MONEY Ask the Expert

Do I Owe Taxes on a Windfall from a Retirement Plan?

Robert A. Di Ieso, Jr.

Q: I am the beneficiary of a $15,800 death benefit from my dad’s pension plan. I was under the assumption that I would not be taxed on it, but is that the case? I want to make sure I deduct any taxes before I distribute the money to my siblings. —Tanya, White Plains, N.Y.

A: The answer depends on the source of the death benefit. If the payout is in the form of a life insurance policy—what your case sounds like—you won’t owe any taxes on the $15,800.

But the tax consequences would be different if you had inherited a tax-deferred retirement plan, such as a 401(k), says Charlotte, N.C. financial planner Cheryl J. Sherrard. The money in that kind of plan is taxed only when the owner makes a withdrawal. As an heir, you would owe income taxes on any distributions.

When you inherit a retirement account, you have few payout options. You can take the full amount in a lump sum, which could push you into a higher tax bracket if the windfall is significant. If you do that, you can request federal and state tax withholding when you fill out the distribution paperwork. Or you can ask for the full amount and pay the taxes later.

To spread the distributions over several years, you can open what’s called an inherited IRA and then move the retirement plan assets into this new account (assuming the qualified retirement plan allows you to). You generally have to start taking annual distributions no later than Dec. 31 following the year of the original account holder’s death. Since the rules are tricky, talk to a tax professional, advises Sherrard.

In this case you would either be gifting a small amount to your siblings yearly, or the full amount all at once. But keep in mind that as a sole beneficiary you are not required to give any money to them.

And no matter what, don’t rush to share your inheritance until you have the full picture of what your father left behind.

“You may want to wait until any other assets of your father’s have been split among all siblings, and then if you desire to equalize with them, you can do so via that net retirement money,” says Sherrard. “This is a common gotcha when one child inherits a taxable asset and then needs to take taxes into consideration before splitting it up.”

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MONEY Ask the Expert

How Do I Find the Best Place to Retire?

Robert A. Di Ieso, Jr.

Q: I live in New Jersey. Which state would be financially better to retire to: Pennsylvania or North Carolina? – Kevin, Bridgewater, NJ

A: Your cost of living in retirement can make or break your quality of life, so it’s smart to take financial factors into account as you decide where to live. Moving from New Jersey where taxes are steep and home prices are high to a more affordable area will allow your savings to stretch further. Housing and property taxes are the biggest expenses for older Americans, according to the Employee Benefit Research Institute.

By those measures, North Carolina and Pennsylvania both stack up fairly well. Neither state taxes Social Security benefits or has an estate tax, though Pennsylvania has an inheritance tax and North Carolina will begin taxing pension income for the 2014 tax year. When it comes to cost of living, Pennsylvania has a slight edge. The median price of homes in Pennsylvania is $179,000 vs. $199,000 for North Carolina, according to Zillow. Income tax is a flat 3.07% in Pennsylvania while North Carolina has a 5.8% income tax rate. You can find more details on taxes in each state at the Tax Foundation and CCH. But both states have cities—Raleigh and Pittsburgh—that landed at the top of MONEY’s most recent Best Places to Retire list.

Of course, you need to look beyond taxes and home prices when choosing a place to live in retirement, says Miami financial planner Ellen Siegel. Does your dream locale have high quality, accessible healthcare or will you have to travel far to find good doctors? Will you be near a transportation hub or will you live in a rural area that’s expensive to fly out of when you want to visit family and friends?

There are lifestyle considerations, too. If you like to spend time outside, will the climate allow you enjoy those outdoor activities most of the year? If you favor rich cultural offerings and good restaurants nearby, what will you find? Small towns tend to be less expensive but may not offer a vibrant arts scene or many dining options.

To determine whether a place is really a good fit for your retirement, you need to spend more than a few vacation days there. So practice retirement by visiting at different times of the year for longer periods. Stay in a neighborhood area where you want to live and get to know area residents. “Having a strong social network is important as you get older and if you move to a new area, you want to make sure you can make meaningful connections and find fulfilling activities,” says Siegel. By test driving your retirement locations before you move, you”ll have a better shot at getting it right.

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The Moves to Make Now So You Can Cut Taxes Later

A financial adviser explains that to maximize income, you need the right kinds of investment accounts, not just the right investments.

In my work with financial planning clients, I can see that people understand the merits of having a diversified mix of securities in an investment portfolio. Investment advisers have done a good job of explaining how diversification can improve clients’ risk-adjusted returns.

What can be a little harder for advisers to explain and clients to understand, though, is the value of “tax diversification” — having investments in a mix of accounts with different tax treatments. By having some securities in taxable accounts, others in tax-deferred accounts, and still others in tax-free accounts, people can maintain the flexibility that makes it easier to minimize their taxes in retirement.

The benefits of traditional tax-deferred retirement accounts, such as IRAs and 401(k)s, are easy for participants to see. Contributions reduce people’s current tax bills. And the benefits continue to compound over the course of the investors’ careers, since none of the income is taxable until withdrawals are made.

Yet what clients don’t often grasp is the price they’ll wind up paying for this tax benefit later in life. Distributions from tax-deferred accounts are treated as ordinary income. It can be more expensive to spend money from a traditional IRA than from a taxable account, since dividends and long-term capital gains in taxable accounts are taxed at more favorable rates. And IRS-mandated required minimum distributions from traditional retirement accounts can force a retiree to generate taxable income at times when he or she wouldn’t want to.

So how do you get clients to understand that traditional IRAs and 401(k)s may cost them more than they think? Sometimes it’s a matter of being blunt — saying that the $1 million they see on their account statement isn’t worth $1 million; they may only have $700,000 or less to spend after paying taxes.

Once clients understand that, they also understand the appeal of Roth IRA and Roth 401(k) accounts, since current income and qualified distributions are never taxable. Another advantage: The IRS also does not require distributions from Roth IRAs the way it does for traditional retirement accounts. For many high income taxpayers, $700,000 in a Roth IRA is more valuable than $1 million in a traditional IRA.

But Roth IRAs and 401(k)s aren’t perfect and shouldn’t be a client’s only savings vehicle either. Participants don’t receive any upfront tax benefit. And it’s conceivable that future legislation may decrease or eliminate the benefits of Roth accounts. If the U.S. or certain states shift to a consumption-based tax system, for example, a Roth IRA will have been a poor choice compared to a traditional IRA.

And it’s useful to have money in taxable accounts, too. People need to have enough in these accounts to meet their pre-retirement spending needs. In addition, holding some stock investments in taxable accounts allows people to take advantage of a market downturn by realizing capital losses and securing a tax benefit. You can’t do this with a retirement account.

Given that each type of investment account has advantages and disadvantages, advisers should encourage all their clients to keep at least some assets in each retirement bucket. That way, retirees have the flexibility to choose the source of their spending based on the tax consequences in a particular year.

In a low-income year, retirees may want to pull some money from their traditional IRAs to benefit from that year’s low tax bracket. Depending on the retiree’s income level, some traditional IRA distributions could escape either federal or state income tax entirely. In a high-income year, when investments in a taxable account have a lot of appreciation, it may make sense for the retiree to spend from a Roth account instead.

Since we don’t know what a client’s tax situation will look like each year in the future, diversification of account types is just as prudent as investment diversification.


Benjamin Sullivan is a manager at Palisades Hudson Financial Group, where he helps the firm’s high-net-worth clients with their personal financial planning, investment and tax planning needs. He is a certified financial planner certificant, an IRS enrolled agent, and a member of the New York chapter of the Financial Planning Association.


WATCH: One Year After DOMA Ruling, What’s Changed For Same-Sex Couples?

One year after the Supreme Court struck down parts of the Defense of Marriage Act, same-sex couples are still fighting for marriage equality.

MONEY Ask the Expert

What’s the Tax Impact of Gifting Money from a 401(k)?

Robert A. Di Ieso, Jr.

Q: My sister has cashed out her 401(k) and wants to give it to me as a gift. How will this affect us tax-wise? The amount is about $14,000. —Beverly, Benton, Ark.

A: Lucky for you, there will be no tax ramifications to you for accepting the gift. But your sister will have to square up with the IRS.

Because your sister cashed out her 401(k), she will owe income taxes on the total amount withdrawn, says St. Petersburg, Fla. financial planner Helen Huntley. If she was younger than 59½ when she pulled the money out, she will also be hit with an additional 10% early withdrawal penalty.

Keep in mind that while your sister probably won’t owe gift tax—$5.34 million in property can be transferred tax-free over one’s lifetime—she may need to inform the IRS. Each year, you’re allowed to give up to the annual gift tax exclusion limit (this year $14,000 per person, though a married couple can double that) without reporting the transfer of funds to the IRS. Above that, the gift giver will need to file a form 709, and the gift will be subtracted from their total lifetime gift and estate tax exclusion.


Same-Sex Couples Need a Good Accountant More Than Ever

Just Married car with flowers
James Baigrie—Getty Images

Now that the IRS recognizes gay marriages, all newlyweds have to tackle new tax rules come filing time.

Soon after last June’s Supreme Court decision striking down the Defense of Marriage Act, the IRS ruled that same-sex couples legally married in any state must file federally as married, starting with the 2013 tax year. That holds true even if you live in a state that doesn’t recognize same-sex marriage.

So gay couples getting married this year will have to decide whether to file jointly or separately next April. Or if you were married last year or earlier and filed for an extension for 2013, you have until Oct. 15 to sort this out. “Most married people are better off filing a joint return,” says CPA Paul Herman of White Plains, N.Y. That’s because married couples filing separately miss out on a bunch of write-offs, including educational tax credits, the student loan interest deduction, and the ability to claim child- and dependent-care costs.

In a few circumstances—say if one spouse makes far less and qualifies for a generous write-off like the deduction for medical expenses—filing separately might lower your tax bill. Test both methods to be sure, says Herman.

Switching from two single returns to one joint return could raise or lower your total tax bill, so you may want to adjust how much is taken out of your paycheck by filing an updated Form W-4 with your employer. If marriage means a name change, alert the Social Security Administration well before you file your taxes to ward off a potential problem with your return.

Long-married gay couples may want to look into amending past federal returns, if you haven’t already. You can do so for up to three years after the return was filed, or two years after the tax was paid, whichever is later. But high earners are probably better off keeping those old single returns, says Melville, N.Y., CPA David Frisch. That group can be hit by the “marriage penalty,” which subjects more of your income to taxes than if you filed as two singles.

Also, the IRS rules do not apply to state tax returns. If you live in a state that doesn’t recognize gay marriage, you will still have to file an individual state return for each spouse. The laws are still a patchwork (and one that frequently changes), as this map from the Tax Institute at H&R Block shows.

State laws for same-sex marriage
H&R Block


What’s more, as this report from the Tax Foundation illustrates, in those states that don’t recognize gay marriage, the rules for how to figure your state taxes vary widely. Bottom line: When you get back from your honeymoon, call your accountant.



5 Ways DOMA’s Demise Changed the Finances of Same-Sex Married Couples (Mine Included)

LGBT Wedding
For same-sex married couples, much has changed related to income tax, workplace benefits, Social Security, and other financial issues. Charlotte Jenks Lewis Photography

One year later, the landmark Supreme Court ruling has had a momentous impact on the financial planning decisions of same-sex married couples.

The Supreme Court’s ruling last year on the Defense of Marriage Act has had a momentous impact on financial planning for lesbian, gay, bisexual, and transgender couples. But the momentous impact has little to do with the case at issue.

The focus of the landmark case, United States v. Windsor, was an estate tax issue. Given that it takes millions of dollars in assets to trigger federal estate taxes, hardly any Americans are subject to them. Yet the decision allowing for federal recognition of same-sex marriages has a major influence on the day-to-day financial lives of LGBT couples — not just the high-net-worth ones — affecting everything from income taxes to Social Security benefits.

Let’s start with income tax. Married LGBT couples can now file joint federal tax returns. This is a mixed blessing, since filing jointly can mean a lower tax bill for some couples and a higher tax bill for others. Generally speaking, the more disparate the income of two spouses (whatever their gender), the more likely they are to benefit from joint filing. That means that some couples might benefit from amending returns filed for 2012, 2011, and 2010 (which is as far back as the IRS allows), while for others there’s no benefit.

That’s true for me and my husband. I’m a financial planner, he’s a corporate accounting manager, and we got married in Massachusetts in September 2005. If we were to refile past returns, I calculate that we’d end up paying thousands more to the IRS. Going forward, we’ll be one of the many married couples who will end up paying the marriage tax. It’s a price we’re willing to pay.

Some other areas where the DOMA case has a major impact:

  • Employee benefits. In past years, if either of us had gone on the other’s health plan, the additional coverage would have translated into additional taxable income for whoever’s plan we were on. That’s not true anymore, and I’ll be joining his plan next January, with no additional taxes.
  • Pensions and retirement accounts. Before the DOMA case, same-sex couples couldn’t enjoy the same tax benefits as could opposite-sex couples who listed one another as beneficiaries. I, for example, have a cash-balance pension plan through my work. Previously, I wasn’t able to list my husband as a beneficiary; if I had died, the pension would have gone into my estate and my husband would have lost the tax deferral. Now, it could be rolled directly into his IRA and not create a taxable event.
  • Social Security. Now same-sex married couples residing in a state that recognizes same-sex marriage can enjoy spousal benefits, just like other married couples. There’s a caveat, though: If you file for benefits after you relocate to a state that doesn’t recognize same-sex marriage, you would not be eligible for these spousal benefits. That brings me to something I’ve cautioned my clients about: If you move to a state that does not recognize your marriage, some benefits may travel with you and other won’t — in areas such as state taxes or dying without a will.
  • Divorce. No one really wants to think about this part of marriage, but the reality is that the DOMA decision allows for much more flexibility should a marriage break up. If, as a result of a divorce settlement, assets such as an IRA or real estate holdings were split up, a couple might have faced significant taxation. Now, though, those possessions can be divided without generating a taxable event. While I’ve had a good chuckle about this with some clients, it’s no laughing matter really.

One year after the DOMA decision, same-sex married couples, including my husband and me, have celebrated the positive changes that marriage recognition has brought. We’re also more aware of the financial implications — ones that extend far beyond estate taxes.


Armstrong is a certified financial planner with Centinel Financial Group in Needham Heights, Mass. He has guided clients since 1986 in matters of financial planning, insurance, investments, and retirement. He currently serves on the national boards of the Financial Planning Association and PridePlanners. His website is

MONEY Ask the Expert

Should I Gift Stocks to My Heirs Now or Make Them Wait?

Robert A. Di Ieso, Jr.

Q: Is it better to transfer stock to my children before my death or let it go into the estate?—Sandra, Kernersville, N.C.

A: If your children have no immediate need for the money and your estate is small enough to avoid estate taxes, your best move is to hold on to the shares, says Charlotte, N.C. financial planner Cheryl J. Sherrard. By letting your children inherit the stock later instead of transferring it now, you’re helping them reduce the potential tax hit when they sell.

The price you paid for your stock is known as your cost basis. That’s the number you use to determine your gain or loss on the investment and figure out how much you owe in capital gains taxes when you sell. When you pass stock to an heir as part of your estate, your heirs get a “stepped-up” basis. That means their cost basis becomes the value of the stock at the time of your death.

So if you bought the stock for $100 and the price has reached $250 when you die, your heirs’ cost basis will be $250. If and when they chose to sell that stock, they will owe taxes only on any capital gains over $250, not $100.

If you simply gift the stock to your children during your lifetime, you’ll also pass on your original cost basis. In this example, that means your heirs would owe taxes on any gains over $100. Any time you’re sitting on big profits, gifting that stock could cause your heirs to pay significantly more in taxes than they would if they’d received the shares via the estate.

There’s one more consideration: If you expect your estate to be worth more than $5.34 million, which is when the federal estate tax kicks in, you may want to gift the stocks during your lifetime to reduce the size of your estate, says Sherrard. As an individual, you can gift up to $14,000 a year per person in 2014 without incurring any gift tax. A married couple can give up to $28,000 a year.

MONEY real estate

Retiring? Stay or Go, You’ve Got Moves to Make

Housing accounts for the biggest part of your costs in retirement. So spend wisely.

Once you start looking at retirement over a horizon of five years or so, it’s time to start thinking about how you’ll manage your biggest single asset: your home.Whether you intend to stay put or move to that lake cottage, keeping real estate costs under control is key to your security.

Those costs may be larger than you think. On average, housing makes up one-third of spending for those ages 54 to 74—the largest single category. More than half of Americans ages 55 to 64 are carrying mortgages, higher than in previous generations. “Paying mortgage debt into retirement reduces your lifetime wealth and limits your spending,” says Pam Villarreal, a senior fellow at the National Center for Policy Analysis.

Staying in your house, with your mortgage paid, doesn’t free you from making decisions. Few pre-­retirees think about adapting their homes for retirement living. “It’s hard for active people in their fifties or sixties to think about what they might want 15 years from now,” says Bonnie Sewell, a financial adviser in Leesburg, Va.  Should you end up not being able to get around easily, though, you’ll have fewer choices and less ability to make them. So take action now:

Moving? Don’t take your mortgage with you. Nearly 30% of boomers plan to relocate when they retire, according to a new AARP survey. Many of them are seeking to cut costs by moving to a lower-tax state. Carry a mortgage, however, and this strategy may not have a big impact on your cash flow, as a recent analysis by Villarreal found. Mortgage debt can easily erode the benefits of lower taxes. Run your own numbers at

Cash flow

Sure, if you’ve got plenty of cash, mortgage payments may not seem like an issue. But there’s security, and flexibility, in not carrying debt. “Many of my clients see having no mortgage payments as a way of freeing up cash for future health care costs,” says Philadelphia financial planner Cathy Seeber.

If you plan to stay, renovate now. By your late fifties, your kids are probably out of the house, and the tuition bills are behind you—or nearly so. Time to renovate? Use this opportunity to make a few additional changes that will let you stay in your home for the next couple of decades. “The last thing you want to do in your seventies or eighties is manage a major rehab in an emergency,” says Sewell.

If you have a house with stairs, make sure you can live on one floor if necessary, says Mary Jo Peterson, a design consultant in Brookfield, Conn.  That may mean expanding a powder room to a full bath. You can also add design touches that appeal to people of all ages—a sloped ­entrance-walk instead of steps is more convenient for moms with strollers and college students dragging suitcases, not just the elderly. Find more ideas at­livable-communities, and your family home can last for generations.


MONEY Airlines

Your Best Shot at a Cheap Flight to Europe Is in Jeopardy

Norwegian Airplanes
Norwegian Air has drawn criticism alongside its reputation for low-cost flights within Europe and, more recently, on transatlantic flights from the U.S. Scanpix Sweden—Reuters

Airline worker unions and the world's biggest airlines are ganging up on a carrier that recently brought long-awaited cheap transatlantic flights back to U.S. travelers. How cheap? Often under $500 total.

In early June, Norwegian Air marked the one-year anniversary of the launch of service between the U.S. and Europe. The airline, known for much of its history as a low-fare carrier mainly in competition with Ryanair, EasyJet, and other airlines duking it out for budget travelers flying within Europe, has gotten plenty of attention over the past year for its incredibly cheap transatlantic flights.

Last year, Norwegian introduced several round-trip U.S.-Europe fares for under $500—amazingly, with taxes and fees included—on routes between Scandinavia and U.S. gateways such as Orlando, Los Angeles, Oakland, and New York-JFK. Lately, Norwegian is advertising one-way fares such as New York to London for $259, New York to Oslo for $211, and Oakland to Oslo for $244. Again, all taxes and fees included, which is astonishing considering that travelers have grown accustomed to the taxes-and-fees portion of transatlantic flights tacking on several hundred dollars in addition to the cost of, you know, actually flying.

In addition to drawing the attention of travelers eager for the arrival of a cheaper means to cross the Atlantic Ocean, Norwegian Air has also been a magnet for criticism from both airline competitors and airline employees. Airline worker groups have accused Norwegian of being ruthlessly anti-union for its policy of hiring Thai pilots and American airline attendants on the cheap, rather than higher-paid union Norwegian employees. The major U.S. airlines have been trying to stop Norwegian from expanding service for the transatlantic market via a subsidiary airline (Norwegian Air International), claiming that the company’s plans of setting up headquarters in Ireland amount to the creation of a “shell company,” and that its business practices are “not in the public interest.” At the end of May, the U.S.-based Air Line Pilots Association began lobbying federal authorities to block planned Norwegian Air flights to the U.S. because the airline supposedly is circumventing labor rules to gain an unfair advantage over the competition. There has been plenty of hinting that flying on Norwegian is unsafe as well.

On June 4, the day of its one-year anniversary for service to the U.S., Norwegian attempted to set the record straight with a press release taking on the accusations one by one. For instance, the release states that Norwegian Air is not anti-union:

A majority of Norwegian’s pilots and cabin crew members in Scandinavia are union members. Technicians and administrative employees are also union members.

There’s nothing unsafe about the business model either, the release claims:

Norwegian has been running a safe airline operation since 1993 with no registered accidents or major incidents. Safety has always been the company’s number one priority.

Most interestingly, Norwegian takes several shots at the competition, accusing the big carriers of charging far more than is reasonable for international flights:

Norwegian believes that competition on intercontinental flights is long overdue. Flights between the U.S. and Europe have traditionally been way too expensive. Why should a flight between New York and Europe cost three times as much as a flight between New York and Los Angeles? The flight to Europe is only about an hour longer, sometimes even less.

Previously, Norwegian Air has been more brash in lashing out at critics. When asked about concerns that the airline was no longer really a Norwegian carrier, and that is abandoning its homeland by establishing a home base in Ireland, CEO Bjørn Kjos said bluntly, “We don’t give a s*** about that. We go where the passengers go. Norway is just too small to survive.”

“It’s obvious that they’re afraid of competition,” Norwegian spokesman Lasse Sandaker-Nielsen said earlier this year, referring to the airline competitors arguing against Norwegian’s plans. “Their strategy is to make false allegations in an attempt to prevent American travelers from getting inexpensive airfare to Europe.”

It’s no surprise where travelers and consumer groups stand on the issue. They want cheaper flight options to Europe, even if it’s via the Norwegian Air model, which–also no surprise–is rife with fees as a tradeoff for inexpensive upfront fares. Many believe it’s high time for true competition to return to the transatlantic flight market (if it ever actually existed, that is). “The other airlines are used to jacking up their prices because there is virtually zero competition,” a recent post at Consumer Traveler stated. “Only three alliances compete against each other across the Atlantic. Oneworld, Star Alliance and SkyTeam control about 85 percent of transatlantic traffic.”

For an example of how Norwegian matches up against the competition, a recent fare search showed a round-trip from Oakland to Oslo at the end of the summer coming to a total of $592, including all taxes and surcharges. The nearest competitor for a Bay area round trip to Oslo on the exact same dates was well over $1,000. Even if you never fly on Norwegian Air, you should probably be happy that it exists—and that it’s putting some pricing pressure on the competition.

[CORRECTION: An earlier version of this story stated that airline groups have been trying to shut Norwegian Air out of the transatlantic market. The efforts are focused on stopping Norwegian Air's plan to expand transatlantic flights via a subsidiary airline being established in Ireland.]

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