mary, and it depends on the type of 1099 that you're talking about. If you mean someone with earned non-employee compensation, that would be a 1099-NEC non-employee compensation, say for a business that you own, and if you're contracting and paid via 1099, that's essentially you owning a business. Then for sure that is considered earned income and you could make Roth IRA contributions, or you can even establish your own small company plan if you have regular income in that form.
But if you mean a 1099-R, distributions from say a retirement account, then no. That type of income is not eligible. In terms of meeting the income requirement in order to make a Roth IRA contribution. So, the rule of thumb is it has to be income reported as 1099. That's actually income from work.
QUESTION FOUR
All right. Our next question is actually a comment question from Teresa on the March episode we did on going from two to one.
Teresa says,
"Hey, Roger, I've been listening for about a year and have learned so much from your show." Oh, that's awesome, and Teresa wants to make sure that at some point we cover not just going from two to one because you lose a spouse, say to death, but going from two to one because of divorce and separation.
That's a great point, Teresa, and you share your story, I read your story that you shared with me. No one ever expects this to happen later in life and gray divorce or divorce is, A big issue. It's a devastating issue for many people at any time, but definitely later in life. When we thought about going from two to one, initially we were going to incorporate both losing a spouse to death or divorce. We decided that although they have some similarities, there's more there that needs to be done separately.
As you shared in the story with me, there's a lot more implications and considerations that come from a divorce that are just different. We do plan on covering that topic in the future. I want to thank you for sharing your story, and although we didn't take it on in March, we are going to take it on as a specific theme, so stay tuned for that.
QUESTION FIVE
Our next question comes from Al related to the ordering of taking money specifically to de-accumulation, and Al was kind enough to leave us an audio question.
Al: Roger, I've been a listener to your podcast for several years and have really enjoyed your down to earth explanations and advocacy for your listeners to rock retirement.
I have a question about withdrawal sequence. I will retire at the end of 2023. I have a feasible plan of record and I am working on resilience and optimization. Traditional advice recommends utilizing after tax assets first, tax-deferred assets next, and tax-free assets last as a sequence. I have a six figure 457 deferred comp asset with my employer, a large, stable healthcare organization, so no worries about default.
Employer rules dictate the account remain with the employer, so no rollover option possible, and retirement distribution options are limited to a lump sum distribution or an annuitized distribution over a number of years of my choosing.
I feel that I want to access this early in retirement since it technically is only a promise of payment, even though it is a tax-deferred asset, and I will have several years of after-tax assets still available.
Just wanted to get your thoughts. Again, enjoy your show tremendously. Keep doing what you're doing.
Roger: Great question, Al, and thank you so much for listening to the show and letting me be a small part of your journey on rocking retirement. So, Al's question is, where do I pull fund first and I have this special asset, this 457 plan.
Well, you're exactly right. The default assumption in retirement planning is that you drain all of your after-tax assets, first, those bank accounts, et cetera, before you touch your tax deferred assets, IRAs, and traditional 401ks. That is a simplifying assumption. That rarely is the right answer that comes from spreadsheets in what makes sense from a mathematical formula over a very long period of time with a lot of simplifying assumptions built into those spreadsheets. Your retirement's a lot more than a spreadsheet, as we know and there's a lot more nuance to this answer. It's awesome that you have a feasible plan, that's critical. Now you have a home base to create what if scenarios on how to make it resilient and then ultimately how to optimize it. I would say primarily, you're right in both of those categories, probably more on the optimization stage from a tax management stand.
You want to begin this journey from home base, Al, by asking yourself and then getting clarity on the answer.
What am I trying to solve for? In making this decision of where I'm going to draw assets from the different tax categories, what am I trying to solve for? Am I trying to solve this problem to reduce my required minimum distributions later in life? Am I trying to solve for staying below Medicare, IRMAA surcharges or taxation of social security?
Am I trying to solve this by leaving as much money as I can to my heirs? Am I trying to solve for delaying social security for as long as possible, so I get a higher benefit of secure social capital? Understanding what you're trying to solve is going to help you find your pathway best because each one of those will lead to a different decision.
Since you have a home base, this feasible plan of record, using the traditional simplifying assumption of draining your after-tax accounts first, et cetera. You can forecast where you should be from a tax bracket standpoint at least over the next five years with some clarity, and then you can start to create what if scenarios.
You go to first base and let me test this out, what if I turn on my 457 to pay me income so I can solve for filling the income gap to pay for my life so I can delay social security. Let me map that out and test it and see how that looks. Then you build that model, that cash flow model to see how that impacts your taxable income on a year-by-year basis.
What if I take it as a lump sum today? Really get hit one year with high tax brackets, perhaps IRMAA, surcharges on Medicare, et cetera. But now I have even more after-tax assets that I can use to supplement life and or give away or spend, and that allows my tax-free assets to grow further. You get the idea.
I can't really give you the answer because I don't know what you're trying to solve for. Maybe you're going to work in QCDs, qualified charitable distributions as part of this strategy. But the fact that you have this home feasible plan of record makes everything a lot easier Al so you can test one by one and get to the decision with the 457 of how you actually structure the withdrawals.
Some ways that I've seen it done successfully have been creating a series of payments over a specific time. A good example here is I have one gentleman who I know that retired at 59 and he structured his series of payments to come out over 10 years, which is allowing him to preserve his after-tax assets, stay in a reasonable tax bracket, and delay social security for as long as possible.
That basically filled the gap because these 457 plans, like most of these types of structures, are deferred compensation. So, you're realizing the compensation now to replace the compensation that you just gave away after retiring. That's one that I've seen that's been very successful. But the key is just iterating Al.
You're going to get to the point where you're not going to get it wrong and you're not going to get it right. You're just going to have to make a judgment call, but you're already in a position to make a really thoughtful judgment, and hopefully this helps you on that journey.
QUESTION SIX
The next listener that wanted to share is Jim and Karen regarding passwords after somebody passes.
Jim and Karen: Hey, Roger,
During one of my trips on your way back machine, I was reviewing episode 50. About leaving a mess when you die, estate planning. During that episode, you recommended recreating an ICE document that contains all your information with your financial, social media, and email accounts along with your passwords.
My question is with today's ever-changing online environment, I find myself constantly updating my user logins and passwords. Is there an easier way to update this information and make it accessible to my surviving family members when it's needed the most? It just seems that pen and pencil are so outdated nowadays.
Thanks again. We really enjoy your podcast. Jim and Karen.
Roger: Hey, Jim and Karen. Wow, you did go on the way back machine. Episode 50! We're on episode 482 today. We just had our ninth-year anniversary last month. I'm glad that even something that far back was so helpful.
Good point. Now, we talked about creating an in case of emergency binder, which is sort of the old school way of doing it, which is very comfortable for our vintage of human.
But as you point out, Jim and Karen, hey, there's a lot more digital stuff going on that can get very complicated in having to change passwords every 90 days on all sorts of financial accounts. I do think there is a better way, and for me that way is using a password manager, a digital password manager.
I use 1Password. I've used it for years. Last Pass is another password manager. Apple has its own built-in one. I like those structures because they allow me to dynamically update the password in the manager as I have to update it on whatever website I'm logging into. In my case, I use 1Password, and when I change a password, it asks me, do you want to update the password in our records?
I like it for that reason. I also like it for another reason, Jim and Karen, is that all of my passwords are much more complex as a result because these password managers, these digital password managers, have a password generator of these strings of numbers and symbols and letters and all sorts of things where literally don't know the password to most of my accounts because it's kept in 1Password in my instance.
When I go to that website, it will automatically fill in the username and password for me in that particular site. So that ends up with me having much more robust passwords that are different for all the different sites I go to, which helps me from a security standpoint. 1Password, Last Pass, and I'm sure there are some others. One of the potential downsides for this is that all of this data is going to be held at the service and they are at risk of being hacked just like anybody else.
Years back, and we did an episode on it, Equifax was hacked. If Equifax, the large credit bureau can be hacked, and the government can be hacked. Pretty much anybody can be from time to time. So, there's a risk there. You could say the same thing for paper.
Now, with these password managers, generally they have the master password. Like 1Password has one password that lets you into the kingdom of all the other passwords and you better remember that one password. So as a result, from an in case of emergency planning standpoint, you have to have someplace where that one password, the keys to the kingdom is that your spouse or the children or so forth can have access to it to access this.
The way that I like to do that, I use a digital in case of emergency plan now. I use Everplan, which is an online in case of emergency portal that acts a lot like TurboTax. It will interview you and it helps make sure that you have it complete, and we actually have that as a free benefit for club members because I think it's so important. Within a digital structure like that, you can assign deputies, meaning that my password to my 1Password is logged in my Everplan, my digital in case of emergency plan, and then my son Spencer, he can get access to it only under certain circumstances. You can manage those circumstances, if Roger dies, then Spencer gets everything, or this deputy gets everything.
So, I do think there's much more eloquent ways than paper and pen, although that is probably the most comfortable thing for us.
With that, let's move on to the Bring It On segment.
BRING IT ON SEGMENT
Welcome to the Bring It On segment where you are the hero that you've been waiting for.
Today we are going to talk about mindset. The question I want to ask you is, are you ever enough? Do you ever have enough? Are you ever fully complete?
Literally, every time I'm done recording this podcast, this is an example, we had just had the ninth anniversary of the show and I give it to the editor. I walk away saying, dang it, that could have been better. I could have been more articulate. I said "So" too much. I didn't finish my sentence. I beat myself a lot. I need to be better. I need to be better.
Recently I learned a reframing that I want to challenge you to adopt in your life.
Generally, we frame things as I need to be better. I need to do better. I need to get better stuff. The stuff I have isn't good enough. I need better stuff. I need to make better friends. I need better opportunities. I need to build a better retirement plan. This type of framing is a loser's game. It implies that you are not enough, that you don't have enough, that you are lacking in some way.
It's a never-ending cycle that frames you and your life as incomplete. That's not healthy, mentally or financially. I need better returns. I need better investments. Framing it with I need better, or I need to do better isn't healthy. So, I say that we get off the better bus and we get on the best bus.
I'm going to remind you, which I have to remind myself of all the time. It's like, dude, you are only human. You're only human, and you have different levels of energy and attention moment by moment, day by day. All you can do at any moment is your best and give all you've got. Being on the best bus stops the cycle of constantly putting yourself and your situation down.
You don't need to be more than who you are. You just need to focus on being your best self, more often. You don't need a better house, cars, clothes, spouse, spreadsheet. You, and what you have is enough, now just do your best in this moment. This reframing from the better bus to the best bus stops. Putting ourselves down, sort of frees us to be like, okay, I got to do my best.
When you do make a mistake, you will just look at it and say, oh, okay, that needs work. That needs work. This will stop the cycle of beating ourselves down as if we're not enough.
So, I'm going to challenge you to start thinking about just doing your best with who you are, and don't worry about doing better.
TODAY’S SMART SPRINT SEGMENT
On your marks, get set,
and we're off to create a little baby step we can take in the next seven days to not just rock retirement, but to rock life.
All right, in the next seven days, why don't you confirm with your spouse that they know how to access the passwords for the things that are important. Just ask them a question, this will take two seconds. That will identify either potential areas to work on or give you confidence, okay, I checked that box.
CONCLUSION
We create the show to empower you to rock retirement.
We want to do this with focus and always want to be focused on you and your journey and help you have hope for the future. I think you can totally do this.
We want to do this in an authentic way. No pretense. We want to be humble. We want to be respectful on every topic that we hit on.
You and I, we must continue to be curious and look at things with fresh eyes, just like Jim and Karen did on the password and ICE plan.
We want to hold our beliefs up for examination to either confirm them or amend them. We are always going to be free from big finance and financial products that taint a lot of the information that we get.
We're just like you, trying to figure this out, and create a great life. We're not going to talk about products for money. We're not going to use gimmicks on you, and we're going to be focused on you taking incremental action or expanding your perspective. I am all in on helping to empower you to rock retirement. So, let's go do this.
The opinions voiced in this podcast are for general information only and not intended to provide specific advice or recommendations for any individual. All performance references are historical and does not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal, tax or financial advisor before making any decisions.